Waiting to see if new mortgage rules will pop a bubble or prevent one: Don Pittis

I guess it's not much use saying that something should have been done sooner. To some extent, you have to give the new federal government credit for making an attempt to put a lid on what so many experts fear is a Canadian property bubble.

The debate now is what impact the move to increase down payments on houses worth more than $500,000 will have.

Is it too much? Enough to pop the bubble that so many people have identified? Or, at the other end of the spectrum, will it be too little to have any serious impact on a mortgage market that is constantly finding freshways to entice new buyers?

As always when trying to solve real-world problems, the government is making policy in uncharted waters. Unfortunately, the only way to be sure of the effect isto wait a few months and see what happens.

• Bill Morneau tightens mortgage rules, hikes minimum down payments
• OSFI moves to raise bank's capital requirements for residential mortgages
• 1st-time homebuyers at risk because of heavy mortgage debt, says C.D. Howe study

At first blush the new rules seem targeted at the richer end of the market. Ostensibly, houses selling for less than $500,000 will be unaffected by Finance Minister BillMorneau'sincrease in down payments.

The new rules are structured so minimum downpaymentsbegin to rise gradually as the selling price moves above that point.

Not just for the rich

Unlike other parts of the country, in the two most overpricedCanadian real estate cities, Toronto and Vancouver, homes priced over half a million aren't just for the very rich.

Even forhouses listedfor more than $1million, sellers offer deals that seem to be aimed at first-time buyers.

Just days agothe C.D. Howe Institute, a Canadian economicthink-tank, warned that many first-time buyers are so overextended that they are teetering on the edge of ruin.

"The share of households that have no financial buffer has been going up. There's more financial vulnerability now than there was before," saidC.D. Howe economist CraigAlexander.

Many studies have reported that young people are already getting large chunks of their downpayments from the Bank of Mom and Dad.That means even the down payment can bean invisible loan that will need to be repaid, especially if it comes from anest eggthe parents will need for their extended retirement.

• 18% of first-time homebuyers get help from parents, CAAMP says

The question that really cannot be answered yet is whether the new rules will have the desired effect. Clearly the government wants to cool the market without crashing it, aiming for the storied soft landing.

According to efficient-markets theory, any price rise will have a slowing effect. But having just readRichardThaler'snew book on behavioural economics, Misbehaving, I fear the power of psychology will have much more effect on howbuyers respond.

Popping or reining in abubble?

If new buyers really are willing acceptthe kind of danger that C.D.Howe is warning about, it may be theywill just find new ways to overextend themselves.

As mentioned previously, quoting an Economist writer discussing a different kind ofmarketaltogether,"speculative fervour thrives on expectations of rapidly rising prices rising rapidly enough that buyers find it rational to make bets they could not normally afford."

While a case could be made that price rises will not be enough to rein in a bubble, in a psychology-driven market, it is not hard to make the opposite case that is, that increased mortgagecostsmaybe enough to pop the bubble, if one does indeed exist.

Maybe in combination with a rule to push more risk onto mortgage lenders, plus anexpected rise in U.S. interest rates,the entire housing market may turn from optimism to pessimism.

Certainly the Canadian Real Estate Association has expressed concern that markets outside the target price ranges and regions could be affected.

"It could turn buyers and balanced markets into distressed markets, at a time when our economy is struggling, including in places that are facing economic headwindsfrom the collapse in oil prices," said CREA'schief economistGreg Klump in a releaseFriday.

CREA has repeatedly insisted that the Canadian housing market is not in bubble territory. If that's true, the government's attempt to take a little heat out of the market will merelydiscouragea future bubble from growing.

On the other hand, if the many critics and international bankers are right about the Canadian property market,that it has alreadyinflated into a bubble ready to pop, then the time to intervene was years ago.

But we can hardly blame the current government for that.

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