Canada's Housing Bubble

Dec 17, 2010 Ben Rabidoux financialinsights.wordpress.com

More media nonsense

Another “we’re different from the US therefore we have no housing issues” article has hit the media, this time on the Moneyville website, which is associated with the Toronto Star.

Our housing market to side step U.S. style bubble Author: Mark Weisleder

Now I always like to look at the substance of the argument rather than the person making it, so I will debunk some of the ridiculous and misleading statements contained in the article in a moment.  But in this case it is also worth noting who the author is.  From his own profile on his website:

“Mark Weisleder has presented seminars for the Ontario Real Estate Association …since 1983″

“Mark is currently providing consultation services to the real estate industry, including the development of accredited continuing education courses for salespeople and brokers.”

“Mark became a certified Real Estate Instructor for the Ontario Real Estate Association in 2007 and has lectured thousands of real estate salespeople”

So in the name of full disclosure which is lacking in this article, a portion of Mr. Wesileder’s income is payed by the real estate industry in Ontario.  Enough said.  On to the article.

“American politicians encouraged banks to make it easy for consumers to buy a home. The banks ended up lending to people who never would have legitimately qualified for a mortgage. Basically, if you had a pulse, you got approved.”

Completely agree.  The excesses in the US mortgage markets were never equaled here in Canada.  But that’s not to say we haven’t had our own excesses.  What does the author mean by “the banks ended up lending to people who never would have legitimately qualified for a mortgage”?  Does he mean that we have not loosened lending standards since 2005, raising allowable amortizations to 35 years (briefly 40) and dropping minimum down payment requirements to 5%.  Is it not true that extended amortizations now comprise nearly 50% of all new mortgages?  These 5/35 are a massive change from the 20/25 standard just a few years ago.

Perhaps he means that we do not have a government agency guaranteeing the banks against default risk so that borrowers who would otherwise face higher lending costs if they were required to ‘legitimately’ qualify without a taxpayer guarantee.  

With regards to “American politicians encouraged banks to make it easy for consumers to buy a home”, is it not true that in an effort to prop up the real estate market in 2008 (when affordability nosedived and the economy soured), the Harper government directed the CMHC to approve as many high-risk borrowers as possible and to keep credit flowing?  Is it not true that the approval rate for these risky loans went from 33% in 2007 to 42% in 2008?

Back to Mr. Weisleder:

“Government programs allowed buyers to get a down payment from the government as well. In other words, many bought properties with none of their own money…..There are no free down payment programs in effect in Canada.”

Ummm…..

Seems our government will give certain home buyers (namely the riskiest) a downpayment.  So much for that.  But suppose you don’t qualify for this program.  No worries!

Just borrow the 5% required down payment either from family, a credit card, line of credit, etc then repay with the cash you receive when the mortgage funds are released.  If you’re doing the math, that means you can buy a property with none of your own money, a situation the author implies was ‘unique to the US market’.

It’s not just CIBC offering this either.  Most of the big banks make similar offers.

“These mortgages came with very low interest payments, but after a few years, the home owner had to make a large lump sum payment. Many couldn’t afford the payment and so these mortgages were called ‘sub-prime.”

The equivalent sub-prime market in Canada was virtually non-existent.  Point for him.

Well not quite.  Let’s remember that there are structural differences in the way mortgages are structured.  In the US, you can lock in an interest rate for the entire term of the mortgage.  That current rate is still around 4.5%.  We have nothing remotely similar here in Canada.  The closest we have is a 15 year closed term mortgage from FirstLine Mortgages which carries a hefty %9.55 rate.

What that means is that virtually all fixed rate mortgages come up for renewal every 5 years, at which point it is renewed at the new market rate.  Let’s connect two dots:  1)  5 year fixed rate mortgages in Canada are still hovering near historic lows with only one direction to head.  2)  A recent CAAMP report indicated that 16% of Canadians with a mortgage could not manage an extra $300 increase in mortgage payments.  In addition, 11% of households would run into financial trouble if mortgage rates rose only 1.5%.

Get it?  If we have even a modest increase in the fixed rate to a level still well below historic average, come renewal time, we’ll find out just how many ‘sub prime’ borrowers we really have in Canada.

Added:  For more insight into the term ‘sub prime borrower’, check out ‘Lumpen’s’ insightful post in the comment section of this article.

“The U.S. lets homeowners deduct interest paid on their home mortgage from their income tax. Thus, whatever was paid by the borrower to carry the mortgage was taken as a deduction on their income tax returns. You can’t do that here.”

Excellent point.  What this means is that average house prices to income ratios should naturally be higher in the US. Are they?

Well, here’s the most recent Stats Canada income comparison:

Let’s also note that the median resale home price at last check in the US was $170,500 while in Canada the average is a bubblicious 344K.  I know we’re comparing average to median and I do get the difference.  But this is how the data is reported and it should be obvious that an apples-to-apples comparison  does little to change the fact:  Canada’s home prices are WAY above those in the US despite similar incomes and massive tax incentives for American home owners.

Let’s also note that our current home price to income ratio is 4.5, nearly 50% above the long-term norm and above the high water mark achieved by the US in the run-up to their bust.

“Many states in the U.S. have non-recourse mortgages. This means that if you default on a mortgage loan, the only remedy for the bank is to take back the property. They cannot sue you for any loss suffered.”

Partially true.  As I’ve noted before, many states do in fact have an element of recourse.  The impact of recourse has been estimated to curb defaults by 20%, not 100% as implied by the author.  Furthermore, the greatest predictor of default is not recourse or affordability, but negative equity.  For more on that, read my post highlighted above.

“When you put this together, there was no incentive for home owners to pay down the mortgage principal.”

Yes, thank goodness Canadians are prudently paying off their mortgages and not expanding their aggregate debt levels by tapping their home equity.

“While it may be true that Canadian household debt may be increasing, but with less than 1 per cent of mortgages under water, this is not the basis for any kind of housing collapse.”

With home price appreciate looking like this, why would there be a significant portion of borrowers underwater?

Though often bandied about by the media, this fact has absolutely zero predictive value.

“Banks have made sure over the last few years that even if you qualified for a 1-year mortgage rate of 2.5 per cent, you had to have the ability to pay the 5-year rate, which was closer to 5.5 per cent, in order to qualify for the mortgage.”

By ‘the last few years’ does the author mean ‘since April’ when new CMHC rule changes came into effect?  Mr. Weisleder has obviously honed his skills of data manipulation and sleight of hand while practicing law.  The man has skills!

Once again we see our media swallowing this type of industry-sponsored drivel.  It absolutely sickens me.  It astonishes me that a practicing real estate lawyer can be so ignorant of the facts.  The question in my mind is whether he is willfully ignorant or whether he happens upon it honestly.  I’m not sure which one troubles me more.

-Ben