Federal parties caught off guard by housing affordability crisis

Canada’s housing crisis has become the defining issue of the 2021 federal election.

This may be surprising given all the other issues we are facing: a pandemic, an ecological emergency, and growing geopolitical tensions.

But spiraling home costs beyond Toronto and Vancouver—where they have been a political hot potato for over a decade—have made housing a central issue for many voters.

Why are house prices spiraling upward, apparently out of control? Is it a bubble? Toronto has waited 20 years for its bubble to pop, is it really a bubble or something worse? What is the nature of the crisis that we are in? And most importantly, how does the federal government have a role in it?

I have written on rental housing elsewhere, but here I want to focus on how finance has changed the market for single family homes—one of the most important investments any working family makes in their financial future.

The average house price in Fredericton in the first seven months of 2021 was almost 25 per cent higher than the first seven months of 2020. Increasingly in communities like Fredericton, where wages have stagnated by comparison, we are hearing about a lack of affordability for folks who are trying to buy their first home, or even a larger home for their expanding family.

In light of this, all major political parties have made announcements about housing, most promising construction of new construction—as though the rising cost of housing has to do with the relative scarcity of housing, generally.

It is not.

Since spring 2017, Canadian builders have completed 840,940 housing units, according to Statistics Canada and the Canada Mortage and Housing Corporation (CMHC).

Over the same period, Statistics Canada estimates that the population has grown by 1,733,064. The average household size, according to the 2016 census data is 2.47, meaning the new construction that has come onto the market is more than enough to meet population growth (though some spot markets may be tighter, notably Toronto).

The massive increases in housing do not, primarily, have anything to do with supply and demand of houses, despite what economists continue to harp on about.

The dominant approach in economics and in business schools—neoclassical economics—is based on a facile version of supply and demand analysis, which lacks attention to what sociologists and institutional economists look at: how supply and demand are put together.

The important component of supply and demand here is not in homes, but credit and the regulations governing it. This is what is leading to runaway house price inflation.

Before the 1987 and 1992 Mulroney government reforms of the Banking Act, Canada’s financial regulations required that banks, insurance companies, and equities traders (the folks who sell stocks and bonds), operate separately from one another. Canada had what it referred to as the “four pillars” of its financial system, which were kept separate from one another to protect consumers and manage risk.

Mortgages, therefore, were held by one institution, and not sold as commodities by others. The post-World War II rules governing banking and mortgage lending were undone so that Canadian bankers could compete with rapidly globalizing American banks in the 1980s, and with the swing towards continental free trade.

The ability of financial firms to compete with one another in activities that were once kept separate led to significant “financial innovation” in Canada, innovations that helped substantially increased banking profits in the late 1990s, helped lower interest rates, and also increased household indebtedness.

One of the most significant innovations was the rise of the Mortgage-Backed Security or MBS. MBS pool mortgage loans originated by commercial banks, split them into revenue-generating securities (or units of ownership over a pool of mortgage debt), and then sell them to investors who are paid out of mortgage income. This process is know as “securitization,” and while it may be obscure to voters, it is having a major impact on how bankers end up with more of workers’ money.

The advantage of selling off MBS for the mortgage originators (commonly commercial, or chartered banks in Canada, but also private equity firms) is that it removes debt from their balance sheets, enabling them to “leverage” their money, and originate yet more loans, which in turn can be packaged and moved off-balance sheet at each “turn.”

Because commercial banks traditionally make money on the spread between the money they borrow (from depositors or other sources) and the money they lend (for instance mortgages), lending out more money means much higher returns for Canadian banks, and, ostensibly, lower interest rates for borrowers (because there is more capital available).

However, one of the effects of securitization is that mortgage originators no longer hold the risks of mortgage debt. Those risks lie with households (who might lose their homes if they default) or with investors (who will lose income on their MBS, and whose risk tolerance is priced into different types of MBS which might be graded by the riskiness of the loans, e.g. insured vs. uninsured).

MBS and the various tiers of MBS are famous at this point for their role in the US subprime real estate fiasco of the mid-2000s. Canada did not have a well-oiled subprime real estate industry.

Mortgage origination is, for the most part, more firmly regulated in Canada through the CMHC. But that does not mean that all is well with Canadian mortgage markets.

As Canadian banks sought to compete with international banks, especially American ones, mortgage securitization played a key role. However, there was a very limited private market in the early 2000s for Canadian MBS, which would allow banks to increase their leverage, so the federal government created a market for them.

In June 2001, the Chrétien-Martin government authorized the CMHC to create the Canada Housing Trust, a special purpose vehicle to buy banks’ mortgage debt, and repackage them to large investors in the form of Canada Mortgage Bonds (CMBs). This helped move mortgage loans off the balance sheets of banks, and onto that of the CMHC/Government of Canada.

CMBs are also guaranteed by the Canadian government at fixed rates and terms, essentially pump priming the supply of available bank credit for mortgages, while nationalizing all the systemic risk.

In the low-interest environment of the 2010s—during which time central banks could not increase interest rates for fear of sparking the collapse of highly leveraged and indebted firms (especially banks)—CMBs became very popular securities for institutional investors to hold, because they were guaranteed by the Bank of Canada, and because they offered interest rates substantially above zero. They became a key component of most balanced portfolios.

The impact on Canadian housing, however, has been dramatic.

There is no easier way for Canadian bankers and private equity firms to make money than to initiate mortgage loans, because the debts will in most cases be bought and guaranteed by the government of Canada.

While various federal governments have taken measures in recent years to “reign in” home price inflation (especially in Ontario and Vancouver), it has not made any substantial attempt to divest itself of its role in buying MBS, and indeed, it is difficult to see how it can without harming the housing market.

Anything that hampers the leverage of mortgage originators—especially chartered banks—will
lead to higher borrowing rates.

But in the absence of this type of action, the housing market continues to receive as much credit as house buyers can borrow (but not equally to all buyers).

As house prices continue to increase, the size of mortgage loans have increased as well, in addition to the size of household debts, as more and more Canadian families face “house poverty.” More and more of the income of Canadian workers is being paid in rent to bankers, who make money by packaging those higher loans into MBS for investors, with the help of the CMHC.

In short, the market has been rigged.

Who did this? The banks did, aided in no small part by our Ministers of Finance, who have been Bay Street insiders for years (Paul Martin, Jim Flaherty, Joe Oliver, and Bill Morneau, all grew up amongst Canada’s elite financial classes in Montreal and Toronto).

These financial elites have often done what they felt was in the best interest of the country and its economy, but their notion of the public good may be blurred by their own class position, and the needs of Canada’s business elite. It has not taken into account the fact that banking profits would come from working Canadians paying more for their housing.

Our emergency pandemic measures have not made this better.

In the midst of the Corona Crash in March and April of 2020, Canada’s government announced a massive nationalization of private debt: particularly the purchase of Canadian mortgage debt through the Bank of Canada.

In the depths of the crisis, the Bank of Canada tripled its purchase of Canadian banks’ MBS, to the tune of $150 billion over the summer of 2020. This moved the risks of continued mortgage origination onto the public in the midst of the greatest economic crisis since the Great Depression.

In return, the Canadian public received nothing but the risk of default.

We are living on borrowed money, and borrowed time. Eventually, housing prices will burst, and the cost of credit will increase.

But who will benefit from that? You might think: well if prices collapsed, at last, young people will be able to buy homes again.

I am afraid that is not so.

In 2008, US commercial banks quickly realized that the biggest problem they had with the foreclosure crisis was that they were stuck with sizeable stocks of housing, and no one ready to buy them.

The same will not occur in the 2020s, because new firms emerged during the foreclosure crisis in the US to “buy the dip” in housing prices. Houses are now being bought by private firms, who are renting them out to people no longer able to afford to buy.

In the process, they are transferring a source of workers’ savings into private banking profits, which are mostly held by wealthy families and investors.

Take firms like Saint John-based Canada Homes for Rent, as an example. It specializes in property management for wealthy individual investors, who are buying properties as a source of passive rental income. Similar firms help manage properties on behalf of private equity firms and real estate investment trusts (REITs) who have turned rental incomes into a profitable investment class for institutional investors. But it is mostly the wealthy who own shares in these firms, and not regular working people, whose housing is being dispossessed.

Unless there are substantial reforms to the National Housing Act and the Banking Act, wealthy elites will continue to use our financial system to game the housing market and take more workers’ money.
Whatever government comes to power after Monday will have to confront this situation and the powerful political cocktail it will unleash. One study by the Washington Post showed that nearly 60 per cent of people arrested for the January 6th riots had a history of financial trouble and home foreclosure.

Do similar problems underpin some of the distrust in established political parties and scientific authorities during the pandemic in Canada?

There are real causes and real injustices behind the Canadian housing crisis. But as it continues to spiral out of control, there is no certainty that those affected by it will grasp these complexities and find a way to fix it without first breaking many other things.

Matthew Hayes is a professor of sociology and the Canada Research Chair in Global and International Studies at St. Thomas University.