Why Was There No Canadian Housing Bust? The US Fed Says That They Were Probably Just Lucky Except…
Courtesy of Jesse’s Café Américain
This paper from the Cleveland Fed, which used to shine under the governorship of Jerry Jordan, suggests several reasons why there was no significant housing bust in Canada. Interesting that after each politically correct reason stated, there is an ‘oh-by- the-way’ in addition that cuts to the heart of the problem.
The Canadians were probably just lucky, according to the Fed, except they actually did things to stem the growth of off-balance-sheet securitization and tightened lending standards earlier on while the US Fed was cheerleading banking speculation and the growing housing bubble even to the point of its collapse.
Chairman Ben struck the party line in a recent speech, blaming the regulators. But in fact the Fed had a significant role to play in both regulation, monetary policy, and in the verbage they put out attacking regulation of banks and enabling their off-balance-sheet vehicles and derivatives speculation at every turn.
Yes, Fannie and Freddie played a significant role in the US. But the Fed set the tone for banking regulation and they not only did not take away the punch bowl, they spiked it with high grain alcohol. The Fed was the ‘cop on the beat’ and they looked the other way. And they still are.
The Wall Street banks bought the White House, the Congress, and already owned the Fed. It was a failure of stewardship in the US that allowed the bubble then, and the continuing abuses on Wall Street today. And while the US Fed is not the sole perpetrator, it was their duty as the "independent regulator" to take away the punch bowl. And they never did it. And have not done it yet.
From the charts, it is obvious that there is a bubble in Canadian housing, not of the dimensions of the US, but likely a bubble nonetheless. The bubble is partly due to Canada’s heavy export involvement with the US, and a certain interdependency implied with the devaluing dollar, and a desire to keep the loon at par with the dollar. The key difference between the nature of their bubble is that it is not founded on the fraudulent securitization of mortgages held by their commercial banks.
Will the Canadian housing bubble ‘pop’ or will the Canadians be able to grow out of it gracefully? That is not quite the issue being addressed here. Certainly the Canadian monetary authority and regulators are not exemplary, but certainly less inept then the US Fed, at least so far.
Addendum: Canadian readers are quite concerned about the actions of the Harper government and the CMHC, which is similar to a Canadian version of Fannie Mae apparently. CMHC Bubble 100% Made in Canada Several were kind enough to write in and say that Canadian housing is still overpriced relative to rents, and that the debt held by the CMHC is likely to end in tears at some point. I think the chart of home prices indicates that, but it appears that a gradual decline in activity and pricing is possible, which is the conclusion I believe that the Fed was assuming in their paper. Canadian readers of this blog are not so sanguine, and believe that a collapse will happen.
That is always a possibility. It would take considerably more analysis on my part to determine the size of the debt relative to its servicing, and factor in the possible steps that the government might take to manage that debt relative to homeowners.
But the point I think the Cleveland Fed writer makes is not entirely lost here. So far Canada is holding up rather well. It was a characteristic that interested me because Canada also held up remarkably better than the US during the Great Depression, and the people suffered much less, largely because their banking system was more conservative than the US.
It will be interesting to see how the Canadians deal with this issue going forward. Perhaps they really have just been lucky, and are heading towards a similar fate. But one thing remains that at least for now they have many more policy options than the US, which was taken down hard by its banks, and their propensity to leverage up, mismark risk, and pack it into their balance sheets recklessly. Whether they do the right things now is another matter again.
"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. (That’s quite an oh-by-the-way – Jesse)
There are also several institutional details that played a role. 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. In addition, 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. (Another significant oh-by-the-way – Jesse)
Finally, as noted above, the fact that the 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.
A Challenge for Policymakers
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 and 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 the Canada-U.S. comparison tells us little about what would have happened if U.S. monetary policy had been tighter earlier. 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. The Canada-U.S. comparison does, however, highlight the practical challenge facing policymakers in assessing whether a rapid run-up in asset prices is a bubble or a “sustainable” movement in market prices."
Why Didn’t Canada’s Housing Market Go Bust? – Cleveland Fed
Here is a little more detail on the shenanigans of Tim and Ben by John Hussman.
The banks must be restrained, the financial system reformed, and the economy brought back into balance before there can be a sustained recovery.
