CHRYSTIA FREELAND’S CRUCIBLE: HOW THE UPCOMING CANADIAN FEDERAL BUDGET MIGHT AFFECT THE REAL ESTATE MARKET, AND WHY HER RESPONSE IS ALREADY WRONG

“The will of man is not shattered but softened, bent and guided; men are seldom forced by it to act, but they are constantly restrained from acting. Such a power does not destroy, but it prevents existence; it does not tyrannize, but it compresses, enervates, extinguishes, and stupefies a people, till a nation is reduced to be nothing better than a flock of timid and industrial animals, of which government is the shepherd.”

- Alexis De Tocqueville, Democracy in America, 1835

 On Monday April 19, Canada’s Finance Minister Chrystia Freeland will table the first federal budget in 2 years. On the minds of Canadians are the economic impact of COVID-19, the green economy, wealth inequality and especially what the government plans are with the real estate market. Any decision to forcibly intervene in the market in the name of wealth inequality by Ms. Freeland will be entirely misguided with substantial unintended consequences. The political will to ebb the real estate market price increases as a quantitative measure of wealth inequality and help lower income families to afford to purchase a home echoes of the rancid US policies that spurned Fannie Mae and Freddie Mac to discard rational underwriting practices that helped contribute to the housing bubble which transitioned into the financial/mortgage-backed securities crisis of 2008.

What is the problem with government intervening in the real estate market?

 The fundamental issues with government invention is that all action carries unintended consequences, and all action does not even guarantee to produce the desired results. Pulling one lever switches or rebalances another automatically and inexorably. Attempting to coordinate the actions of each citizen is not as simple as changing laws and taxes in hopes of changing behaviours, which is a fallacy that a person or committee exists that has the knowledge required to do so perfectly. In a planned economy, bureaucrats and elected officials attempt to coordinate a response with directing limited resources over unlimited choices. These decisions are never guaranteed and can only be best guesses on how the consumer will act or react. In a market economy, the private sector understands the consumers are the kings and queens, and businesses must learn to serve and adapt to their changing needs in order to survive. No one – not the private market or elected officials - have a crystal ball that can guess exactly where the economy can and will go.

The main difference between the private and public (government) action is in who pays the price for being wrong. Many argue that the free market might produce the same results as action by the State would, but in a free market error, the consequences are insulated from the pockets of the taxpayer – or at least should be. Profit is a feedback measurement whether the entrepreneur and investor has made a good decision, and losses are a feedback measure for bad decisions. Without the feedback of profit and loss, government intervention is left with being measured on its intentions of policy instead of actual real change. 

Government action is always at odds with the actions of individuals and the private sector in general, and this tensive conflict between the desires and goals of the private sector and desires and goals of the State plays out repeatedly until the State (having unlimited ability to tax and create debt) wins out in this “competition of resources” as Murray Rothbard wrote in “Anatomy of the State.” Coordinating an economy is, according to Nobel Prize winner FA Hayek, is a logical impossibility; but to assume the ability coordinate the values and priorities of all people in a nation is a downright absurdity.

Starting with this understanding of the consequences of government action compared to action made by the private sector, let us examine what the Finance Minister might try to suggest and how that might affect the Real Estate industry.

Bank economists are suggesting that the government step in and take top-down action with national policy to stem the run in the Real Estate industry. These economists believe that if the market is left to its own devices, will crash instead of ease off gently, putting their self-interest at risk and exposing weakness in their lending policies and pool of mortgages. Having government solve their private issues is equal to cronyism and having the taxpayer bear the weight of bad business decisions in the private sector.

Bank economists and others have suggested that the course of action necessary to cool off the real estate market boils down to a few primary options:

1. Increasing the Capital Gains inclusion rate for property. Capital Gains is a tax that is levied on 50% of the appreciated value of capital property in Canada while the remaining 50% is received tax-free to the owner. There have been many calls to increase the inclusion rate up to 100% on specified property which would mean the entire realized gain would be fully taxable.
2. Limiting the Principal Residence Exemption or expanding the Speculation Tax. Canadians who own property can normally take advantage of this exemption when claiming the capital gain on what would qualify as their principal residence, within certain limitations. CRA has been highly interested in collecting data on these sales and have updated disclosure requirements with the advent of the T2091 form. This new process has been viewed by many as being a possible source of change to narrow the definition in order to qualify for such an exemption. This could include increasing the duration of ownership to qualify for a full exemption, or create a sliding scale for shorter ownership periods, or even remove the exemption for owners taking residence for less than 5 years. Any updates to the Speculation Tax might also be rolled in and updated nationally.
3. Change the stress test on mortgages. There have been many changes to the stress test in the last several years, so we know this always on the table and even recently has been called to change.

None of these rules are guaranteed to change or help ease the pricing of the Real Estate market, especially to the extent that the politicians promise to meet their altruistic and subjective goals.

1. Both possible responses of increasing the capital gains inclusion rates or reducing the scope of the Principal Residence exemption will simply reduce the supply of housing available on the market and increase the pressure on prices. Although the Liberal party’s recent national convention unanimously approved a resolution to implement a national universal basic income, it did reject a resolution to increase the capital gains inclusion rate by 40%. This does not mean capital gains are off the table by any measure, especially when the rules could be manipulated to affect duration of ownership of any kind of capital property.
2. Changing the stress test rules on mortgage applications is on the table that could have a direct initial impact, but even that only affects newer homebuyers to the extent they have not already ridden a wave of rising property values. Furthermore, the Office of the Superintendent of Financial Institutions (OFSI) is already re-looking at the stress test on mortgage which is already at 2% above the Bank of Canada’s current 5 year posted rate.
3. Where will the line of speculation tax or foreign buyers tax end? Foreign buyers have been virtually absent since the beginning of the pandemic, accounting for less than 15 total sales on a monthly basis after March 2020.
4. If they decide to ban “bully” (full cash; no subjects) offers – that will only force more people to take unnecessary mortgages.

We already know that the Bank of Canada has expressed their intention to maintain loose monetary policy in place for an extended period of time after the economy has recovered from the pandemic in order to encourage more first-time home buyers. The combination of low interest rates and high money printing has allowed many millennials to consider purchasing a home a reality, but both interest rate and money supply policies have contributed to the surge in asset prices. According to a poll released last week by the Bank of Nova Scotia, 40% of millennials aged 18-34 have accelerated their plans to buy a home because of low interest rates. In terms of the affect of stimulus on asset prices, Karl-Friedrich Israel PhD, Senior Researcher at Leipzig University, released a study in May 2020 that empirically correlated any increase in the supply of money and the rise in prices of financial securities and real estate. To be sure, even consumer and commodity prices are also on the rise, such as construction materials and food.

To this point, on April 7th, Peter Schiff tweeted:

 “The government and most economists tell the public that #inflation results in too much prosperity. But more people working to produce more goods causes prices to fall, not rise. The general price level rises because of too much money printing not too much employment growth.”

Schiff’s point of course is that the fiscal stimulus taken by government and monetary stimulus taken by Central Banks have real consequences that are both unintended and unavoidable. Economic miscalculations, errors and secondary consequences cannot be avoided even by the greatest economists and financiers, including Finance Ministers. A significant threat to the economy however is the lack of education and experience by the incumbent Finance Minister who is running on ideological narcissism instead of empiricism.

The real solutions are not in a national top-down strategy coming from central planners; on the contrary, the free market is the most efficient entity at solving these problems on their own.

Rising or falling prices are not problems - but rather signals - to investors and entrepreneurs that reveals increasing or decreasing consumer demand in certain industries and sectors. If housing prices are skyrocketing, that respective of bad policy decisions affecting those prices, demand is clearly high. FA Hayek explained this point in his best-known work, “The Road to Serfdom”:

“Prices in the free market are responsible for coordinating the actions of investors and entrepreneurs. As prices prove a market for something exists, and if monopolies are not instituted, then competition thrives, driving down prices and increasing quality.”

Increased attention to the Real Estate market attracts entrepreneurs and investors to respond to the market. Without the governance model of restricting the market’s response, more competition (builders/developers) would meet the demand of the consumer, therefore naturally allowing for prices to fall. The other barrier to bringing on more supply is municipalities with that shadow NIMBYism behind delays in development approvals, exorbitant fees, and protracted hearing processes that even oppose OCP-conforming properties.

Solving Real Estate prices will take some fortitude on the part of politicians and the public. The Vancouver Real Estate market is already softening ahead of the government’s announcements on Monday, so it is possible that announcements with the Budget could amplify and exacerbate the shift in trajectory. Government can only react to historical and lagging economic indicators to implement knee-jerk reactions and is not a good judge of managing leading indicators. As Thomas Sowell once said about politics, “it is easy to be generous when you’re not paying the price” and I would add that “it’s easy to look busy and think you’re acting with moral pre-eminence.”

People demand change, but the most ineffective apparatus to enact change is the lumbering leviathan of the state. We have been conditioned to think that if change were left to the private sector, that somehow the ensuing disaster would create calamities beyond repair. This is a false flag that perpetuates the hegemony of State action. Neither the public or private sector are perfect in their response to changing market demands or price feedback. But the benefits of the private market do not lie in its perfection but rather in the mechanism of its correction. Government action results in massive public debts and drives out high quality private investment. Private sector action results in private sector losses or rewards. True capitalism isolates both the rewards and the losses, but as of late, private losses have been a driver for government intervention and bailouts. This is not capitalism – this is borrowed favours in cronyism. If we leave profits and losses alone for entrepreneurs and investors to win and to lose, the learning and improvements they make on their next decision benefit society as a whole. Who could imagine correctly calculating the loss or failure of government action when the blame is usually cast to insufficient funding or inheriting a weakness from a previous administration, or the malfeasance of the private sector?

If we know that the free market is better equipped to handle the fluctuations of the market, is more nimble and can protect the taxpayer from unrelenting deficit spending, what should the market be empowered to do?

The response to soaring prices in the Real Estate market could be the pushed down to local municipalities to resolve. This could include:

1. Ensuring adequate supply by either ensuring OCP-compatible developments or increased density proposals are approved without delay,
2. reducing protracted regulation,
3. reducing the process and costs of permitting.

 Any municipality unwilling to deregulate and simplify their processes would face competition from other municipalities willing to compete for an increased property tax base and would offer more services or even lower property prices based on higher supply. Competition works in every other sector to increase the quality and supply and reduce the prices of goods and services, and it would benefit the real estate industry as well. As Dustin Romney, author and attorney concluded, "every decrease of regulation has been followed by an unprecedented influx of private investment that has dwarfed government economic benefits." To add, the Finance Minister on Monday should focus on limiting government intervention especially when it relates to loose monetary and fiscal policy. The Finance Minster holds 100% of the shares of the Bank of Canada in trust for Canadians and should ensure Canadian Central Bank policy not creating an environment that limits supply creates unnecessary stimulus.

I think it is time we consider and examine what real solutions look like to the Real Estate industry’s problem on price, and deregulation should certainly be on the table.