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Regarding The Stress Test
 May 28 2018     Posted by


by Mel Gilbert AMP

There's been a lot of talk surrounding the introduction of the 'Stress Test' for mortgages of less than 80% loan to value, which was introduced in January of this year. It's been 'newsworthy' and has created a lot of discussion.

What many people seem to forget is that there's been a 'benchmark rate' for insured mortgages of more than 80% loan to value since mid 2016. At that time the rate for a 5 year fixed mortgage was in the mid 2% range and the benchmark rate was 4.64%, approximately 2% above the going 5 year fixed rate.

The argument when introducing this benchmark rate was that borrowers with a lower amount of equity were a larger risk to the taxpayer, since CMHC is a crown corporation and any losses incurred when borrowers default is borne, in large part since there are two other private mortgage insurers, by CMHC. Fair point? Quite possibly, but what gets lost in the wash is that first of all those borrowers are taxpayers themselves, and secondly that CMHC has been pumping billions of dollars into the government's coffers for decades.

That's right Billions, with a B. Why wouldn't any losses be recouped from their retained earnings like any other business or financial institution in a poor year? All other FI's simply consider those losses to be part of the cost of doing business. And what are the odds of every CMHC insured mortgage falling into arrears at the same time anyway? It would have to be a catastrophic economic event in which case there would be many more pressing problems for the government to fix before they got around to selling off their real estate portfolio.

The next point to consider is that the benchmark rate is set based upon the chartered banks' 5 year 'posted' rate, which is quite frankly these days a fictitious animal. The term 'posted' comes from the notion that this is the rate posted up on the wall in the branch, denoting the rate a customer would pay for a 5 year fixed mortgage, by far the most popular choice among borrowers. Since the emergence of more and more 'monoline' lenders, so called because they offer one product - a mortgage, the posted rate has given way to the 'discounted rate”, which is what everyone pays today and which sits at about 2% below the posted rate.

Ignoring the fact that the banks by and large made a 2% mark up more than they needed to for years and years, leading to the exponential growth in the mortgage broker community and the mortgage industry in general, they are still controlling the market by manipulating their posted rate, which the government slavishly follows when setting the benchmark rate. The monolines, whose mere competitive existence is saving each borrower in Canada approximately 2% of their mortgage balance each year remember, have to fall in line - and their business model has been hurt quite badly by the introduction of this latest 'stress test'. To the point that there are numerous conspiracy theories that the banks lobbied for the latest rule changes purely and simply to sabotage their competition, the monolines.

I digress however and so what's my point you say? Simply this - if the introduction of the benchmark rate in 2016 was to make sure that borrowers could continue to make their payments if and when interest rates increased by 2%, why has nothing changed when, two years later, rates have now increased by approximately 1%? Shouldn't we only have the other 1% to go? If 4.64% was considered to be the safe plateau in 2016, what's changed, why isn't 4.64% still the correct number? Shouldn't the benchmark rate still be at 4.64%?

I get that property values have continued to climb, in particular in Vancouver and Toronto. But many experts put that phenomenon at the door of restricted supply in those two cities, since in most of the rest of the country it simply isn't the case to the same extent, especially in rural areas and eastern Canada.

You might be forgiven for thinking that these changes have been brought about more due to the politicians' need to be 'seen' to be doing something, rather than actually fixing the problem; it’s political, not economics.

The demographic most penalized during the past two years seems to be the millenials, current first-time home buyers. Most real estate sales are part of a chain of families moving into, up or out of the market at various stages of their lives. At the end of each chain you will find a first-time home buyer. Presumably if there's no-one at the bottom of the chain to buy that first home, then the whole chain breaks apart.

Look what happened in the USA in 2008. All that paper the US government bought for 'T'rillions of dollars wasn't toxic due to mortgage fraud, criminal activity of some sort or negligence, although no doubt there were many of those factors in evidence, it was toxic purely and simply because the real estate market collapsed. The security behind the paper was suddenly worth something like 10 to 20 cents on the dollar or less. Entire subdivisions were vacant.

What I'm trying to say is that if you take the first-time home buyer out of the equation then the whole house of cards (excuse the pun and the mixed metaphor) could so very easily come crashing down like it did in the US in 2008.

PLEASE be careful what you wish for Mr. Trudeau, because you just might actually get it.

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