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Canada Moral Hazard Corporation?
Submitted by Leo Kolivakis, publisher of Pension Pulse.
As the world's spotlight turns to the Vancouver Olympics,
all eyes will be on Canada. Our nation suffered comparatively less than
other G7 economies during the last recession, and our banking system
has received praises for being good and boring (read the Sceptical Market Observer's comment on this).
To
be sure, our economy is adding jobs, our stock market has rallied
sharply, our currency is close to reaching parity with the USD,
commodity exports are up, everything looks great. A buddy of mine even
told me that our currency is being bought by central banks around the
world. Canada seems to be on a tear.
But things are far from perfect. For one, there is a housing bubble in the making
that could last a lot longer than people think. Stephen Jarislowsky,
one of Canada's best known investors, says he believes government
measures aimed at juicing the housing market has put the sector in a bubble:
"I am convinced there is a housing bubble in Canada," Mr. Jarislowsky told Bloomberg News. "… I conclude that the
prices of housing today in the U.S. are cheaper than they should be,
and that the prices in Canada are far more expensive than they should
be."
Mr. Jarislowsky is not alone. Other economists have also
fretted about a bubble given the stunning rebound in real estate after
the slump, and projections for record sales and prices this year.
Ottawa is now considering tightening some rules. Said Mr. Jarislowsky:"They have basically encouraged people to buy houses based on cheap
mortgages. That has created the opposite effect of what was desirable."
Then, there is what Peter Foster of the National Post calls the Canada Moral Hazard Corporation:
There
has been much official chest swelling over Canada's relatively strong
performance during the financial crisis, but perhaps Canadians
shouldn't -- if you'll excuse the mixing of metaphors -- be counting
their chickens until they are sure that there are no black swans
present. And in fact there does seem to be one dark, plump, bird
looming around the back of economic barnyard: the Canada Mortgage and Housing Corporation. Or is that a turkey that should be renamed the Canada Moral Hazard Corporation?
The
CMHC was never given a cutesy acronym like its U.S. equivalents, Fannie
Mae and Freddie Mac. But why not "Morrie Haz," acknowledging that it
has always been an instrument of moral hazard, the situation where
insurance makes the insured-against event more likely?
As we
know, Fannie and Freddie -- which were privately-owned but
"government-sponsored," which meant they inevitably got bailed out --
were front and centre in the U.S. housing market meltdown, which in
turn precipitated the global financial crisis.
There are increasing
concerns that the Canadian housing market is headed the same way as
that of the U.S., stoked by the same factors: artificially low central
bank interest rates, and the government insurance/promotion of risky
mortgages.
This policy double whammy explains the growing
calls for somebody -- banks? CMHC? Carney? Flaherty? Anybody else? --
to tighten mortgage regulations. These requests appear puzzling until
we realize the role of the CMHC in encouraging perverse behaviour.
In
a free market, if banks felt a housing bubble building, they would
simply tighten standards themselves, either by demanding higher credit
qualifications, hoisting rates, or shortening amortization periods.
Hoisting rates is out of the question, since rock bottom mortgage rates
are now considered by the Bank of Canada to be essential to national
economic recovery and protection of our export industries. That leaves
Morrie Haz waiting there to insure mortgages, and gives the banks every
incentive to hand out any loan that can get insurance. However, they
obviously grasp that such cosmic policy fecklessness will ultimately
come back to haunt them.
A couple
of weeks ago, Peter Routledge of credit analyst Moody's pointed out
that the overheating of the housing market was goosing an unsustainable
increase in household borrowing more generally. "As witnessed in the
United States," he wrote, "this movie does not end well." Specifically,
once the punchbowl of low interest rates disappears, households find
themselves in trouble, and so do their bankers.
Mr. Routledge
noted that Canadian banks likely wouldn't wind up in the same depths as
their U.S. counterparts, but that is only because their riskiest
mortgages are backstopped by CMHC. But this makes the systemic threat
to the Canadian economy greater.
The U.S. crisis was massive
but did not fall entirely on Fannie and Freddie. It was shared with
other financial institutions. Nevertheless Fannie and Freddie both
failed and had to be taken into government "conservatorship." Mr.
Routledge suggests that the situation is more "secure" in Canada, but
as a recent report from the Fraser Institute points out, what this
really means that the Canadian system features "massive taxpayer
exposure."
Mr. Routledge suggested
that CMHC should tighten its insurance criteria, and this week he was
seconded by former Governor of the Bank of Canada David Dodge.
The
Fraser study, by Neil Mohindra, confirms that the taxpayer risk from a
housing collapse is greater in Canada than elsewhere. He notes that a
stunning 90% of all insured residential mortgages in Canada are covered
by the CMHC. This amounts to an estimated $480-billion for which
Canadian taxpayers would be on the hook if the housing market tanked
(although any loss would obviously only be a fraction of this amount).
The
study suggests that the CMHC's activities should be privatized, but
that possibility appears a long way down the road, both for practical
and political reasons. The biggest problem is that nobody is going to
want to privatize a property which harbours a potential time bomb.
The
whole thrust of CMHC insurance is to encourage banks to make riskier
loans. Normal insurance provisions are based on actuarial principles.
CMHC insurance is based -- like the activities of Fannie and Freddie --
on promoting home ownership. Mixing social and economic objectives
usually ends in taxpayer tears.
There is no indication that
the Canadian mortgage market has been subject to the lunacies of the
U.S., where -- for a while -- anybody with a pulse could get a home
loan. Still, high ratio mortgages -- that is, ones with down payments
as low as 5% -- inevitably carry a hefty risk of default when a bubble
bursts. That default then becomes the CMHC's problem.
As such, notes Mr. Mohindra, Canada is not a model for anybody. Morrie Haz has always been an accident waiting to happen.
According
to Moody's Mr. Routledge, "If policymakers deploy the appropriate tools
early rather than late in this period of household credit expansion,
perhaps the Canadian movie will end differently."
But Finance
Minister Jim Flaherty knows that ending the party is not going to be
popular, which is where inevitable political self-interest compounds
those practical problems. Meanwhile CMHC isn't just a provider of
potentially reckless insurance and the depository of last resort for
mortgage assets the banks don't want. Yesterday a representative of
Diane Finley, Minister of Human Resources and Skills Development, who
is also responsible for CMHC (go figure), was in Montreal handing out
stimulus slush under Canada's Economic Action Plan.
Mr.
Flaherty doesn't want to see a bubble, much less a bomb. But when it
comes to which movie we're coming to the end of, maybe he should check
out The Hurt Locker. Just in case.
Of course, lenders like ING, oppose any clampdown to rein in mortgage borrowing.
Sound familiar? I agree with Stephen Jarislowsky and I also fear that
this movie isn't going to end well. Enjoy the Vancouver
games, because I feel a post-Olympics winter chill headed our way.
»
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What is perhaps most shocking about all of this is that the current housing bubble is driven exclusively by policy of the conservative government. The looney mortgages started to creep up once the Harper government came to power and lowered the rules on CMHC and the banks.
One wonders whether this is all an attempt to fuel economic growth enough so that they can call an election and get a majority. After that when the bills come in - with a pretty severe landing - they will have their majority and do what they want.
i'm half newfy on my mother's side, u.s. born, and i saw our bubble coming. i have two words for my canadian half-cousins. SELL! NOW!
There will be no financial collapse. We are in a New Age !!
Nice post Leo.
I've been thinking the same thing about the time frame (post Olympics) because of what happened in China shortly after Beijing. By the way, wasn't it Greece who hosted the Summer Games in 2004? Hmm...will Canada need an IMF bail-out by 2016?
I laugh everyday when I hear the economic eggheads dancing around the issue of whether or not Canadian housing is in a bubble. Someone from the TD Bank who should know better even had the audacity today to repeat the old Greenspan mantra about not being able to recognize a bubble until it bursts! What a tool.
I have noticed that very few of those pontificating on this subject mention how out of whack income is in these cities and this country in general in terms of house affordability. To his credit David Dodge is not one of them but when he was Governor of the Bank of Canada he waffled and obfuscated with the best of the current crop.
Being a student of history, a re-reading of Charles MacKay's timeless 1841 classic Extraordinary Delusions and the Madness of Crowds is the only sure-fire antidote to the constant bombardment of news of the economic absurdities that have gripped and will eventually enslave a whole generation of naive and greedy Canadians.
Wht are you complaining Leo ? This new Canadian frenzy will drive your stocks to new highs !!
I disagree with this post. The housing market in BC is crap compared to the pre-Lehman collapse. Ask any realtor - the housing market is hurting. If this article was correct, it'd be far more active. I'm not saying that CMHC may not have over-extended itself but nothing is safe (not even Canada) to the coming financial collapse.
Canadian real estate never goes down!
The gains are permanent.
Buy now, or be priced out forever!
If I recall it correctly I read somewhere that Bank of Canada already bought 50 billion in mortgages from banks (in 2 shots). If we multiply it by 10 to get some comparison with US is about 0.5 trillion, and that is just begining, if interest rate goes up we will be in much worse situation. It's been interesting too me that all those "big names in economics" in Canada always asure everybody that Canada is not in bubble yet!We will see!!!!!
Yikes, and I thought our good neighbors up North were more purdent and learned from our greed, stupidity and lies. So much for that currency. More physical gold anyone? Cause the dollar is not going to save us...long term.
What has happened to our society to make money and greed most important above all else.
Greed in a good sense is a good thing. But not when it destroys lives financially. I can't go there.
This will all end badly. It will get ugly.
Canada should buy some Chinese Solar on the dips.
Rolling on the photo volatic panel laughing!!!!!!
I live in a large town in Alberta, no oil, retail agriculture and govt services. Margins are thin, construction self-employment is huge. There are two houses facing one another on the same street one is $319 and another is $625. The former has not sold for well over a year. I get the feeling this is a make it or break it for alot of people who needs to deleverage.
My belief is that there was a bubble in Canada before the US popped, and it has only become larger - Saskatoon and Regina both more than doubling in the last five years, for example, and Vancouver continuing on in part due to low interest rates but also the China stimulus (or its knock-on effects).
But who in the %$#% would live in Saskatoon and Regina if they didn't have to? And how high are wages for those who must?
The answers are almost no one, and not high enough.
But the problem for me personally is that I live in Vancouver, which in past bubbles has been referred to by some as Hongcouver. If so, now it must be Shangcouver, or Beicouver, because a large part of the PRC stimulus (or its knock-on effects) has ended up here over the last year. I gave up trying to understand China years ago, and despite the compelling arguments of Chanos and others noted on this site, and my own brain and gut telling me that it is never "different this time" anywhere in any market, I fear it might be "different enough this time" to mean the bubble in Vancouver stays inflated...
If China pops, though, I imagine Vancouver housing will take a hit; deflation globally will likely ensue. I myself have been waiting to get into the market which, anecdotally, is starting to see more listings in the neighborhood I want. Also anecdotally, friends in CRE and national law firms (mid to senior level partners) are more pessimistic NOW re: Vancouver and BC's prospects than at any time since they began their careers. There will be a post-Olympic hangover, no domestic (BC) engine for growth -- but still the possibility that $$ out of China will continue to prop up this housing market... As well, interest rates will still likely be close to zero here, and the CMHC will still be backing the morally hazardous system that is definitely beginning to take root.
Vancouver also has a condo market set to implode. Prices are $1000/sq.ft for virtually any apt over 1200 sq.ft! There are many buildings levitating from $1200 to well OVER $2000/sq.ft! (a 2500 sq.ft apt = $5Million) Sound like an 'affordable' place to you?! Sounds down right 'bubblicious' to me... Good luck with that!
Removing the punch bowl is never going to happen in a democracy --- there is only a mechanism for spending and buying votes --- there just is no mechanism for tough love. We are doomed to boom and bust. Even Germany is wavering, even Germany! It looks like the profligate, lying Greece will be bailed too. What else are these zero rates anyway?
This would be a much needed splash of cold water on complacent Canadian faces. My humble abode in small town Ontario has doubled in price in the past decade, while the average income has been generally stagnant. Something has got to give.
A 30 year, 95% loan on 375,000 at 7% amounts to a monthly loan payment of nearly 24-hundred dollars per month, not counting housing insurance, PMI, etc. (if they even have PMI up north.) That works out to a yearly salary of 115,000 dollars or about 55 dollars per hour. THIS IS ENTRY LEVEL? Sorry for sounding shocked, but most of the employees in my area are scrambling for jobs that pay $10-12/hour and you're talking entry level at 55?? Yeah, that sounds like one heckuva overheated housing market with lots of speculation going on. Tears are on the horizon in Vancouver and not for missing the medal podium.
Anon #229886,
few weeks ago the variable interest rate in Ontario was 2.2% or so.
That rate gets the monthly payment quite a bit lower. As long as the interest rate stays low, the game can continue; when rates go up, good luck.
And if commodity prices collapse from a crash in China...
Agreed, I am on Vancouver Island, and a realtor friend tells me that entry level homes are moving like crazy.
"Entry level" is $375 to $450k.
It would seem to me that either wages must rise dramatically, or prices must decline dramatically, or perhaps at least a little of both.