Stephen Poloz is the last person who will stop Toronto’s out-of-control housing market

by Invesbrain Friday, April 28, 2017
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Star Trek fans considerably less devoted than Bank of Canada governor Stephen Poloz know the Spockian adage that the needs of the many outweigh the needs of the few.

But does the greed of the few outweigh the needs of the many?

That’s a dilemma Poloz weighed on April 12 as Canada’s central banker decided to hold the benchmark interest rate at 0.5%.

On the face of it, Poloz’s decision is a marginal, innocuous affair. As BNN reported, StatsCan has offered some strong numbers from Canada’s economy, including estimate-topping growth (0.6 per cent in January vs 0.3 per cent estimate), job gains (19,400 in March vs 5,000 estimate), and retail sales (2.2 per cent in January vs 1.1 per cent estimate). On the other hand, Canada’s balance of trade swung into the red with a $972 million deficit in February. Based on those numbers, Poloz could find plenty of justification and little criticism for whatever decision he made.

But there of course is a surging, frothing elephant in the room -- Canada’s housing market, particularly in Vancouver and Toronto. And perhaps the only person with the means, will and desire to rein in that beast is Poloz. The question is, should he jack up interest rates -- and possibly harm the Canadian economy as a whole -- in an effort to calm down the excesses confined mostly to the Toronto housing market.

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“The use of interest rates to cool things down is justifiable,” said Stéfane Marion, the National Bank’s Chief Economist, told his clients on April 10.

BNN reports Marion’s team estimates more than half of regional housing markets in Canada are posting price inflation of ten per cent or more; Toronto notoriously posted year-over-year price increases in March of 33.2%, taking the price of an average property to $915,567 from $688,011.

"This record proportion is very similar to that observed in the United States in 2005 at the peak of the market," Marion wrote in a report titled ‘Irrational Exuberance?’ "The Bank of Canada must change its narrative and abandon its easing bias as soon as this week."

Related: Canadian housing starts solid in March

These days dates are being bandied about almost as quickly as offers for single-family homes in the GTA: 2008, the year sub-prime mortgages triggered the U.S. financial crisis; 1989, the last time the Toronto housing market ended a heady run with a massive pratfall; and 1637, the year of the Dutch Tulip Bubble (ask BMO chief economist Douglas Porter).

1989 is particularly interesting since sharp interest rate increases from the BoC back then cut the legs out of that housing bubble.

“Fully understanding that rate hikes are not local, a four per cent, five-year fixed rate would quickly do to Toronto prices what an array of other cute policy tweaks haven’t/won’t be able to do,” BMO wrote in a report to clients.

But Poloz has given no indication he is going to use interest rates to cool off the Toronto housing market -- even as the central bank’s loose monetary policy is being blamed for fuelling speculation in the GTA.

Indeed, Doug Porter, BMO Capital Markets’ chief economist, recently implored Poloz to at least add a hint of hawkishness to his tone.

“The BoC should cease and desist with talk of possible further rate cuts, which simply fuel the sense that rates are never going higher, and instead start warning that rates will someday rise,” Doug Porter, chief economist at BMO Capital Markets, told BNN via email. “Even if this causes a shadow of doubt in the housing market, it would be helpful.”

Poloz did take some of Porter's advice on April 11. While he dismissed the idea that interest rates could cool speculation in Toronto's housing market -- he said even a hike of several points wouldn't stop a speculator if they believed a house was going to go up 20% -- he did say such speculation was "unsustainable." He also signalled a rate hike could be coming next year -- the first since 2010.

His comments came as the Teranet-National Bank National Composite House Price Index – which measures monthly price increases in 11 major metropolitan markets in Canada – saw major gains in four cities February to March: Hamilton, Toronto, Victoria and Vancouver – with Hamilton rising most quickly at 2.1 per cent in March, and Toronto gaining 1.8 per cent.

The Globe reported both cities set price-gain records for March.

One could argue, however, that Poloz and by extension Canadian monetary policy has effectively been held hostage by the current Toronto housing crisis. As both the Globe and Mail and Business Insider opined recently, real estate and especially real estate in the GTA, commands a disproportionate place in the Canadian economy.

As a result, Poloz faces the same dilemma that has paralyzed governments at the municipal, provincial and federal level: as the Globe points out, if he raises interest rates, he might pop the Toronto bubble, while also raising borrowing costs for the whole country and driving up the loonie; if he lowers rates to stimulate the rest of the economy, he further spurs speculators and others in the GTA to take on more mortgage debt.

“The Toronto real estate market is probably one of the reasons you have a long hold on the current [Bank of Canada] interest rate,” Frances Donald, senior economist at Manulife Asset Management told the Globe.”You can't apply regional interest rates. So the Toronto housing market is helping to dictate monetary policy being applied in places like Saskatchewan and Nova Scotia.”

The dilemma goes even deeper than that. If Poloz doesn’t step in and use interest rates as a macroprudential tool to deflate the Toronto housing asset bubble, he risks it bursting and rippling through the Canadian economy as a whole; if he does nothing, the Toronto housing bubble will burst and will ripple through the Canadian economy as a whole.

Related: Stricter rent controls in Ontario will only hurt housing affordability

It’s a risk Poloz’s own staff identified in its Financial System Review, pointing out the Toronto market had surpassed Vancouver as a bigger concern and, more worryingly, a much more heavily indebted area. Indeed the FSR contained a ‘heat map’ of how households with mortgage-to-income levels north of 450% were multiplying and spreading within Toronto over the past couple of years.

As the Globe piece points out, the Toronto bubble bursting will be felt across the country. The Conference Board of Canada estimated that Toronto’s economy expanded by 3.4% last year -- and suggested that nearly half of the entire country’s 1.4% growth in real GDP in 2016 stemmed from that. Driving that Toronto surge was construction, real estates services, the financial sector as well as the wealth-effect gains, presumably through those soaring housing prices, in consumer spending.

Indeed, the Globe reports the GTA is home to more than a fifth of Canadians and a similar share of the country’s wealth. Citing StatsCan, Business Insider wrote housing construction and real estate activities combined to account for 15.5% of Canada’s GDP, up from 14.7% in 2011.

Wolf Richter of BI goes on to point out that in the City of Toronto, after rates were hiked in February, property taxes and land transfer taxes will combine to provide 45% of the city’s tax revenues -- a record $4.7 billion.

“This is why the housing bubble and the accompanying crazy housing speculation must be maintained and further inflated, no matter what,” he writes. “It has become an addictive drug for the Canadian economy.

“The entire economy – including government revenues and thereby the services offered by these governments – depends on wild property speculation. And everyone is praying that it can somehow be maintained.”

Everyone that is but Stephen Poloz. He’s probably praying for someone to come beam him up so he doesn’t have to deal with being a central banker with no way out of a bubble.

Related: Ratings agency says Canada faces risk from potential housing correction

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