Why the mortgage rate wars can rage more freely: No Flaherty, no Carney

TORONTO • Why did Bank of Montreal risk a (verbal) slap from Finance Minister Joe Oliver for daring to chop its five-year mortgage rate below 3%?

Because they knew the mortgage war is going to be different this time.

On previous occasions when the banks publicized rates below the government’s favoured minimum, they found themselves on the receiving end of angry calls from Mr. Oliver’s predecessor, Jim Flaherty, who resigned on March 18.

Mr. Oliver seems in no mood to quarrel with Bay Street and ready to largely leave the mortgage market to its own devices.

“There’s a market and the bank made its decision, and the chief executive officer of the Bank of Montreal informed me about it,” Mr. Oliver told reporters Thursday in Ottawa. “I listened to his explanation, his reasons. I reiterated what I’ve just stated — the government is gradually reducing its involvement in the mortgage market.”

Asked if the government would take further steps if a housing bubble formed, Mr. Oliver said: “I don’t have to get into a hypothetical negative.”

It’s a big change from Mr. Flaherty who didn’t jump on the banks every time they cut rates to new lows but certainly always let them know he was a coiled spring. He also didn’t mind opining on the “hypothetical negative” of what he viewed as overpriced housing in Toronto and Vancouver.

And, without Finance calling out the banks, there is a dearth of negative voices around this high-profile plunge below 3%.

Home loans are simply products that people buy, and when demand is strong the companies that produce those products — the banks — can charge higher prices, said Peter Routledge, an analyst at National Bank Financial. When demand falls off, prices move in the opposite direction.

“What [the rate cut] tells me is that household credit growth is slowing and BMO has reacted to slowing demand in the way one would expect,” Mr. Routledge said. “It’s textbook economics.”

In fact, other lenders are already providing even lower offers for five-year mortgages, though they’re mostly going about it more quietly.

“Were these [five-year rates below 3%] not already available in the marketplace?” said Gregory Klump, chief economist at the Canadian Real Estate Association. The site ratesupermarket.ca, which allows potential buyers to compare the various rates available, lists the lowest at 2.94% for that term.

In recent years Canada’s banks have enjoyed surging volumes of home loans as households took advantage of record low interest rates to enter the housing market in unprecedented numbers. As a result, real estate in many cities is the most expensive it’s ever been and consumers are sitting on a bigger debt pile than ever before.

This seemed to be no end of concern to Ottawa’s previous economic policy tandem of Mr. Flaherty and former Bank of Canada governor Mark Carney. For whatever reason, Mr. Oliver and governor Stephen Poloz appear significantly less concerned.

But it’s not like Ottawa doesn’t always have a lot of skin in the game. Canadian banks are in some ways shielded from potential problems such as a housing meltdown thanks to their use of insurance provided by the Canada Mortgage and Housing Corp. — a federal Crown corporation which protects roughly 60% of their outstanding home loans.

So while the banks to some degree share the government’s concern about over-leveraged consumers, they face huge pressure from shareholders to maintain their impressive record of growing profits. The simplest, and perhaps less overtly risky, way to stay on track is to ensure consumers keep on taking out new government-insured loans.

This is the time to do it, too. It is the start of spring, traditionally one of the hottest periods in the real estate market. “This is the time when banks have to be a little more competitive,” said Laurence Booth, a professor of finance at the University of Toronto’s Rotman School of Management.

The good news from the standpoint of the government is that consumer debt is growing less quickly than a few years ago. If the trend continues, overall debt levels will start to subside, but that hasn’t happened yet. Indeed, mortgage volumes are probably close to record levels due to a number of factors including higher house prices, new construction and a still-hot housing market, Prof. Booth said.

Yet another reason is attractive deals like BMO’s 2.99% offer, a reduction of 50 basis point from the previous rate. Higher mortgage volumes mean that lenders can charge less on individual loans but still end up with a fat profit at the end of the quarter. It’s a good deal for banks and “it’s a good deal for consumers as well,” Prof. Booth said.

For now, it also seems to be a passable deal for Ottawa.