Friday, February 20, 2009
Credit crisis visualized
The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.
H/T to Tim Ayers for the video link.
Canadians like to say this didn't happen here. We especially like to claim that our banks are the best in the world. And we love, especially if we make money in the real estate industry, to spread the myth that our banks didn't play this game in Canada, that Canadians didn't buy properties they can't afford and that because of these two "facts" we are somehow immune to a Canadian version of these events.
Hogwash. There is absolutely no proof that Canadian banks didn't engage in these behaviours. In fact, there is proof that they did. The difference, it would seem on the surface, is scale.
A friend of mine bought a house last week. She's self employed. She had a down payment, albeit a small one, so she trucked off to a mortgage broker to get a loan. The house she wanted was outside of her qualification range. Because she is self employed, she was using a stated income loan application (no proof of income required). No problem says the broker, we'll just up your income.
Of course she had some misgivings. Enter the REALTOR who explains it's only a temporary miss-statement of income because your income really will go up when you start collecting the rent from the basement suite you're going to build. Fair enough, says my friend.
The broker, the REALTOR and my friend all were complicit in this little work-around to get the deal done. But sole responsibility for the deal rests with my friend. She wanted the house and was willing to do anything to get it. She's aware of the market conditions, but after having just lost her previous house to a relationship breakup, she just couldn't "go back to renting." And the mortgage she bought is not considered a sub-prime product. In fact, it's available, only through a mortgage broker, but is a product underwritten by a Big 5 bank.
We've seen estimates of so called sub-prime lending in Canada at 5%. We're starting to see all kinds of ads for low-interest, interest only and subsidized monthly payments as builders try to liquidate their inventory without dropping sales prices. All of these incentives, incite people to spend money they don't have, to take on debts that leave them hyper-extended, and contribute to Canada's homegrown version of sub-prime. The disease may be called something different, but the symptoms are the same.
Last year the government recognized the toxic nature of 0 down 40 year amortization loans. After a year or so where pretty much 50% of all mortgages sold were "low-down and extended amortization products" the government got rid of only the most toxic. And then promptly bought them from the banks transferring the risk to the taxpayer.
The problem isn't solved in Canada. The same products that existed in the US are still being used today. The big difference here is CMHC insurance. Because the banks have insurance on these deals, they don't typically turn around and sell them. But over the past 6 months, they have. The Government of Canada bought $125 Billion of these toxic debt products from the banks. And the banks in turn have lent out more in the form of credit card debt, low-down mortgages and HELOCs.
All Canadians are on the hook. All of us who pay taxes anyway. Home prices are falling. People are losing their jobs. Some will lose their homes (granted our walk-away laws are very different than the US which should prevent voluntary walk-aways up here).
Any way you try to explain it away, Canada did engage in this same credit swap scheme. The players involved are slightly different and so are the products. But to make the claim that people didn't buy what they couldn't afford using products that leave them perilously close to default is misleading.
Time will tell how bad our credit unwinding will be. But as long as prices continue to plummet, and plummet they are, credit will have to tighten. The scale will be less, but the damage may end up being just as bad. I fear the only true measure of the real problem will be the number of "motivated" sellers we see over the coming years. And like our US cousins, this correction will be played out over years, not months.