What Can Be Learned From The Canadian Experience?

A variation of the old cliche about how the grass always seems greener in the neighbor's yard has taken place in the North American housing markets. In this case, the U.S. plays the role of the dissatisfied neighbor who looks across the fence at the grassy success of the next-door neighbor, played by Canada.
Indeed, the Canadian experience has even been used as an example of why Fannie Mae and Freddie Mac should be eliminated. In a speech before his bank's annual shareholders meeting in April, Robert G. Wilmers, chairman and CEO of Buffalo, N.Y.-based M&T Bank Corp., noted how the neighbor to the north got along quite well without government-sponsored enterprises.

‘Canada doesn't have the equivalent of Fannie and Freddie,’ Wilmers said. ‘Nor does it permit the deduction of mortgage interest from an individual's taxes. Nevertheless, its homeownership rate is 68%. Canadian banks have weathered the financial crisis particularly well and required no government bailouts.’

However, it is important to note that Canada has not been unscathed by recent economic forces that reshaped the global economy, nor is its housing finance market immune from tumult.

‘There is a lot of misinformation floating around,’ says David Min, associate director for financial markets at the Center for American Progress, based in Washington, D.C., and author of the new report ‘True North: The Facts about the Canadian Mortgage Banking System.’ ‘We've seen a lot of comparisons to Canada. It is a comparable country in many ways to the U.S., but it did not go through the extremes of the U.S. bubble.’

The key historical similarity between the U.S. and Canadian markets was the traditionally strong role of the federal government in mortgage financing. Min's report notes that the ‘Canadian government explicitly guarantees 90 percent of the mortgage insurance obligations of the two private insurers and stands 100 percent behind the obligations of the government agency, the Canadian Housing Mortgage Corp. (CHMC).

‘In many ways, Canada was like the U.S. prior to securitization,’ Min continues. ‘The largest difference was that Canada did not have an unregulated secondary market. In the U.S., that channel grew to 40% at the height of the bubble.’

At its peak in the last decade, Canada's private-label securitization market was less than 3%. Jim MacGee, associate professor of economics at the University of Western Ontario, points out that homeowner attitudes and lender product offerings were very different in Canada.

‘There was no buildup in the large number or homeowners gambling on house appreciation,’ he explains. ‘There was also the difference of subprime markets. In Canada, some finance companies tried offering subprime loans, but their market share was really small.’

Canada is also different from the U.S. in how it measures its housing markets. According to David MacDonald, research associate with the Ottawa-based Canadian Centre for Policy Alternatives (CCPA), the measurement of Canada's housing health is linked to six major metropolitan areas.

‘In some ways, Canada was similar to the U.S. for a couple of years in the early 2000s,’ he says. ‘In 2001, the markets began to inflate at three to four times the median household income. Toronto and Vancouver boomed and busted – over a five- to six-year period, housing prices increased significantly and then saw relatively small interest-rate spikes, which then caused housing prices to drop for three to five years. In the other four major cities – Calgary, Edmonton, Montreal and Ottawa – housing prices increased at the rate of inflation.’

Although the housing markets created concern in Canada, the U.S. housing-induced economic implosion did not spread north, MacDonald notes.

‘There were significant differences in terms of what happened when housing prices dropped,’ he says. ‘We didn't have the same circumstances – the banking crisis that followed the U.S. housing decline did not happen here.’

Yet a decline is taking place. A report issued in August by the Conference Board of Canada, a nonprofit research organization, determined that existing-home sales fell 11% between June and July and fell 31% year over year. The most severe declines were in Vancouver, at 20.1%, and Toronto, at 13.6%. The CHMC chimed in with the prediction that home sales and prices will fall across Canada for the second half of this year.

MacDonald believes that Canada will be facing its own set of problems in the near future. In August, the CCPA issued ‘Canada's Housing Bubble: An Accident Waiting to Happen,’ a report by MacDonald that warned Canada was experiencing a synchronized housing bubble across its six major metropolitan areas. In MacDonald's view, that situation can result in one of three scenarios: a market correction through housing-price deflation, which occurred in Vancouver in 1994; a deeper housing crash that would mirror Toronto's experience in 1989; or a steep decline that would echo what happened in many U.S. metropolitan areas in 2008.

MacDonald warns that many Canadians have fallen into the same trap as Americans did in regard to housing appreciation values. ‘We forget housing prices in Canada do go down,’ he says. ‘Unless we take steps now and take some air out of the bubble, we will see housing prices decline.’

However, MacGee takes a contrary view of Canada's housing markets in his report ‘Not Here? Housing Market Policy and the Risk of a Housing Bust,’ which was published in August by the C.D. Howe Institute. MacGee states that the absence of a vigorous subprime market in Canada and a continuation of strong underwriting standards during the past decade will prevent a U.S.-style meltdown from taking place.

‘Canadian housing policies, which avoided the sharp decline in underwriting standards seen in the U.S., worked well in reducing the possibility of a housing bust during 2008 to 2009, and continue to mitigate the risk of a massive wave of defaults in the future,’ MacGee writes in his report. ‘To the extent that current policies impose on taxpayers a significant exposure to mortgage insurance guarantees and, therefore, some of the aggregate risk of a decline in housing prices, it will be in the interest of all Canadians if policy-makers recall the lessons of the 2008 to 2009 experience, should pressures to relax underwriting standards reoccur in the future.’

(Please address all comments regarding this article to Phil Hall, editor of Secondary Marketing Executive, at hallp@sme-online.com.)


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