This past weekend, an article appeared in The Globe and Mail about a potential mortgage foreclosure problem in Canada. It was entitled, “How high-risk mortgages crept north.” The story of their arrival in this country is quite interesting. There are extra downside risks for the economy as a result of their presence. However, the negative effects due to Canada’s equivalent of the sub-prime mortgage market may be exaggerated.

The Canadian equivalent of sub-prime mortgages is 40-year mortgages with zero down payments. These were intended to serve low-income earners, immigrants and those with previous credit difficulties. They evolved gradually over time, but the main driver was looser government regulation, until a clampdown was imposed in June of this year.

Canada’s commercial banks won’t lend out mortgage money without insurance to cover them in the case of default. This is where Canada Mortgage and Housing Corporation (CMHC) has traditionally come in. CMHC has long provided mortgage insurance when down payments are less than 25%. However, for longer-term mortgages and even lower down payments at the height of the housing market, there needed to be some new players.

In early 2006, through lobbying efforts and as a result of Ottawa’s desire for greater mortgage availability, insuring firms such as Genworth (spun-off from General Electric) and AIG made their way north. To its credit, the federal government did take the extraordinary step of saying that it would backstop the insurance firms if they ever ran into financial difficulty. At the time, nobody ever expected that to happen.

PMI Group, Triad and Mortgage Guaranty Insurance also came here to participate in a lucrative mortgage insurance market. As the financial crisis and liquidity problems accelerated in the U.S. and throughout the world, many of the same firms had to seek government bail-out equity or loans. Meanwhile, in the U.S., foreclosures on sub-prime mortgages have caused house prices to collapse and consumer spending to nosedive.

The Globe article implies, rather than states directly, what the impacts of the long-term mortgage situation are likely to be in Canada. A reader might well assume a problem of equal measure as in the United States. This is not necessarily the case and there are four reasons to think otherwise.

(1) The period of time during which high-risk mortgages proliferated here was somewhat limited, from early 2006 until June 2008. In the U.S., they were popular for a much longer stretch of time and, as a consequence, involved many more write-ups, on a proportional basis. Furthermore, 2006 was a testing period during which insurers fought to see who could go one step further in offering longer terms and lower down payments.

(2) U.S. sub-prime mortgages were mainly of the ARM variety (i.e., mortgages with adjustable rates). The initial teaser rate was quite low, with subsequent adjustments coming in two or three years’ time. A large number of U.S. sub-prime mortgages were written when the Federal Reserve’s key interest rate (i.e., the federal funds rate) was extraordinarily low. It was dropped to only 1.00% from mid-2003 through early 2004.

Two years later, the federal funds rate had climbed to 5.25% and there it stayed, from early 2006 through August 2007. Low income earners saw payments on their adjustable-rate mortgages bumped up by hundreds of dollars per month. This is what first raised the alarm over potential, and later realized, mortgage foreclosures.

Individuals and families that are holding high-risk mortgages in Canada may have problems meeting payments due to the recession and job losses or income declines. But a bump-up in mortgage rates and, therefore, monthly payments is a less likely problem. The Bank of Canada’s current overnight rate, at 1.50%, is about as low as it has ever been.

(3) The sub-prime mortgage mess in the United States spilled over into the general economy due to aggressive practices by financial institutions, mainly the investment banks. In Canada, investment banking operations are divisions with the commercial banks. Canada’s commercial banks resisted any temptations they might have had to bundle mortgages and issue them as collateralized debt obligations (CDOs). In the credit crunch, it was the “dodginess” of sub-prime mortgages within CDOs that caused banks to stop lending to each other. Canadian banks were left holding “bad paper” but they issued none of their own.

(4) Finally, in the U.S., it turned out that sub-prime mortgages did not have proper insurance backing. Government was not standing behind the private insuring firms. In Canada, there was a commitment by the federal government to backstop insurance on mortgages, even the riskier ones. This included underwriting by private insurance firms and by the quasi-government agency, Canada Mortgage and Housing Corporation.

The Globe report, towards its conclusion, mentions that almost all of the foreign mortgage insurers have now withdrawn from the field, leaving CMHC to take up its old prominent position. CMHC insurance on mortgages is government backed. Even if there are substantial foreclosures, Canada’s financial community will not be seriously affected.

None of this is to say that mortgage defaults for people, mainly at the lower end of the income scale, won’t be a tragic situation on a personal level. But the concentric-circle effect from one stone dropping should be contained to a degree that was not achieved south of the border.

What is really surprising about all of this is that high-risk mortgages were allowed to continue in Canada long after August 2007, when their potential for harm for individuals, the financial sector and the economy as a whole, was first exposed in the United States.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News.

» View all comments (0 total comments)

Post Your Own Comments

» Not a member? Register now to become one. Otherwise, login to post your comments on this article.

11/19 - Starts remain low in CanaData’s latest forecasts, but there are signs of a pickup in optimism

11/11 - CanaData’s October Construction Starts and Remembering Planned Obsolescence with Some Fondness

11/04 - It’s a World of Opportunities as Economic Thoughts Turn to Recovery

10/28 - Housing markets in Canada and U.S. tell complex stories

10/22 - The Current Grace Period for Construction Costs will Expire within Six Months

» Back to Alex's Blog