Our debt isn’t like their debt

Garry Marr | Financial Post Oct 30, 2012     (please see my comments at the end)

CIBC Deputy Chief Economist Benjamin Tal sounds like he’s getting tired of the comparisons linking the Canadian housing market to a U.S. style crash.

Canada is just not going to have a severe crash, he says in a report dubbed “Should We Worry About a U.S. Style Housing Meltdown?

You could lose a “night’s sleep” if you glance at charts comparing U.S. household debt and prices before their correction with today’s Canadian housing market but Mr. Tal says a closer look reveals vast differences.

“To be sure houses prices in Canada will probably fall in the coming year or two but any comparison to the American market of 2006 reflects a deep misunderstanding of the credit landscapes of the pre-crash environment in the U.S. and today’s Canadian market,” says the economist.

He lays out a number of myths used to compare the two markets, listing everything from the difference in the quality of debt to the false assumption that most Americans had long-term 30-year mortgages before the crash.

“I just think the comparisons are irrelevant,” says Mr. Tal. “There are two different questions. Are we slowing? Yes, we are slowing. But not every slowdown should be a U.S. type crash. Just because it happened there doesn’t mean it happens here.”

The Canadian Real Estate Association said this month that September sales across the country were down 15.1% from a year ago. Many commentators expect prices to fall next but CREA said last month’s average sale price of was up 1.1% from a year ago.

Interestingly enough, Mr. Tal says some of the defences used to explain how the Canadian housing market is different than the U.S. probably are not valid.

For starters the low rate of mortgage arrears means nothing, it was just as low before the U.S. crash. Canada is a recourse country where borrowers in every province but Alberta can go after a homeowner’s other assets but that’s not much different than America where only 12 states are non-recourse states. Mortgage industry deductibility has long been seen as a contributor to the U.S. housing crash but only about 15% of Americans use that tax break, says Mr. Tal.

But the economist doesn’t need those excuses. He says the debt-income ratio in Canada is high but look at the quality of debt which rose quickly in the U.S. with almost 22% of the market considered risky — some of those people with a negative equity position even before prices crashed. In Canada, you must have a minimum of a 5% down payment.

While the 30-year fixed rate mortgage has long been the U.S. standard, 80% of new mortgages in the U.S. went for an adjusted rate mortgage leading up to the crash. Those mortgages had teaser rates for two to three years that were almost 4.25 percentage points below prevailing rates.

“[That teaser] expires and overnight you’ve got two years worth of [Federal Reserve] increases in one day, that’s a shock,” says Mr. Tal.

He says the Canadian market has room for a soft landing which is what Australia experienced recently. “They demonstrated there is such a thing as a soft landing, interest rates went up and prices went down by 7% to 8%.”

So why are we so obsessed with comparing ourselves to the U.S.? Mr. Tal says it’s normal. “It makes sense because it happened in the U.S. and everybody was talking about it and we are going through a significant increase in house prices. I can understand why people do it but it should be based on fact.”

There is a distinct possibility that those who got into the market with 5% down, and therefore incurred a CMHC fee, may be teetering close to becoming under water if prices in those areas go down. The answer is to hold on and wait until the real estate cycle brings prices back up. The other thing to consider is the interest rate increase which is inevitable although no one knows when it will happen. The solution, if you believe rates may go up to 4 or 5% (where they were 5 years ago), is to consider a 10 year mortgage term. This hedges both rate increases and inflation and 10 year rates are the lowest they have been. 


To your wealth;


Skip to toolbar