Collateral damage

A precursor of the US real estate mashup was serious trouble at big lenders like Countrywide – famous for agents giving loans to people who could breathe and sign a document at the same time. Those days of pre-bust madness were characterized by falsified mortgage aps, NINJA loans (for folks with No Income, No Jobs and no Assets), interest-only payments, fat home equity borrowings and adjustable-rate mortgages, offering people ‘teaser’ rates for a year or two – just to get them into epic debt.

Of course nothing like that could happen here, right?

Hmm. Well, we have interest-only payments, a burgeoning HELOC industry, teaser rates and now the largest independent lender stands accused of application fraud. It also happens that Home Capital Group is Canada’s biggest sub-prime lender, doling out billions to people the banks found too deplorable to actually qualify as homeowners.

How serious is this? Are there lessons?

Serious enough that CEO Martin Reid ended up with a big boot mark on his pinstriped derriere Monday night as the company fired him. “Home Capital requires leadership that can bring to bear a renewed operational discipline, emphasis on risk management and controls, and focus on improving performance,” the board of directors said in a release, as the coyotes from the Ontario Securities Commission circled outside.

This was not enough to keep the company’s stock from being spanked badly on Tuesday, shedding more than 9% of its value in a single session, taking it back to 2010 levels. Home Capital has been an investment star for years now, soaring from around a buck a share to a high of $55 three years ago, before being pummeled back down to the $25 range now. There could be more blood coming.

The company has received an enforcement order from the OSC and the regulator is apparently unsatisfied that Home Capital did enough in response to evidence agents fibbed on mortgage applications for at least two years – handing out loans to borrowers who simply didn’t qualify to get them. About 45 brokers and brokerages were punted after the news broke, but it’s probably a safe bet that where there is smoke, fire’s not far behind.

The OSC has also served a number of company officers, directors and former execs with enforcement orders, which Home Capital admits are related to the NINJA-like fraud. Making matters worse is a class-action lawsuit that’s been filed against the company claiming it lied on public disclosures in 2014 and 2015, which helped drive company stock into the stratosphere and misled investors.

Mortgage changes brought in last October have already hurt HC, making those poor, house-horny moisters pass a mortgage stress test, knocking about a fifth of them out of the market. If Ontario makes good for a foreign buyer’s tax or a speculator levy in next month’s budget, there’ll be more grief at head office.

Is mortgage fraud and lax lending rampant in Canada, or is this just a company caught with a mess of rogue agents? How many clients actually received loans to buy houses they probably can’t afford? We’ll see. Meanwhile the real estate market continues to be driven higher by borrowers who can legally use credit cards for down payments or whose parental loans mask their income deficiencies. Realtors push values higher with blind auctions and engineered bidding wars, while lenders offer 1.99% short-term financing in a world where interest rates are destined to plump.

Meanwhile, CMHC’s decision not to offer mortgage insurance for homes above $1 million – in a market where the average is $1.5 million – means buyers are forced to have 20% down payments, a big chunk of which comes from outfits like Home Capital, and the rest from the banks. This is why 65% of the $2 trillion in personal debt (rising daily) is in residential mortgages and real estate borrowings. Outta control.

As for DIY portfolio-builders, if you need a fresh example of why owning individual stocks is gambling, not investing, here ya go. Home Capital’s share values detached from reality about the same time houses did, and now we know there are enough irregularities within the company to cost Martin Reid his head and have the regulators kicking in the doors. You’re far better off with a broad-based ETF owning an index than trying to score with a handful of companies you really know nothing about.

And what does this say about the Canadian housing market?

Maybe nothing. Perhaps these are just careless, greedy dudes. Or maybe they’re harbingers.

Last call?

“We bought a house in Oakville in 2013 for 506K,” Brian writes me.  “We could sell that property now for 950K.  I’ve done nothing to warrant that gain, just painted and a few minor upgrades.”

Sweet. Windfall profit. So, whaddya going to do about it?

“I’ve debated the idea of cashing out now and just buying a nice townhouse in the area for 500K.  I’d be liquid then with a paid off home (overvalued at 500K but whatever).  we are 36 with 2 young kids in school.  They would be in the same schools with the move just with a smaller backyard, they can go to their friends houses for a swim if they want.

“We’d be freeing up 2k a month in mortgage fees, half of that could go to investments, the other half could go to lifestyle/travel. We already have pensions and savings plans for kids school. Any thoughts would be great.”

So I replied:

At what other point in your life could you make $450,000 in four years, tax-free, while reducing your debt and increasing your cash flow and future financial security?

What’s to debate? — Garth

And Brian replied:

“My thoughts exactly, why does everyone tell me it’s madness then?  The fear of missing out on future growth?”

Now, I’ve no idea who this guy is, other than he reads the blog and is therefore (naturally) a superior being. High IQ. Likely brawny with rakish whiskers, confident dog, planning to rescue wildlife this summer holiday, work on his doctorate, then buy a Harley. Typical. Or, maybe he’s the normal Globe or HuffPost reader, incapable of acting on rational thoughts because he’s under the emotional thumb of his dominant MIL and nest-happy spouse. Because, you know, real estate always goes up.

Thus there are two kinds of people when it comes to this all-consuming topic. One group believes house price growth is infinite and only idiots would leave the table. The other (much smaller) group are astonished at the bubble, understand it’s irrational, assume reality will return, think Mom is a loon, and know they’re staring a gifty nag in the snout. Brian, for example, realizes his house made more money than he did every one of the past four years, and tax-free. He also understands what goes up can come down as easily. Especially in a world of rising rates, Trumponomics, a 74-cent dollar, pervasive house porn, epic debt and rampant financial illiteracy.

Speaking of property lust, Jamie’s just sold a business in the wild fringe burbs of the GTA, now wants to downsize and move to Hicksville. The boring house he and Dawn own cost them $650,000 in 2007. “I told the realtor I want two million for it,” he told me on Friday, as they prepared to list it Monday. But that day at noon, a bully offer – $2.3 million, after the agent yakked about the property in his office. Will he take it? No showings. No stress. No vacuuming.

Nope. “I’m not leaving any money on the table.”

Well, this will be interesting. Ontario’s government revealed Monday it’s on the verge of bringing in one or more measures intended to douse the market’s flames next month, making legends out of guys like Brian and Jamie. The premier calls it a “comprehensive set of plans” to deal with out-of-control house prices in the vast GTA area, which has now infected locals all the way from Prince Edward County to Georgian Bay to the shores of Lake Erie.

Among the possible moves: (a) a foreign buyer’s tax, like in YVR, although local realtors say offshore buyers are just 5% of the market; (b) a special speculation tax levied on people who buy non-principal-residence properties; or (c) the ask Ontario made to T2 before the last federal budget, to increase the capital gains tax on secondary properties in order to nail flippers. We won’t know if one (or all) of these emerge in some form until the Ontario budget, now expected in a few weeks.

If Vancouver is any guide – where a narrow tax on foreign buyers ended up collapsing sales within just a few weeks in an unbalanced, frenzied market – the Big Smoke could be in for a jolt. It might be the Ontario budget, or higher mortgage rates later in 2017, or the simple fact listings are disappearing because nobody can afford to move, but rest assured some catalyst will occur.

The house pumpers will then sit around on this pathetic blog, stare into the campfire and say, ‘why didn’t we see that coming?’