The Pandemic Credit Boom

Steve Saretsky -

Suffice to say there are a lot of Canadians out there wondering why house prices are going up in the midst of a global pandemic / recession. As I have said before, it has nothing to do with fundamentals, but instead, liquidity. Let’s keep this simple.

Back in March/ April 2020 at the onset of the pandemic, when businesses were closing their doors, people were ordered to stay home, and fear was at all time highs, there was a genuine concern we were setting the stage for another depression, unlike anything we had seen since the 1930’s. Given the grim economic outlook, it made sense that banks would have to tighten lending, which would only compound the issue. Policy makers had to intervene quickly, they desperately needed banks to keep the credit taps open. So, what did they do?

First, the Bank of Canada intervened, purchasing government and corporate debt, suppressing yields from shooting through the roof. The banking regulator, OSFI, then lowered capital reserve requirements at the banks, freeing up spare capacity for the banks to issue loans. The federal government then backstopped many of these loans, essentially making them risk free for the banks.

Fast forward today, and we now have residential mortgage credit growth running at 10 year highs. Policy makers have spurred a credit boom, responsible for record home sales, and rapid growth in house prices. The effects of which are twofold:

1. By spurring a housing boom, they have created liquidity, and higher prices, allowing over indebted, and delinquent homeowners to sell and or refinance. After all, a rising tide lifts all boats. If the housing market was instead experiencing weak sales and falling prices, this would have compounded mortgage arrears, prolonging an economic recovery.

2. They have successfully kicked the can down the road, creating an even larger household debt burden in the process, and inflating already extreme house price valuations. Remember, the bigger housing gets as a proportion of the economy, the larger the systemic vulnerability it becomes. It then requires even more government support to keep it from breaking.

You can certainly argue, given the facts at the time, policy makers made the appropriate choice. I am not here to debate whether it was right or wrong, but simply to identify that for every action there is a reaction. The consequences of these policies are an increasingly fragile financial system. We are compounding an enormous mountain of debt, and one single snowflake could be enough to set off the avalanche.

For instance, imagine a scenario where markets begin to worry about inflation. Bond yields start to push higher and mortgage rates in this country jump from 1.5% today to 3%. The Real Estate market will undoubtedly reprice, as it did back in 2018 when we hit those levels. It is for this reason that the next battle for policy makers will be to control the yield curve. Rates can not be allowed to rise, an era of financial repression is upon us, whether you like it or not- they will have to try.

Three Things I’m Watching:

1. Policy makers have stoked a credit boom in housing. (Source: Bloomberg)

2. Canadian restaurants and bars suffered their worst year for sales on record in 2020. Sales at eating and drinking establishments in Canada dropped 28% from the year before. (Source: Bloomberg)

3. Credit boom in the US too. Mortgage originations reached almost $1.2 trillion in the final three months of 2020, the highest quarterly volume in the history of the New York Fed’s data. Americans refinanced more mortgage debt last year than any time since 2003. (Source: New York Fed)

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The Saretsky Report. December 2022