Trudeau’s Affordable Housing Proposal Is Not Only Discriminatory, It Is Also Counterproductive
This is not a political or ideological critique. The same arguments apply to other platforms.
Since Prime Minister Justin Trudeau called for early elections a few weeks ago, and as different political parties ramped up their campaigns, the topic of housing, and especially housing affordability, rose to the surface as a key concern facing Canadians.
For over a decade now, the real estate market, especially in key urban locations, has seen extraordinary and relentless price inflation. Canada has been consistently ranking as one of the frothiest and most expensive countries to buy a dwelling. This has raised the specter of a growing Real Estate bubble — akin to the 2007 crisis in the US — posing substantial risks not only to homeowners but the economy overall.
The topic is on every tongue and the center of conversations. The pandemic, which at first glance should have frozen the market, precipitated an exodus of WFH masses outside of urban peripheries and into further and more remote and un-commutable towns, taking the market for another spin. Many of these far flung markets registered 30–40% year-over-year price increases as people awash with cash sold their houses or condos in Toronto, Vancouver or Montreal to overbid each other while urban centers held firm.
This summer highlighted even more how out-of-whack the real estate market is. Many of the conditions that were common during the previous peak (2017) in Toronto and Vancouver became common place from Montreal to Moncton or Albertan countryside. Blind bids, no-view purchases, a flood of offers for the same listing, often with no inspection requirements. FOMO (the Fear of Missing Out) has been running rampant.
With this came the realization that the dream of someday becoming a homeowner — while maintaining a balanced budget — is fading for younger and first-time prospects. Regulators also fear that the bubbly market poses systemic risks to the economy.
The Proposal
As a result, the Liberal party has announced a set of proposals and promises to address the housing affordability concern. These include plans to build more houses and discourage speculation, as well as supporting access to housing. The latter objective is mostly based on a new program to help first-time young home buyers quickly save for a down-payment.
This plan, called the tax-free First Home Savings Account (TFFHSA), combines features of existing savings vehicles already known to Canadians. On the one hand, the TFFHSA would function just like an RRSP, with money invested being tax-deductible (meaning that it will reduce imposable income, and therefore income taxes owed.) And like investing in a TFSA, money put in a TFFHSA can grow tax-free with no tax obligations on returns even when selling or withdrawing. “Tax-free in, tax-free out” — as the online platform describes the proposal which
… will allow Canadians [] to save up to $40,000 towards their first home, and to withdraw it tax-free to put towards their first home purchase with no requirement to repay it.
Does this proposal, and others, do anything to address the affordability crisis?
Defining Affordability
Instead of relying on raw prices alone, affordability measures how expensive houses are in relation to the ability of buyers to pay for it, using factors such as average incomes or rents. Affordability for a specific market and demographic can be gauged in different ways. More commonly, it can be expressed as a ratio of:
- Average house prices to average income (P/I)
- Monthly mortgage payment to disposable monthly income (M/I)
Using any of these measures shows that housing affordability has deteriorated in Canada as prices largely outpaced wage growth for decades now. Across the country, the ratio of average house price to average income (P/I) has jumped from x3 at the turn of the century to over x7 nationally — far exceeding the recommended x4 valuation as an upper bound. In expensive markets the situation is direr: over x10 in Vancouver area and the GTA.
Monthly mortgage payment as a portion of household income (M/I), paints a similar picture. It exceeds 50% in many markets — meaning the households are spending more than half of their incomes on mortgage payments as opposed to the sustainable ratio of 30–40% recommended.
Causes of the Affordability Crisis
Since affordability is a relative measure, mainly centered around housing prices, mortgage rates and income we can express the measure thus:
I In Canada, as in many developed countries, income hasn’t kept up with inflation leading to generally stagnating real wages. And this is even before considering that official measures of inflation frequently underestimate the true loss of purchasing power to the consumer. When it comes to housing specifically, wage growth trailed house price increases consistently and significantly over decades. Only lower mortgage rate, driven by suppressed interest rate policy , allowed Canadians to continue affording mortgage monthly payments.
P Obviously, the main driver of housing affordability crisis is unchecked price overbidding. Like for any other product, housing prices are driven primarily by the forces of supply and demand. Both components have been conspiring in tandem to.
Limited supply over the years led to a tight inventory. Construction and freeing of additional units, especially destined to lower and middle-income households were trailing for years due to slow actions by governments which frequent failed to deliver on their own promises. Strict zoning and permitting at the local level slowed down developments. In many cases, new constructions were focusing on high-end markets or outside of densely-populated or commutable centers.
On the demand side, demographics such as population increase and new arrivals increase demand. But as the pandemic showed, immigration is not even the biggest driver. Larger portions of the population are excepted to own their dwelling as part of the Canadian dream. Increasingly, owning their place of dwelling is considered, to quote the liberals, a human right. The bank-of-mom became the emblem of a generation that can’t even save fast enough for a down-payment . Governments brought many new programs to incentivize Canadians, especially first-time buyers, to jump into the dream such as the Home Buyers Plan with allowances to withdraw from RRSP with no penalty, or First-Time Home Buyer Incentive with a shared-equity mortgage with the government. And with rising prices year-over-year, it emboldened many to upsize (using built equity to move to bigger houses), buying investment properties and speculation. All these factors and others, combined with FOMO (fear of missing out) common during price bubble formation, drove hoards of new demand on an already tight market.
R However, the biggest driver of price inflation, and of demand for mortgages and financing in general, is the basement-level interest rate policy implemented by the Bank of Canada and other central banks around the world (such as the US’ Federal Reserve.) Interest rates act directly on demand for financing and indirectly, with time, on price levels and the purchasing power of money (i.e. inflation.) Since the financial crisis of 2007, central banks around the world have driven, then maintained, their benchmark rates near 0%. This, in turn, drove borrowing costs, including mortgages to historically low levels.
To highlight the impact of changes in mortgage rates, let’s use an example of a half-million property, with a 10% down-payment.
The monthly mortgage payment would fetch around $2,300 at today’s 5-year rates of around 2%. This compares to a monthly payment of $3,300 at rates prevalent in 2008 and of $4,400 at the low double digit rates that were common in the 90’s.
Looked at in a different way, the same monthly mortgage payment of $2,300 at today’s rates for a $500,000 property could only finance a $350,000 house in 2008 (30% discount) and $270,000 in the 90’s (45% discount.) Central bank depression of interest rates since 2008 can explain, using this quick and gross estimate, at least a 70% price increase of house prices across the board. (House price index — nationally — doubled during that period)
Your house didn’t get bigger, central banks just made sure your mortgage payments got smaller and prices had to adjust upward to reflect that fact.
Does Proposal Solve The Problem?
So now that we have a general idea what factors drive affordability we can better assess if the TFFHSA will help resolve the problem.
It is true that the Liberal party’s platform addresses the supply side by promising to build 100,000 new homes by 2025. However, many successive governments both left and right under-delivered on their promises when it came to building new affordable and middle-income housing in key areas — sometimes due to red tape or zoning and permitting restrictions at the local level.
However, the TFFHSA plan is much more likely to be implemented quickly due its nature.
The plan is ageist and discriminatory in its current form as it will be available to under 40 year old citizens only. However, this is not its biggest weakness and can even be remedied by extending it to all first-time buyers.
More importantly, the proposal is counterproductive as a measure to solve the affordability crisis as it would only add more demand pressure to an already fever-pitched market. It can be argued that the purpose of this proposal is not reducing prices but allowing a path to homeownership to young families. However, the single best strategy to achieving that goal is through increasing home affordability and not shackling young families with burdensome mortgages for decades that will leave them vulnerable to any price drops.
In reality I suspect that, whether constituents realize it or not, nobody really wants the runaway housing train to slowdown or be fixed in any fundamental way. This is for the simple reason that any significant drop in house prices will destroy “equity” that has been built over the years and making most homebuyers underwater (owing more than the market value of the house or apartment) replaying the real estate crisis that last occurred in the US.
As we have seen, I believe that the single most significant cause of the house price inflation is the historically low interest rate policy and other “emergency” programs implemented by the Bank of Canada (and the Fed) since 2008. However, these emergency measures are bound to be lifted, deliberately or forcefully, sooner or later and only then would prices revert back to more affordable levels. The question really is whether this will happen in an orderly or disorderly fashion given central bank actions. Not much else can politicians do about this crisis otherwise.
