Real estate prices are falling, and a U.S.-style collapse could cost taxpayers plenty

Some who borrowed heavily to pre-buy during the Great Canadian Condo Boom are also struggling. Scott Hannah, CEO of the Credit Counselling Society in Vancouver, has seen cases where buyers obtained mortgages to buy condos with no down payment. As the equity in their unfinished properties rose, they took out secondary loans to buy furniture. Now those buyers are underwater, and they still haven’t moved in.

Even in Toronto, where the market run-up wasn’t as big as in the west, some owners face problems. The number of homes listed under power of sale, which refers to repossessed properties, has climbed from 300 to 500 since the spring, says Jim Common, a real estate agent whose monthly newsletter tracks the sector. It’s a small fraction of the total active listings, but he expects the number to rise.

It can take months for the full extent of a collapsing housing market to be felt. For instance, some in the real estate industry point to the relatively low default rate on residential mortgages as a sign the market remains strong. According to the Canadian Bankers Association, the percentage of residential mortgages in arrears stands at just 0.28 per cent of the total market. But when the 1990 housing bubble burst, the national default rate was also 0.28 per cent, and it took two years before defaults peaked at 0.65 per cent.

If defaults rise, claims against CMHC could climb, too. The good news is that because the buck ultimately stops with Ottawa, the country should avoid a mortgage-fuelled banking crisis like the one that has claimed so many victims in the U.S. In fact, through CMHC the federal government plans to buy up to $75 billion worth of mortgages from the banks as a way to inject liquidity into Canada’s financial system.

But could taxpayers be left holding a massive bill? There’s almost no way to know. CMHC doesn’t divulge key information about its lending portfolio, which it considers to be competitive information. Even so, Nick Rowe, an economics professor at Carleton University, recently posted online a “back of the envelope” calculation of CMHC’s potential losses. Based on what is known about the agency’s $334-billion insurance portfolio and $7 billion in reserves, he argued CMHC could lose $9 billion if prices in Canada fall as much as they have in America. (U.S. prices have dropped 20 per cent from their 2006 peak, with some cities down 35 per cent.) By contrast, CMHC posted profits of more than $1 billion for three straight years, thanks largely to insurance premiums it charges homebuyers. Rowe admits his analysis is crude. But he worries CMHC officials may not have accounted for serious price declines when constructing their financial models, believing, as Fannie and Freddie did, a catastrophic economic event would never happen.

For what it’s worth, CMHC remains more optimistic about the Canadian market than some of the real estate industry’s most bullish proponents. On Oct. 30, CMHC predicted the average MLS selling price for this year will come in higher than last, and continue to rise in 2009 to $306,700. A week and a half later, the Canadian Real Estate Association predicted the average price of a Canadian home will end the year down 0.6 per cent to $303,900 from 2007, and continue to fall in 2009 to $297,600. “Somebody needs to work out what the losses for CMHC would be if house prices fell 20 per cent across Canada,” says Rowe. “We’ve got a rough idea of the national debt, and what the deficits are going to be, but there’s an item here that hasn’t been taken into account. There’s no question of anything going bust, but this is something we should know. It’s very clear who is on the hook here, and that’s the taxpayer.”

No one is saying this is all CMHC’s fault. Genworth, Canada’s second-largest mortgage insurer, moved in lockstep with its government-backed rival. Meanwhile, smaller U.S. mortgage insurers rushed into the Canadian market at its peak. (Almost all have since fled Canada.) And CMHC didn’t exactly hold a gun to the head of lenders, who were the ones actually doling out questionable loans at the outer limits of CMHC’s insurance policies.

Still, at the end of the day, CMHC isn’t a private company, which means taxpayers may have to write a sizable cheque if the housing market worsens. It’s happened before. Back in the early 1980s Ottawa had to bail out CMHC when thousands of homeowners defaulted on their mortgages and insurance claims skyrocketed. Much has changed since then, but it’s becoming clear that CMHC’s policies encouraged many homebuyers to jump into the market before they were ready. And the consequences of that could be far-reaching. “[The easy credit] dragged buyers kicking and screaming from the future to today and they were lent money whether they could afford it or not,” says Ozzie Jurock, a Vancouver real estate promoter. “The only test was whether they could breathe.”

With Rachel Mendleson