Cop talk

Like Vlad Putin, inflation’s shrinking. Even bigger news than TO’s new socialista mayor Tuesday morning was a drop in the CPI. It’s got a 3-handle now. Down a full point from last month. And most amazing of all – it’s exactly what Tiff had promised us.

Inflation will be 3% by the summer, the Bank of Canada boss said. And, mirabile dictu, here she be.

So has he won? Is this it? Can he holster the rate gun now?

Nope. One more bullet coming, which will move the central bank rate to an even 5% on July 12th. At that point, we get a pause. Hopefully a long one – maybe a year. Then, perchance, a cut.

The good news meanwhile is Mr. Market thinks inflation’s in retreat, so bond yields have been pushing lower. That could translate into a roll-back of the latest five-year mortgage pop that we saw last week. Cheaper mortgages also help bring inflation down, just as higher rates swell it. In the past year the cost of mortgage interest to Canadians has jumped 29.9% – the most on record in such a short period of time. Those poor variable-rate sods have seen costs rise 62%, or had their amortizations run amok.

Home ownership (and rent) is a big component of the inflation index. So, ironically, as the CB hikes its rate, mortgage payments go nuts, households are squeezed, inflation jumps and the bankers respond with another increase. A vicious circle. Soon to end.

But wait. What’s this?

“The current Canadian economic environment is riskier for regulated financial institutions given higher Canadian consumer debt loads (and) increased borrowing costs in volatile housing prices, therefore, OSFI is taking this targeted action to reduce systemic risk in the banking sector by clarifying our expectations.”

That’s the bank regulator announcing on Tuesday yet more restrictions on consumer credit related to real estate (the big ones are yet to come, later this year). In the crosshairs are those uninsured mortgages which come with a revolving line of credit glued to them allowing people to borrow more than 65% of a home’s equity.

To date Canadians have sucked up $204 billion of these things from the banks – about 8% of the total mortgage debt outstanding. They allow borrowers to have a traditional amortizing mortgage, but to also dip into a deep pool of additional credit on which they typically would make interest-only payments.

Too risky, OSFI now says. Starting later this year any borrowing above the 65% loan-to-value mark will also have to be amortized – meaning blended payments which steadily reduce the principal owed. And funds will no longer be readvanceable, ending the ‘revolving’ part of the loan until it’s paid back down to the threshold.

“Amortizing all lending above the 65 per cent level would limit the extent and duration of borrower indebtedness,” says the bank cop, “thereby limiting the exposure of financial institutions.”

The change is not market-moving, nor is it inconsequential. But the real significance might lie in what it suggests about all HELOCs – which have been at the heart of Canada’s Wild West property market. Gobs of people have used a home equity line of credit to borrow funds needed to purchase an investment property, like a rental condo. They get a mortgage for the rest. And, presto, the deal is done with 100% financing. A lot of these folks are in negative cash flow these days, but still believing they own an appreciating asset.

Of course their HELOC interest is fully tax-deductible, since the loan was used to acquire an income-producing property. Thus it makes sense for then to make interest-only payments, leave the debt untouched, and write off 100% of their monthly.

However, if OSFI decides those HELOCs need to be amortized, as it has just decreed for combined loan plans, only a portion of payments would be deductible. Suddenly no-money-down tenanted real estate wouldn’t look so ducky.

Is that what the regulator has in mind?

Dunno. But the name of the game is risk. Our households owe more than those in any other major industrialized country. The debt-to-income ratio is off the chart. Mortgage debt alone is the same size as the entire Canadian economy. Millions of people owing billions in home loans with variable rates have passed their trigger rates. Debt is growing, not reducing. It keeps the regulator up at night.

And, yes, the central bank rate is going up again in 15 days.

Of course, if you have no mortgage, don’t own a house and can’t afford to buy, simply move to Toronto. Olivia will get you one. She promised.

About the picture: “This is Lira at my family cabin in Princeton BC,” writes Carmel. “She is eight, turning nine next month. I thought it was a stick in her mouth. Turns out it was a hoof!”

To be in touch or send a picture of your beast: [email protected]

Source: https://www.greaterfool.ca/2023/06/27/cop-talk/