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Canada Housing Bubble - Hold Judgement; Don't Praise Canada's Banking System Just Yet

There has been much talk lately about how the Cnadian banking regulatory system is superior to that of the U.S. and many other countries because Canada has not had to bail out any of its financial institutions.  The record needs to be set straight, partly because Canadian federal political leaders are patting themselves on the back and partlay because Canada's major cities have wildly inflated housing prices.  In fact, housing prices are at peak levels.  It could all end horribly...

Compared to the U.S., Canada did not have the enormous extent of sub prime mortgages before the financial crisis, but the Great White North may have caught up to the US since then. CMHC (Canada Mortgage and Housing Corp.), the government backed insurer of mortgages has increased it holdings of MBS (which are guaranteed by the federal government) from $127B in 2007 to $290B as of Q2 2009.  It was on target to reach $340B by the end of 2009 and $500B by the end of 2010.  During the same period, the private banking sector's mortgage holdings remained virtually flat.  It's unbelievable that the Canadian government took this path, copying the U.S. housing market, even as it watched the consequences unfold south of the 49th parallel.

At the same time the government forced CMHC to support the housing market with these purchases of MBS, the feds also enabled for the first time 0% down mortgages with amortizations up to 40 years (this was done in 2007) - essentially interest only loans.  Worried about the apparent housing bubble he was helping to create, the Finance Minister, Flaherty, recently (in March 2010) ratcheted back these terms to 5% down and 35 year amortizations, but the damage has been done (in fact, there is a rush of homebuying as buyers move to beat the deadlines for when the new rules kick in, which is pushing prices up).

Our regulators are not geniuses.  In fact, evidence indicates otherwise - our regulatory authorities and the Finance Minister re-inflated a housing bubble even having the US experience as a lesson.  The Canadian economy's performance often follows that of the US with a lag, perhaps 6 months.  Canada benefited from this lag during the financial crisis - the US crashed and interest rates came down quickly both in the US and in Canada....the Canadian housing market did begin to late 2008/2009 prices came down 10%-20% in a matter of months....but record low interest rates combined with the opening of our own sub prime market, by Minister Flaherty's actions,  resulted in an influx of new buyers beginning in mid 2009.  Since then, Canadian house prices have returned to the previous 2008 peak, except that now the government is directly on the hook for hundreds of billion of dollars in guarantees of Cdn "sub-prime" mortgages.

Minister Flaherty and the governor of the central bank, Mark Carney, are probably deathly afraid of the bubble popping, but they are now stuck....having created the conditions to enable the bubble to reinflate and at the same time allowing the CMHC (and, by guarantee) the federal government to take on $500B in MBS exposure.  That $500B is 33% of GDP.  They are hoping to engineer a soft landing...trying to reign the housing market just enough to keep prices going sideways for a few years.  It's never easy trying to pull something like that off.

There's an insightful report done by an Alexandre Pestov "The Elusive Canadian Housing Bubble" (Feb 2010).  He does a good job reviewing Canadian housing prices, debt and the mortgage market structure, as well as providing comparisons to US and many other markets.

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