Changes May Be Coming to Mortgage Stress Test

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Text transcript

Benjamin Tal, deputy chief economist, CIBC.

If you look at the real estate market overall, clearly it is starting to rebound. The question is, why? The answer is that we have to remember in 2016 the market went through a major, very important, and I will say healthy, correction. Especially in centres like Vancouver and Toronto. So, now we are seeing a rebound from this correction. Now, this correction was needed because in 2016 the market was simply unsustainable. Prices went up way too quickly, and I believe that in some centers — again, like Toronto, Vancouver, important centers — we have seen some speculations and flipping activity during that period of 2016. Since then, we have seen gravity taking place. Basically, prices were way too high. And of course, an array of policy initiatives coming from all level of governments and regulators to slow down the market, including B-20, and the market did slow down.

Over the past two years, we were in a price searching mode. I would suggest that in Ontario, we found that price. In Vancouver, we’re almost there — we’re basically in the ninth inning of the correction. And places like Ottawa and Montreal did not experience the correction because their cycle is very, very different. Eastern Canada is doing relatively okay. Clearly, we’re not seeing a rebound in places like Alberta, unfortunately, given the fact that they are dancing to the tune of oil prices, and we haven’t seen the rebound there fully materialized. So it’s clearly a tale of where you live, but the number one story is the correction is over and now we’re starting to recover. This is a market equilibrium.

In order to slow down the market, the regulators introduced B-20 stress test, basically aimed at slowing down demand for housing, and it seems that it worked. As we know, the market slowed down notably in 2016, in 2017 and early 2018 until now. So the question, of course, is to what extent this test is the right thing to do. Of course, you cannot argue with success, but maybe it’s too much of a success.

I suggest that this test is not flexible enough to accommodate a real growing market. The 200 basis points over the five-year rate is designed with no flexibility. And regardless where we are in the cycle, if interest rates are low or interest rates are high, you apply the same 200 basis points, which to me is suboptimal. Also, we have to remember that the 200 basis points are imposed on the official interest rate, basically what is officially available out there, not the real interest rate that people pay with a discount. So that’s, again, something that we have to take into account because the official number that is published, we all know is much higher than the discounted rate that everybody gets. So you apply 200 basis points on the rate that is already high — again, too much of a stress test, in my opinion.

So it seems that governments now are toying with the idea of maybe playing a little bit with that test, making it a bit easier, maybe more flexible to the interest rate environment. So I think it’s coming. But overall, yes, it did work, but we need to change B-20 in a way that makes it more flexible and consistent with where we are in the cycle. The easing in the stress test that will be coming from the regulators will not be significant enough to totally change the game. This will not be a game changer. It will ease the test at the margin. It will be positive for demand, there is no question about it. But it will not change the way the market is operating. The number one reason why prices are rising is not demand, it is actually the lack of supply in places like Vancouver, Toronto, even Montreal. So I think that’s where the issue is. But, absolutely, to the extent that the regulators will ease B-20, that will be a net positive for overall demand for housing in Canada.