Wednesday, September 23, 2009

Canada's proactive bank bailout

And they said we are different here. Of course, they were right: we bail our banks out before they need to be. Apparently, the proactive bail out program will continue:
The banking industry has been pressing the Finance Minister to extend the length of the program because they continue to benefit from it and because there is still the possibility that liquidity pressures could re-emerge.
I think we should make no mistakes about what is happening here. It is very clear that mortgage holders don't want to be lending at today's rates. There is tremendous risk for lenders with home ownership rates at all time highs, home prices at all time highs and interest rates at their lowest in history. There is no wiggle room, the banks would usually price in the risk with higher interest rates, but because they know if they did that, market prices would fall, they don't want to. Thankfully, they have the Canadian taxpayer.

I'd write more, but I came across a piece of writing that has already summed up the issue better than I can:
True, Canadian banks have avoided some of the sillier extremes, particularly those related to off-balance sheet leverage. But the key problem in Canada is precisely the same as it is in the other western countries now experiencing bank solvency crises. Home prices have grown to an abnormally high multiple of employment income, supported by a rapid expansion in mortgage debt.
The key difference between Canada and other markets is that in Canada the cost of bad home loans have been socialized in advance. In Canada, we didn’t need to disguise our sub-prime excesses within dubious mortgage-backed securities. Why create an alphabet soup of bogus AAA paper when our government provides seemingly limitless quantities of underpriced mortgage insurance? As a formula for creating housing froth it has been virtually unbeatable. Housing markets may be cratering throughout the world, yet one observes a perverse new high in Canadian real estate prices in May of 2009.

The key to Canada’s bubbly housing success been the CMHC . The Canada Mortgage and Housing Corporation writes guarantees on most Canadian mortgages originated at greater than 80% Loan-to-Value. This agency has been on a massive expansion binge of late. In 2008, a year of synchronized global recession, the CMHC expanded its mortgage insurance in force by a whopping 18%. CMHC now guarantees $407.7 Billion of high loan-to-value mortgages and an additional $233.9 Billion of securitized mortgages.

In all, the CMHC mortgage guarantees are equal to slightly more than half of Canada’s GDP. Against this total, CMHC has miniscule equity capital of $8.1 Billion. How is it that more than $630 Billion of dodgy mortgages can be guaranteed by an entity posting just over 1% in equity? This is a question that curiously appears to have escaped the notice of Canada’s top notch financial regulators.

The role of the Canadian banks has been to commit capital to CMHC-insured mortgages as quickly as they receive applications. It is not mortgage lending in the traditional sense, more like underwriting government bonds and taking a 150 basis point spread as compensation. In this way, the Canadian real-estate bubble looks a lot like its American cousin. Home loans are being written for those who likely cannot pay by lenders who pass through the credit risk to a third party. However, in the case of Canada, the third party is our own government and not the Chinese or Saudis who snapped up American mortgage paper.
All of the above was quoted word for word from Geoff Castle's blog. The comments over there, on this post anyway, seem to be very intelligent. Discuss away here if you'd like.

30 comments:

maniac78 said...

Was there a corresponding interest rate hike in 2006 that lead to the US housing market crash? If not does anyone know the precise reason for the bubble popping? If there was no interest rate hike or other sudden event which set off the collapse then I suggest the bubble could burst in Canada for the same unknown and mysterious reasons.

HouseHuntVictoria said...

Maniac,

The bubble did burst in May 2008 without any precipitating event. Ultra low interest rates have re-inflated it here. In the US, the bubble burst because of supply demand ratios. They didn't drop interest rates rapidly like we did.

Reid said...

IMO the real estate market in Victoria started to correct in May 2008 because the cost of living took a major jump as oil prices skyrocketed. Gas prices were about $1.50 per litre, the price of food had jumped and companies were all pushing cost increases because of higher oil and transportation costs. Many people started to reassess what they could afford and with interest rates at about 6% housing was no longer affordable.

In the US, the bubble burst for a few reasons. One reason was that many mortgages were issued with teaser interest rates that would move to market rates in the future (2-3 years), and when interest rates did rise (2006 for example) many of these mortgages started coming up for re-pricing and the homeowner was facing both the loss of the low teaser rate and the higher market rates which in many cases doubled their payments. This coincided with banks/investors being able to lever their mortgages investments with very low capital requirements, so when people starting defaulting things got ugly fast. In Canada our financial institutions were forced by legislation to maintain higher capital ratios, which have helped the banking industry through the past year.

Just Jack said...

I think one of the ways this market could collapse is through the back door of our marketplace. And that is the vacancy rate. It does not matter what happens to the interest rate if one, two or a dozen of the properties you bought on speculation of appreciation goes empty. Your cash flow drys up and the banks are on you.

The other enemy of the marketplace is flat or near flat appreciation. The market must increase at double digits each year, otherwise it is not possible to re-finance yourself out of debt. Our rate of appreciation has seen some up and down swings, but essentially it has been flat lined since May, 2008. In the past you could use your line of credit or up your global limit based on home appreciation. For people that have bought in the last three years with high ratio financing the home ATM machine has gone empty. How long can you keep the creditors away? I think most people could revolve their debts by paying one credit card with another as well as stall payments for about two years. Those who have high ratio financing would not have the option of selling the home as the mortgage would be higher than the sale proceeds after expenses. This is the case of a Boeing 747 heading for a mountain top and the pilot is locked in the bathroom. In our case this might just be Bear Mountain.

In consideration of the above, the proof might be that our rates of personal and business bankruptcies should start to spike upwards to new levels. Anyone following these numbers out there?

Robert Reynolds - GBA said...

Just Jack said...
This is the case of a Boeing 747 heading for a mountain top and the pilot is locked in the bathroom.


That has to be one of the weirdest analogies I have ever heard, bravo.

;)

Roger said...

Here is today's...

Chart of the day..

Blaine said...

This was on MSN homepage this morning:

http://money.ca.msn.com/investing/news/business-news/article.aspx?cp-documentid=21884077

I agree with previous poster's comments about how there's no regard for WHY things are occuring in headlines. Also interesting to see who provides the report --I'm sure Re/Max is very impartial with their opinions....

Roger said...

Interesting news article:

Canadian credit card default rate at record level in Q2, Moody's says..

"Canadians have had record debt levels and the result has been that now the chickens have come home to roost so to speak," she said.

"They're tapped out. They can't get more credit. The banks are shutting off the stream of credit because their losses are so great, which is one of the reasons that debt load has not increased."

Animal Spirit said...

HHV - great post, explains exactly what I thought - gov't is underwriting the whole thing, it likely has gotten out of control and the pilot has his zipper stuck in the washroom.

Roger - Charge-off rate of 4.96% in June, was 3% approx. in 2nd quarter of last year. In comparison, Capital One was running a 3% charge-off rate in the U.S. in mid-2006, and hit 5% in December of 2007. (see: U.S. Charge off Rates

(note to readers, this is complete hypothesis without any true analysis behind it)

Charge off rates are a sign of consumer stress. Our charge off rates may be lagging those from the U.S. by around 19 months. Would foreclosures and housing market prices here also lag by the same amount of time?

Doubtful.

NanHousing said...

Pam Anderson now in debt for over a million dollars over construction financing in the states...wonder how this will go over with regards to her new development which was supposed to get off the ground soon (or has it already?)

PainInThe said...

Never see the light of day.

Vic said...

My daughter tells me today she has had two "unhappy owner" couples just tell her in no uncertain terms, no matter what, DO NOT buy a house and wait at least 3 years. Thank God there is finally a sign,a glimmer,that maybe there is some sanity coming back into the youth of today.

Basically it is the story we all know is happening but never admitted to, and that is they hate being tapped out every month,no money left for anything,having to redo loans and consolidating credit cards etc so they can stay afloat. In other words one big pain in the financial ass.

Such is the life of a "happy owner" in VicTown. NOT !

Roger said...

Here we go folks...

BMO Is the first big bank to lower it’s 5-year variable rate to prime (2.25%) ..

The smaller players have been offering variable loans at prime for a few weeks. Now that a major bank has lowered the variable rate watch the FTB's sign up in droves. However, once the BOC starts raising rates they will be in for a shock.

My suspicion is that the glow of home ownership will wear off fast once they start paying more every time the BOC raises rates. Look what happens when they go to switch to a fixed rate.

Mortgage payments..

Just Jack said...

We just got in from a drive along Beach Drive. I have never in all the years of living here seen that many for sale signs. Wow!!

S2

mr4am said...

Don't be fooled by the stock market (bear) rally. Video: Wall Street is now disconnected from the economy.

Stocks are rising because governments are pumping in $$ like mad (at the cost of greater deficits socialized by Mr.Tax Payer & the *cough* unlimited *cough* ability to sell bonds/debt), and they can't stop, or the wheels will fall off to 2008 lows or lower.

North America is a consumer driven economy. The consumer is (financially) dead. Increasing Unemployment, Wall Street investment losses - even if some recovered - , massive Pension Plan losses, flat or decreasing wages, home appreciation flat, daily consumables still inflating and energy may also go higher, export industry is hurting with high canadian dollar, banks are cutting back on credit (though not yet on mortgages it seems), and high interest rates are probably just a year away. The only reason the markets are still floating, on very low volume I might add, is because of government stimulous - which can NOT go on forever... in fact the longer it goes on, the more taxes joe 6 pack is going to pay - that is, another nail into the coffin of the consumer. A jobless recovery is not a recovery of the economy, only a recovery of wall street.

This will not end well, Flaherty isn't naive, he will raise rates... or the bond market will force them up. Either way no way in hell this housing market will keep going up ad nausea. I give it another year, 1.5 max. Then POW!

Only a question of time folks, the longer this charade goes on, the larger the fall... then high interest rates & inflation will hit like it's 1980 all over again.

Another great video here on the state of the economy from BNN, with Harvard University Niall Ferguson. I agree with pretty much everything he says, except for the Chinese recovery - that's fake too. Watch this excellent (video) piece on what's going on in China.

Next wild cards:
- War with Iran in ~1 or 2 years?
- China to slowly stop buying US Debt? First long term debt, then short term.
- US Fed audit to shock and awe?
- G20 to solve nothing as tensions between the involved nations are escalating & self-interests oppose each other.

tick tock tick tock
Mr.4AM

Vic said...

No need to worry that tourism will he hit hard by the HST. The tourism minister has his crystal ball intact stating there will be so many people coming here after the Olympics you won't feel a thing. Isn't that like when the doctor is about to stick the needle in ? This government is on crack and in major damage control.




"Many of the fears in the industry about the HST won't be realized because [tourism operators] will have such an upswing in business as a result of hosting the Olympics that their anxieties about this will be distant memories," he said"

HouseHuntVictoria said...

Roger,

Do you think there are a disproportionate number of FTBers buying using variable rate mortgages?

Most of the homeowners I know, 5 year owners or more, are in them and wondering when to lock-in. But they're all in discounted below prime rate products.

I'd be surprised if banks were encouraging high ratio lending at variable today.

PainInThe said...

""Many of the fears in the industry about the HST won't be realized because [tourism operators] will have such an upswing in business as a result of hosting the Olympics that their anxieties about this will be distant memories," he said"

Only until March 1st, that is.

HouseHuntVictoria said...

^ tax doesn't kick in until July 2010 either... it's a BS argument.

Roger said...

HHV said,

Do you think there are a disproportionate number of FTBers buying using variable rate mortgages?

Yes I do. I had a conversation with my financial representative at one of the major banks last week. He said that variable was the way to go for clients because you could switch to a fixed as rates rise. When I said fixed rates will be much higher when people start considering a switch there was a long pause.

People switching will be a great business for the banks. They make a nice profit on the variables now because GIC and savings account rates are low. When people get scared (once rates rise) they will switch to a fixed and pay hundreds more a month. Banks know this is a great "bait and switch" manoeuvre and they can't lose because the client has paid for their CMHC insurance.

Roger said...

HHV said,

Do you think there are a disproportionate number of FTBers buying using variable rate mortgages?

Yes I do. I had a conversation with my financial representative at one of the major banks last week. He said that variable was the way to go for clients because you could switch to a fixed as rates rise. When I said fixed rates will be much higher when people start considering a switch there was a long pause.

People switching will be a great business for the banks. They make a nice profit on the variables now because GIC and savings account rates are low. When people get scared (once rates rise) they will switch to a fixed and pay hundreds more a month. Banks know this is a great "bait and switch" manoeuvre and they can't lose because the client has paid for their CMHC insurance.

Leo S said...

@Roger.

I don't know. I thought the same way (I had an argument about this with Garth, who is a big proponent of VRMs). He's got a good point in that the stats show that in the last 30 years, something like 80% of the time choosing the variable rate will save you money over going fixed.

Not surprising really. You get increased risk but have the potential to earn/save more money. Just like any other investment.

HouseHuntVictoria said...

VRM's statistically do save you money over time. That's not really the point. For someone who has no equity, and therefore no way out, AND who is stretched to the limits of affordability by a 5% down 35 year amortization and 6-7 times income to purchase price it's not about saving money over time, it's about not losing a home because monthly payments jumped 40% over the term of the mortgage.

Roger said...
This comment has been removed by the author.
Roger said...

I agree with Garth. With variable mortgage rates at 2.25% this is a viable way to go under the following conditions:

- The buyer must be able to qualify and feel comfortable with the payments for the same mortgage amount at five year fixed rates.

- Once you start with variable you need to ride along with the inevitable increases. Switching in the middle of the term to a fixed could cost more than taking a fixed to begin with.

- Taking a 35 year term and not paying extra every month will mean a significant payment increase every time rates go up. A way to sleep at night and pay off the mortgage earlier is to make extra payments. One way is to make the same monthly payment as a 4.5%, 35 year fixed rate mortgage. At renewal time there will be less increased payment shock.

Disclaimer: An FTB that takes a 35 year 2.25% mortgage, with monthly payments that they can barely afford, will be heading for disaster in a year or two.

Just Jack said...

When you've purchased a high ratio, 35 year mortgage at 6 or more times your gross income, you have given up the ability to make a paydown on your mortgage that could maintain your level of payments when the interest rate increases.

There is NO Money left in the cookie jar for extra payments.

You miss a payment here and there and the lender will add the payment to the mortgage, thereby extending the life of the mortgage and significantly increasing the total money to be paid back.

OUCH, you DO NOT want to be in this position! You have effectively leased the home from the bank at 1.5 times the property's rental rate. And when your term is up, you will have to vacate the property. AND you will still owe the lender the difference in the mortgage and the forced sale price plus costs incurred by the bank to sell the property.

Frankly, I'd rather be a cabin boy on a Greek freighter holding a bottle of baby oil.

Robert Reynolds - GBA said...

EI numbers for July are out. The number of claims dropped. Pumpers are out declaring green shoots.

Ottawa Citizen Story


The improvements reflect a slackening in the pace of recession-related job losses. The national job market has lost 31,000 positions during the last five months compared with the decline of 357,000 during the five-month period following October 2008, when employment peaked.

Yet the data masks an underlying weakness, said Erin Weir, an economist at the United Steelworkers in Toronto, who remarked, "This news would be good if it reflected former recipients finding work. However, employment also declined sharply (by 45,000 jobs) in July.

"A more likely explanation is that significant numbers of unemployed workers are now running out EI benefits without finding jobs."


Why can't they track how many claims ended due to running out of benefit? Seriously, what is so hard about tracking that stat?

HouseHuntVictoria said...

Victoria Real Estate Board month-to-date stats: Sales: 684 - New Listings: 1002 - Total listings: 3412

via @timayres on Twitter

HouseHuntVictoria said...

Sales rate continues to fall, though September sales will be higher than previous 3 years (2005 highest in last 4 years). Listings remain stable.

I expect to see average and median SFH prices higher MOM, still down from April 2008 peak.

PainInThe said...

Thanks SO much, Just Jack... I ASKED you not to tell anyone how I got my name...