Canadian government is making the right moves in cracking down on lending practices: Neil Macdonald
The virtuous need protection from the stupid and greedy
If you didn't live through the American financial disaster of 2008, then you've probably never seen contagion spread through a residential neighbourhood. I have, and it makes you understand how badly we need protection from stupid, greedy neighbours.
Contagion starts with one neighbour missing mortgage payments, perhaps because the interest rate has shot up and he can't afford it any longer, which means he's been operating on the thinnest margin possible and is probably carrying a ton of debt. He never should have bought the house (or been allowed to buy it) in the first place.
The bank forecloses. The house sits empty. Weeds spread. The pool sits half full of stinking, dirty water. Kids start tossing stones at the windows.
The dilapidation begins to infect the value of the homes around it (banks, apparently, have actual tables measuring the impact on property values of houses based on proximity to a foreclosed property).
Some of the neighbours, particularly the ones whose down payment was, say, five per cent, are now squeezed hard. Their little bit of equity vanishes as the value of their homes is dragged down. Some go underwater, meaning they now owe the bank more than the house is worth. Turns out they've been living far beyond their means, too; some owe credit card companies $20,000 or more, at 18 per cent interest.
As values keep dropping, people find themselves $50,000 or $100,000 in the hole, and more lose their homes. Some just walk away, preferring bankruptcy to unrepayable debt. "Jingle keys," they call it in America, after the sound the house keys make when they're tossed in the mailbox for the bank to collect.
Now there are four, five, or six foreclosed houses on every street. In poorer neighbourhoods, thieves strip copper piping from empty buildings. At this point, even the neighbours who have lots of equity, who have sacrificed and paid the mortgage and made repairs and generally behaved virtuously, are in deep trouble, severely punished for the irresponsibility of others.
They realize everything is beyond their control, and always was. We are all connected to one another, something rugged-individualist conservatives choose not to believe, but which a great many Americans discovered is true in the horrible months that followed the autumn of 2008.
- Proposed mortgage rules aim to reduce financial risk in Canada's hot housing markets
Until that point, those conservatives thought "government is the problem, not the solution," and believed in endless deregulation and unchaining free enterprise, and "letting the markets work."
Well, they didn't. Or they did, depending on how you look at it. In the end, millions lost their homes and their jobs. Their government bailed out the banks that caused the disaster, and let the chumps sink.
Which brings us to Canada in the here and now.
Happily, our government is cracking down ever harder on lending practices, doing things Americans would consider socialism.
Since 2008, Ottawa has ended 40-year amortizations for insured mortgages, bringing them down to 35 years and then, in 2012, to 25. It began requiring more skin in the game from the borrower, meaning higher down payments, and it forced banks to raise the credit bar.
It banned mortgage insurance on homes worth more than $1 million. It began drastically shrinking the number of borrowers who buy government insurance on their debt – the people who put down less than 20 per cent.
Now, Ottawa is going further: it will likely begin demanding that even borrowers who arrive at the table with 20 per cent or more down be able to prove they can withstand an increase in interest rates of 200 basis points. Rules will be particularly stringent in volatile markets.
Realtors are angry, predicting a drop in sales and prices.
But the rest of us should be happy little clams. Comforted, even. I am. Let sales and prices drop. Good.
Because, simply put, the situation in some Canadian cities is nuts, and the virtuous need protection from the stupid and greedy, and the only entity that can offer that is the government.
Benjamin Tal, deputy chief economist for the Canadian Imperial Bank of Commerce, points out that in Toronto, the average home price rose 25 per cent last year. "It's not a stretch to think it could drop by the same amount this year."
If that happens, someone who bought a million-dollar home last year in Toronto (which is about the average price now), and who put down $250,000, would have precisely no equity left. And interest rates are rising.
No wonder the government wants that extra stress test. Kill the contagion before it can begin.
The federal measures will mean fewer mortgages, says Tal, but "we do want a boring housing market."
Ballooning personal debt
Consider this: Canadians' level of personal debt is 15 to 20 per cent higher than what Americans were carrying at the time of the 2008 meltdown. We are among the most indebted people on earth.
In cities like Vancouver and Toronto, desperation to get into the housing market has provoked extremely risky behaviour – taking on enormous debt and operating on frighteningly thin margins.
Louis-Philippe Rochon, a professor of economics at Laurentian University, says things are so tight that the Bank of Canada's recent decision to raise interest rates by a puny 25 basis points has rocked some homeowners.
And, he says, "We're talking about nine more increases until we get to a point the central bank thinks is normal" (the rate is now 0.75 per cent; the bank considers 3 per cent to be where interest rates should be in normal economic circumstances).
Rochon argues against such rises, given all our debt. But Christopher Ragan, an equally accomplished economist at McGill University, makes the opposite argument. The economy is coming back, he says, and inflationary pressure must be contained. Raise rates.
So, smart experts disagree, just as they disagree on the importance of the $12 trillion or so (yes, $12 trillion) printed by the world's most important central banks since the 2008 meltdown. That ocean of money has unquestionably fueled the rise of stock markets, and probably real estate markets.
It may also be fueling the next crash.
The truth is no one really knows. Old economic theories have been proven wrong and dumped. We are in unknown territory.
But this much we can all agree upon: the virtuous need protection from the venal.
Bravo to the Canadian government. Bravissimo.