Saturday, July 18, 2009

Two profiles: US Banks, CMHC

Two snapshots of institutions on either side of the 49th parallel for you today.

First we start with with our favorite whipping post, the US Banks.

As our Prime Minister commented on last year, the recovery will not begin until the US Banking system stabilizes.

So what's the outlook?

Yesterday there were four more bank failures on Bank Failure Friday bringing the total to 57 for the year. Unfortunately that may only be a drop in the bucket compared to the tsumani of failures on the horizon.

A report in (see article here), notes that the banking industry is bracing for continued losses from consumer loans due to the rising unemployment rate and an expected wave of commercial real-estate losses.

At a Senate Banking Committee hearing in Washington on Thursday, Sen. Jim Bunning (R-Ky.), repeated a comment relayed to him by Federal Deposit Insurance Corp. Chairman Sheila Bair that another 500 banks could fail "unless something dramatic happens."

So much for stabilizing.

Meanwhile there is the Canada Mortgage and Housing Corporation (CMHC).

As I have already stated the Canadian goverment, in a desperate attempt to prevent a repeat of the US real estate collapse, has thrown massive fiscal stimulus and ultralow interest rates at the Canadian economy in a desperate attempt to supercharge real estate and forestall the collapse of values.

Not only could such a development put the Canadian economy is jeopardy, but the Canadian goverment could be facing a supreme risk as well.

Consider... Canada’s housing insurance agency, run by Ottawa and accountable to the Minister of Finance, provides endless amounts of cheap insurance for high-ratio loans (with minimal down payments). In doing so, CMHC allows Canadian banks to pass off the risk of these home loans to the federal government.

Presumably this allows them to be more willing lenders.

Currently CMHC guarantees about $630 billion in mortgages, an amount of equal in size to half the Canadian economy.

Half! That's an astonishing amount of money.

And what assets stand behind this? Down payments worth about $8 billion (plus the book value of the real estate).

So what happens if the real estate bubble bursts and asset values crash? For starters it will mean that up to 98% of its liabilities will not be covered. Moreover Canada will be facing a situation worse than that which faced US mortgage giants Freddie Mae and Fannie Mac, which lost 90% of their market value.

Some of you have asked why the government is moving heaven and earth to keep the real estate market afloat. That's why.

But as economic recovery takes longer and longer to come into play, we have a situation where the current average home price can only be supported at artificially-low interest rates. And our Canadian banks only make those loans because they are backstopped by a federal government now running its worst-ever deficit.

Over $600 billion in mortgage risk belongs to the taxpayers – and Ottawa is already tapped out. So what is going to happen when interest rates rise?

What we have is Canada's own little subprime crisis in the making. The Bank of Canada has ushered in interest rates that are comparible to the US subprime-style teaser loans.

I say this because the Bank of Canada knows that these rates will be doubled or tripled in the years ahead. Yet, by dropping their key lending rate to the lowest point ever, they have created a situation that allows 3% mortgages to further inflate house values.

And just like the US subprime teaser-rates, when the mortgages reset at the higer rates... a wave of defaults and foreclosures will result.

When that first wave hits, the banking system will seize up, credit will stop dead in it's tracks, and the goverment will be pushed to the brink of insolvency.

A series of dominos are building. And when they start to tumble, the result is going to be devestating.

The housing crisis has not been avoided in Canada. It's only been delayed as officials pray for a swift economic recovery that is not coming.

One only has to look at the US Banking system's failure to stabilze for that evidence.


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  1. Thanks for the series of great posts. I wish this kind of writing was in our local newspapers.

  2. Decided to google 'CMHC bomb' as I saw today that house prices increased 19% since last year.

    And yet I know people in Toronto - old enough to remember double-digit rates, old enough to remember how stubborn recession can be, old enough to remember the last housing crash - who think now is a good time to get 'in'! Gahh!!!