Comparing Canada's Rigid Banking System with U.S. Innovative, Yet Lax Banks

The housing market in U.S. and Canada have taken a different path since the credit crisis began. In the U.S. it continues to get worse since the crash that started last year. In 2008, more than 3 millions foreclosures were filed setting a record. Foreclosures in 2008 were up 71% from 2007. This year foreclosures have been in excess of 250K each month reaching 342K in April but backing down to 321K in May according to Realtytrac. A recent New York Times editorial mentioned that rising unemployment numbers and falling home prices are causing new foreclosures with no end in sight.

Unlike the U.S. housing market crash, home foreclosures have not yet become a serious problem in Canada. Other than losses sustained due to their sub-prime exposure in the U.S., the five major Canadian banks - Bank of Montreal (BMO), Bank of Novo Scotia (BNS), Toronto-Dominion Bank (TD), Canadian Imperial Bank of Commerce (CM) and Royal Bank of Canada (RY) are staying strong and their earnings have not take a huge hit due to mortgage defaults. This is not the case with American banks such as Bank of America (BAC), Citibank (C), US Bank (USB), Wells Fargo (WFC) and many others who have been forced to seek government aid to prevent complete meltdown.

This brings us to the following questions: What are the primary causes of the housing market collapse in the U.S?. Why is the housing mortgage market so strong in Canada? What are the real differences between the Canadian and American mortgage systems? Why didn’t Canadian banks suffer huge losses due to mortgage loan losses?

Some of the answers to the above questions can be found in the following table which lists the differences between the housing markets in Canada and US.

Canada	USA
Deposit-taking hold majority of outstanding mortgages	Deposit-taking hold only some of outstanding mortgages (30% at end of 2007)
Mortgage securitization not very pervasive (only 29% secritized)	Mortgage securitization is very pervasive (about 60% securitized)
Majority of the MBSs issued are guaranteed by government-owned Canadian Mortgage and Housing Corporation (CMHC)	Not so here
Most mortgage insurance is underwritten by CMHC (70%)	Most mortgage insurance is underwritten by private insurers
Mortgage Insurance covers the full loan amount	Mortgage Insurance covers amounts that exceed a certain LTV ratio (eg. 20% on a 80% ceiling)
Entire mortgage insurance is paid upfront by the borrower	Part of mortgage insurance is paid upfront by the lender and some paid monthly by the borrower
Mortgage insurance cannot be cancelled	Mortgage Insurance can be cancelled once the LTV drops thru a ceiling eg. 80%
Mortgages are five-year fixed rate loans amortized over 25 years reflecting the conservative credit culture	Most mortgages are 30-years and have fixed-long term rates
Upfront costs for mortgages are lower	Upfront costs for mortgages are higher
Origination fees does not exist	Origination fees are high
Rate-lockins are free to hold interest rate during application processing	Lenders charge for rate-lockins
The market for Alt-A mortgages is very small	The market for Alt-A mortgages is relatively large
Most mortgages are not initiated by brokers	Most mortgages are initiated by brokers (70%)
Brokers only act as a middleman	Brokers act as originators of loans
Banks service their own mortgage portfolios	Not so here
All mortgages are recourse loans	Most are non-recourse loans
Lenders have recourse to all the assets and income of borrowers in case of default	Not legally possible or very expensive to pursue borrowers
Virtually all mortgage payments are made by auto-debit from the bank account of borrowers	This option not much popular here
Borrowers can opt for weekly, biweekly, semimonthly, or monthly payment schedules	Most loans require payment at the beginning of the month
Though mortgage markets seem less innovative, consumers are well served	Mortgage markets are highly innovative but consumers may not be well-served

Source: Canadian Residential Mortgage Markets: Boring But Effective?, By John Kiff, June 2009, IMF Working Paper

In summary, in Canada lending standards are much more strict and banks are not as innovative and aggressive as their peers south of the border but perform their main function as deposit takers and housing loan providers. American banks on the other hand, have deviated from their primary functions over the years in order to generate higher above-average returns year after year. Relaxation of regulations by the government and creating favorable environment promoting home ownership by all added fuel to the fire.

Disclosure: No positions

Comments

[AuGod!:]

Canadian borrowers, like their lending counterparties are of a relatively conservative business culture. Canada's housing situation though not without its own challenges, is therefore more stable for various reasons, perhaps foremost being that people, often financially unsophisticated folks, were not preyed upon aggressively by mortgage brokers.

But looking back into America's past, there once was a similar culture where people believed that "neither a borrower nor a lender be" was a sensible way to conduct one's personal business. That changed to become one of servicing debt principal. Not altogether a bad thing but as with almost anything, if taken to extremes, the practice can lead to a lot of heartbreak if expansion of the economy slackens or goes into reverse with concomitant discontinuity of employment and shrinking credit sources. A strong credit market combined with individuals committed to personal savings is not mutually exclusive. A positive balance (forgive the pun) is only good sense.

Jul 05 04:32 PM

[daveddawg:]

This was a very informative article, and points out some major differences between CA and US banks. Some of these differences, IMO, are based on the mentalities and geographies of the countries.
In CA, the winters are brutal, and will not suffer fools kindly, as in certain parts of the US. These cold regions tend to breed conservation of scarce resources. In other regions of the US, the proverbial grasshopper to the ant will survive (especially due to influences of Uncle Sugar).
This disparity in climates is, IMO, the main difference in the relative conservatism of the CA banks, and the CA citizens. Three cheers to all who live within their means!

Jul 05 09:25 PM

[Teutonic Kn...:]

daveddawg's made some astute and interesting comments.

I'd like to add a couple, having lived there for a good part of my life (23 years). However, since I have been away for so long, my remarks would probably be out-dated.

As I recall in the days of the 60's and 70's much of Canada's industrial base was U.S. and U.K. branch plants, and the government literally owned and operated another huge chunk of the industries called "Crown Corporations". Taxes were high, cars would rust out every five years because of the roads being heavily salted in the winters, not to mention the heating bills and the clothing and snow shoe needs just to keep warm. Sunshine was a premium so one would have to save enough to come down to FL to soak up every year.

Yes, daveddawg is right on. Thanks for a good comment stream.

Jul 06 12:02 AM

[maryanne:]

Biggest problem in the USA Is that mortages are NON recourse. Irresponsible buyers (poor, minorities, illegals, greedy, etc) can simply walk away with only a stain on their credit record and can buy another house after about 7 years. Does bankruptcy in Canada allow borrowers to run away?

Jul 06 09:40 PM