Dale Roberts – SeekingAl​pha​.com

There’s a lot of chat­ter today on the Cana­dian real estate mar­ket — that Canada will soon go the way of the U.S. real estate mar­ket circa the 2000′s. Those who write such pop­py­cock (been dying to use one of Con­rad Black’s favourite words) have not taken the time to read a study or two of the under­ly­ing con­di­tions in the Cana­dian mar­ket, com­pared to the U.S. in the lead up to the mort­gage crisis.

First off, let’s be clear. The Cana­dian mar­ket is start­ing to cor­rect. Hous­ing starts are falling, though aver­age hous­ing resale prices are still hold­ing up rel­a­tively well in most areas. Most econ­o­mists, even those who still view the Cana­dian real estate mar­ket in a pos­i­tive light, acknowl­edge that Cana­dian real estate prices are likely to decline over the next year or two. There is the con­sid­er­able pos­si­bil­ity of a hous­ing “soft landing”.

Com­ment: The most likely sce­nario is an over­all flat­ten­ing of the recent ris­ing trends we have seen. Sales vol­ume will set­tle some­where near the 10-year aver­age while prices stay close to flat, with infla­tion­ary increases. Regional vari­ances, of course, will see Van­cou­ver trend down while Toronto stays hot, for exam­ple. Not even sure what a soft land­ing is any­more, but I guess it is a sim­ple slow­down, a flat­ten­ing. It is obvi­ously not a crash.

But here’s why Canada is very unlikely to expe­ri­ence a U.S. style implosion.

First off, and most impor­tantly, Canada does not have a Fan­nie or Fred­die Mac or Gin­nie Mae. And on that, why do these state owned cor­po­ra­tions have such friendly names? I’d pre­fer Gov­ern­ment Owned Agency of Mort­gage and Eco­nomic Destruc­tion, or some­thing that pro­vides that kind of clar­ity and hon­esty. Fannie’s and Freddie’s pur­pose is to expand the sec­ondary mort­gage mar­ket by secu­ri­tiz­ing mort­gages in the form of mortgage-backed secu­ri­ties (MBS). Hmmm? Did a gov­ern­ment agency cre­ate the infa­mous MBS? The ulti­mate weapon of eco­nomic destruc­tion? That looks to be the case.

It has never been Canada’s hous­ing pol­icy to encour­age or sub­si­dize lend­ing to the lower income Cana­di­ans. Pri­vate banks (notably Canada’s six largest banks) make loan deci­sions based on the merit of the home buy­ers. All income must be ver­i­fied and the buyer must be in a posi­tion to afford a five year fixed mort­gage rate. Period.

Which brings us to the root cause of the U.S. mort­gage implo­sion — pol­icy. It was – and is – U.S. gov­ern­ment pol­icy to “make” hous­ing avail­able for lower income cit­i­zens. It was all dur­ing the Great Depres­sion when the Fannie’s and Freddie’s were cre­ated. You can blame both par­ties. As a Cana­dian, and hence, one who is on the out­side look­ing in, there should be no argu­ment about which party caused the hous­ing melt­down. It was both par­ties. It has always been both parties.

It is not Repub­li­can pol­icy, or Demo­c­rat pol­icy, it has been U.S. pol­icy to social engi­neer and social­ize the risk by putting lower income Amer­i­cans in homes.

I’m not for a sec­ond sug­gest­ing that there was not a long list of unscrupu­lous pri­vate sec­tor mort­gage providers who went on a good ol’ fash­ioned and unscrupu­lous prof­i­teer­ing ram­page, but gov­ern­ment set the con­di­tions and laid the ground­work. And as we read above, they even invented the MBS product.

I’m a big fan of the U.S., I some­times joke that I’m an Amer­i­can born into a north­ern nation known as Canada. But in the area of mort­gages, the U.S. is more social­ist than Canada, or Europe. It’s unfor­tu­nate that the land of the free, in the pur­suit of the Amer­i­can dream and home own­er­ship, attempted to accom­plish the goal by means of gov­ern­ment, instead of the free mar­ket. Canada is cer­tainly more of a “social­ist” coun­try when it comes to health­care, and … well I guess it’s health­care and that’s about it. And for­tu­nately we leave the lend­ing to the pri­vate sec­tor and our sound bank­ing indus­try to decide who gets to pur­chase a home. We do (unfor­tu­nately) have a gov­ern­ment mort­gage insur­ance scheme, but that is being unwound by our cur­rent fed­eral gov­ern­ment. Hope­fully, one day the gov­ern­ment (aka the tax­payer in Canada) will be com­pletely out of the mort­gage business.

Com­ment: The tax­payer never was – and cer­tainly is not – on the hook for mort­gage insur­ance. Every­one who buys a home pays a pre­mium to CMHC or Gen­worth, that is where they get their fund­ing. Tax­pay­ers give them nary a red cent. And the whole “they are on the hook for $500 bil­lion in mort­gages” is bunk as well. They insure those mort­gages, all of which have been paid down since they insured them. And the homes the mort­gages are on have all gone up. Truly they have about $400 bil­lion in lia­bil­i­ties against prop­er­ties worth about dou­ble or triple that. Even if every mort­gage they insure went into default tomor­row, they could sell all the prop­er­ties at a dis­count and make a PROFIT! It is not like they are insur­ing worth­less assets…

And on that, the gov­ern­ment mort­gage insur­ance agency mod­els of the U.S. and Canada are essen­tially polar oppo­sites. Canada, by law, has to ensure all mort­gages with a LTV (loan to value) above 80%. In essence, when the buyer does not put down more than 20% of the home value, he or she must pur­chase mort­gage insur­ance. In the U.S., it is essen­tially the oppo­site. The Fan­nies and Fred­dies of the world insure the LTV’s greater than 80%. The riskier mort­gages are not insured.

That’s like insist­ing that the best dri­vers on the road who haven’t had an acci­dent in the past 30 years should all be insured, but the 17 year-olds who bang into a few cars every year or two should not be insured.

Here are a few other “facts”. Cana­di­ans on aver­age, own over half of value of their homes. Cana­dian banks are ranked the most solid on the planet. See my arti­cle on the “One Stock Port­fo­lio” that details the his­tory of the Royal Bank of Canada and the Cana­dian big banks as an invest­ment option. Cana­dian bank­ing oper­ates under a unique oli­gop­oly sit­u­a­tion where the “Big Six” rule – and profit. Those six banks are Royal Bank of Canada, Toronto Domin­ion Bank , Sco­tia­Bank, Bank of Mon­treal, Cana­dian Impe­r­ial Bank of Com­merce and The National Bank of Canada.

And accord­ing to a friend of mine who holds a very senior posi­tion in a major Cana­dian bank, here’s the num­ber one rea­son why Canada can­not have the same expe­ri­ence as the U.S. hous­ing mar­ket meltdown.

Our mar­ket can­not and will not freeze up, as it did in the U.S.

In the U.S., almost half of the mort­gage mar­ket sim­ply went away. That sent shock waves through­out the entire U.S. mort­gage mar­ket. One of the key and dam­ag­ing char­ac­ter­is­tics of the U.S. real estate melt­down was the inabil­ity to get a non-conforming (higher risk/subprime) mort­gage. Some 30–40% of the U.S. mort­gage mar­ket com­pletely closed. It dis­ap­peared. Many peo­ple had non-conforming mort­gages in the U.S., either due to high loan to value, due to large mort­gage size, or poor under­writ­ing cri­te­ria. In Canada, even if there was a sig­nif­i­cant pull back in house prices, CMHC (Cana­dian Mort­gage and Hous­ing Cor­po­ra­tion) will still be avail­able to insure high LTV loans. And Cana­dian banks can pay CMHC to have them insured at their discretion.

So it is dif­fi­cult to imag­ine any rea­son for banks to stop lend­ing any form of mort­gage that exists today. While it’s cold up in Canada these days, the mort­gage mar­ket is not about to freeze up.

Com­ment: Heck no! Not when our banks are mak­ing bil­lions in prof­its, bil­lions. And mort­gages make up 20–40% of that profit. They have a rather vested inter­est in mak­ing sure they keep­ing hand­ing out mort­gages, strict rules or not.

We sim­ply don’t do a lot of sub­prime. For that rea­son alone, the risk of a major Cana­dian “hous­ing bust” is greatly mit­i­gated, at least com­pared to the U.S. expe­ri­ence. Also, you can­not sim­ply walk away from your mort­gage and debt respon­si­bil­i­ties in Canada. They have laws against that sort of prac­tice. LOL!

Com­ment: The US had 30–40% of their mort­gages as sub­prime, Canada has some­thing like 4%. Andour default rate just fell again, to 0.31%. That is only 3 out of every 1,000 mort­gages default­ing – and they are all insured.

If a mort­gage does run into arrears, Cana­dian banks do not have a stay period of 90 days (or any extended lock­out peri­ods) to fore­close on that mort­gage. They can swoop in and imme­di­ately take care of their invest­ment. Once again, the pri­vate sec­tor does its thing. If you can’t pay your mort­gage, banks will take back the prop­erty and then go after your future earnings.

In Canada, there also is no incen­tive to over lever­age to take advan­tage of the mort­gage tax deduc­tion. A mort­gage does not qual­ify for a tax deduc­tion in Canada. Cana­di­ans take on a mort­gage and in most cases try to get rid of it as quickly as pos­si­ble. There is very lim­ited use of teaser rates in Canada.

Cana­dian banks are not forced to lend to lower income appli­cants, such as the coer­cion that exists in the U.S. CRA, the Com­mu­nity Rein­vest­ment Act that man­dates banks (okay, okay — “encour­ages”) to lend a cer­tain per­cent­age of their book to low income communities.

And a few points from a paper by Avery Shen­feld of Cana­dian Impe­r­ial Bank of Com­merce. The spec­u­la­tive activ­ity in Canada is well below that of the U.S. (when they were head­ing into the melt­down). Hous­ing starts in Canada have recently been about 10% above house­hold for­ma­tions. In the U.S. it was 80% of house­hold for­ma­tions. That’s dras­tic to say the least. Non-conforming mort­gages in Canada for 2012 are just above 5%. In the U.S. they were well above 25%. The num­ber of neg­a­tive equity posi­tion mort­gages in the U.S. in 2005 and 2006 was one third, even before the price drop(s). In Canada, the neg­a­tive equity posi­tion is zero, accord­ing to CIBC.

It should be very clear, that Canada is not the U.S. when it comes to the mort­gage indus­try, and sit­u­a­tion. It’s just not apples to apples. It’s more like apples to maple trees.

Given the strengths and pre­cau­tions out­lined above, it’s pos­si­ble (but not guar­an­teed) that Canada can engi­neer a soft land­ing. That’s dif­fi­cult for sure, but the cur­rent gov­ern­ment has been tight­en­ing lend­ing reg­u­la­tions, and our Cen­tral Bank has been try­ing to talk down Cana­di­ans, warn­ing them of the risks of high debt lev­els. Some steam is com­ing out of the mar­ket. Falling and sta­bi­liz­ing home prices, is a healthy event.

Com­ment: Why do we have to have a soft land­ing, or land­ing of any sort? Prices for most things always rise over time, be they houses or cars or choco­late bars. Movies used to be a nickel for Grampa, remember?

And as I wrote in the “One Stock Port­fo­lio” arti­cle, I still think that Canada’s big banks are a great place for Amer­i­cans to invest (long term) and Canada sits in a very unique place, full of oppor­tu­nity with expo­sure to the U.S. and emerg­ing mar­ket growth. Cana­dian banks are worth a look. Just recently, they’ve reported some incred­i­ble num­bers. Royal Bank led off the Cana­dian Banks’ earn­ings sea­son with fourth-quarter prof­its that rose 22% to $1.9 bil­lion. RBC also reported record prof­its for the year.

A U.S. style mort­gage mar­ket melt­down in Canada? Don’t bank on it, eh.

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Con­tact the Jef­frey Team for more infor­ma­tion – 416−388−1960

Lau­rin & Natalie Jef­frey are Toronto Real­tors with Cen­tury 21 Regal Realty.
They did not write these arti­cles, they just repro­duce them here for peo­ple
who are inter­ested in Toronto real estate. They do not work for any builders.
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