Will “tougher mortgage rules” hurt the economy? Don’t listen to the shills for the mortgage industry.

The folks in Canada who sell mortgages are complaining about the federal government reducing the subsidy to its business.

From the Financial Post:

The Canadian Association of Accredited Mortgage Professionals says since new rules went into effect in July, 2012, resale housing activity is 8% lower between August and October than a year earlier. Among the changes instituted by the government was a lowering of allowable amortization from 30 years to 25 years for consumers borrowing with mortgage default insurance which is backed by the federal government.

Let us think about this for a moment. By providing insurance against default, the Federal government provides a huge benefit to the mortgage industry. It insulates them against potential losses. This causes them to extend loans to to submarginal borrowers who would not be otherwise creditworthy. I can tell you I would make much riskier investments if someone would pay me back for any money I lose.

Jim Murphy, chief executive from CMAAP, is not happy:

“My concern is that a policy-induced housing market downturn creates unnecessary risk that directly affects not just housing but job creation and the economy as a whole.”

This guy really is clueless. First of all, what is this about “a policy-induced housing market“? The “policy-induced” aspect of the housing market is, clearly, the availability of government backed loans for houses and the inflationary policies of central banks, not the reduction in the subsidy to his friends.

More importantly, it is simply false that reducing this subsidy will hurt the economy.

A great deal of resources are shifted into the housing industry that would otherwise be used in a different way because of federally backed mortgage loans. If you are a mortgage lender, a 30-year amortization increases the amount of interest you will take in. On an $375,000 house, you are talking about an extra $65,000 in interest. If more loans are made, housing prices will be bid up. Money flows into the financial industry and the construction industry. More people will be employed at banks, mortgage brokerages, and home-builders, and related businesses.

As resources shift into some sectors, they are necessarily shifted away from others. Everyone now has to pay more for houses than they would without so many buyers, who are effectively subsidized to a greater or lesser extent. But beyond the price of the home itself, for the guy buying a house, he is paying an extra $65,000 in interest to the bank. Assuming that is about equal to his annual salary, he basically has to devote an extra year of his life to pay the bank. He likes this, because “Pay less now, more later” is the mantra of our age, but he would pay less overall with the shorter amortization. $65,000 is not chump change — it would buy his wife a new car and send his kid through university. More money and jobs goes into housing, but less money and jobs are produced elsewhere as a result.

So we can understand the impact of this sort of intervention in the mortgage market. Resources are allocated not according to how the market would most efficiently allocate them, but rather are diverted to profit from the government’s protection of the financial industry. Therefore, the elimination of this subsidy would represent a favorable change to the overall economy. This means that some people would be unable to get low mortgage rates that are backed by the taxpayers. Housing prices would fall. It means homebuilders would have fewer homes to build. Lenders would make less money.

To some people, these consequences are bad. To the economist, these consequences must be considered good, because they represent the economy re-allocating resources according to efficiency, rather than government intervention. Resources will have a greater tendency to shift to uses consumers actually need.

Unfortunately, the insurance still exists. It has not been eliminated. The government will merely provide less of a subsidy than they did before. Therefore, the market will be distorted relatively less than it was previously. The economy will be slightly better, because fewer resources will be shifted to inefficient uses (i.e. housing and Jim Murphy’s summer home).

The best thing that could happen would be for the Canadian government to eliminate taxpayer backed mortgage insurance completely, which would do a great deal to restore a free market in housing.