There was a morsel of good news in
the Jan. 20 move by the Bank of
Canada to lower the overnight rate
charged to banks for loans to one per cent.
The central bank rate for overnight loans
between banks influences other loan rates.
So the rate cut could make it easier to buy a
home. Lower mortgage rates imply a
reduced cost of housing. And that implies
quicker turnover and easier moves up from
starter homes to sprawling suburban manses.
That's the theory.
Now let's have a dose of reality. What is
driving interest rates down is not the goodwill
of the Bank of Canada but tough economic
times. It is hardship that is driving
interest rate moves. Cheaper money, as well
as the expected aid that would flow from the
BoC to any chartered bank in trouble,
should be lubricating the financial system
and making any bank more willing to take
on some risk. Unfortunately, it isn't working
quite that way.
The problem is that the cost of capital is
not controlled by Mark Carney, the governor
of the Bank of Canada. Rather, it is the
credit markets that set the cost of capital to
the banks. And those markets are saying
they are worried, indeed terrified, that the
problems that have visited American and
European banks will soon come to test
Canadian banks. As a result, it's gotten very
expensive for banks to borrow. Chartered
banks and other financial institutions are
having to pay 6% for money that goes into
their senior deposit notes, like GICs, but
traded among institutions, 10% on subordinated
debt that goes into their Tier 1 capital,
the first loans that will default if banks are
in deep trouble, and even higher interest on
some preferred shares that count as bank
capital.
Back in the trenches in the mortgage business,
there is a chance that the BoC's interest
rate cut would lower rates on closed,
five-year terms, now about 4.5% to perhaps
3%. If that happens, a $200,000 mortgage
with a 25-year amortization would see its
monthly payment decrease from $1,107 to
$946.50. That's a saving of $160.50 or
about 14%.
Andrew Allentuck
Whether that saving is passed on to homebuyers
in a substantial way depends on
whether lenders are able to revert to discounting
the prime
rate. The prime rate of
interest, which is what
banks charge to their
biggest and most credit-
worthy customers,
stands at 3.5%.
Lenders have been
charging a premium
on top that to push the
5-year closed rate over
4%. If they revert to their former practice of
charging prime less a discount, then the
effective mortgage rate would drop to
around 3%.
The housing market is going to remain soft
So which way will the market go? For the
time being, it looks like default anxiety is
going to prevail. That angst pervades the
financial system.
Care to buy some bank bonds? There is
no present likelihood senior bank bonds
will default. But chartered bank subordinated
(i.e., relatively low-grade) debt is being
traded with double-digit interest rates, the
result of investor disbelief that big banks
will be able to pay all their bills on time. For
the record, I don't share that anxiety, but
some banks have put the value of their own
bonds and, through nothing more than guilt
by association, similar bonds of other
banks, into doubt.
In mid-December, Deutsche Bank,
Germany's biggest, failed to pay a bond on
a call date, leaving it to float at a low rate of
interest.
The bond's price plunged and the
prices of the entire class of what are called
fixed floaters are being viewed as ready to
collapse. If you are an investor and all you
want is to make money with bonds or mortgages
or other kinds of fixed income assets,
you can get murdered even if a sound bond
loses favour in the market. And that is what
has happened to bonds that are sold to
finance home mortgages.
Major investors are frightened that any
bond with the name "mortgage" may wind
up on a gurney with a toe tag. However,
mortgage bonds backed by
the Government of Canada
are not the same as the debt
of some overstretched
American bank that has to
hire loan collectors.
Investors can buy mortgage
bonds with a higher yield
than regular government
bonds, even though they
have the same bulletproof
guarantee of payment of coupons and principal.
So Mr. Carney's earnest interest rate cuts
are nice. But nice does not cut it in a fixedincome
market that is just about catatonic
with default fear. For the housing market to
revive, it will take not just lower borrowing
costs, but a return of confidence and a
return to rising gross domestic product.
Until then, with deference to Mr. Carney,
the housing market is going to remain soft.
Andrew Allentuck's newest book, When Can I
Retire? Planning Your Financial Life after
Work, is published by Penguin Canada.
|
