Home Capital scandal may presage a slowdown: Don Pittis
Is false income data a symptom of an industry that has run its course?
Could the scandal at Home Capital just be the beginning? The Canadian alternative mortgage company halted its shares after it was revealed that some of its brokers had been falsifying information on the income of mortgage customers.
As the soaring housing markets in Alberta and Saskatchewan go off the boil, a gradual weakening in Canada's roaring real estate business may reveal more irregularities in the market.
It is a phenomenon we have seen happen so frequently that the uncovering of scandal in a market is often seen as a cause rather than a symptom of a market's decline. Sometimes they go hand in hand.
On a conference call yesterday Home Capital CEO Gerald Soloway insisted that the problem with its brokers was not an indication of a mortgage fraud crisis across Canada. Home Capital's delinquencies remain low, and the company says it has stopped doing business with the brokers that investigators had shown to be pretending customers' income qualified them for mortgages.
Pressure to succeed
It is hard to draw a direct line of cause and effect between the first few scandals in a weakening market and that weakening.
But as markets get into trouble, more and more accounts get shuffled off to the riskier end of the business. Pressure to succeed intensifies. People trying to make a living are more willing to take shortcuts. And it is only as the markets weaken that shortcuts — or outright fraud — are revealed.
There are many examples but the most notorious case is Bernie Madoff, author of what many consider be the biggest swindle in U.S. history. Madoff's scheme was to accept investors' money and falsify the income statement on their investment returns. Even as other funds began to do badly, Madoff's remained strong.
It wasn't until markets began to fall in 2008 that, despite a last-minute push for more clients to keep the system running, Madoff had more redemptions than he could cover. The scheme was found out and Madoff was convicted of fraud.
Of course the Home Capital scandal is of a completely different magnitude, and there is no suggestion of a possible Madoff-like Ponzi scheme here.
As mortgage insurers and banks have been tightening their criteria, wary of a market that even the Bank of Canada has declared 30 percent overvalued, more and more business has been flowing toward alternative lenders.
In the case of Home Capital, the company insists the brokers who falsified information amount to only 53 of 4,000 brokers the company works with.
But the company also revealed that these 53 brokers originated $960 million worth of business from a total in 2014 of $7.6 billion. In other words, the bad apples were producing a hugely disproportionate share of the business. They were the most successful.
CBC News reported in 2012 that the subprime sector was been growing in Canada, but it is by no means the Wild West seen in the U.S. subprime mortgage meltdown of 2007 that led to the global banking crisis of 2008.
In the U.S. subprime crisis, a demand for loans to sell to global financial institutions pushed mortgage brokers to find customers who were less and less qualified. It was only after property prices began to stabilize and fall that it turned out many borrowers could not begin to cover their mortgage payments, leading to a collapse in prices and waves of delinquencies.
There are worries that a similar demand by the financial sector for subprime automobile loans in the U.S. and Canada could lead to another crisis if borrowers begin to lose jobs in a broad based recession.
This is exactly the kind of concern reported this week by credit analysts TransUnion, specifically targeting the oil-producing areas of Alberta and Saskatchewan.
"TransUnion Canada, which assigns credit scores to millions of consumers who hold credit cards, mortgages, car loans and credit lines, said overdue payment levels could soar as much as 60 per cent by year's end in such oil dependent Alberta communities as Fort McMurray," reported the Edmonton Journal.
The credit analysts say that if lenders use the normal indicators of default, the indicators used when there is no generalized slowdown, they can be caught unawares.
So far, in most parts of the country, the housing market remains stable. But if interest rates rise and or the country heads deeper into recession, the trouble TransUnion predicts for Alberta could be coming to the rest of us.
Having seen one irregularity in a sector so crucial to the country's economic health, regulators will be on the watch for more, hoping to nip them in the bud before they lead to greater trouble.
Perhaps the scandal at Home Capital is a unique example, a one-off, and now that the company has revealed all, there will be no more trouble in the Canadian housing market. Perhaps there are no more secret shortcuts to be uncovered.
We would need some more examples to find out for sure.
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