The Canadian Housing Market: Problems & Solutions
In order to properly address the housing market challenges we, as a nation, need to decide what our goals with respect to this market are. There are two choices.
The first is to create an environment where families can live and afford to raise their families. This approach allows our citizens to lead product lives and deploy their excess savings into the growth of the economy, either through an investment in a small business or an investment in publicly traded companies via a savings account, a TFSA or an RRSP account.
The second is to create an environment fueled by speculation where prices run rampant and the average citizen lives simply to pay the mortgage. There are no excess savings to invest and grow the economy. In this environment wealth becomes concentrated in the hands of a few, political favours are doled out to developers while banks and mortgage companies who are involved at every step of the process reap the rewards.
Unfortunately our politicians and the Bank of Canada have been willfully blind to what is happening. Now the problem with the Canadian housing market has grown to a point that some serious pain will need to be inflicted to cure it.
The thing about governments and the Bank of Canada is that they often believe they are smart enough to implement policies that will allow everyone to avoid the pain. We can plainly see that that hasn’t worked.
Canadians who have diligently saved all of their lives have been penalized by a policy of artificially lower interest rates in the name of the greater good. Why should this group bear the brunt of trying to avoid an economic slowdown.
Economic cycles have always existed and they always will. Trying to avoid them leads to huge dislocations in capital (money), many of which are unexpected.
The housing market is a great example. Artificially low interest rates have not spurred the underlying economy as Stephen Poloz expected they would, they have spurred a real estate frenzy. Of course, low interest rates meant people could borrow more and keep their payments the same. Consequently buyers felt they could pay more for the same house and their lifestyle would be unaffected.
Unfortunately, when that snowball began rolling downhill it got bigger and bigger. Prices didn’t stop at that point of equilibrium; they kept rising. Potential buyers looking back could see that if the trend continued they would be shut out of the market, so they jumped in.
The situation became a self-fulfilling prophecy and the snowball kept getting bigger. Now we are in avalanche territory.
The first thing that has to happen to correct the situation is for Stephen Poloz to recognize the error of his ways with his low interest rate policy. However he seems unwilling to change course and a normalization of interest rates would temporarily create a great deal of pain for a sector of the population.
It becomes a choice of who should feel the pain, those who indiscriminately borrow and spend or those who have been fiscally responsible. The Bank of Canada, it seems, has chosen to reward bad behaviour and penalize good behaviour.
Poloz continues to hide behind the smokescreen that low interest rates and a weak Canadian dollar are necessary for business to remain globally competitive.
That approach is nothing more than a crutch. Rather than businesses looking for ways to innovate and improve efficiency in their operations, they simply look to the Bank of Canada to solve their problems with another round of rate cuts and a weakening Canadian dollar.
The interest rate environment is the biggest factor in creating and maintaining the housing bubble but there are other factors at work.
The real estate industry and legal profession have done an abysmal job of identifying money laundering activities that are rampant in real estate transactions. All of the efforts and regulations put in place by various financial institutions to prevent money laundering are easily circumvented by using the real estate industry as the vehicle of choice. There is nothing wrong with legitimate foreign money flowing into our real estate markets; illegally obtained foreign money is another matter.
These two groups need to be held accountable for their actions.
Our governments really need to look at other activities in the housing market. It seems the real estate market has also become a place to create tax free wealth rather than a market that is designed to provide comfortable homes for as many as possible.
A simple first step would be to limit the tax free capital gain a homeowner could earn upon the sale of a primary residence. If their capital gain exceeded that threshold, the amount over that threshold would be subject to capital gains tax.
A second step would be to tax gains realized by those who frequently trade their primary residence. Any gains made within the first five years of purchase would be treated as income. Thereafter, the capital gains exemption as mentioned above would apply.
Another problem exists with non-resident ownership. Again, there is a solution. Provinces could apply a property tax rebate to those who pay income tax in the province and who pay property tax within that province.
That would allow municipalities to raise property taxes. Non-residents would not receive an income tax credit because they are not filing tax within the province but residents would receive a tax credit which would offset their higher property taxes.
There are several ways in which to implement this kind of program. The Homestead Act and the reduction of Ad Valorem property tax in Florida is one approach. https://en.wikipedia.org/wiki/Homestead_exemption_in_Florida
With some critical thinking and cooperation, additional measures could also be implemented.
These steps, taken together, would have the potential to stabilize the housing market without unduly penalizing those who have purchased a home for the purpose of securing a comfortable living environment for their families. On the extremes, it takes the froth of out of the market and clamps down on illegal money laundering activities.
Financial pain is already being felt by many. Changes to the system will inflict additional financial pain on some and will reduce it on others.
With the real estate market completely out of control now is the perfect time to develop a comprehensive approach to creating a stable and sustainable environment for housing in Canada. Unfortunately political territorialism and influence by powerful special interest groups such as banks and real estate developers will likely prevent it from happening.