LENDERS ARE resisting efforts to tighten mortgage rules, arguing the market is stable
Flaherty has since hinted he might clamp down, but such a move would be unpopular and the industry is already resisting. In a recent speech, Royal Bank CEO Gord Nixon said consumer debt in Canada is “extremely different” than in the U.S. Bank of Montreal CEO Bill Downe has said the bank is “heavily engaged with the consumer about how much debt is too much.” At the same time, CIBC put out a statement highlighting research from its economists that concluded: “Make no mistake: Canada is not doomed to see a U.S.-style housing and mortgage blow-up.”
Then earlier this month the Canadian Association of Accredited Mortgage Professionals (CAAMP), a professional standards and lobbying group, attempted to throw cold water on the Bank of Canada’s debt warnings. It released a report arguing the vast majority of first-time homebuyers last year opted for safer, fixed-term mortgages over riskier variable mortages, which are more exposed to short-term rate hikes. “The concern federal officials are voicing is that a lot of people are going to variable [rates],” says Jim Murphy, president of CAAMP. “We found that wasn’t the case. The market is already working very well.”
Newspapers eagerly took up the story, declaring Canadians to be “cautious,” “prudent” and a people who “play it safe.” But while the report fit perfectly into the narrative of Canadians as the epitome of diligence and responsibility, no one questioned its conclusion that out of 13.25 million homeowners in Canada, only 4,000 “might” be at risk.
Economists aren’t buying it. “I have difficulty with the CAAMP report,” says Scotiabank’s Holt. “It’s a very different picture than what I get from talking to people in the mortgage industry.” Holt doesn’t subscribe to the view that a rise in interest rates would trigger a debt crisis in Canada. But he also believes the risks are far greater than lobbyists are letting on. He says as many as 40 per cent of first-time buyers have opted for variable rate mortgages, while another 10 per cent chose fixed mortgages with just a one-year term. That means half of all new mortgages are heavily exposed to short-term rate changes. “I think their study grossly underestimates mortgage rate sensitivities,” says Holt. “It doesn’t even really matter if they went variable rate or fixed rate, because pretty much all of the mortgage market in Canada resets in the next five years.”
And in that way Canada’s mortgage sector looks somewhat like America’s did before the bust. No, we never had institutionalized mortgage fraud like they did in the States. Lending practices here were also tighter. But the ultimate reason so many American homeowners got into trouble was because one-third of them bought homes using mortgages with artificially low teaser rates. Once those low rates reset higher, even by just three or four percentage points, owners couldn’t keep up with their payments. In Canada mortgage rates are artificially low because of the massive intervention by the central bank, and some day, probably within the next year, they too will reset higher.
But here’s another more fundamental reason we’re not all that different from Americans. Thanks to a loosening of mortgage rules over the last two decades and steadily lowering mortgage rates, 68.4 per cent of Canadians now own a home—roughly the same rate as in the U.S. The average national house price in Canada is about the same as what the U.S. experienced right before the bust. And yet incomes in Canada are, on average, lower than in the States. Economists offer theories for how Canada has achieved all this without taking on the same housing problems the U.S. did—it could be because of higher health care costs in the U.S., suggests one, or the cross-border comparisons could be distorted by the effects of averaging.
But it could also simply be that we’re not as different from the Americans as we’d like to think when it comes to debt. “The Americans threw prudence out the window and drove off the cliff with their eyes wide open,” says Lee. “We’re just backing up to it.”
There is good news in all of this—if you’re a banker. When America’s debt bomb blew up, it took many of Wall Street’s biggest names with it. That’s unlikely to happen here, says the Bank of Canada. While a crisis among indebted homeowners could lead to big losses for the banks, they remain far better capitalized than U.S. banks ever were, so the hit to their bottom lines should be muted. If the Bank of Canada’s worst case scenario comes true, Canada’s banks face losses of just 4.8 per cent as a share of their capital.
For households, though, the outlook is grim. Cracks have already begun to form in family finances. The fault lines can clearly be seen from the offices of the Credit Counselling Society of B.C. Over the past two years, the agency, which helps consumers resolve their debt woes, has seen more people coming in for help carrying more consumer debt—that is, non-mortgage debt—than ever before. “Five years ago it was common to see debt loads of $40,000, but this year we’ve seen people with $256,000,” says Fernanda Capela, a counsellor. “$150,000 is very normal now.” As Kyle Peters, another employee, notes, “Somewhere along the way we lost sight of the notion that if you don’t have enough money to buy something, you shouldn’t.”
It’s a lesson many have apparently forgotten. The recession has caught thousands of households off guard and sent the number of consumer bankruptcies and insolvencies soaring. In all of 2008, more than 115,000 Canadians were insolvent. By September of last year, we’d already blown past that number and when the final tally for 2009 is in, the number of Canadians who went broke could easily exceed 160,000. And that’s with interest rates at nearly zero. At the same time, Bury, the Vancouver foreclosure lawyer, says foreclosures remain at elevated levels despite the economic recovery.
There are still many who dismiss fears of a crisis triggered by household over-indebtedness. They point to countries like Denmark, where households carry twice as much debt relative to their incomes as Canadians do. And this isn’t the first time soaring household debt has set off alarm bells.
But the laws of financial gravity say debt levels can only reach so high before households are forced to deal with their addiction to borrowing and spending. In the U.S., deleveraging has come about through tremendous upheaval. Canada’s banks won’t blow up, and bankruptcy legislation makes it far harder for Canadians to walk away from their obligations. That could put Canada in an even tougher position because we’ll have to bring our debts under control the slow, hard way—by dramatically cutting back on spending and paying down our loans. If the housing market does collapse, and people have to drag themselves out of debt, they won’t be doing all the things, like buying cars and renovating kitchens, that have helped drive the recovery. In other words our “buy now, pay later” ethos could become one of “don’t buy, just repay your debts.” And that could leave the Canadian economy in a deep rut. As a new report from consultancy McKinsey states, Canadian households are highly likely to face imminent deleveraging and an unwinding of unsustainable debt that could “drag down growth rates for years to come.”
There’s one more lesson to take away from the U.S. experience. Once it was clear America was in dire straits, many asked: why didn’t anyone see this coming? The easiest answer is that as long as everything kept humming along smoothly and everyone was benefiting from the borrow-and-spend culture, most people simply chose not to look. If we’re going to avoid our own debt explosion, maybe it’s time to open our eyes.
