Canada’s dirty little sub prime loan secret

[rekabis]

Canada's dirty little sub prime loan secret threatens to sink housing market
by: Tim Pelzer
2012-03-09

VANCOUVER - While the U.S. is still suffering from the sub prime debacle, Canada's housing market is an island of tranquility. House prices continue to rise, people are buying houses and apartments and paying their mortgages. The banks are on a solid footing, making profits and not facing bankruptcy or asking for bailouts.

According to the federal government, the media, business economists and the real estate industry, the Canadian real estate market is balanced and healthy because of the bank's prudent lending practices and government regulation. Unlike the U.S., the government never allowed sub primes loans and therefore no housing bubble emerged. The health of Canadian financial institutions has been praised abroad.

However, critics are beginning to question this rosy picture of the Canadian housing market. They point out that if you scratch below the surface, the Canadian housing market shares many eerie similarities with the US market before the sub-prime housing bubble began to deflate in 2006. House and apartment prices have gone up more than 100 percent since 2000 and are at least double the price compared to the U.S. market. In the U.S., the average house costs $173,000 while in Canada it is $348,178. In Vancouver, where the housing bubble is the most extreme, the average single family home costs $900,000 Cdn. Buying a house or apartment has become unaffordable for most Canadian working people.

According to Garth Turner, a former Conservative Party Cabinet Minister and Member of Parliament, the Conservative government of Stephen Harper has deliberately created a housing bubble through low interest rates and down payments and long amortization periods that is beginning to deflate. The Canadian government, through the Bank of Canada, has kept interest rates low at emergency levels. By 2009 they were lowered to less than 1 percent. Today it sits at 1 percent. The vast majority of mortgage holders in Canada have 5 year fixed mortgages at 3.5 percent interest. In the past, home loans were in the 8 percent range.

The Canadian government requires that buyers only pay 5 percent down payments although this rule is not enforced. However, for buyers who do not have 5 percent, the 6 major banks offer no down payment mortgages or cash back mortgages where they loan the buyer the 5 percent down payment, offering 100 percent financing. The banks also give mortgages to the self-employed and new immigrants without verifying income.

In the past, Canadian banks required down payments of 25 percent, but this amount was gradually lowered. The Conservative government "embraced the sub-prime culture as nobody has done before", writes Turner on his Greater Fool Website. After 1999, it lowered down payments from 10 percent to 5 percent. From 2006 to 2008, Parliament even passed legislation allowing 0 percent down payments and 40-year amortization periods.

Until last year the government allowed the Banks to offer 35-year mortgages to buyers, and before that 40 years. To cool the housing market, the federal Conservative government last year lowered mortgages to 30-year repayment periods. Now there is speculation that Finance Minister Jim Flaherty will kill the 30-year mortgage and reduce it to 25 years.

Turner contends that 5 percent or no down payments, low interest rates and long repayment periods have expanded the number of buyers who have bid up housing prices to unsustainable levels and pushed ownership levels to 70percent of the population. Meanwhile, for most Canadian working people, wages have stagnated or failed to keep up with inflation. Unemployment (including involuntary part timers and discouraged workers) is around 10.6 percent, some 2 million workers, and economic growth is beginning to stall.

Many Canadians have also used their homes as ATMs, taking out additional loans using their homes as collateral to finance private consumption. Lines of credit backed by homes made up 50percent of all consumer credit last year, largely to finance home renovation.

The federal government has insured all these low down or no down payment mortgages through the Canadian Mortgage and Housing Corporation (CHMC), a state housing agency whose 10 member Board of Governors is heavily represented by the Housing industry -- 3 developers, 1 real estate broker and 1 partner in a plumbing, renovation company. The CHMC would be the Canadian equivalent of the US government backed Freddy Mac and Fanny Mae insurance holders. The banks therefore can lend money to house buyers with zero risk. By removing risk from lenders who do not have to worry about the credit worthiness of the borrower, the government has encouraged imprudent lending practices, according to Turner. The Harper government even increased the agency's insurable loan limit to $600 billion in 2009, an amount larger than the national debt.

Like in the US, Canadian banks are bundling these risky mortgages into securities and selling them to unwary investors.

Turner argues that the 5percent down payments are Canada's version of US sub prime loans. Many new buyers have bought expensive homes for 5 percent or less at low interest rates that will eventually reset to higher levels, at least double the current low interest rate today of 3.5 percent. The Bank of Canada has been warning over the last year that it will eventually raise interest rates and has been urging Canadians to pay down debt before rates go up. Recently, federal finance Minister Jim Flaherty told reporters that, "interest rates are going to go up. They have nowhere to go but up. So people must make sure that they can afford higher mortgage interest."

"We've systematically lowered mortgage-lending standards, encouraged banks to take excessive risk, eliminated the need for money when buying real estate, and turned what used to be an accomplishment and a privilege into a right and an entitlement. Now that 70percent of us have swilled the kool - aid, pushing prices house prices and debt levels to historic highs, a melt in both sales and prices seems inevitable", writes Turner.

Turner warns that when interest rates go up, mortgage payments will increase and housing prices decline. Many Canadians will face negative equity where they are left paying mortgages that exceed the value of their properties, as in the US, causing economic distress, hardship and a wave of foreclosures. Turner says this is beginning to happen in smaller towns and cities across Canada. A decline in housing prices will also hit the economy hard, as housing spending constitutes 20percent of the Canadian economy. For mortgage owners who cannot pay their mortgages that are insured by the CHMC, the Canadian taxpayer will be on hook to pay the banks, states Turner.

Lax lending practices and climbing house prices have increased household debt to their highest levels. Canadians now have higher per-capita debt levels than Americans and British. For every dollar of income, Canadians owe $151. Debt levels continue to increase each month, much of it mortgage debt, and show no sign of halting. Bank of Canada Governor Mark Carney calls these debt levels "the greatest risk to the domestic economy."

Financial analyst Ben Radiboux shares many of Turner's concerns about the Canadian housing bubble. "In real terms, prices have risen higher and for a longer length of time than at any point in time over the last 40 years [as far back as there is data on house prices]. Relative to underlying fundamentals, things have never looked so ugly", writes Radiboux on his website Economic Analyst. "The balance of probabilities leans strongly towards a housing price correction."

Radiboux argues that there are similarities between US sub prime lending before 2006 and Canadian lending practices today. US lenders gave mortgages at low fixed teaser interest rates for 2 years before resetting to a higher rate adjusted every 6 months for the rest of the mortgage. Canada's fixed mortgages, carrying an average interest rate of 3.5percent, reset every 5 years, exposing borrowers to interest rate fluctuations. A Bank of Canada stress test last year showed that a 0.5percent increase in interest rates would put 1.1 million households " under significant financial pressure."

High loan-to-value mortgages were another feature of sub prime lending in the U.S. where debt is greater than 90percent of the value of the home itself. Yet, CMHC insures mortgages where loan to value is 95percent (5 percent down payment). In addition, Canada's 6 large banks offer 100 percent financing for home purchases with no down payment mortgages and cash back mortgages where they lend the buyer the 5percent down payment.

Radiboux is critical of the CHMC for not being forthright in disclosing the makeup of their insured portfolio, exposing the Canadian taxpayer to great risk in the event of a housing crash.

Another factor that will help depress housing prices is demographics, claims Radiboux. Nine million baby boomers will be retiring in the next few years and many of them will be selling their houses to help finance retirement or simply to downsize into a smaller living space.

It is not just Turner and Radiboux who have been ringing the alarm bells about the Canadian housing bubble. The Bank of Canada said that Canadians are becoming increasingly vulnerable to a housing correction, exposing them to a perfect storm of high debt and falling assets. The International Monetary Fund has also warned that Canada could face a price correction if house prices and debt levels do not come under control.

Capital Economics, a British macro research consultancy that provides independent economic analysis to the global corporate and financial sector, is predicting that Canadian housing prices will crash by as much as 25 percent when the Canadian housing bubble falls.

When the MSM starts printing stuff like this, I know the downturn has begun to happen. And this article is just reiterating what I’ve been saying for the last few years. Upper Mission is seeing a flood of for sale signs with very few “Sold”s. Stock is flooding the market like rats making a break from a sinking ship. Sales are stagnating across the board, with this spring shaping up to be even worse than 2008’s (which was the worst ever year on record for the rate at which home values plummeted). And Realtors everywhere are starting to get very, very nervous, and very, very defensive.

We may be a little down from our April 2008 peak (and “a little down” is laughable - the largest previous housing crash was in the early 80s with a 16% drop in values, and we are WELL beyond that by now), but 2012-2013 seems to be the year when things are really going to start plummeting, and probably even worse than in 2008. Prime can no longer be lowered any further, and in fact BoC has been warning that prime is going to go in the other direction sooner rather than later. Rates will rise, the amount that people can borrow will shrink and wither, and the contagion will finally take hold.

And it’s about time, too. Just keep in mind that this housing bubble has been several times larger than any previous housing bubble in our history. As such, for anyone who bought within the last few years, once you factor inflation into the equation you may never see your home reach its purchase value again in your lifetime.

That’s not to say we won’t have another housing bubble again -- we will. And that’s not to say the raw dollar value won’t be reached again -- inflation will erode the power of the dollar so that eventually you will see the same dollar value again. But this one was a once-in-a-century event, fuelled by a rare and fortuitous convergence of events. Once we factor in inflation, these kinds of insanely stratospheric home values are not going to happen again for a very, very long time.

[rekabis]

Wow. Three days posted (almost to the minute), and no responses by any of the Real Estate Bulls. None. Nada. No rebuttals. No “But prices ALWAYS go up”. None of the ever-present attacks on the mere thought that home values may decline by more than a few thousandths of a percentage point.

The silence really is telling. Four years ago, this thread would already be 50 replies long, with the vast majority of them telling me how stupid the idea of a housing crash is, that we are NOT in a housing bubble and that it would never ever happen here in the Okanagan, because “it’s different here”. And that home values may moderate, but that they would never, ever, ever (to the tenth repetition) go down more than a few percentage points (and certainly never reach the double digits). Because people want to move here. Because the Okanagan is desirable. Because “it’s different here”.

I guess the fact that this housing bubble has already popped further (in percentage down from the peak) than any previous housing bubble in all of Kelowna’s history, has made some perma-bulls stop and think that I may have actually been right all along.

And the party has just started. Yes, it’s been restricted to a “slow leak” thanks to prime sitting at practically 0%. But now there are clear warnings that prime is going to go up sooner rather than later. CMHC amortization periods have been slashed from 40 years back to 30 years (as of Yesterday, the 18th of March), dramatically reducing the amount that the vast majority of home buyers can borrow (over 90% of homes bought in Kelowna within the last five years were CMHC insured… and those mortgages are therefore, by definition, sub-prime).

It appears that the “slow leak” is starting to tear open to a full-blown blow-out. Actually, scratch that… it’s turned from a tread-area nail puncture into a full-blown Bowie-knife slashing of the sidewall. No patch is strong enough to stop that kind of deflation.

[duke98]

This is the time those RE bulls are in doubt but they don't want to admit. Upcoming stats will tell us the truth.

[amourus]

We're too busy doing real work and making money with our Real Estate to waste time with another "sky is falling" thread. Go tell Garth Turner your news.

P.S. have you seen all the SOLD signs going up in the last two weeks. The market is HOT HOT HOT.

[process99]

We're too busy doing real work and making money with our Real Estate to waste time with another "sky is falling" thread. Go tell Garth Turner your news.

P.S. have you seen all the SOLD signs going up in the last two weeks. The market is HOT HOT HOT.

Apparently a fool is parted from their money even easier than I thought..
Who in their RIGHT mind would pay over a quarter million dollars for something they will never really own?
Heck I can find some nice crown dirt somewhere in BC plant a mobile on it an pay WHAT for that piece of paridise.
Better yet keep it mobile and see the entire country. I would much rather do that than strap myself naked to a bank so I can spend the better part of my entire LIFE paying them not to put me on the street completly busted and labled a failure becaue I could not maintain the status quo.
Not this person , not in this life or the next or the next. :dyinglaughing:

P99

[Cooljoe]

OK, first off, not a Real Estate agent in any way shape or form. Second, quoting Garth Turner does nothing but lower your credibility as all he does is fear monger these days about housing in Canada, warranted or not.
Now, any comparison with the US market just aren't right without all the facts, which I don't have, but do know that our system of mortgages and such are different enough from theirs that halve truths / facts will work either way for making us look good or bad.
Average single family home in Vancouver last I heard was more in the 600-700 range, not 900. And don't forget how West Van and such affect this with their 1.4 mil + average range.
I was just in the bank the other day talking about our mortgage, pretty sure that the 0% down days are gone, as are the long terms. Lets not forget too when comparing the recent drop to those in the past (ie 80's) that this followed the biggest boom ever. So seeing the 20% drop we have sounds bad, but after the 200% + increased (guessed at from my own homes increase) we saw it kinda puts it in perspective.

Not saying things are going to jump back up, just a little more optimistic that things aren't gonna crash as hard as the media is saying. Lets not forget that 2010 and 2011 were also predicted to crash as hard and didn't. Getting just a bit tired of all the negative, false leading reports.

[Captain Awesome]

Not this person , not in this life or the next or the next. :dyinglaughing:

Some people like to live in houses. Some people like to live in vehicles. It's all personal preference, really.

[kgcayenne]

Rek, have you sold your condo yet? Or did you renew that mortgage at a lower interest rate like the rest of us did?

[dirtrider]

Oh...Ouch, cayenne, that's a little below the belt, although ironic to say the least. But let me guess Rek....bought at the height of the housing "BUBBLE"..... typical 5 year mortgage will put the renew sometimes in 2013. I'm sure the way it's going, you'll be able to lock in at the lower rate, say, 3% for 5 more years. I think you timed that perfect. Aren't you glad you don't have to pull out your chute yet?

[rekabis]

Oh...Ouch, cayenne, that's a little below the belt, although ironic to say the least.

Why? Her question seemed quite innocent to me. It was an honest question, devoid of the snarkiness and derision (compensation, perhaps?) that you usually inject into your posts.

But let me guess Rek....bought at the height of the housing "BUBBLE"..... typical 5 year mortgage will put the renew sometimes in 2013. I'm sure the way it's going, you'll be able to lock in at the lower rate, say, 3% for 5 more years. I think you timed that perfect. Aren't you glad you don't have to pull out your chute yet?

Reasonably close to the actual rate; but we have already done our first renewal, and it is an entirely different time span. Try 10 years at a fixed rate. We should have the entire mortgage paid off long before a third renewal ever occurs (2021). Yes, that’s our goal: 15 years or less for a mortgage-free place. It would have probably been less than seven if I hadn’t been doing my second Bachelor’s over the first few years of the mortgage. Doing six classes per term, three terms per year kinda puts a crimp into full-time work; especially when the student average tends to be three classes per term and only two terms per year.

And no, we did not buy at the height of the housing bubble. Try almost a good two years earlier. We missed the worst of the price increases. Even now most comparable places are still more expensive. Some are far less opulent (tiny, cramped, and ceilings at just under 8 feet) and yet are nearly twice the price - they are made for Napoleon’s stature and have the price to match.

I’ve got a very nice place with excellent soundproofing (12 inch dead air gaps in both the adjoining walls and floors!) on a top corner SE face, massive bedrooms, nine foot ceilings (which makes a MASSIVE difference!) and more floor space than 90% of apartments in Kelowna (just over 1,200 sq ft). The last time my other half hosted a dessert party for coworkers, we packed in close to 35 people in just the living and dining rooms and it wasn’t cramped at all. We could have probably packed in 50 before things got uncomfortable. The kitchen alone is one of the biggest I have ever seen in any apartment, both for raw square footage as well as counter space. And I’m including those swanky new penthouse suites that go for several million. Heck, our kitchen is even bigger than the one in my parent’s home (that I grew up in), and that house has got close to 3,500 square feet.

Even now when I search for condos for sale (on MLS) that are feature-similar to my own, a significant minority in the price range I paid for are fractional ownerships. And I don’t have to share. Or 55+, which would exclude me anyhow. And a majority are well over 15 years old, which would suggest that major repairs are going to start showing up on the strata bill in the next few years.

Frankly I would have a really tough time, even before viewing the place in person, to find another apartment (less than a decade old) that would be a straight-over trade for my place for the same or less than what I paid for it.

Besides, while this may be a place to live right now, we have no intention of selling for at least two to three decades if not more. Enough, at least, to allow rental income (once the mortgage is paid out) to make up for any shortfall in home value we may experience; even after costs, strata and property taxes. And that’s assuming we even move.

Problem is, the vast majority of home owners can’t and won’t have that kind of a time frame to work with. And that is why they will end up being eviscerated in this coming downturn.

[dirtrider]

WOW....are you an ostrich? I can't speak for cayenne but seems to me, the question was out of the blue and dripping with sarcasm.

So it's do as I say and Not as I do....is that it Rek?. :coffeecanuck:

So you're saying you are only one of the few that can buy a home at or near the peak of THE "housing bubble" and be OK with it? No one can do exactly what you have done and doing? What a crock. Why is it you want to be an accountant again? Is the world going to need one if the financial doom you've predicted for the last 5 years comes to fruition?

edit to add: Oh sorry Rek, I did confuse the timeline, you had posted this on Aug 2008....by my calculations, you bought the condo almost at the peak....Jan of 2007.

Actually, three years ago I wasn’t a HOME owner. Even two years ago I wasn’t a HOME owner. And I am still not a HOUSE owner (which is where my desire truly lies), although I do profess to owning a CONDO for the last 20 months.

And if you must know, it was a combination of a partner with a very strong nesting instinct (renting was not an option if vows were to be exchanged), an opportunity to obtain a decent unit, and long-term intentions (20+ years) of holding onto said unit.

Once the Kelowna housing market bust this springtime, even my partner agreed that we had made a BIG mistake. Unfortunately, the sales by that time were so dismal that we were unable to garner a decent interest in the place, so we have committed to holding onto it for the next several decades.

With that said, however, I did make sure to garner the maximum bang for our buck in terms of the location, floorplan and facing view… we may be resigned to living here for the next 3-5 years, but at least the unit has enough unique features to be pleasurable to live in. And we *are* living very frugally in order to pay down all of our debts as fast as possible… I have every intention of keeping ahead of negative equity, as I fully expect our unit to loose at least 60-80% of its value before prices bottom out.

Yes, that’s right. A possible maximum drop of 80% on my unit alone. And that is with it being the nicest and largest one in the block, with a top-floor SE corner view that is shaded by a gorgeous maple tree.

You've done well!!!! It's only dropped 10%....

[dirtrider]

......so now that you've experienced your first renewal....did you have to make up for your negative equity at the time of renewal?.....

[amourus]

... (snip)
So it's do as I say and Not as I do....is that it Rek?. :coffeecanuck:

So you're saying you are only one of the few that can buy a home at or near the peak of THE "housing bubble" and be OK with it? No one can do exactly what you have done and doing? What a crock. Why is it you want to be an accountant again? Is the world going to need one if the financial doom you've predicted for the last 5 years comes to fruition?
...(snip)

Everytime you slap him down I'm just in awe! :hailjo:

[zyzzx]

^^QFT^^

[zensiert]

WOW....are you an ostrich? I can't speak for cayenne but seems to me, the question was out of the blue and dripping with sarcasm.

So it's do as I say and Not as I do....is that it Rek?. :coffeecanuck:

So you're saying you are only one of the few that can buy a home at or near the peak of THE "housing bubble" and be OK with it? No one can do exactly what you have done and doing? What a crock. Why is it you want to be an accountant again? Is the world going to need one if the financial doom you've predicted for the last 5 years comes to fruition?

edit to add: Oh sorry Rek, I did confuse the timeline, you had posted this on Aug 2008....by my calculations, you bought the condo almost at the peak....Jan of 2007.

You've done well!!!! It's only dropped 10%....

I don’t usually post on this subject, but brilliant math there dirtrider.

August 2008 less 20 months equals December 2006. And I'm sure that must be wrong, because AFAIK the actual purchase was nearly a year earlier. In effect, you're probably off by an entire year. I can only assume that either your recollection of that post's date is wrong, or rekabis did the math wrong to get to 20 months.