As if to follow up on yesterdays post, Canadian Business Magazine hit the newsstands today hilighting the Canadian Housing Bubble.
And it's an excellent read.
The magazine hits all the key points we've been talking about for the last year and a half.
They zero in on the central causes of the massive rise in home values the last 10 years: the Canadian Mortgage Housing Corporation (CMHC).
Canadian Business Magazine (CBM) cuts right to the chase and points out how the federal government stoked the housing market for an extended period and that "Canadians should brace themselves accordingly for a more jarring correction in residential real estate."
CBM attempts to outline how CMHC played its "critical, if underappreciated, role."
As we noted yesterday, CMHC over the last decade has dramatically lowered its minimum qualifying standards for insuring mortgages. CMHC sets the bar for home ownership through those minimum qualifying standards.
Lowering standards for acceptance, insuring mortgages with no downpayment and increasing amortization periods from 25 to 40 years for that insurance had a profound effect on housing prices.
- "If people were able to purchase houses with zero down, they were doing that," says Jerry Marriott, a managing director at bond-rating agency DBRS. "If people were able to purchase houses with longer amortizations and therefore have a lower monthly payment, they were doing that...That was partly what was supporting an increase in house prices."
CBM also notes the Bank of Canada's role:
- "The Bank of Canada did its part. Officially, it sets the overnight rate (the short-term interest rate at which financial institutions lend among themselves) primarily to keep inflation in check. That rate stood at 5.75% a decade ago but has trended lower ever since. Interest rates are a powerful influence on consumer behavior: lowering them encourages citizens to borrow and spend, while raising them rewards savers and punishes debtors. The housing market is particularly sensitive to interest rates: they're critical in determining a mortgage's monthly carrying costs."
And like the naive car buyer who is lured into buying a new car based, not on what they can afford, but upon whether or not they can make the monthly payments... so too have millions of Canadians been hooked into buying houses based on a mortgages monthly carrying cost.
And in the process they set off a decade long bidding war for real estate.
It was a purposeful strategy by the federal government.
Between September 2008 and April 2009 the nation was spiralling down into the recession that was gripping the world. In an attempt to cushion Canadians from the recession, CBM notes that:
- Ottawa electro-shocked the housing market. "There was this absolutely massive assault on the recession by focusing on the housing sector," says David Rosenberg, chief economist and strategist at Gluskin Sheff. "And probably that wasn't an unwise decision, when you consider all the powerful multiplier impacts it has on the rest of the economy." Housing-related spending — a broad category that includes not only home purchases but also furniture, appliances, renovations and a host of other items — accounts for one-fifth of all economic activity. Rosenberg says federal measures to stimulate housing markets accounts for 100% of Canada's economic recovery.
As we know, the government attacked the problem with two key tactics. First the Bank of Canada instituted rock-bottom interest rates (0.25%). RBC economist Robert Hogue called the resulting low mortgage rates "undoubtedly the rally's most powerful driver."
Next Ottawa authorized CMHC to buy up to $125 billion in mortgages from banks and other financial institutions under the Insured Mortgage Purchase Program (IMPP). We talked about this move here, and it lays waste to the myth that Canada never bailed out it's banks.
They did, big time.
- The idea was to ensure lenders had a ready source of funding when traditional methods had been closed, which in turn allowed Canadians to keep borrowing. "This was a very good thing," says Tsur Somerville, an associate professor at the University of British Columbia's Sauder School of Business. "Financial system meltdown is a whole lot worse than governments taking on some additional mortgage-default risk."
These actions allowed credit to flow and gave the housing boom it's fuel to ignite a massive R/E bonfire. In Vancouver home prices have more than doubled since 2000.
More importantly, family incomes have not doubled.
- The value of outstanding mortgages surged from $427 billion to nearly $930 billion during the same period, which helped catapult the average debt-to-income ratios of Canadians to 145%, just shy of current levels in the U.S. and Britain. The Bank of Canada is mildly concerned. "Household balance sheets are still a significant source of risk," it reasoned in its latest review of Canada's financial system, "since the rapid expansion of consumer and mortgage credit implies that a greater proportion of households are likely to become vulnerable to adverse income and wealth shocks as interest rates rise from their exceptionally low levels."
CBM notes that the unwinding of the powerful housing-market stimulus is already underway.
- Ottawa terminated the IMPP on schedule in March. It has tightened CMHC's lending standards, albeit modestly. And the Bank of Canada began ratcheting up interest rates this year. Renewed government intervention cannot be ruled out, but it would be expensive and only delay the reckoning.
The magazine attempts to temper how bad the reckoning will be. They say that when Canada's correction arrives, it'll likely prove less traumatic than America's.
Canada's lenders generally have legal recourse to borrowers, meaning they can pursue a borrower's other assets in court in the event of foreclosure. That makes it more difficult to simply abandon a home that has become a financial albatross.
Many argue that this will keep Canadians from defaulting on their mortgages.
We will see.
I suspect that as values start to drop, the number of people who bought the maximum amount of house they could at emergency level rates will find that they are seriously underwater when mortgages come up for renewal.
Even if interest rates never rise, this will be problematic.
But bump interest rates up just a few percent, and I forsee enough Canadians being forced into foreclosure that it will cause a devastating domino effect - especially here in Vancouver.
I seem to be in the minority on this issue, even amongst R/E bears.
And I seriously fear what this could do to our country. As we noted yesterday, CMBC is on the hook for $770 Billion dollars in mortgages and only has $9 Billion in assets - a condition which CBC noted was "more leverage than any U.S. bank or lending institution ever had."
If CMBC has to pay out even only 10% of that $770 Billion, it would require a taxpayer bailout of $60 Billion.
It took our nation over 10 years, and the introduction of the GST to get rid of a then-record $40 Billion deficit a decade ago.
If the dominos fall as I worry they will... Canada will be in serious trouble.
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