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On the Economic Implications of the Yield Ceiling on Government-Insured Mortgages*

Published online by Cambridge University Press:  07 November 2014

Lawrence B. Smith
Lawrence B. Smith*
Affiliation:
University of Toronto
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Extract

Policy makers have recently devoted a great deal of attention to the interest rate ceiling on bank loans, one of the two main impediments to the free flow of funds within the Canadian capital markets. The other major impediment, the interest rate ceiling on government-insured mortgages, has largely been ignored despite the pronounced impact it has upon the allocation of funds, and the recommendation of the Royal Commission on Banking and Finance that it be abolished. Recent instability in the residential construction sector has, however, once again focused attention upon this ceiling and raised the question of its desirability. The purpose of this paper is to correct a major misconception concerning the impact of this ceiling and to point out some of the other major implications of an interest rate maximum on governmentinsured mortgages.

Cet article scrute l'opinion voulant que le plafond au taux d'intérêt sur les hypothèques garanties par le gouvernement canadien soit le facteur déterminant du succès de cette opération de politique monétaire. On soutient que ce plafond est responsable de la grande élasticité du secteur de la construction résidentielle aux changements des conditions de crédit, et on invoque généralement comme argument à l'appui de cette assertion, l'amplitude des fluctuations dans le secteur assuré par le gouvernement par rapport au secteur de l'habitation financé de façon conventionnelle. Bien qu'il soit vrai que le plafond sur les taux d'intérêt entraîne des fluctuations plus considérables dans le secteur assuré par l'Etat que dans le secteur conventionnel, la présente étude démontre qu'il ne s'ensuit pas a priori que le marché hypothécaire dans son ensemble ou que le volume de la construction résidentielle serait substantiellement moins vohtile si les taux d'intérêt établis en vertu de la loi Nationale sur l'habitation étaient libéralisés.

La volatilité qui caractérise le secteur sujet à la loi nationale sur l'habitation est en grande partie attribuable à la position relative de ce secteur par rapport au secteur conventionnel. De plus, la volatilité du secteur assuré est responsable, dans une large mesure, de la stabilité du secteur conventionnel. Si le plafond sur les prêts assurés par le gouvernement disparaissait, les transferts d'un secteur à l'autre seraient éliminés, ce qui aurait pour effet de diminuer les fluctuations dans le secteur de la LNH et d'accentuer les fluctuations dans le secteur conventionnel. Une telle mesure aurait cependant assez peu d'effet sur la disponibilité des fonds hypothécaires puisque notre analyse de régression indique que le plafond explique seulement 20 pour cent des variations de l'activité hypothécaire globale. La disponibilité des fonds hypothécaires continuerait à fluctuer parallèlement aux variations des rendements des obligations car l'inertie caractérisant l'ajustement des taux d'intérêt hypothécaires aux changements des conditions sur le marché du capital entraîne des changements considérables dans les rendements relatifs, même lorsque les taux hypothécaires varient librement.

Type
Articles
Information
Canadian Journal of Economics and Political Science/Revue canadienne de economiques et science politique , Volume 33 , Issue 3 , August 1967 , pp. 420 - 431
Copyright
Copyright © Canadian Political Science Association 1967

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Footnotes

*

The author would like to express his gratitude to Yehuda Kotowitz, John Winder, Ed Neufeld, and Wahidul Haque for their helpful comments and suggestions.

References

1 Royal Commission on Banking and Finance, Report (Ottawa, 1964), 285.Google Scholar

2 Alberts, W., “Business Cycles, Residential Construction Cycles and the Mortgage Market,” Journal of Political Economy, 1962, 263.Google Scholar Smith, W. L., “Impacts of Monetary Policy on Residential Construction, 1948–58” in US Senate Study of Mortgage Credit, (Washington, 1958), 261.Google Scholar J. J. O'Leary, “Effects of Monetary Policies on the Residential Mortgage Market,” ibid., 234. Grebler, L., Housing Issues in Economic Stabilization Policy, NBER Occasional Paper 72 (New York, 1960), 8.Google Scholar Woodworth, G. W., “Impact of Monetary Policy on Residential Capital Formation,” in 1960 Conference on Savings and Residential Financing (US Savings and Loan League), 72.Google Scholar G. M. McKinley, “Impact of Monetary and Fiscal Policy on Residential Capital Formation” in 1959, ibid., 117.

3 Institutional liquidity-buffers cannot be restored out of the increased net inflows of funds which are generated by this increased lending (resulting from temporarily running down liquid positions) because of time lags and friction in the feedback process. Increased lending generates increased spending and savings flows, but in the short run only a small percentage of this flows back into the institutions directly involved in mortgage financing.

4 Guttentag, J., “The Short Cycle in Residential Construction,” American Economic Review, 1961, 290 Google Scholar, and “The Federal National Mortgage Association” in Commission on Money and Credit, Federal Credit Agencies (Englewood Cliffs, NJ, 1962), 85.Google Scholar Smith, , “Impacts of Monetary Policy on Residenial Construction 1948–58,” 261–3.Google Scholar US Joint Economic Committee, 86th Congress, 2nd Session. Staff Report on Employment Growth and Price Levels, (Washington, 1960), 363.Google Scholar

5 See discussions by Break, G., “Federal Loan Insurance for Housing,” in Federal Credit Agencies, 32 Google Scholar, and Federal Lending and Economic Stabilization (Washington, 1965), 63.Google Scholar Guttentag, , “The Federal National Mortgage Association,” 95–6.Google Scholar Colean, M., “A More Effective Mortgage Insurance System,” in US Senate Study of Mortgage Credit 301–2.Google Scholar Grebler, L., “The Role of Residential Capital Formation in Post-War Business Cycles” in 1959 Conference on Savings and Residential Financing, 73–6.Google Scholar Woodworth, , “Impact of Monetary Policy on Residential Capital Formation,” 71.Google Scholar

6 Grebler, L. and Maisel, S., “Determinants of Residential Construction: A Review of Present Knowledge” in Commission on Money and Credit, Impacts of Monetary Policy, 591.Google Scholar Colean, , “A More Effective Mortgage Insurance System,” 301–2.Google Scholar

7 This refers to life insurance companies, trust companies and mortgage loan companies, which accounted for almost 80 per cent of private mortgage loans for new construction during the period under study. The chartered banks, who accounted for approximately 15 per cent of private mortgage loans for new construction, are excluded from this analysis since they were permitted to participate only in the NHA sector.

8 For a similar model designed to describe variations in financial institutions mortgage lending activity see L. B. Smith, “A Model of Financial Intermediary Lending Behaviour in the Postwar Canadian Mortgage Market,” forthcoming in the Quarterly Journal of Economics.

9 In order to examine directly the influence of monetary policy upon mortgage lending activity we attempted to separate the mortgage-bond yield differential into its component parts, and include both the bond yield and the mortgage yield as independent variables in our model. Unfortunately, possibly owing to the lagged response of mortgage yield adjustments to changing market conditions, the mortgage yield variable proved insignificant.

For a discussion of specification biases inherent in the mortgage yield variable, see Smith, L. B., The Postwar Canadian Residential Mortgage Market and the Role of Government, unpublished doctoral dissertation, Harvard University, 1966, 99–114.Google Scholar

10 Although the absolute size of the Δmd coefficients differed in the non-bank financial institutions regressions, owing to a surprisingly small coefficient in the conventional equation, our conclusions remain valid because the sign and significance of this variable were not affected.

11 This correspondence is not exact since conventional mortgage yield changes tend to lag 3 to 6 months behind variations in bond yields and since the NHA interest ceiling is periodically adjusted.

12 The coefficients are approximately the same for trust and mortgage loan company NHA and conventional equations because the volume of their conventional lending far exceeded their NHA lending. The cross-elasticity of supply, however, remains larger for the NHA sector than for the conventional sector here also.

13 This assumes that the influence the ceiling exerts on total mortgage lending activity operates only via its impact upon the yield spread between mortgages and alternative security investments, i.e., that the influence the ceiling has upon the Δmd variable has no net effect upon the total availability of mortgage funds since its effects upon the NHA and conventional sectors offset one another.

14 Because the coefficients of the Ab variable estimate respectively the partial derivatives for conventional and NHA mortgage lending with respect to the bond rate and because the mean levels of institutional conventional and NHA mortgage lending in this period were approximately equal, a comparison of these coefficients is roughly equivalent to a comparison of the corresponding elasticities calculated at the means.

15 Klaman, S., The Postwar Residential Mortgage Market, National Bureau of Economic Research (Princeton NJ, 1961), 75.Google Scholar Poapst, J. V., The Residential Mortgage Market (Ottawa, 1962), 122.Google Scholar McKinley, , “Impact of Monetary and Fiscal Policy on Residential Capital Formation,” 116.Google Scholar

16 Alberts, , “Business Cycles, Residential Construction Cycles, and the Mortgage Market,” 272.Google Scholar Woodworth, , “Impact of Monetary Policy on Residential Capital Formation,” 72.Google Scholar

17 Johnson, H. G. and Winder, J., Lags in the Effects of Monetary Policy in Canada (Ottawa, 1962), 199–201.Google Scholar

18 It has often been contended that the interest ceiling was imposed to guarantee that government insured loans would provide a subsidy for the borrower. This, however, is unnecessary since the lower risks associated with NHA lending would ensure a lower rate than on conventional financing.

19 National House Builders Association, Submission to the Royal Commission on Banking and Finance (Ottawa, 1962), 41.Google Scholar McKinley, , “Impact of Monetary and Fiscal Policy on Residential Capital Formation,” 118.Google Scholar

20 Guttentag, , “The Federal National Mortgage Association,” 88.Google Scholar

21 Central Mortgage and Housing Corporation, Canadian Housing Statistics (Ottawa, 1965), 70, 74.Google Scholar

22 Ibid., 58.

23 Under the winter works program 35 per cent more homes were started with conventional financing in the over $20,000 price range than in the under $12,000 range. The over-all proportion of upper-income to lower-income conventional borrowing, however, is considerably greater than the percentage under this program, because the winter works bonus represents a much greater percentage saving on lower-price than on higher-price homes. Purchasers of higher-priced homes are, therefore, the principal beneficiaries of reduced instability in the availability of conventional financing.

24 Since this paper was written the government has introduced a greater degree of flexibility in the NHA interest ceiling through a policy of quarterly adjustments in the ceiling to maintain it at approximately 1½ per cent above a three-month average on long-term federal securities.