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Liar Loans Pop up in Canada’s Magnificent Housing Bubble

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Wolf Richter   www.wolfstreet.com   www.amazon.com/author/wolfrichter

For a long time, the conservative mortgage lending standards in Canada, including a slew of new ones since 2008, have been touted as one of the reasons why Canada’s magnificent housing bubble, when it implodes, will not take down the financial system, unlike the US housing bubble, which terminated in the Financial Crisis.

Canada is different. Regulators are on top of it. There are strict down payment requirements. Mortgages are full-recourse, so strung-out borrowers couldn’t just mail in their keys and walk away, as they did in the US. And yada-yada-yada.

But Wednesday afterhours, Home Capital Group, Canada’s largest non-bank mortgage lender, threw a monkey wrench into this theory.

Through its subsidiary, Home Trust, the company focuses on “alternative” mortgages: high-profit mortgages to risky borrowers with dented credit or unreliable incomes who don’t qualify for mortgage insurance and were turned down by the banks. They include subprime borrowers.

So it disclosed, upon the urging of the Ontario Securities Commission, the results of an investigation that had been going on secretly since September: “falsification of income information.” Liar loans.

Liar loans had been the scourge of the US housing bust. Lenders were either actively involved or blissfully closed their eyes. And everyone made a ton of money.

So Home Capital revealed that it has suspended “during the period of September 2014 to March 2015, its relationship with 18 independent mortgage brokers and 2 brokerages, for a total of approximately 45 individual mortgage brokers,” who’d together originated nearly C$1 billion in single-family residential mortgages in 2014. That’s 5.3% of the company’s total outstanding loan assets, and 12.5% of its total single-family mortgage originations in 2014.

That’s a big chunk. The company, however, didn’t disclose why it took so long to disclose this.

It said an “external source” had warned it about income falsification on mortgage applications submitted by a number of brokers. Its investigation did not find any evidence of falsified credit scores or property values, it said.

It’s not hard for a lender to require income verification. Not requiring it is precisely what US lenders had done before the Financial Crisis. Add a little encouragement from a broker, and that’s how you get perfect liar loans.

Home Capital had already announced on July 10 (Friday afterhours!) that in Q2, originations of high-margin uninsured mortgages had plunged 16% and originations of lower-margin insured single-family mortgages had plummeted 55% because it had axed some brokers. Its shares plunged 20% the following Monday and another 4% the next day [read… Largest “Alternative” Mortgage Lender in Canada Plunges, Denies “Systemic Problem” in Housing Market].

At the time, HCG was the fourth most shorted stock in Canada. By July 29, the day before the current announcement, HCG had risen to the second most shorted stock. Today, massive short-covering set in, and shares soared 13%, but remain 42% below where they’d been during the halcyon days last November.

“Everyone had their ideas about what transpired in the past six months; this corroborates some suspicions but dispels some others,” Shubha Khan, an analyst at National Bank Financial told the Financial Post, adding – with Canadian understatement – that there were “still some questions.”

Among them, whether these insured liar loans would continue to be insured; and whether this was an isolated problem, rather than an industry issue in the Canadian housing market. In other words, is it just the tip of the iceberg?

Housing bubbles are money generators. Temptations are huge. Falsifying mortgage applications is easy if no one checks them. It’s a mad scramble to extract as much money as possible for as long as possible – but with a devastating aftermath.

Now liar loans are coming out of the Canadian woodwork. The much touted down-payment requirements in Canada have already fallen apart. Don’t have the money for even 5% down? Solutions are openly promoted, for example:

It is not a problem anymore!!! Canada Mortgage & Financial Group (CMFG) has a new product that now allows you to borrow your down payment from any source…. The only amount you need to show on your own is 1.5% of the purchase price….

With regulators breathing softly down their necks, banks might have become more careful in lending to people to buy homes that are among the most overpriced in the world. What has that accomplished? The rise of alternative lenders in the shadow banking system. They’re not subject to the same regulations as banks.

“There’s a lot more that can be hidden from the public, things that are not right could not be noticed early on,” Michael Dolega, a senior economist at TD Economics, told the Huffington Post of Canada. “The quality is slipping, and it’s far more questionable for some of these smaller lenders, but at the same time I think it’s still better than it was in the U.S., when it went south pretty quickly.”

Yes, this time it’s different.

But the patterns are crystallizing: Home Capital Group with liar loans on its books, CMFG with ultra-low down-payment loans on its books…. In banking, bad deals are made in good times.

Even the Bank of Canada, in its most recent Financial System Review in June, fretted over the risks in the shadow banking system due to its “less regulated nature” and outright “opacity,” and considered it a “particularly important vulnerability” to financial stability. While the sector is still relatively small, it would impact the overall economy, it said.

But it’s not so small anymore – estimated at 10% of Canada’s mortgage market and growing rapidly: A report by CIBC (Canadian Imperial Bank of Commerce), cited by the Huffington Post, found that lending by alternative lenders had doubled since 2012, and as of the Q3 last year, was still growing 20% year-over-year.

This comes at the worst possible time for Canada. The economy likely shrank in the first half. Hence, the Conference Board of Canada just downgraded growth to 1.6% in 2015, worst since 2009. It sees some deep problems, after a 15.5% plunge in business investment in Q1:

Oil and gas firms are expected to chop their investment by almost one-third…. Outside the energy sector, firms remain hesitant to invest. Purchases of machinery and equipment suffered a substantial decline in the first quarter of the year, and a decline in building permits suggests a downturn in commercial construction in 2015. Overall, business investment will drop by close to 7% this year.

Household spending is also expected to weaken, despite savings for consumers at the gas pump and federal tax cuts. Soft employment growth, weak wage gains, high level of household debt and job losses in oil producing provinces will combine to limit growth in consumer spending to 2.1% in 2015.

That would be the optimistic scenario. It assumes that the magnificent housing bubble can be maintained; but all bets are off if it takes liar loans, among other underwriting schemes, to maintain it. And when the housing bubble deflates, all these schemes that are forgiven as long as prices rise will turn into an unappetizing mess.

The problems are already spreading in the Canadian real estate sector. Read… Epic Glut of Office Space Crushes Hope in Canadian Oil Patch

 

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Sat, 08/01/2015 - 15:25 | 6379156 elizabethforbes
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Sat, 08/01/2015 - 10:59 | 6378421 New_Meat
New_Meat's picture

I knew it!!!

Linda Green would eventually land on her feet!!

But it took a long time, whew.

- Ned

Fri, 07/31/2015 - 21:19 | 6377552 bytebank
bytebank's picture

Visited Vancouver in June again. Prices are insane. The place is gorgeous but how can anyone afford it? I guess everyone is taking out second and third mortgages as well as sub dividing. Never seen so many nice cars as in West Van.

My guess is that it cannot continue but it has somehow. I have no idea how the people with minial jobs survive? Where do they live?

Fri, 07/31/2015 - 23:33 | 6377805 GuyBaker76
GuyBaker76's picture

bytebank,

Your concern is well founded.   The major source of demand by far is that Canada has an out-of-control immigration problem, which it refuses to acknowledge.

Ottawa has no idea what to do about it.  The BANKS want it and so do the companies who import goods like cars to sell to the overwhelming mass coming into Canada.  

But Canada makes NOTHING . . . it just exports oil, gas and natural resources without any value added.  It has never developed any sustained system to "add value" for export.

So it relies on the biggest immigration flow per capita in the world, practically ALL from Asia, to sustain its contruction industry.  The Chinese Communist Party has allowed some of its newly minted "rich" class to park their families in Canada, while they continue to work in China.  They send enough cash to house and take care of their wives and kids.   They're the ones you mention driving fleets of exotic automobiles.   Part of this is a result of  FEAR, . . .  Real fear that their "luck" in China will end on the whim of a party apparachik.  

Li Qa Shing is the biggest builder  and financer in Canada ever since he bought the Expo '86 lands, . . .  (350 acres of the best real estate on the continent) for a little over $70 million in the late '80s.  His partners include Power Corp and the Royal Bank.   They sure don't want this golden goose to die.   

The brilliance of his plan is that these hundreds of thousands of pigeon holes in the sky he and others are building from Vancouver to Toronto, ALL get filled not just with people, but also with . . . .

•  Furniture from China,  •  Appliances -- dish washers, stoves, washer/driers, etc.   from China and S.Korea,    •   Flooring from China,   •  Glass from China,     •  Kitchen cabinets from China

Canada's lunch is getting eaten.  Builders and banks are raking in billions in profits and incomes.  Good for them.  But Canada and the Canadian taxpayer are in deep trouble.  The average Canadian owes much more personally than the average America.  

This is a bubble.

 

Fri, 07/31/2015 - 18:29 | 6377086 GreatUncle
GreatUncle's picture

All aided and abetted under Carney (now BOE) in the Canadian central bank.

This is just the consequence of his reign.

Fri, 07/31/2015 - 23:34 | 6377843 GuyBaker76
GuyBaker76's picture

Partly, and add to that Ottawa and of course, The Fed which rules the Canadian Central Bank.

Fri, 07/31/2015 - 12:30 | 6375801 armageddon addahere
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Notice that the baddies came out because the industry dug them out and put a stop to them. Unlike in the US where the big banks were the scammers and continued scamming, and covering up, until the whole scam blew sky high.

I'm not too concerned as long as the industry is policing itself. If the scammers and coverups get out of hand you can start to worry.

Fri, 07/31/2015 - 23:21 | 6377817 rex-lacrymarum
rex-lacrymarum's picture

The problem is not merely scammers and coverups. Canada's housing and consumer credit bubbles are far bigger than those in the US ever were relative to the size of the economy. The BoC meanwhile keeps pouring gasoline onto the fire by cutting its already ridiculously low interest rates further. Canada's banks also rely on the state-owned mortage insurer, a monopoly that is an accident waiting to happen. Bubbles are primarily economic phenomena, caused by monetary pumping. The scams are merely incidental to them, but it is a very good bet that a great many more scams will come to light once the bubble bursts. 

Fri, 07/31/2015 - 17:38 | 6376951 Onan_the_Barbarian
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Hey, maybe this time, there *is* only one cockroach?

Fri, 07/31/2015 - 15:38 | 6376547 Seer
Seer's picture

Canadians ought to retain much of those tar sands because, as we know,  it's easy to hide from problems by sticking your head in the sand...

Fri, 07/31/2015 - 12:03 | 6375717 TradingTroll
TradingTroll's picture

Lets not get too excited. Home Capital may be bad but it ain't no Countrywide. I do think this problem exists but wake me up when it's a big 5 Canadian bank because only that would be comparable to the frauds at Bank of America and other US banks.

Sat, 08/01/2015 - 00:42 | 6377927 Abbie Normal
Abbie Normal's picture

"wake me up when it's a big 5 Canadian bank"

Spoken like someone that has been dreaming away this past decade.  You do realize those vaunted Canadian banks took massive bailouts too, right?

Fri, 07/31/2015 - 15:35 | 6376540 Seer
Seer's picture

Canada is nowhere near the economic level that the US is:

http://www.tradingeconomics.com/canada/gdp - GDP $1786 billion

http://www.tradingeconomics.com/united-states/gdp - GDP $17419 billion

About 9 3/4 times what Canada's is.  So, multiply your issues by 9.75 and see how non-problematic your problems are.

Fri, 07/31/2015 - 14:14 | 6376236 robertocarlos
robertocarlos's picture

I'd bet that the Canadian banks are in serious trouble with the oil business and commercial real estate. How is it that Reits continue to buy everything out there? How can rents still be going up?

Fri, 07/31/2015 - 21:30 | 6377580 slimycorporated...
slimycorporatedickhead's picture

dude I live in oil sands country and rents have dropped big time. Typical $2k/month is now $1500, dont kid yourself, average house price in some of these cities like Edmonton is 400k, 450k? Anyone who locks into a 25 year mortgage to buy a 60 year old house deserves whats comin to them, straight up

-slimy

Fri, 07/31/2015 - 10:11 | 6375218 sudzee
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Housing is just over 20% of gdp. With energy, mining, manufacturing and retail sales falling a drop in housing will devastate Canada's economy. Interest rates will need to go negative soon. Federal, provincial, municipal and city deficits continue as well as record borrowing at all level will leave the taxpayer in dire straits just to survive. A much lower dollar is necessary over the long term.

Fri, 07/31/2015 - 10:02 | 6375176 monkeydart
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At the rate our dollar keeps dropping, there will be no shortage of foreign buyers, global recession or not. Should keep those house prices propped up, at least enough for banks to be repaid in cash or home equity. 

CMHC does have a big pile of guarantees but they make so much money off of poor 1st time homebuyers that they should be able to cover the difference between lower home prices and bank mortgage amounts. 

Fri, 07/31/2015 - 11:31 | 6375584 asteroids
asteroids's picture

Nope. Once people go bankrupt CMHC will start paying out to the banks. They'll implode and our Central Bank will start paying out. They are on the hook for $500B. The Looney will crash.

Fri, 07/31/2015 - 12:55 | 6375937 TradingTroll
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Good. We have all the important commodities, oil, wheat, copper, Natgas, sugar beets. We make cars and planes. Our exports will be cheaper and we can be sel sufficient on everything we make at home.

 

Canada is not Japan and its not the US.

Sat, 08/01/2015 - 00:37 | 6377919 Abbie Normal
Abbie Normal's picture

"We make cars and planes. Our exports will be cheaper and we can be sel sufficient on everything we make at home."

Actually, Canada just assembles those from imported parts.  Unless raw iron ore, bauxite and silicate are going in one end of the factory and cars & planes are coming out the other, Canada relies on imported products for almost everything else.  A lower loonie means increased import costs, which translates to higher export prices so there is no competitive advantage from the currency exchange rate.  Not to mention when Canadian assembly-line workers find their paycheck only buys 50% of what it did last year.  Are we seeing shades of Greece or Venezuela yet?

Fri, 07/31/2015 - 15:28 | 6376513 Seer
Seer's picture

No, you're not going to be self-sufficient in the context of comparing to what you currently see around you.

You think you can just do more of the same that currently isn't working?  Sure, you can gain market share, but only with lower prices.  There's STILL the issue of margins.

Main markets are where, US and China?  US economy is just plain faking it.  China's ecnomoy is imploding: they're becoming a consumer economy, consuming their own products (or products manufacturerd there, which might be branded and headquartered elsewhere in the world).

Sorry, but the momentum isn't there any more.  The legs are soon to kick out from under you.

NOTE: If you could go back through archives here you'd find that nearly since day one (over 5 years ago) I was stating that the top three countries able to show any semblence of operating as they've become accustomed to are: Canada, US and Russia.  Never, however, did I, or would I, state that they would be at the same levels, just that they could operate in appearance to what they currently have: exports were expected to drop significantly (which is now happening) and that they'd be more for internal consumption, until, that is, you consume your own stock (but that's  my point- Canada, US and Russia have a fair amount of stock to go through until it gets to the stoneage level).

Fri, 07/31/2015 - 11:48 | 6375642 Seer
Seer's picture

And the Looney has already been crashing.  No other way for it to be since Canada is heavily reliant upon exports.  Oil/energy sector is tightening up, as with all downturns it's now a matter of competitors pushing to retain market share; Canada with it's tar sands cannot compete with Russian, Saudi, Iraqi and Iranian oil.

As others have noted, there's a lot more posed to take down Canada's housing market than just these liars loans...

Fri, 07/31/2015 - 10:02 | 6375174 monkeydart
monkeydart's picture

At the rate our dollar keeps dropping, there will be no shortage of foreign buyers, global recession or not. Should keep those house prices propped up, at least enough for banks to be repaid in cash or home equity. 

CMHC does have a big pile of guarantees but they make so much money off of poor 1st time homebuyers that they should be able to cover the difference between lower home prices and bank mortgage amounts. 

Fri, 07/31/2015 - 11:43 | 6375619 Seer
Seer's picture

"At the rate our dollar keeps dropping, there will be no shortage of foreign buyers, global recession or not."

You're confusing exchange rate drops with actual people having money to purchase housing units in Canada.

If there's a global recessoin then that means BY DEFAULT that there's a slow-down in expansion.  Canada, as has been the case with every other country, has been operating as though we're NOT in a recessoin.   It's going to be really ugly up there when the crossing-of-the-fingers and the assumptions are overpowered by reality.

Fri, 07/31/2015 - 09:27 | 6375063 asteroids
asteroids's picture

Canadians are totally fucked. Have household debt is now over 160% of take home. With interest rates coming that will zoom to 200% in a very short period of time. Interest rate hike will really slow down the economy. Expect a lot of people to declare bankruptcy. Poof, housing collapses. The Looney tanks. Rinse and repeat.

Fri, 07/31/2015 - 09:43 | 6375110 tradingdaze
tradingdaze's picture

Canadians are totally fucked

I live near Toronto and I approve this message.

Fri, 07/31/2015 - 13:46 | 6376124 rainingFrogs
rainingFrogs's picture

The number of payday loan outlets is astounding. On one 5 block stretch, there are 5, once on each block.  This has got to be an economic indicator, likely pointing to the financial situation of the bottom third of households. 

Everyone I know, however, is oblivious to the obvious.  Many have bought condos as investments.  At some point in the not too distant future, shit meets fan ... kaboom!  Underwater.

Toronto, massively overbuilt.  Calgary/Edmonton, energy collapse.  Vancouver, Chinese stock market collapse & capital controls. 

Canada is screwed.  Canadians just don't know it yet.

Fri, 07/31/2015 - 20:14 | 6377412 ExploitedCitizen
ExploitedCitizen's picture

I am just outside Toronto and I see the same thing.  Everyone is so poor they just borrow money to not have to cut back.  Well this fall things will get real.  Sold my house, for double what I paid 6 years ago, not too swift folks.

Canada is broke by December if rates go up.  Ontario is royally screwed.  Idiots elected a fucking teacher to run the province.  Teachers are professional leaches with zero business skills.  Sit back and watch the fireworks, don't own a house or have $$ in the banks either, cause Wynne is a commy and will steal it.

Fri, 07/31/2015 - 12:30 | 6375844 taoJones
taoJones's picture

Simultaneously funny and sad

Fri, 07/31/2015 - 08:24 | 6374808 FranSix
FranSix's picture

It was Alfred Little that sent the letter.

Fri, 07/31/2015 - 08:00 | 6374739 overmedicatedun...
overmedicatedundersexed's picture

rbc banker I golfed with last weekend, said toronto realestate is blazing via foriegn money (think china)..

rest of canada not so much, even vancouver..sounds like trouble ahead..and he does not see it coming.

Fri, 07/31/2015 - 12:31 | 6375832 armageddon addahere
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I recently sold a waterfront property near Belleville Ontario. 1 1/2 acres, treed lot on the Moira River, 325 feet of water frontage, 265 feet of road frontage,  1400 square foot bungalow with 300 square foot deck, 30X40 foot barn, cement dock, for under $200,000. It took 2 years to find a buyer and I ended up losing money on the property.

Mark Toronto and Vancouver on a map of Canada, if drawn to scale you will have a hard time finding them without a magnifying glass.

Those areas may be hot, the other 99.99% of the country, not so much.

Fri, 07/31/2015 - 17:32 | 6376932 ebear
ebear's picture

Good point. Outside of commuting distance prices fall off sharply. I expect them to continue falling as vacation and second homes get sold to shore up personal balance sheets.

Fri, 07/31/2015 - 17:16 | 6376886 Never One Roach
Never One Roach's picture

Ditto in the USA. Pull most areas up on Zillow and you see plenty of big houses for $112,000 or less. MSM and the NAR focus on the handful of hot areas. the rest of the nation is languishing in deep recession. After all, there's 93 million unemployed.

Fri, 07/31/2015 - 07:24 | 6374652 JustObserving
JustObserving's picture

When it becomes serious, you have to lieJean-Claude Juncker

The Canadian real estate bubble bursting will plunge the country into depression for years.

Fri, 07/31/2015 - 01:21 | 6374243 pitz
pitz's picture

The bigger elephant in the room is the CMHC's $900B of loan guarantees against subprime mortgages.  $1B of questionable paper at Home Capital is just a mere drop in the bucket. 

Fri, 07/31/2015 - 15:00 | 6376396 TradingTroll
TradingTroll's picture

Chinese,  Iranian,  Korean buyers in Vancouver mainly buy homes for cash and which are valued over $1m. The median Vancouver house price is $1m. Downtown Toronto also $1m give or take.CMHC doesn't insure houses over $1m.

 

That means only half the houses have insurance. That means CMHC has a synthetic hedge.

Fri, 07/31/2015 - 10:51 | 6375388 FrankDrakman
FrankDrakman's picture

$1 billion is 1,000 million dollar homes (average sale price in Toronto), or 2,000 $500k homes, or 4,000 $250k homes. 

Canada has 13 million households. Say this problem exists at other sub-prime lenders, of which Home is the biggest. Say there's 24 others, all with similar problems (which is a huge overestimate). Thats 25 * 4k = 100,000 homes. Out of 13 million. Less than 1% by my admittedly huge overestimate. 

Real estate in Toronto and Vancouver still less than in Sydney, Singapore, or Shanghai. Why are we in a bubble? 

 

 

Fri, 07/31/2015 - 18:23 | 6377066 ebear
ebear's picture

"Real estate in Toronto and Vancouver still less than in Sydney, Singapore, or Shanghai. Why are we in a bubble?"

Well, it's a question of ratios, isn't it? If everything inflated at the same rate there wouldn't be a problem because the price to income ratio for home buyers would remain constant, as would the level of employment, given that commercial and industrial land would maintain its ratio to profits earned, and their customers would have the same ratio of disposable income, instead of spending everything they earn on a mortgage.

Not the case however. Young people where I live (Vancouver) are totally shut out of the housing market, including, ironically, some second and third generation Chinese and Indian Canadians. Sure, their culture allows them to live at home, but who wants to do that when you've grown up here and have adopted Canadian ways? As for inheritance, considering family size, 1/3, 1/4 or 1/5th of a $1M dollar home doesn't go very far.

As for jobs, many companies are relocating east of here because the cost of operating in Vancouver is prohibitive. I talk to young people studying at university and most of them don't see themselves staying. Work is scarce, and better offers from places with better ratios are beckoning. For example, there are annual job fairs here where second and third tier US cities attempt to lure recent nursing grads to come work at their hospitals. Pretty hard to resist when your only alternative is Saskatoon or Thunder Bay.

Another example is the RCMP. Anyone living around here will notice how young most of their constables are. That's because owning a home here is a tough go on a mountie's salary, so most of the good assignments go to their senior people and the rookies get what's left: Richmond, Burnaby and Surrey. (Vancouver has its own police force).

So, is it a bubble relative to other big cities, or is that an irrelevant comparison? Depends who you ask, doesn't it? People around here seem to think it is, and since they live here (or are trying to) I place more weight on their opinion than that of international investors.

Sat, 08/01/2015 - 10:32 | 6378334 BurningFuld
BurningFuld's picture

Here it is in a nut shell. Nobody ever mentions this in all the doom and gloom Canadian housing articles:

"Canadians have significant equity in their home, averaging about 74 per cent of the home’s value2"

I own my home outright all but one of my friends ...yes including one that lives in Vancouver owes their home outright.

Bet against Canada's housing market at your own peril. I said the same thing in 2008 btw.

Fri, 07/31/2015 - 11:38 | 6375602 Seer
Seer's picture

"Why are we in a bubble? "

GROWTH IS a bubble!  Simple math.  It's a finite planet.  Growth CAN NOT continue indefinitely. (influx of money in to Canada is going to dry up, well, decrease substantially as China's economy continues it's backwardation [I'd callled this several years ago]).

Since prices have been increasing and the number of housing units have been increasing it is, therefore, by default, an expanding environment.  EXPANSION = [increasing] BUBBLE.

What most people completely lose track of is that everything works on margin.  It's really all about that little sliver of margin, and that equates to GROWTH.  When all of our economic systems DEMAND growth, positive/growing margins, a loss of margin is a push toward collapse, it's about negative growth (elevated prices cannot persist).

We're talking about a reversal of growth here.  Going from a positive margin to a negative one.  It might only be "1%" but when full, cumulative margins are nearing zero this "1%" decrease DOES have a BIG impact.  Further, due to the highly optimized ways in which money is leveraged this %1 is likely compounded by several orders of magnitude: "Ah, but it's only ONE domino!"

Fri, 07/31/2015 - 17:13 | 6376875 Never One Roach
Never One Roach's picture

These Canadian liar-loan lenders saw the harsh, inhumane, brutal treatment Mozillo received for all his fraudulent mortgages ....

 

 

Fri, 07/31/2015 - 10:29 | 6375293 y3maxx
y3maxx's picture

Update...

Home Capital shares surge after company provides additional details about mortgage fraud allegations

http://business.financialpost.com/investing/home-capital-group-incs-stoc...

Fri, 07/31/2015 - 18:26 | 6377076 ebear
ebear's picture

Short covering. The article mentions that.

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