The Canuck subprimes

“As of the fourth quarter of 2007 there were over 2.1 million vacant single-family homes for sale, and with what will be a sizeable wave of foreclosures over the course of 2008, this number will surely rise further, thus compounding the inventory overhang and adding to downward pressure on home prices.” For more on this, go here.

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‘I don’t see the same threat in 40-year mortgages’

Hi Mr. Turner,
I have a question about your contention that 40 year amortizations are Canada‘s subprime and will be key to triggering a housing crisis here, similar to what has happened in the US.

As I understand it, the problem with subprime is that mortgages were given to people who simply shouldn’t have qualified, through vehicles such as NINJA loans. They were given teaser interest rates that spawned a huge amount of defaults after they reset. It seems that excess demand (in the form of unqualified buyers) drove up prices and once these buyers were removed from the market, prices have tumbled, due to a lack of greater fools, as you would term them.

I don’t really understand how 40 year ammortizations will lead to the same result here. We don’t have NINJAs in Canada, and there are no teaser rates with these 40 year mortgages. So assuming buyers are able to manage their payments, it would seem that there is not the same threat of massive defaults. While these people end up paying more in the long term, I don’t see how 40 year amortizations pose a threat to the overall housing market.

Am I missing something here? I would welcome your thoughts.

Thank you,
Adam Molson

Your question underlines what most Canadians think, that the US market collapsed because unworthy people got loans to buy houses they did not deserve. This is untrue. The fundamental cause, as I detail in my book, was the same reason all asset inflation booms end – prices.

When the average American home price exceeded the ability of the average American family to buy it, then the market should have corrected. The excess in home prices had been caused by a collapse in interest rates and a risk-averse mentality in the wake of Nine Eleven, among other things. Markets like Florida and California led the charge higher, and ultimately became a speculator’s paradise.

Subprimes were a reaction to this. By allowing people to enter the market with little down and a discounted rate that dropped monthly payments, they lowered the cost of entry. Thus, the market could continue to rise. And so long as prices appreciated, then those who had little or no equity profited with everyone else. Resetting rates were no problem, since equity could always be siphoned off to pay for additional financing.

However, the bubble burst with the widespread realization prices had hit an artificial level, concurrent with a softening in the economy and a string of interest rate increases. Many recent buyers with little equity soon found that the value of their homes had fallen below the amount owed on mortgages, and it made no sense to continue paying – especially when loan rates increased. The dominoes started to fall. Now most Americans have been affected by this collapse in the real economy, with the fallout rippling across the world.

In Canada, we have experienced a similar run-up in real estate values. As in the US, family incomes have barely budged, but homes have doubled in cost over the last five years. The average family in Toronto, Calgary or Vancouver – in fact, most cities – no longer can afford the average home.

The solutions: Phantom down payments and forty-year amortizations. Today many new homebuyers put less than 2% down – just enough to cover closing costs – then take those long loans with lower monthly payments, but which dramatically increase the overall debt. So long as the market continues to rise, then those with virtually no equity are okay. If it flatlines or declines, they could easily see their debt exceed their equity.

So how, precisely, is this different from the United States? And why should we expect a different outcome?

Even in Canada, real estate does not go up forever. Even here, all booms end badly.



#1 hal on 03.21.08 at 7:04 pm

The Feds say we have low inflation, maybe 2 % per year. If house prices go up 10% per year how is this not inflation? If gas prices rise 10% from 1.08 to 1.20 how is this not inflation? If refinancing a mortgage goes from5 to 5.5 per cent, a 10% increase in cost, how is this not inflation? House prices, gas prices, and interest rates take a huge bite out of my wallet. But if a loaf of bread goes from 1.00 to 1.10 that’s inflation and we have a screaming emergency. I don’t get this. Are all the economists frickin nuts or am I just a dummy?

#2 hp on 03.21.08 at 8:02 pm

There is another factor with the 40 year mortgages. Big banks (like BMO) offer 5% (or more) cashback on many of these mortgages. This 5% is just added to the mortgage value, often making the mortgage value more than the house purchase price. I heard that these are common from a BMO mortgage provider. Debt exceeds equity from day one.

#3 Lawrence on 03.21.08 at 10:16 pm

There is ample evidence to support the assertion that the sub-prime mortgage, by its definition as “sub-prime” (read “bad”), was a scheme to lend money to people who were not credit worthy. The assumption that allowed this scheme to be sold as ABS’s was that the inevitable defaults would be absorbed by the market, not decimated by it.

Subsequently, these mortgages were packaged and sold as Asset backed “securities” and were to be blended with other safer “securities”. (interesting use of the term isn’t it?) This caused a world wide credit crisis because even the safe Swiss Bank, UBS, got suckered as did many others. Sold a bill of goods by the cigar chomping boys on Wall Street who made billions.

It turns out that people bought a paper that was only useful in the bathroom. The same is true for stock certificates for Citi Bank, Bear Stearns and others. Ultimately, the sub prime mortgage debacle was a securities scam not unlike other frauds that have been concocted ever since junk bonds emerged in the 80’s with Michael Milken.

But here is the part that I just don’t get. Instead of casting a suspicious eye at the scheme concocted by the “Bearn Sterns” of the world, Garth concludes that the problem was that house prices were too high?? A most illogical conclusion if ever there was one.

The logical conclusion is that a lack of security regulation, bank oversight, and fraudulent schemes by Wall Street “investment houses” makes the instruments they sell highly suspect.

So stay away from securities. Don’t trust your Financial Planner. Buy something safe that you can use every day. Something that is essential – a roof. Pay it off as quickly as you can. When you retire, you will have equity and a prosperous life. If you don’t buy property you will be a tenant and not the master of your own destiny.

#4 Huy on 03.22.08 at 9:47 am


You’re not nuts! You get it! We hear that inflation is 6 – 7% in China, Middle East etc. etc. The inflation rate is probably the same here. It’s just that in China and the Middle East they don’t skew their inflation numbers with bogus CPI (core inflation) like we do here.

How is that inflation is high in China & Middle East when their currency is pegged to the US$? Inflation in the Middle East is 7% and its only 1.8% in the US or whatever their Core Inflation is? It doesn’t make sense.

China & the Middle East subsidize their energy sector too, so inflation is probably much higher if they had to pay market prices. But they can’t subsidize food and other commodities.

That’s why China is letting their currency rise much faster. That’s why the Middle East is talking about a de-pegging of their currency to the US dollar. I think Kuwait has already done it and there’s a massive pressure on the Saudis and OPEC nations.

That’s why this US recession has not hit Canada YET. Our dollar has been rising against the US$, so its softened the blow a little. That’s why we’re still spending like drunken sailors for the pass several months on “cheaper” goods like cars, electronics from the US. But it will hit us because we have the same problems. Mainly, too much debt. I believe Garth is right on, a housing crash is coming because its the same problems.

People are too stuck on these “sub-prime” labels and the “40 year mortgages” and how they are or are not the same. At the end of the day its cheap money and easy credit that will bring down housing. Inflation is great at the beginning because everyone benefits, but in the end everyone suffers.

The best term I heard is “Uflation”. Everything You want to buy goes up, and everything You want to sell goes down.

Most economists are idiots, if you want to understand this stuff, you have to listen to the Warren Buffetts, Jim Rogers etc. These guys made their fortunes on understanding how real economies work.

#5 Keith in Calgary on 03.22.08 at 10:15 pm

We have NINJA loans here……..we have 100% financing here……..we have mortgage interest rate buydowns here……..just read your paper or visit your local mortgage broker.

CAAMP just released a statement that 37% of mortgages granted to 18-34 year olds had amortizations greater than 25 years. Where I come from that is called “rent”.

A $400,000 mortgage amortized over 40 years at 6.5%, would, in 5 years, have the principal paid down roughly $9,800…….yet $139,080 of principal and interest payments would have been made over that period. And I still haven’t accounted for insurance, utilities and repairs.

I’d rather rent for $1,000 a month ($60K in total over 5 years assuming no inflation) and save the difference.

Anyone who buys a property under these terms is not a “greater fool”……but an outright moron.

#6 Dale on 03.23.08 at 8:32 am

I believe the first cracks in Canada housing markets have appeared it is just a matter of time. The western Canadian economy started at ground zero Calgary head offices over the oil boom. I have benefited from this because I was a property owener. I live in Edmonton the capital of Alberta which 2 years ago had bidding wars on homes but now has a massive inventory of homes and it will only increase this spring.
What a difference a year makes. When I talk to young people they can not buy a 300k home they are waiting on the side lines. If you have not noticed all the advertising trying to flogg you a new home or reassure you that realestate is a conerstone to wealth building then you need to open your eyes. In 2005, 2006 in the Edmonton market I did not hear half the advertisements I am hearing now this was when the boom was really under way. Mid 2007 a few people woke up to the this cycle of maddness and inventories grew. I peg the crash in Alberta at the end of 2008, yes we will still have jobs and yes are economy will slow some but the rose will be off the b(l)oom.
I have sold 2 homes in the red hot Saskatoon market for
100K above what I paid for them not even 10 months latter, yes I was speculating to pay of my Edmonton house early. Now after reading Garth Turners book I am cashing out and renting even though I could have my home paid for. Why be silly the prices are not going up the momentum is going down. There is a window of time that I believe we are in where the signs say sell and that time is now 6-10 months maybe 1 year and then the ship will sail. I choose to hold on to my cash in these times and wait for the sales that are 3-5 years away. You to can choose bankruptcy and the albatross or paitence and true wealth building. Read the book and look for another way to build wealth this area will dry up quick and leave you land locked.

#7 CMU on 03.23.08 at 2:02 pm

The correction is coming.

In light of the coming housing correction (collapse?), I’m personally licking my chops when I can go in and pick up my first home from someone who is in dire straits from their own greed/ignorance/stupidity.

#8 William on 03.23.08 at 4:42 pm

Dear Sir,

I thumbed through your book on the upcoming crash in the housing market and found it timely. While living in Calgary last year the news reports were full of stories on the dramatic increases in real estate, which I have no doubt helped fuel the bubble. I wonder whether your new book, newsreports on the unravelling in the US and plain common sense will now take hold.

The one thing I think commentators are failing to take into account, however, is the impact of zonning regulations on the supply of housing. If more land in and around urban centers is becomming rezonned and more pressure is being put on large cities to curb urban sprall then some (and only some) presure on the upward increase in the average cost of housing is not speculative, but a man made decrease in normal housing supply.

No doubt the resurgance in the rural economies will stem somewhat the tide of urbanization, but so long as more people are flocking to the cities in faster numbers than the ability of developpers to increase supply real estate prices will increase at a quicker rate than the general growth rate in the economy.

In summary, urbanization and new building regulations have imposed a constraint on the supply of new residences which justifies some of the above average increase in housing costs. This combined with the overwhelming tendancy of families to break down, has had the normal affect on the housing market. New mortgage developments have had a huge impact on the housing industry but it is half the story.

It is great that this debate is being had. It is insane for families to keep mortgaging their futures (forgive the pun).


#9 patriotz on 03.24.08 at 3:11 am

“The one thing I think commentators are failing to take into account, however, is the impact of zonning regulations on the supply of housing”

The reason they aren’t taking this into account is that zoning has been around for about 100 years. So how on earth could it be responsible for the current bubble? Note also that some of the biggest US bubble areas, such as Florida and non-coastal California, have very loose zoning.

#10 SMWhite on 03.25.08 at 7:53 am

Zoning, running out of land and immigration, all weak reasoning for the run up in prices…

As patriotz pointed out the zoning boogeyman, just how many immigrants are able to afford to get into the market as it sits right now. I also think its safe to say that in Canada we’ve got a few extra acres of land to build on and cities are only too happy to develop out lying areas to increase municipal tax revenue, which when factoring new housing assessments, you would think a lot of municipalities are smacking their chops on all that potential future tax revenue!

Hal, Huy has it bang on. You have to be careful of whom your listening to when CPI and Core CPI numbers are being spewed.

Core CPI:
A variant of the CPI that excludes eight of its most volatile components which account for 16 per cent of the CPI basket—(fruit, vegetables, gasoline, fuel oil, natural gas, mortgage interest, intercity transportation, and tobacco products) as well as the effect of changes in indirect taxes on the remaining components. (Prior to May 2001, the Bank of Canada used the CPI excluding food, energy, and the effect of changes in indirect taxes as its measure of core CPI.)

Hard to believe its only 16% when you factor in the increase in transportation costs because of the accent of fuel over the past 7 years…

#11 Lawrence on 03.25.08 at 12:42 pm

I guess I am a contrarian. While the masses leave the real estate sector and pursue wealth in “securities” I am planning my second real estate purchase in the U.S.

Low interest rates, buying a real asset compared to ABCP (read toilet paper), no sweet talking financial planner to argue with. Just a simple business of buying low and selling high. To do that effectively, you do have to make a purchase.

Every credible expert is saying the market will not hit bottom until, likely 2010. What’s the hurry? — Garth

#12 Lawrence on 03.26.08 at 11:49 am

That is the joy and the risk of being a contrarian. I think people will soon realize that a house is the most accessible and safest investment that anyone can make. The stock market is full of scams. The “securities” market has been decimated by the fraudulent packaging of high risk mortgages and investment banks are reeling, as are their shareholders, employees, and the public.

Do people think they can count on their RRSP in retirement? Not a chance because no matter where you put your funds, you are subject to vicissitudes that you can’t see coming. If you plan to retire with some wealth and real “security”, you better own at least one property.

People will want to put their money where they can see it, use it, and control it themselves. The house is the best investment one can make. There is nothing more essential than a roof and interest rates today make that purchase easier than it was six months ago.

There is good product on the US market at low prices right now. Excellent location is the key to every good real estate purchase. These are the first to rebound as supply in these locations dwindles. Now is the time to get going and make a smart purchase with a three year time frame on a tidy profit.

I will let you know how I do Garth.

#13 Tony Danza on 04.01.08 at 3:33 pm

Mr. Real Estate Agent, uh, I mean Lawrence , hate to break it to you, but you are definitely not a contrarian. Contrarians won’t be buying real estate until 95-99% of society believes that it’s the worst investment you could possibly make. All of your friends and family will be begging you not to throw your money away on houses when you are truly contrarian.

#14 Tony on 03.25.09 at 7:28 am

I’ll go on record as saying Calgary and Edmonton Alberta prices will bottom out this October 2009. How do i know i’m nibbling in both cities right now and will start seriously buying this October. My guess is the real estate market in the depressed areas of America will bottom out around March 2010. You may hear premature stories earlier but my guess is March 2010.