The housing market in Canada has gone through a full cycle since 2009. During 2009, the prices were at an all-time low. Ever since the prices have increased at break-neck speed. The prices rose so much that real estate simply became unaffordable for most people. However, in the past couple of years, housing prices have started to crash in Canada. As a result, the Canadian government has started taking several initiatives to bring home buyers back to the market.
The millennials find themselves priced out of the housing market. This is because they have just joined the labor force. A lot of them already have student loans as well. Hence, with their meager wages, they simply cannot afford to buy real estate in Canada. This has slowed down the housing market as well as allied industries. This is the reason that the developers, as well as financiers, have been continuously pressurizing the Canadian government to relax the lending norms.
At the present moment, Canadian banks assume a hypothetical rate that is 2% higher than the actual interest rate while calculating the affordability of a house. This ensures that only the people who will not go bankrupt if the interest rate increases at a later date are given loans. The developers and financiers wanted this to change. However, the Canadian government has resisted the temptation to do so.
The problem is that Canada has created some other policies which are equally worse. For instance, Prime Minister Justin Trudeau has set aside $1.25 billion to help first-time home buyers make purchases.
The Canadian government is planning to use public money raised by levying taxes to finance people’s homes. The Canadian government is planning to take about 10% equity stake in the homes of people. This will help them circumvent the minimum down payment requirements.
For instance, if the value of a home is $100, then the buyer will have to put down $10 as a down payment. This is very similar to lowering the loan underwriting standards.
The only difference is that instead of allowing private parties such as banks to take risks, the Canadian government is directly taking positions in the housing market using taxpayer money. Hence, if the housing market moves up, the Canadian government gains. If it doesn’t, the Canadian government loses. Fearing backlash for taking excessive risk, the Canadian government has capped the eligibility of this policy at $120,000. This means that only families with incomes less than $120000 can avail of this offer. Also, the cash disbursed will not be more than four times the annual salary of the family.
For instance, the government is allowing people to borrow increased sums of money from their retirement plans if they want to invest in the real estate sector. Earlier the limit was $25,000 per person. It has now been raised to $35,000 per person. Hence, a couple can borrow up to $70,000 from their retirement and invest in the housing market! This will cost the government $10 billion over the next decade.
The Canadian government seems to be repeating the same mistakes which were made by the American government. The government does not understand the fact that if indebtedness is the problem, more debt cannot be the solution. This is not very different from the subprime mortgage program. At the end of the day, people who shouldn’t be getting loans are getting loans thanks to government intervention
It is a well-known fact that Real Estate markets do the best job when it comes to capital allocation. In Canada, the government is trying to replace the market and make capital allocation decisions on its behalf. The problem is that because of this intervention capital will get erroneously allocated to housing. This means that other more productive industries where there is an actual consumer demand for goods will end up getting less capital.
The bottom line is that the Canadian government is behaving like the parents of many homebuyers. It is taking equity stakes in the houses of common people. This policy is unprecedented and threatens to magnify the bubble in the Canadian market.