Why Canada's housing market didn't burst

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Why was the subprime market in Canada smaller?
Given the key role played by the "subprime" market, the question is why the Canadian subprime market was both smaller and levels of securitization were lower than in the U.S. While it is difficult to disentangle the reasons why Canada avoided the subprime boom, some factors can be identified that may have contributed to the differences in the Canadian and U.S. subprime markets.

Perhaps the simplest story is that Canada was lucky to be a late adopter of U.S. innovations rather than an innovator in mortgage finance. While the subprime share of the Canadian market was small, it was growing rapidly prior to the onset of the U.S. subprime crisis. In response to the U.S. crisis, some subprime lenders exited the Canadian market due to difficulties in securing funding. In addition, the Canadian government moved in July 2008 to tighten the standards for mortgage insurance required for high LTV loans originated by federally regulated financial institutions.

This further limited the ability of Canadian banks to directly offer subprime-type products to borrowers.
There are also several institutional details that played a role. For one, the Canadian market lacks a counterpart to Freddie Mac and Fannie Mae, both of which played a significant role in the growth of securitization in the U.S.

Secondly, bank capital regulation in Canada treats off-balance sheet vehicles more strictly than the U.S., and the stricter treatment reduces the incentive for Canadian banks to move mortgage loans to off-balance sheet vehicles. Finally, government-mandated mortgage insurance for high LTV loans issued by Canadian banks effectively made it impossible for banks to offer certain subprime products. This likely slowed the growth of the subprime market in Canada, as nonbank intermediaries had to organically grow origination networks.

The Canada-U.S. comparison suggests the low interest rate policy of the central banks in both countries contributed to the housing boom over 2001-2006, but that a relaxation of lending standards in the U.S. was the critical factor in setting the stage for the housing bust.

A caveat worth emphasizing, however, is that it tells us little about what would have happened if U.S. monetary policy had been tighter earlier, as tighter monetary policy in the early part of the decade may have helped to limit the subprime boom by slowing the rate of house price appreciation over 2002-2006.

One thing the comparison does highlight, however, is the practical challenge facing policy-makers in assessing whether a rapid run-up in asset prices is actually a bubble, or just a sustainable movement in market prices.


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  • mortgage needs on 2010-06-30 3:10:14 AM

    "The Canada-U.S. comparison suggests the low interest rate policy of the central banks in both countries contributed to the housing boom over 2001-2006, but that a relaxation of lending standards in the U.S. was the critical factor in setting the stage for the housing bust.

    A caveat worth emphasizing, however, is that it tells us little about what would have happened if U.S. monetary policy had been tighter earlier, as tighter monetary policy in the early part of the decade may have helped to limit the subprime boom by slowing the rate of house price appreciation over 2002-2006"

    Yes, given that what was done was done ( i.e. too loose a monetary policy 2002-6 ) it is also necessary to go easy on the brakes so that engine does not seize up altogether.
    Leverage is a great thing but it is nevertheless a slippery slope.
    That said, and as unfortunate as it is, putting the process into reverse gear requires a time-table for soft landing.

  • mortgage needs on 2010-06-30 3:37:33 AM

    If it is housing asset that we are concerned about, we may not need Central Bank interest rate intervention; a tightening of which will have across-the-board effects on the general economy, restricting financing to other industry sectors not requiring tightening.
    Adjustments in lenders' underwriting criteria over a range of lending products and programs will do the job nicely.

  • mortgage needs on 2010-06-30 4:02:43 AM

    Adjustments are possible where necessary, in some sort of mix or to various degrees, on permissible:
    1) loan-to-value, this not only in terms ceilings for what is considered conventional vis-a-vis high ratio, but for example e.g. at the height of the market borrowers could borrow on higher appraised values rather than the lower purchase price - so this is one area that can be tightened to stick to the lower of appraised or purchase price; 2) sliding scales on property values; 3) credit score brackets; 4)# of properties owned; 5)loan limits per borrower; 6) all property and other liabilities to be declared ( including out of state/province, if not country ); 7) amortization or life of loan for purposes of calculationg monthly debt service payments; 8) Gross & Total Debt Service ratio criteria for owner-occupied; 9) Debt Coverage Ratio criteria for rental properties; 10)Rental offsets thresholds; 11) new immigrant or overseas borrowers' thresholds on # properties and/or duration of time in the country ..
    Lenders and mortgage brokers out there know any and all these factors can be adjusted before even interest rate comes into play.
    If in a tightening, we do not tighten non-housing sectors, the housing sector will also have a better chance of recovery any time things are bad, or obtain better and sustainable housing price increases.

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