By Charles Lammam
and Ben Eisen
The Fraser Institute
Ottawa recently announced a series of new regulations for the housing market to “protect the long-term financial security of borrowers and all Canadians.” You have to love the irony. While the federal government increases regulation of household debt, it racks up more debt with no end in sight.
Among the new regulations, the federal government will mandate a “stress test” that requires all homebuyers taking out insured mortgages (mortgages with less than 20 percent down payment) to qualify for a loan at the Bank of Canada’s five-year fixed mortgage rate (4.64 percent), which is significantly higher than mortgage rates (two to three percent) typically offered to actual homebuyers.
What are we to make of this new rule? For one thing, it suggests Ottawa thinks Canadians are poorly managing debt and that financial institutions are improperly screening mortgage applicants. Ironic, as the federal government is not exactly a model of rectitude when it comes to fiscal management.
For example, the federal government has piled on $162 billion in new debt since 2007/08, for a total of $619 billion. Just like households, the federal government pays interest on debt, which costs $26 billion each year. That’s close to what Ottawa collects from the GST ($33 billion).
And over the next five years, the federal government will add at least $113 billion in new debt with no plan for a balanced budget. We say “at least” because a recent Fraser Institute study found the new debt over the next five years could total up to $200 billion under more realistic spending scenarios. Even a new TD Bank report pegs the five-year cumulative deficit at $17 billion more than forecast in the government’s March budget.
Critically, very little of the debt-financed spending is being used to invest in growth-enhancing infrastructure. Instead, much of the debt is being used to finance increased spending on current government operations and transfers. In fact, just $4 billion of the $29.4 billion projected deficit this year is for spending on new infrastructure.
In family finance terms, the government is racking up credit card debt by buying consumer goods rather than borrowing to invest in hard assets such as a new home.
Meanwhile, Canadian families are generally accumulating debt responsibly and for much better reasons. As Philip Cross, former chief economic analyst at Statistics Canada, concluded: “Overall, there is little evidence that Canadian households (unlike some governments) are being irresponsible in taking on new debt. The long-term increase in household debt has been leveraged into a much larger gain in household assets, boosting both incomes and net worth.”
Yet the government is behaving as if Canadian families can’t be trusted to manage their finances responsibly. Perhaps Ottawa should undergo its own financial “stress test.” It’s digging deeper into debt at a time when the economy is growing, albeit slowly. But what happens if the economy falls into recession or if interest rates spike?
Running large deficits during non-recessionary times puts Canada’s finances at risk should the economy experience a significant slowdown or recession. Unexpected slowdowns can markedly and quickly reduce revenues, and if the government is already in a deficit position when a recession hits, the result can be a rapid run-up in debt. The government’s own estimate show that a one percentage point drop in inflation-adjusted economic growth would increase the annual deficit by $5.0 billion.
Federal finances could also be strained by a spike in interest rates, which would require higher interest payments, increasing the cost of carrying debt – the very risk Ottawa believes Canadians are unprepared to assume. If the federal government does not get better control over its own debt, it risks losing credibility in continually trying to deter consumers from doing their own, more responsible borrowing.
Charles Lammam, Hugh MacIntyre and Ben Eisen are analysts at the Fraser Institute.