Canadians need to stop worrying and learn to love higher home prices
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On Monday, as members of Parliament returned to Ottawa from their summer break, Canadian Finance Minister Chrystia Freeland unveiled new measures to expand access to government-backed mortgage insurance for homebuyers.
She called it the boldest mortgage reform in decades but are the new measures really significant enough in terms of size and scope to earn that title? Maybe not. But in terms of direction, they just might be.
Federal officials have tinkered with the availability of government insurance for at least 60 years, but nothing to the extent of the past two decades. Since the 2008 global financial crisis, policymakers have worked hard to cool demand in the housing market by tightening lending rules and raising underwriting standards. We’ve come a long way from no-money-down, 40-year mortgages.
Between 2008 and 2012, then Finance Minister Jim Flaherty reduced the maximum mortgage amortization to 25 years, from 40 years, and worked alongside OSFI (the banking regulator) and CMHC (the housing regulator) to shore up capital rules and limit government exposure. (Flaherty once told me he was embarrassed by his move in 2006 to loosen credit by raising the allowable amortization to 40 years.)
Strict rules
Efforts to cool housing demand continued into the Justin Trudeau era. One of his first major economic measures came in December 2015 when his government raised down-payment requirements. Even today, our banking regulator maintains relatively strict mortgage qualifying rules to try to ensure buyers don’t get in over their heads.
Freeland’s move this week to extend the maximum amortization to 30 years for all buyers of newly built homes—and for first-time buyers, for all homes—marks a substantial shift. She also raised the ceiling for government-backed mortgages to $1.5 million, from $1 million.
Why now? And what does this tell us about the housing market?
Freeland’s rationale, as laid out at Monday’s press conference, is noteworthy: “This is really, at heart, a supply-side measure. It’s about creating more demand for new builds because, crucially, Canada needs to get more homes built faster. And to do that, we need more buyers. That’s what these changes will enable.”
For two decades, policymakers sought to curb housing demand because they were worried supply constraints would fuel excessive price increases—yet despite these efforts, prices have continued to march higher. Now, Freeland is flipping the argument: Demand, she suggests, is a major constraint on supply.
Keynes’ Law
Economists might recognize this argument as a version of Keynes' Law: demand creates its own supply. In the housing context, the theory implies higher demand spurs new construction, largely by boosting confidence about future prices.
This logic holds when there’s plenty of slack in the market—say, lots of underemployed construction workers or a glut of unsold homes. But the risk is that if those conditions aren’t present, engineering greater demand will just lead to higher prices if there’s no capacity to increase supply.
If the government is really concerned there isn’t enough demand for housing, there’s another solution: allow the market to correct itself.
The real estate market is struggling. Sales have picked up slightly from last year’s lows but remain well below historical averages. In Toronto, the average time a property spends on the market jumped to 44 days in August, compared with 28 days a year ago.
Maybe the problem is that prices are too high. Toronto’s average home price of $1.1 million has barely budged over the past year. Nationally, it’s $650,000, but the median income is only about $45,000. People aren’t buying because they can’t afford it—especially with today’s higher interest rates.
A sharper correction in prices would bring demand back in a big way. (And if demand really does create its own supply, we’d solve our supply problem too.)
Permanently higher?
So, is the government trying to avoid a market correction?
At her press conference, Freeland was asked whether her message to Canadians is that prices aren’t coming down anytime soon. She didn’t answer, but judging by her latest policy, she may be hoping they don’t.
That’s not necessarily a bad thing. In fact, politically and economically, preventing a sharp price decline makes sense. And I don’t think that would be any different under a Conservative government.
Canada’s economy has become deeply tied to an expensive housing market. It has become a feature of who we are.
Trying to unwind it now would cause real pain. Net equity in homes is a huge driver of consumer spending, and many Canadians are buried in debt. Home prices may fluctuate, but debt stays the same—that’s why housing bubbles represent such a financial risk.
If home prices fall, we’re looking at a potential wave of defaults and a sharp drop in consumer spending. Despite the government’s nod to Keynes’ Law, lower prices would also kill new home construction, even if demand does pick up.
Freeland’s new measures probably mark the start of a new trend. Policymakers and banks alike will need to adapt to a world of permanently expensive housing. For lenders, that means innovating on products. For developers, it means innovating on construction methods and materials, along with offering smaller homes. For the government, it means finding ways to nudge first-time buyers into a deeply unaffordable market.
Don’t be surprised if 40-year mortgages one day make a comeback—and along with them, more government backstops to reduce risk, because higher home prices are likely here to stay.
