Thursday, October 11, 2012

It's Different Here - you believe that, right?

A few wandering thoughts this morning for you.

One of the comments you will hear on a lot of 'bear blogs' is the statement that "we will not have a US-style housing crash. Our crash will be uniquely Canadian."

It is a sentiment this blog agrees with and it came to mind while reading the Globe and Mail this morning.

If you followed the US Housing Bubble and collapse, you know that one of the elements that lead to the creation of the bubble was securitization.

Because mortgages were packaged and sold off, the risk of lending the money was removed from the individual organizations that originated the mortgages.

Basically the fee's and incentives paid out for initiating these loans are criticized as the basic reason many loans were issued for amounts greater than should have been made, and to people who shouldn't have received them.

Homes weren't properly appraised, values were inflated to justify loans, and loans were made on faulty data.

This blog wrote several posts detailing this process and if I can track down the exact posts I will link to them.

Of course things like that don't happen in Canada.  Our 'sound' banking system didn't make many of the mistakes that contributed to the US housing collapse... or so the myth goes.

Enter the article from the Globe and Mail:
Flaws in a national databank that helps determine the value of houses across Canada have helped fuel inflation in home prices, putting mortgage lenders and borrowers at greater risk, key players in the housing sector have warned. 
Documents obtained by The Globe and Mail detailing confidential statements from banks, appraisers and mortgage insurers show rising worry over the use of a database operated by the Canada Mortgage and Housing Corporation (CMHC). 
Introduced in 1996 as a way for the CMHC, banks and other lenders to quickly and inexpensively determine how much money can be lent against a residential property, the database known as Emili is relied upon too heavily by lenders. 
Emili is an automated system that uses figures such as recent sales of nearby homes to gauge values, without sending an actual appraiser to the address. 
However, the potential margin of error in calculations may pose significant problems. 
For home buyers, or homeowners with home-equity lines of credit, an inaccurate valuation by the database could allow them to overpay or borrow much too heavily for the home, industry members argue. 
For banks, it could mean the collateral they have against the mortgage is not worth as much as believed. 
“Although it provides very rapid responses, this automated approval system has significant shortcomings,” says one industry respondent in the documents, which were obtained by The Globe and Mail through access to information requests. Because the database does not evaluate a specific property, but uses generalities to determine the risk level of a mortgage, “CMHC insured loans are often granted without truly taking into account the property’s market value,” the respondent says. “This poses a real danger of altering housing market data.”
Canadian home loans being made without truly taking into account the property's actual market value?

Really? Didn't we just say that the American's did something similar (but different) in their housing bubble?


It's interesting when you take a look at the wikipedia page on the Causes of the United States Housing Bubble, other similarities pop up with our Canadian situation.

On the subject of down payments.
Some borrowers got around downpayment requirements by using seller-funded downpayment assistance programs (DPA), in which a seller gives money to a charitable organizations that then give the money to them. From 2000 through 2006, more than 650,000 buyers got their down payments through nonprofits.
In Canada, didn't many people get around down payment requirements here by using bank-funded down payment assistance programs (cash-back)? The new OFSI regulations have shut that door, but this program has played a huge role in creating our bubble too.


And didn't the US have something called 'liar loans'?
A stated income loan is a mortgage where the lender does not verify the borrower's income by looking at their pay stubs. These loans are nominally intended for self-employed borrowers, or other borrowers who might have difficulty documenting their income. Stated income loans have been extended to customers with a wide range of credit histories, including subprime borrowers. The lack of verification makes these loans particularly simple targets for fraud.To address the problems arising from "liar loans", the Internal Revenue Service updated an income verification tool used by lenders to make confirmation of borrower's claimed income.
Don't we have something similar In Canada?  Stated income loans have been prevalent here until just recently when the OFSI shut the door on this lending tactic too.


So in the United States you had banks getting away from doing proper assessments of individual properties before lending excess funds (which lead to people overpaying for properties), you had people circumventing down payment requirements (which lead to people buying properties at values which were actually out of their reach), and you had liar loans (which lead to people getting mortgages which they shouldn't have qualified for).

Meanwhile in Canada you have a national data bank that facilitates banks granting mortgages that are greater than they should be (which has lead to people overpaying for properties), you have people who have been circumventing down payment requirements (which has just now been halted), and you have  self-employed borrowers securing loans with unverified levels of income (which has just now been halted).

Hmmm... is Canada really all that different?

In the United States inflationary pressure caused by such factors as increased fuel and housing costs, and changes in foreign investments in the U.S. economy, triggered an increase in interest rates. The US Federal Reserve raised interest rates 17 times, increasing them from 1% to 5.25%, between 2004 and 2006.

This triggered the collapse of the housing bubble.

In Canada, the Bank of Canada has been sounding the alarm for months now that there will be a "normalization of interest rates" and that Canadians must heed these warnings vis-a-vis their debt situation.

We have also seen changes in foreign investment here, a factor that some are blaming for the vaporization of HAM (Hot Asian Money).  

When you consider that our real estate market is already "softening", does anyone care to speculate what will happen as the Bank of Canada rates rises from 1% to 5.25% (possible pushing mortgage rates back to the historical average of the past 20 years of 8.25%) ?

Even without an increase in interest rates, what will a declining market mean for mortgage holders here?

There will be no US-style housing crash in Canada. It will be uniquely Canadian with variants on the US experience.

I can't help but wonder how bad it would have been in the United States if things there were like Canada.

Consider this for a moment.

In the United States you can get 30 year mortgage at the same low rate. The only people who didn't have 30 year mortgages were those who were 'riskier' borrowers.

Those 'riskier' borrowers had to arrange 1-7 year mortgages with mortgage rates that 'reset' after those short term periods (1-7 years).  They called these borrowers 'sub-prime' borrowers.

When property values fell, these people were severely hurt when it came time to renew their mortgages.  The domino effect these people had on the housing market was severe.

How many people do you know in Canada with mortgages that last longer than 5 years before their interest rate 'resets'?

Our entire nation is made up of mortgage holders that are as vulnerable as the 'sub-primer's' in the United States were.  What will be the impact here if the real estate market continues to 'soften'?

We won't have a US-style collapse. Ours has the potential to be far worse that anything the Americans went through. 


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  1. Very good article and very truth.

  2. I sincerely hope the Feds do not step in and try to avert the collapse with more meddling interference.

  3. There is a lot of truth to what you say in your post. However, there is one major misconception that needs to be pointed out.

    "In the United States inflationary pressure caused by.... The US Federal Reserve raised interest rates 17 times...

    This triggered the collapse of the housing bubble."

    This is NOT what caused the housing crash. These were certainly factors that contributed to it, but not the root cause. It's so important to understand this because the exact thing is happening here.

    The US housing crash was caused by two factors, a complete oversupply of homes and condos, and a complete lack of buyers. Construction in the US was in full throttle in 2007 where developers had no concept of the idea that maybe there wouldn't be buyers. At the same time, everyone who could have gotten into the market was in at the current price points. Many I knew when I lived there borrowed money from family. But yes it's true in a lot of cases loans were given out when it was clear the person lacked the capability to actually pay it.

    When prices went down that is when things went to hell in a handbasket.

    Inventory levels are currently at 19k. How many people do you know who are looking to buy a primary residence?

  4. "we will not have a US-style housing crash. Our crash will be uniquely Canadian."

    I wholeheartedly agree. The US had a sharper boom and bust and spent much less time at elevated prices. Canada has slowed it down and dragged it out with explicit government backing (moral hazard), while somehow believing itself immune. Our response to grossly elevated house prices has been vastly stupider, and the economic damage caused by overpaying should be greater based on Volume Weighted Average Price.

  5. From way back in 2009:

    Why Canada's Housing Bubble Will Burst
    'The largest sub-prime lender in the world is now the Canadian government.'
    "In an effort to prop up the real estate market in 2008 (when affordability nosedived), the Harper government directed the CMHC to approve as many high-risk borrowers as possible and to keep credit flowing. CMHC described these risky loans as "high ratio homeowner units approved to address less-served markets and/or to serve specific government priorities." The approval rate for these risky loans went from 33 per cent in 2007 to 42 per cent in 2008. By mid-2007, average equity as a share of home value was down to six per cent -- from 48 per cent in 2003. At the peak of the U.S. housing bubble, just before it burst, house prices were five times the average American income; in Canada today that ratio is 7.4:1 -- almost 50 per cent higher."

  6. I was at retail banking lending section before. Those crazy years between 2003 and 2007, realtor had so much power to push mortgage deals, show client more and more expensive houses, and pushing bank staffs to increase approved mortgage amount, etc etc.
    As for CMHC, I remember there was Self-employed individual's stated income policy. (now should be removed) With 20% Downpayment or something, if you can prove you are business owner for more than 3 years, you don't need to show confirmed income.
    Just provide business statement, or corporate / sole owber registration older than 3Y. This I think is extremely risky mortgage lending practice.

    Personal opinion, other than this stated income CHMC mortgage for business owner, regular CHMC mortgage was pretty strict on Income confiramtion. Cannot negotiate GDS/TDS override, so I am not too much worried there.

    Most risky ones maybe the "Equity lending" mortgage.
    Again, no need to show confirmed income to support debt service, but you need to have at least 35% down. Some banks had cap purchase amount to $1MM, or had sliding scale method and others have no limit as long as you have 35% or 40% downpayment.

    Also, Real Estate agent in old days (pre-internet era), had specific important inforamtion that agents only had. (remember thick MLS hard copy book?)
    Now most of the info are accesible for public,
    so not much special tools they have now.

    As someone said, RE Agents should be more regulated, enhanced ethics and moral course, due deligence during licensing, just like securities broker or legal representatives.

    I just cannot stand RE agents talking about "Market" like stock brokers.
    They may just need to know client's budget, family structures, area preferred, etc and find the right place for them!
    If in securities broker's world, many shuold have been already suspended.

  7. Hate to break it to everyone but rates arent going up. A Romney win adds a risk of rate pressure, but I dont think even he has the balls to install a hawk in the Fed.

    1. We will see Cdn rates nudge up in 2013, irrespective of the US.

  8. We are no different here.
    As the global engine slows the house of card's teeters and falls.
    The weakest link determines downward housing prices, no job, gotta sell.
    Worried about the market going down and willing to cut losses, going to sell.
    The market is hooped, 20k inventory around the corner.
    Desperation, going to sell.
    Its still a bit of a stand off but necessity will eventually shake things up and then it will quicken the downward spiral.
    It is the way this always end.

  9. There are many other factors that make the Canadian housing market more vulnerable than the US market was before it crashed.

    Canada's current oversupply is 41%, much higher than the 29% that was seen in the US at their peak. This will become more evident as prices correct/crash.

    Americans can write off their mortgage interest, while Canadians cannot.

    The cost of living in general is much higher in Canada than the US. Food, fuel, cars, airfare, furniture, etc. are all much more expensive in Canada than in the US.

    Overall, Canada's price to income ratio is currently higher than it was in the US at their peak.

    All these factors add weight to the coming correction/crash of Canadian house prices, making our market much more vulnerable than the US market was.

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