Thursday, March 21, 2013

On Flaherty, Interest Rates and the Free Market

On Tuesday the Finance Minister Mike Flaherty Called Manulife about Interest rates. Manulife had cut the their 5 year fixed mortgage rate to 2.89% and Flaherty thought that was to low; so he rang them up to communicate his displeasure over the drop in rates. Later that day Manulife went back to the old offered rate. This is the second call Flaherty has made to banks over mortgage rates: BMO received a call earlier this month, though they declined to take his advice and kept the new rates.

The Finance Minister has taken some criticism over these interventions into the market place. Business leaders dislike being told how to run their businesses(unless they need money). Conservatives generally opposed Government intervention in the Economy, believing that it leads to inefficiencies and likely to bring about Totalitarian Socialists dictatorships. We have the NDP leader Mulcair suggesting "banana republic behaviour"; interim Liberal leader Rae explained that "either we have a free market or we don't". Tough  going when Liberals and NDP criticizes a Conservative for intervening in the economy.

I believe Governments have the right to intervene in economic matters and should do so when the need is there and congratulate Flaherty on his ideological shift. But was there cause and are his methods reasonable?

Flaherty's concern is over an American housing crunch/debt crisis hitting Canada. Our recovery, if steady has been slow and would be damage by a collapse in the housing market. Household debt has been rising to uncomfortable levels. He already reined in amortization periods, reducing them from 40 years to 25; the longer the period, the lower the payments and the more you can spend on a home. Lower interest rates also mean lower payments making more expensive homes affordable. But as the Bank of Canada warned, interest rates will eventually go up and the consequences of that  can be defaulting on mortgages and loans. If a large enough number of Canadians find themselves in dire straights it will have a sizable impact on the Canadian economy.

Flaherty sees the mortgage sectors competition for customers, through lower rates as potentially destabilizing; putting unqualified buyers in homes they can't afford, awaiting the first interest rate shocks. A house of cards. I think he is right to be concerned and its the type of problem that requires action way in front of the problem, if there is a problem at all. The downside of ordering banks to maintain higher rates, (keep in mind very low BoC rates) is that citizens pay more for their homes. That is as unpopular as tax hikes. It is awkward that a Conservative Minister of finance must intervene personally to ensure that banks don't make bad loans and people don't borrow unwisely. That tells you a bit about what he thinks of the self regulatory powers of the Free Market that economists boast about.

Tightening rules on lending have already had a softening affect on the housing market. So it seems past actions taken by this government are working. I have no problem with Government being active in the Economy when need arises, the manner of action is important. I also accept in principle that a Well Regulated Free Market is essential to the prosperity of Canada and Canadians. So the idea of the Finance Minister cold calling Mortgage lenders and suggesting appropriate rates is too micro management and somewhat dictatorial  Are there only hammers in the Minister"s tool chest.

I applaud the concern, I question the method.

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