Entries from December 2009 ↓

What problem?

“A hammer to kill a fly.”

And with those five words, Benny Tal summed up the case against the finance minister. The CIBC economist was one of a number of people who trotted out from the bushes to tell the nation why it would be a bad idea for the government to stop sanctioning 95% leverage in the real estate biz.

As you might imagine, he’s been joined by others in the business of selling and financing houses. Safe to say they’ll all be dumping on Jim Flaherty from the 54th floor over the days and weeks leading up to the next federal budget.

Do they have an argument?

In case you missed the news, it’s finally come to Jim’s attention we have a housing bubble. Actually that’s not fair. The government knew it long ago. Ottawa wanted a bubble because it was desperate to ignite inflation after our recent flirt with deflation. That was the reason for (a) the home reno tax credit, (b) $17 billion in stimulus spending in eight months, (c) a $56 billion runaway deficit and (d) a central bank rate of 0.25% leading to mortgages at 2% and young couples borrowing their brains out.

But instead of the little bubble planned on, we have a mother of a gasbag. Here is the result:

  • Low rates encourage excess borrowing. Purchasers hot to buy houses in a rising market tend to think existing mortgage rates will remain at that level for the foreseeable future, especially first-time buyers who’ve never faced a renewal. Rock-bottom lending rates mean people with below-average incomes qualify for loans they’d simply not be able to service in normal times. This is a time bomb destined to ignite, and the height of irresponsibility by policy-makers.
  • They spawn bidding wars and recklessness. When money’s so cheap and measured in monthly payments rather than overall debt, frenzied and inexperienced buyers in a competitive situation (often created by realtors promoting an auction environment) are willing to pay tens or hundreds of thousand extra to ‘win’ the competition. Realtors call such a tactic a ‘bully offer’ – blasting through a bidding war with an extreme offer.
  • They making houses more expensive. Obviously. By massively increasing the amount of money people can borrow on the same level of income, low rates and high leverage flood the market with liquidity, allowing sellers to raise prices and establishing new levels of expectations or all homeowners. And while market rates will eventually turn things cold and dampen valuations, affordability for everyone has been dealt a blow.
  • Government policies remove lender risk, encouraging less prudent lending. By erasing the risk from lenders who don’t need to worry so much about repayment or the creditworthiness of the borrower, this practice is akin to that in the US when government-sponsored entities Freddie Mac and Fannie Mae backed loans, and along with Wall Street investment banks securitized them.
  • These policies skew the market for risk and responsibility. With CMHC standing behind all high-ratio loans, and banks off the hook for default, lenders don’t need to charge a risk premium on loans to dodgy borrowers. That means a young couple with no savings and just 5% down can borrow money as cheaply as the move-up buyer with 80% equity. So much for caution.
  • Artificially low rates destroy housing affordability for most families. Perhaps for an entire generation. The legacy of this bubble will be a real estate drought the consequences of which will be long lasting and profound.
  • Low rates encourage and facilitate debt. By every measure, consumer debt has raced ahead as the bank of Canada dropped its key lending rate. Household indebtedness increased by 9% during 2009, and mortgage debt is at an historic high. Odds are that all of this indebtedness will have to be paid off at far higher future costs.
  • Therefore this sets us up for a massive drop in disposable income. Interest rates will increase, as inflation becomes a destructive force, the US tries to support its faltering dollar, new issues flood the bond market and as central governments move to contain the limit the damage they have caused. As the cost of money increases, so will the debt servicing charges faced by millions of families now carrying bigger mortgages, lines of credit and consumer loans which were encouraged by rock-bottom rates. This drop in disposable income is one of the reasons we are entering into a long period of stagnant growth every investor must prepare for.
  • All this guarantees real estate is a spent asset. After every asset bubble, people always reconsider what they have done and this one will be no different. The legacy is a raft of equityless and indebted owners, unaffordable houses, a badly distorted marketplace and the potential for a lifeless economy.

Any realtor who argues against market interest rates, an end to government subsidies for buyers without money or more prudent lending limits is making an argument against their own industry and future.

Mr. Flaherty fuelled this fire. Now it’s incumbent upon him to stomp it out.

Before it incinerates the middle class.



Defenders of the Canadian way are predictable.

Without saying so, they always have the same refrain: we’re superior to the Americans.

Used to be that Yanks shot people in anger, while we kept the peace. Not so much now. Or that Americans dismiss altruistic causes such as the environment, while we embrace them. Er, not according to Copenhagen. Or that they apathetically eschew politics, while we take voting seriously. Oops, not after half of us didn’t bother turning up last time. Or how about those lax US lending standards and excessive debts, while we save and be frugal? Pffft there, too.

In fact, this myth du jour has been bandied about a lot recently by those seeking to justify Canadian house prices, and swearing our banks are buttoned-down, puritan, mormonesque, Amish pilgrims compared to those dollar-drenched, easy-credit Yankee hucksters. No subprime loans here!

Of course, this is untrue.

  • Canada sanctioned government-insured mortgages of 100% as well as 40-year amortizations with which virtually no principal was repaid. If encouraging people without money to buy houses is prudent, I’m on the wrong bus.
  • Of course Ottawa saw the error of its way and changed this to a 5% down and 35-year am. So how does 95% state-sanctioned real estate financing in Canada compare with that to the south? I think the following statements are interesting – the first from the US government mortgage giant Fannie Mae, and the second from our own beloved CMHC:

Fannie Mae: “Your lender will ask how much money you have available for a down payment. A down payment of 20 percent or more of the home purchase price demonstrates your commitment to long-term homeownership and provides you with immediate equity in a new home.”

CMHC: “Down Payment. With mortgage loan insurance from CMHC you can own your home with as little as 5% down payment.”

  • As for so-called ‘liar loans,’ a staple of the subprime culture in the US, in which bankers handed over money to people without asking them to verify income, we’ve been doing the same in Canada for some time. Like this, from CIBC:

“We recognize that the self-employed have traditionally faced greater scrutiny in qualifying for mortgage financing. That’s why CIBC has streamlined the mortgage approval process to ensure our self-employed customers receive the respect and credit they deserve when applying for a mortgage. Approval is based on your self-declared income, strong equity and excellent personal credit history. Best of all, you don’t need to prove your income.”

  • Hmmm. And how about those ‘teaser’ loan rates that trapped hundreds of thousands of Americans into mortgages which were destined to reset at higher interest charges? Lenders told borrowers that rising equity would bail them out, but that just didn’t happen. And how were those so different from the ‘Teaser Carney’ rates we currently have in effect in Canada? Are lenders telling people they should borrow only on the condition they qualify under the rate structire we all expect to be in place in a couple of years?

Not according to people posting on this site. From Sunday’s comment section:

“The banks will give a loan to anyone. Just go to the bank and see. The bank wanted to give us $700,000 and we make $115,000 together.”

“Yeah, the bank also wanted to give me $458, 000 and I make $68,000 a year. I walked out of there thinking there is absolutely no way I can carry that big of a mortgage. People I know were all happy for me the bank gave me such a figure, the same people telling me to buy buy buy.”

While the official policy of the Big Banks and CMHC is that borrowers should have mortgage debt service costs no greater than a third of their income, or restrict home loan borrowing to less than four times their annual take, comments like these make a lie of it. When people in Toronto, Calgary and especially Vancouver are offered mortgages equal to six, seven or eight times their yearly household income – at interest rates which can only go in one direction – how can anyone expect anything other than what we have?

There’ll be plenty of blame to spread.

None of it to the south, eh?