Carpe Diem

A Canadian perspective on America’s housing bubble

In the video above, we hear a Canadian perspective on the US housing bubble and financial collapse from Pierre Poilievre, a member of Canada’s Parliament representing the Nepean-Carleton (Ontario) district. He was speaking to Canada’s House of Commons in April 2012 about the economy and how to avoid a fiscal cliff, here’s a slice (emphasis mine):

What went wrong in the United States? Many believe that the 2008 financial collapse and recession were the result of irresponsible behavior by business and banks. In fact, this behavior was merely the symptom. The illness was massive government intervention to turn the mortgage business into a social program.

The roots of this go back three decades. Presidents from Carter to Bush Jr. wanted to expand home ownership, a worthy mission no doubt. To do this, they mandated government-sponsored enterprises like Freddie Mac and Fannie Mae to cover the risks of loans to people who would otherwise not qualify for them. We call these subprime mortgages.

According to a 2010 World Bank report, Freddie and Fannie, both government sponsored enterprises, bought an estimated 47% of these toxic mortgages. Harvard financial historian Niall Ferguson estimated that between 1980 and 2007 the amount of government backed mortgages increased from $200 million to $4 trillion. Furthermore, the American government not only encouraged but forced banks to provide these loans.

To quote the World Bank report, “In the mid-1990s, the government changed the way the Community Reinvestment Act was enforced and effectively compelled banks to initiate risky mortgages”.

Once Americans are in debt, the U.S. government encourages them to stay there by allowing them to write off their mortgage interest. The bigger the mortgage debt, the lower the taxes.

In sum, the government encouraged millions of Americans to spend money they did not have on homes they could not afford, using loans they could never repay and then gave them a tax incentive never to repay it. The state had pumped so much air into the mortgage bubble that it burst. Financial institutions collapsed, taxpayers were on the hook, millions were jobless and one in five American households went under water, and that is to say their mortgages were bigger than the value of their homes.

HT: Don Geng

15 thoughts on “A Canadian perspective on America’s housing bubble

  1. The central bank of Canada responded more quickly than the Federal Reserve.

    Also, Canada does not have a mortgage interest tax deduction.

    Funny, how when people discuss the overallocation of credit to the housing sector, they always neglect to mention the mortgage interest tax deduction.

    • “Funny, how when people discuss the overallocation of credit to the housing sector, they always neglect to mention the mortgage interest tax deduction.”

      Yes, Benji, you’re the lone truth-teller, none of us have ever read about the market distorting effects of the mortgage interest deduction.

      But did the deduction has existed for decades, long before the bubble and the bursting.

      • also worth considering:

        while i agree that the US tax code is set up to encourage consumption and debt assumption at the expense of savings and investment, the mortgage tax deduction is not some weird unicorn in the tax code.

        it fits right in with the rest of it. a business can subtract interest payments on debt above the pretax line. interest expense is paid with pretax dollars almost everywhere in the tax code. it’s not some special treatment for homeowners. such treatment is very common.

        we can argue about it being good or bad, but there seems to be this assumption that many make that the mortgage interest deduction is some sort of wild outlier and bizarre exception in our tax code. it’s not. it is more the rule than the exception.

  2. the irony here is that canada started to emulate these policies in 2007 and may be getting into some trouble of its own.

    canada had a stable system due to large downpayment requirements and full recourse loans that made people think long and hard about going into mortgage debt.

    this system is being dismantled.

    you can now get much higher ltv rates if you get heavily subsidized and mispriced federal loan insurance. this is also opening up a pile of subprime risk for them.

    it also take the full recourse threat out of the game as your mortgage is insured and therefore the rest of your assets are safe.

    note that most of the mortgage insurance in canada (and virtually all of it for bad credit risks) comes from the government. such scenarios only unfold when the government is underpricing risk and has driven all the private players out by doing so.

    canada may be getting ready to learn its own lesson on subsidizing subprime and federal risk assumption.

    • this system is being dismantled.

      you can now get much higher ltv rates if you get heavily subsidized and mispriced federal loan insurance. this is also opening up a pile of subprime risk for them.

      I agree. Canada is playing a very dangerous game by meddling in the housing markets as the US did.

      • http://business.financialpost.com/2012/09/06/canadas-new-mortgage-rules-will-cool-housing-but-higher-rates-still-needed-td/

        I respectfully have to disagree with both of you. The mortgage market in Canada now has about the same credit requirements that existed 10 years ago. The Canadian Gov’t has made 4 tightening changes in the last 4 years as they saw the market continue into bubble like territory.

        The current low interest rates, strong Canadian $ and relatively good economy and unemployment rate are the most likely causes of the majority of the price increase.

        The real estate market in Canada may be in for a correction, and it might be a big one, but it will not be because the gov’t inflated the bubble with politically motivated interventions into the housing market.

        • gmf-

          but the usage of insurance to get to low down payments has been way up.

          you need at least 20-25% down to avoid insurance. when rates were high, this was less of a bid deal as people that could afford the insurance on top of a 6% rate could generally afford a downpayment.

          now, 45% of Canadian loans get insurance, a huge jump. people who cannot come up with a down payment can still afford a bit tacked on to such low rates.

          a drop from 25% to 5% down can add an awful lot of leverage and risk to a system.

          does that prove there is a bubble. nope. but if i were trying to create a bubble, that would not be a bad way to go about it.

          it ups leverage considerably and shifts risk to a government agency that is not run with profit as a primary goal.

          • Agree on all points.

            Sure, there is some gov’t intervention in the Canadian housing market, but as I said in another post, Canada Housing and Mortgage Corp has been around for 65 years, so this is not a new measure by the Canadian Gov’t.

            Where I disagreed with Vangel and yourself was in the assertion that the Canadian gov’t has been intervening to inflate the bubble recently. That is not the case, they have been trying to throw water on the flames.

            The changes you cite above wrt downpayments and mortgage insurance are not being driven by gov’t intervention but are primarily being driven by homebuyers who can now get mortgages at 2% to 3% rates and are buying houses that have doubled in price over the last 10 years so many cannot afford 25% downpayment that you need to have in order to not be required to get mortgage insurance (or should I say more accurately not by “direct” government intervention since the gov’t is responsible for the very low interest rates).

            The homebuyers in Canada are making many of the same mistakes that buyers in the US made before the crisis and this may be the cause of a similar crisis in Canada in the years to come. My point was that the primary cause of the run up in prices is not the intervention of the Canadian gov’t into the housing market over the last few years. They have actually been trying to cool the market.

          • gmf

            (or should I say more accurately not by “direct” government intervention since the gov’t is responsible for the very low interest rates).

            And there you have it. The same conditions of low interest rates and easy credit, along with transfer of risk from lenders that allowed the US housing bubble. You will find that lenders and home buyers respond to the incentives offered. In a period of rising home prices caused by artificially induced demand they have little to lose, but it will end badly.

        • I respectfully have to disagree with both of you. The mortgage market in Canada now has about the same credit requirements that existed 10 years ago. The Canadian Gov’t has made 4 tightening changes in the last 4 years as they saw the market continue into bubble like territory.

          I have friends who have only put 8% down on their purchases. That is not very sound given the fact that their jobs are not as secure as they used to be.

          The current low interest rates, strong Canadian $ and relatively good economy and unemployment rate are the most likely causes of the majority of the price increase.

          I agree that the artificially low rates are a driver. But they are artificially low because they do not offset the risk of inflation. Many people will find themselves renewing at higher rates and will find it harder to make their payments.

          The real estate market in Canada may be in for a correction, and it might be a big one, but it will not be because the gov’t inflated the bubble with politically motivated interventions into the housing market.

          The Bank of Canada kept rates too low for too long. There is no way to claim that did not help blow up a bubble in the real estate market.

          • Vangel and Morgan,

            Your comments are valid. However Vangel, it was always the case that you could put minimum of 5% downpayment and get CHMC mortgage insurance, this is not something that the government did in the last few years that has caused the recent run up in prices. You could get 5% down 10 years ago as well.

            As for interest rates, they are artificially low, as they are in most developed countries around the world, but the Canadian government did not drop rates with the intent to inflate the real estate market. They really had no choice in the matter as the spread between the US rates and the Cdn rates would have caused the CDN $ dollar to appreciate even more than it did. Over the last 10 years, the Canadian $ went from being worth 0.60 US to being now at par. Had the Cdn. gov’t not dropped rates and allowed the spread between US rates and Cdn rates to widen significantly then the Cdn dollar would be significantly higher than par. This is something that would have badly hurt an export driven economy like Canada’s (particularly one that has the US as its biggest trading partner).

            Dr. Perry’s post was talking about the US government’s direct interventions into the US housing market that lead to the US housing bubble. You two commented that the Canadian gov’t is now doing the same. I tried to point out the they were not and that in fact they have intervened 4 times in the last 4 years to try to deflate the bubble.

          • the case that you could put minimum of 5% downpayment and get CHMC mortgage insurance, this is not something that the government did in the last few years that has caused the recent run up in prices. You could get 5% down 10 years ago as well.

            That is not in dispute. But when you are putting down 5% when rates are near zero and the employment situation is shaky you find a lot more risk than most previous periods.

            As for interest rates, they are artificially low, as they are in most developed countries around the world, but the Canadian government did not drop rates with the intent to inflate the real estate market. They really had no choice in the matter as the spread between the US rates and the Cdn rates would have caused the CDN $ dollar to appreciate even more than it did.

            So what? A higher dollar would have attracted more capital investment and would have meant more productive economic activities. Taking the Zimbabwe route just because the US is doing it does not seem to be very prudent. Canada needs to be more productive and a strong dollar is a positive on that front.

  3. http://www.cmhc-schl.gc.ca/en/co/buho/index.cfm

    The Canada Housing and Mortgage Corporation is the Canadian Federal Agency that insures the bulk of the morgages in Canada, and has been for 65 years now. It is similar to Freddie and Fannie, but without the blatant political intervention that you saw in the US.
    Further, long term Canadian home ownership rates are consistantly higher than US rates, despite the US political intervention designed to increase US home ownership rates.

  4. Why is expanding home ownership “a worthy mission no doubt”? It is a fairly poor financial investment over the long run and over the short run a potentially disastrous one. It ties you to a physical location at a time when job tenure is shortening and mobility pays off. I understand it gives people a warm feeling, but there are plenty of ways to get warm feelings. In any case why should the federal government be subsidizing home ownership? Was it REALLY important to our nation that the percentage of home ownership increase by 4 points from 1975 to 2005? How?

    • I agree SeattleSam, governments should not distort markets, whether it is real estate, stocks, consumer products, etc.. Let the market decide price.

      I was not supporting the Canada Housing and Mortgage Corporation just highlighting that even without the blatant political intervention, homeownership rates in Canada where higher than in the US.

      I don’t think that either country is better served by having government agencies dominate the home insurance business. They should not be subsidizing home ownership this way.

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