Oh No, Canada! Are We Watching Another North American Financial Crisis Unfold?

  • Share
  • Read Later
Photo-Illustration by Alexander Ho for TIME; Getty Images

For some time during and after the financial crisis, it was fashionable to point to Canada as a paragon of fiscal and regulatory prudence. In the years leading up to the crisis, the Canadian government ran budget surpluses, which enabled it to stimulate the economy without creating huge debt loads we now see in Greece and Spain. In addition, the Canadian banking system faced stricter capital requirements and were more risk-averse than their American and European counterparts. Perhaps most important, Canada avoided the sort of real estate bubbles seen in the U.S. and Great Britain due to tighter lending standards and the absence of mortgage interest deductibility — at least until recently.

For the past year or more, Canadian officials have nervously watched as household debt levels has risen to worrying heights, fueled by increased mortgage borrowing. As The Wall Street Journal reported this week:

“Borrowing to buy property has helped make Canadians some of the most leveraged consumers in the world, at a time when their counterparts in other heavily indebted countries—such as the U.S.—are digging out. Household debt is now 163.4% of disposable income in Canada, close to the U.S. level at the height of the subprime crisis.”

(MORE: Canada’s Penny Is No More – Is the U.S. Penny Next?)

Just like in the U.S., housing prices in Canada steadily rose in the decade immediately preceding the financial crisis, soaring 198% over ten years. They dipped slightly during the global recession, but bounced back quickly between 2009 and the beginning of this year, fueled in part by a low interest rate policy the Bank of Canada put in place to nurse the Canadian economy through the global economic slowdown. Real estate prices have risen so high, in fact, that many housing analysts believe the bubble is about to burst. Housing economist Robert Schiller told CBC news in September, “I worry that what is happening in Canada is kind of a slow-motion version of what happened in the U.S.”

Indeed there are signs that the party is already over. Due in part to efforts by the Canadian government to strengthen lending standards, home prices in Canada nationwide dipped year over year in October, and declined in many of the key local markets as well, according to a recent report in Reuters. “With cooling evident in several major cities, speculation has turned to whether the slowdown will be a soft landing or a crash,” the report said.

What will determine the difference between a soft landing or a thudding crash like the one the U.S. experienced in 2007? Lending standards are a big part of the equation. In the run up to the bursting of the American real estate bubble, many homeowners bought homes with little money down and financed the purchases with loans that had low teaser rates that would jump higher a few years into the life of the mortgage. Those sorts of products swamped many homeowners in short order, and also meant that they had virtually no equity cushion when lenders came to foreclose. The lack of equity cushion meant that banks — who were over-indebted themselves due to poor regulatory oversight — had to resell the homes at steep losses, feeding the panic that soon turned into a full-blown housing crisis.

(MORE: Will the Global Economy Tumble Off America’s Fiscal Cliff?)

Canada, on the other hand, requires homeowners to put at least 20% down on a home, or to purchase mortgage insurance from the the Canadian Mortgage Housing Corporation (CMCH), a federal agency. Furthermore, Canadian lenders are in a much better position than U.S. banks were to absorb losses from any housing downturn. As CIBC economist Benjamin Tal told CBC news:

“The Canada of today is very different than a pre-recession U.S., namely as far as borrower profiles are concerned . . . Therefore, when it comes to jitters regarding a U.S.-type meltdown here at home, the only thing we have to fear is fear itself.”

Of course, few analysts in America predicted that the U.S. real estate market would blow up in the spectacular fashion it did in 2007, either. As financial blogger Pater Tenebrarum puts it:

“This kind of thinking has things exactly the wrong way around. It is precisely because such a state-owned guarantor of mortgages exists that the vaunted lending standards of Canada’s banks have increasingly gone out of the window as the bubble has grown. Today some $500 billion, or 50% of Canada’s outstanding mortgages are considered ‘high risk’ according to the Financial Post . . . Through CMHC and government guarantees for privately held mortgage insurers Genworth Capital and Canada Guarantee, Canadian tax payers are on the hook for more than C$1 trillion in mortgages. In other words, there is no practical difference to the role played by the once nominally private GSE’s and credit insurers in the US and the Canadian version of them: in both instances these institutions have enabled vast growth in ever more risky lending, while ultimately tax payers are picking up the tab when things go wrong – as they invariably must.”

That is to say, the difference between a soft landing and a meltdown could boil down to the financial integrity of the CMHC. A report from the agency released yesterday stresses its health and ability to stay solvent in the event of a downturn, and the conventional wisdom is that the Canadian real estate market will go through a rough patch and nothing more.  But anybody who was paying attention during the American housing crisis can remember similar assurances, which turned out to be just plain wrong.

MORE: Home Prices Rise Across the U.S. in September

20 comments
Dachman
Dachman

Hey all of you saying it is only Vancouver and Toronto who are having the housing issues, that may be true but Vancouver and Toronto account for 20% of the Canadian population.

berniebee
berniebee

Canada has many, many,  residential mortgages with low or no equity.  Contrary to all the above mentions of 20% down payments, 5% is the minimum down with CHMC (Similar to Fannie May)  insurance. This insurance is easy to qualify for.  Actually 0% down was not uncommon until very recently. Some banks (We have only five major banks in Canada) were offering a 5% "Cash back bonus"  with mortgage approval until very recently. So you could borrow 5%  for  your down payment from Auntie, the bank would give you "cash back" on approval, and presto! 100% financing. And think on this: Vancouver's average detached house price is just over one million dollars. How many people have 20% ($200,000!) to buy these houses?  Hands up now, who has $200k in the bank? Anyone?!?!?  Didn't think so.  The price rises in pretty well all  Canadian cities do not track rents, do not reflect wage increases and have reached a point where Canadians on average pay about twice for  a house compared to Americans.  But gosh, maybe Canadians are so much smarter than Americans.   And Spaniards, Irish and the Japanese too. And the (Your favorite popped-house bubble-country here.) too.

RobHarrington
RobHarrington

Derivatives expert Janet Tavikoli explains the financial crisis. IT ALL STARTEDWITH FRAUDULENT PREDATORY LENDING AND FINANCIAL ALCHEMY OF TURNING ASINGLE MORTGAGE INTO MULTIPLE MORTGAGES VIA FINANCIAL ALCHEMY CALLEDSECURITIZATION. OUR FEDERAL AND STATE GOVERNMENTS ALLOWED THIS TO HAPPENTHROUGH LACK OF BASIC REGULATORY ENFORCEMENT OF FRAUDULENT ANDPREDATORY LENDING AND PREDATORY FRAUDULENT SECURITIES SALES VIA MORTGAGEBACKED SECURITIES - YOUR PENSION PLANS. (Kiss YOUR financial futuregoodbye!) She explains this very clearly in this article. "The financial crisis resulted largely from the use of credit derivatives. How?We saw them hide risk and create a lot of leverage in the globalfinancial system in securities and securitization, where one badmortgage could be levered up to be in numerous different deals. Thatkind of malicious leverage had a big impact. A lot of fraudulentsecuritization provided funding for corrupt lending. Had we not donethat, our housing crisis — and the situation we still have today —wouldn’t have been nearly as bad. Derivatives helped supply the leverageto inflate the bubble. Are they still dangerous?Today we see a credit derivatives market that is poorly understood byregulators and even by many of the banks who are participating in themarket. And there just doesn’t seem to be a will to clean it up. What should be done about sovereign credit default swaps?When they were [first] sold, the hype was that they were useful hedgingtools. The result is that they have been a game for speculators morethan a hedge for hedgers. Speculators can go in and depress sovereigndebt just when a sovereign needs to roll over debt — and of course theprice of the credit default swap will shoot up. These games createtemporary dislocations in the market. Given that we haven’t drivenspeculators out of the market, it’s a good idea to ban credit defaultswaps altogether. What else can be done now to try to prevent another financial crisis?In terms of money flow in the U.S., we have to write down debt andmaybe have some sort of debt forgiveness. That’s a radical thought, butsome people will never be able to get out from under their debt in theirlifetime. Going forward, we have to make responsible loans." http://www.advisorone.com/2012/04/25/finding-the-culprits-of-the-crisis?t=economy-markets&page=4

sverry7
sverry7

There is little doubt that if left to its own devices, Canada would continue on the path of fairly stable economic growth. However, we must bear in mind that more than a little of today's economic turmoil is rooted in subjective human psychology as well objective economic performance. If doubts about a particular nation's economy catch on, then investors, those skidish, fear driven beings, may begin to dial down investment in said nation, thus undermining an otherwise functioning economy and possibly setting the stage for the other incremental steps   that lead to full blown financial crisis.

For this reason it is regretable that this writer, hoping for the career advancement that would come with writing a sensational piece, chose to strike out in this journalistic direction. I would recommend more substantial topics for future articles.    

PonnaTharmaratnam
PonnaTharmaratnam

Just last week we heard that Canada's Central Bank Governor Mark Carney had been enticed to go over the pond and try to save the British economy. For the first time a foreigner is going to head the venerable Bank of England. That tells us about the current state of the Canadian economy and the man who had stewardship over it. Sure we are having a hiccup right now but the underlying economy is very sound. The truth is every Canadian wants the US to have the same. As Lord Keynes would like to say,"We are all in this together."

SwiftrightRight
SwiftrightRight

I find this article to be almost laughable. While I dont doubt that the debt ratio might be an issue its a totally different beast from what blew up in our American faces. Not only that, unlike our society were we ignored and dismissed all the warning signs of a collapse the Canucks have acknowledged the issue and are tacking incremental steps to defuse it. While the author brings up the 20% down he totally dismisses that fact that most folks are going to think twice before walking away from even a new house that they have that much equity in.

To me this sounds like more of a political interest story. While it may be "fashionable to point to Canada as a paragon of fiscal and regulatory prudence." for the left there has been a literal cottage industry of right wing blogger telling us every day for the last 3 years that Canada is on the verge of a melt down too.

K.Navaratnam
K.Navaratnam

The very notion of Canada having a real-estate collapse similar to the american one is highly laughable. It wasn't merely in vogue to list Canada as a stable economy in the immediate aftermath of the 2008 financial meltdown... four years later, it remains the best performing economy in the west, with the Canadian dollar now being considered by the IMF for reserve currency status.

The Canadian financial structure is far more risk-averse than its western counterparts and will remain so. While it is true that there are no doubt a few small bubbles in such cities as Toronto and Vancouver, they are concentrated in a few small neighbourhoods and mainly consist of condo properties. If there is any bubble in Canada it is the condo markets of downtown Toronto and West Vancouver and that is that. The country as a whole faces no such uncertainty as put forth by the author of this article - who is no doubt in awe of the spectacular economic performance of his northern neighbour.

rpratt039
rpratt039

@ViableOpYour facts are completely skewed to support your political agenda.You may recall that interbank lending ground to a halt because nobody knew who held what debt or how much unknown debt.In this case government backstopping the banks was perfectly acceptable.

Time is trying to generate a tempest here. Some Canadian housing markets are overheated - Toronto, Vancouver - but this is generally concentrated in the absentee condo buyer class. Our tighter standards (actual proof of income, a credit history, you know, actual standards) pretty much guarantee that if house prices do fall, it means some people will in their houses longer before selling.

A fall in house prices does not mean people are suddenly unable to pay their mortgages, and nor does it mean that banks are going to start foreclosing. As @LordByng pointed out, that 20% of personal equity people in Canada start with when they buy a house makes all the difference.

LordByng
LordByng

But it's that 20% down that makes all the difference. There are no liar loans- no masses of new construction sold to people who used to live in apartments for no money down.

Because everyone who holds a house holds equity of at least 20%, as opposed to the millions in the US who held equity of zero, there is not going to be a raft of abandoned mortgages even if the market does turn down significantly. 

Canada is an experiment in whether a mortgage system that is not undermined by massive fraud can operate smoothly even in the presence of a downturn in prices.  My sense is that we will learn that lack of criminal activity on a grand scale makes all the difference.

mac
mac

@RobHarrington That certainly is the US story. I doubt the Canadian collapse will have the global ripple effect of the US MBS story. Having said that, why did Spain have a deeper collapse than even the US? For that matter, why did Ireland? Dublin is down 50% and that's their gem in the Emerald Isle. Just like Manhattan, SF and NY city which never saw such drastic declines. It must be because each country has its own set of market manipulation and outcomes. By the way... what does the CMHC do with all those mortgages. They wouldn't be selling them back to the banks by any chance would they?

mac
mac

@PonnaTharmaratnam After he rescues England, maybe he can rescue Ireland, Portugal, Spain, Greece, France and Italy. There's no limits to what a GS employee can do. 

mac
mac

@SwiftrightRight Well at least you're not laughing alone. Lots of other Canucks are laughing right along with you saying either it's different here or it's different this time.  By the way, did you know the fed gov't here reduced down payments to zero for a little while? Then they changed their mind. These sensible Canucks upped it to a hefty 5% down for many more years. But not to worry. TD, RBC, and all the other big banks and hundreds of small credit unions came to the rescue with 7% cash back mortgages. 

mac
mac

@K.Navaratnam Are we talking aftermath or immediate aftermath of 2008? Because in Vancouver, the immediate aftermath of the 2008 financial meltdown was a 17% drop in SFH house prices within 6 months. Then, Carney did a Greenspan and reduced the overnight lending rate to 0.25%. And we've been at Greenspan-style 1% rates ever since. Enjoy!

mac
mac

@rpratt039 Vancouver calling: Actually our single family homes are falling much faster than our condos. Whole streets have been bought up on speculation with houses sitting empty. A fall in house prices does not mean people are suddenly unable to pay their mortgages --err first mortgages. But as for their second, third and fourth mortgages, it's hard to say. As for that 20% personal equity, we don't see much of that here. Just 5% with 7% coming back from the bank. 

mac
mac

@LordByng Don't worry. No one in Canada can "abandon" a mortgage. It will follow you around like a red-headed step-child. (No offence meant to red-headed step-children). 

mac
mac

@ViableOp Wow. Someone who gets it. Finally. Too bad it's at the bottom of the posts.