Financial Crisis

[kEiThZ]

The risk is marginal, and thus the premium. And yes, I don't think that the CMHC should be insuring 0% or even %5 down mortgages. You cannot compare mortgage insurance to other types as the the object of insurance is elastic in demand.

Okay. So what in your opinion should be the bar? We already evaluate creditworthiness and the stability of employment when considering an individual's ability to handle a mortgage.

I also do not agree that mortgage insurance is fundamentally different because the 'object of insurance is elastic in demand'. Find me an object of insurance that is not elastic in demand. Higher premiums on younger drivers discourage them from driving and discourage bad driving habits. There's elastic demand right there. Raise the rates, discourage younger drivers. How is mortgage insurance different? Just because it's for a house? If the bank/CMHC has built its model right, the risk premiums that they charge should account for increased rates of default in an economic downturn.

The US situation was fundamentally different. AIG was insuring mortgage backed securities not actual mortgages. They had no clue what the underlying mortgages of the MBS were worth. That's what lead to their troubles. Comparing Canadian and US banking practices in this regard are not apples to apples comparison. Canada maintains significantly stronger regulation and disallows several practices which are freely practiced in the US. Really, how many Canadians actually buy a place with 0 down, or with an interest only mortgage? And how many Canadians use home equity to finance purchases of SUVs and big screen TVs?

Reality in complex systems acknowledges that growth is never linear. Banks in Canada have required mortgagees to come up with additional equity come renewal time before.

Fair enough, that still would not necessarily create a crisis. The bank would foreclose and capture the customer's equity. Hardly a comparison of what is happening south of the border.

Again, the insurance itself act as a form of leverage, at least initially. Do you think that real estate prices in the US would have gone up as much if it were not for making it possible for marginal borrowers to buy?

I disagree that insurance acts as leverage. How so? Nobody counts on becoming bankrupt so they don't have to pay their mortgage. That would ruin their credit rating. What brought in marginal borrowers in the US was ARMs and reduced credit standards.

Your equity after five years point is only valid if the market does not decline.

And true in any case, regardless of whether you put in 0 or 5% or 20%. It just depends on how much the market declines. That's the risk of every home buyer and every lender. And that's exactly what mortgage insurance is supposed to take into account.

Does it really make that much of a difference if it's 0 or 5%? On a 20 year amortization that's allowing the individual to buy a house one year early. If you argue that the bar should be higher, then to what level? Ideally, we could get our policies in line with Islamic banking....you have to have a 100% in equivalent assets to buy....credit lending...yay. See how far that has gotten the Middle East banking sector. Lack of credit is a big reason for why much of the Islamic world has relative poverty. Imagine trying to buy a place in Saudi and being required to have the whole amount available.

In my opinion,
The more you loosen credit (above 95%), the more risky the insurance is.

That's why there are higher premiums. This works like any other form of insurance. If that's the argument for mortgages, should we not insure patients at high risk of heart disease? It's the same problem.

The problem is not with a localized "bubble" -- it is more of a problem with a wide-spread bubble. Loose credit above a certain level (say 95%) that is sustainable - leads to an increase in the likelihood of a widespread bubble being created - pushing up prices further than the market can handle. When the bubble pops, then defaults rise substantially.

It's flawed to say though that the bubble is caused merely by requiring less of a downpayment. It's a supply and demand issue. Builder's built too much house and we ended up with a market glut which eventually brought down prices....

CMHC should not be in the business insuring abnormally high risk.

So you say, they should only insure low risk mortgages. If that's the case why have insurance at all?

 

[cacruden]

Just a guess but....

Our banking industry is typically generally a little on the conservative side (JP Morgan is typically more conservative as well) (except for CIBC which likes to shoot itself), and most of the investment banking is done as part of the 5 large national banks. We did not have any independent investment banks of the likes of Bear Sterns etc (US does not have them either anymore).

There are problems on the horizon (we are likely following the same cycle - but 2 years lag time) - but luckily the areas that are likely to "pop" are Vancouver and Calgary (more regional and smaller in size than - California/Florida/Nevada etc.) and thus will not likely overwhelm the insurance company (which in Canada would be a Crown company - so if it looses money - there is no rescue package - just a very big debt). I am guessing that the big 5 banks are subject to the conditions set out by CMHC (minimum mortgage length, and stricter calculation of whether you are qualified - i.e. income / debt ratio).

If housing prices drop 10% - people are likely going to hang on, 30%+ people are more likely to walk away.

Toronto/Ottawa/Montreal are seeing some softening - but as long as this region does not see a plunge in housing prices Canada should skirt the problem.

 

[kEiThZ]

We might see some regional 'pops' as cacruden said...but I am skeptical that we will see the large price drops that are occurring in the US. More than likely, we will probably see some stagnation in housing prices as builder's skip out new projects and let the backlog clear.

 

[cacruden]

One additional big difference - in the US the house is more like an investment.... which means that interest is tax deductable. The more you pay down the house - the less of a deduction you have

 

[kEiThZ]

Just a guess but....

Our banking industry is typically generally a little on the conservative side (JP Morgan is typically more conservative as well) (except for CIBC which likes to shoot itself), and most of the investment banking is done as part of the 5 large national banks. We did not have any independent investment banks of the likes of Bear Sterns etc (US does not have them either anymore).

Exactly. Our big 5 are consumer banks not investment banks. The latter are meant to take risks, the former are not. So in good times Canadian banks make poor returns (relative to the rest of the world) but they are steady hands when things go south....no pun intended.

There are problems on the horizon (we are likely following the same cycle - but 2 years lag time) - but luckily the areas that are likely to "pop" are Vancouver and Calgary (more regional and smaller in size than - California/Florida/Nevada etc.) and thus will not likely overwhelm the insurance company (which in Canada would be a Crown company - so if it looses money - there is no rescue package - just a very big debt). I am guessing that the big 5 banks are subject to the conditions set out by CMHC (minimum mortgage length, and stricter calculation of whether you are qualified - i.e. income / debt ratio).

If CMHC has done its math right than there should be sufficient capital reserves and enough income to weather the storms. They might have a few bad quarters but that's hardly a crisis, coming off a decade and a half of positive cash flow.

However, it's a mistaken belief that the banks are subject to CMHC conditions. The 2 are not related per se. It's just that Canadian banks as a general practice do not hand out mortgages without insurance. That practice is not necessarily the same throughout the world. In many places, the bank simply absorbs the risk of the mortgage.

If housing prices drop 10% - people are likely going to hang on, 30%+ people are more likely to walk away.

Hopefully, we haven't built up that much surplus housing stock. By some estimates, certain US markets like Miami have built up something like 10 years worth of housing. That's what lead to a crash in prices. I find it odd that everyone blames the schmo who took out the mortgage and nobody points the figure at industry that greedily overbuilt.

Toronto/Ottawa/Montreal are seeing some softening - but as long as this region does not see a plunge in housing prices Canada should skirt the problem.

A correction is coming but it'll likely mean that we'll see stagnation or below inflation increases in values for a few years as the glut is cleared. That's not necessarily a bad thing. Affordability was taking a hit for a while....now many Canadians can finally reach a price point they can afford.

 

[kEiThZ]

One additional big difference - in the US the house is more like an investment.... which means that interest is tax deductable. The more you pay down the house - the less of a deduction you have

EXACTLY. It's surprising that nobody has brought this up. The US system is designed to encourage the maintenance of a mortgage. The Canadian system makes a mortgage a pain in the rear so that Canadians are incentivized to pay it off quick.

I would say this US policy more than anything is responsible for many of the problems in the US housing and financial markets. In what other country in the world does the government help you pay your mortgage?!?! And they call themselves capitalists.....

 

[Brandon716]

For what its worth, home ownership rates between the US and Canada are virtually identical, so the tax rebate doesn't effect home ownership ability.

 

[kEiThZ]

For what its worth, home ownership rates between the US and Canada are virtually identical, so the tax rebate doesn't effect home ownership ability.

I would argue that home ownership would probably be lower in the US if that rebate was not there...or we would certainly see lower and more stable prices at the very minimum.

 

[afransen]

Yeah. I imagine that mortgage interest deductability tends to drive up the prices of homes to the point where the same proportion of people can afford them, only at a higher price. Moreover, the foregone tax revenue goes to the banks.

 

[Glen]

Okay. So what in your opinion should be the bar?

I like 20%.

We already evaluate creditworthiness and the stability of employment when considering an individual's ability to handle a mortgage.

The idea is to promote stability in supply and demand. Protecting from negative equity situations prevents walkaway's and the downward price pressure they create. Similar to the way a hedge funds 20 and 2 rule promotes liquidation over salvation when there are declines.

I also do not agree that mortgage insurance is fundamentally different because the 'object of insurance is elastic in demand'. Find me an object of insurance that is not elastic in demand.

Health insurance.

The US situation was fundamentally different. AIG was insuring mortgage backed securities not actual mortgages. They had no clue what the underlying mortgages of the MBS were worth. That's what lead to their troubles. Comparing Canadian and US banking practices in this regard are not apples to apples comparison. Canada maintains significantly stronger regulation and disallows several practices which are freely practiced in the US. Really, how many Canadians actually buy a place with 0 down, or with an interest only mortgage? And how many Canadians use home equity to finance purchases of SUVs and big screen TVs?

The down-payment should be enough to allow for equity o remain in the even of a downturn. Not a pathological one, but average.

 

[Glen]

One additional big difference - in the US the house is more like an investment.... which means that interest is tax deductable. The more you pay down the house - the less of a deduction you have

Nope. Here it is more like an investment as it can increase in value tax free. In the US it more of a tax shelter.

 

[afransen]

It seems to me that if banks are willing to absorb the risk of mortgages with 80% loan to value, should the CMHC insurance only cover the difference between 80% and what is loaned? It is my impression that this is not how it works.

 

[kEiThZ]

I like 20%.

The idea is to promote stability in supply and demand. Protecting from negative equity situations prevents walkaway's and the downward price pressure they create. Similar to the way a hedge funds 20 and 2 rule promotes liquidation over salvation when there are declines.

So if there is a well run company (or crown corporation) that is willing to accept higher risk and charge appropriate premiums to do so, they should not be allowed to do that? How is that capitalistic? Should we also disallow second mortgages as well? Just ban it all. Unless you are a cookie cutter case, no mortgage for you!

Health insurance.

How is demand for health insurance inelastic? In the Canadian socialist paradise maybe. But in most of the world, you get what you pay for: higher premiums for better health care.

The down-payment should be enough to allow for equity o remain in the even of a downturn. Not a pathological one, but average.

There's no such thing as an average downturn. In the current slowdown, prices are dropping by 20% or more in the US. Even under your threshold, defaults would be high.

Nope. Here it is more like an investment as it can increase in value tax free. In the US it more of a tax shelter.

Regardless of the difference, the effect is the same...an artificial inflation of home prices and a subsidy to banks.


I don't believe the situation in the US was caused by low down payments in so much as it was caused by an unwillingness on the part of American financial institution to evaluate the creditworthiness of their clients and potential to pay the full cost of the monthly payment (outside the teaser ARM rates). What's more the insurance companies were not insuring mortgages like CMHC and Genworth do in Canada. They were insuring Mortgage Backed Securities that bundled the mortgage risks of the banks. If their models for calculating risks on the MBS had been accurate we would not have had the financial crisis occur within a few weeks. It was the downgrading of the MBS that contributed in large part to rapidity of this crisis. And quite likely the phenomenon or interest only and low rate ARMs would not have spread to the extent it did if banks were not able to insure their risky mortgages.

You are missing the role of the banks and the MBS. Simply setting the bar to 20% would not necessarily have prevented banks from offering teaser rates or selling off bundles of risky mortgages as securities and it would not have prevented AIG from insuring these bundles. All that would still have happened if the bar was set at 20%. The only difference, perhaps, is that the impact might have been lessened and more spread out over time as there would have been fewer people playing the housing market.

 

[cacruden]

Nope. Here it is more like an investment as it can increase in value tax free. In the US it more of a tax shelter.

Since 1997 (I think), an individual in the US can realize up to $250,000 (couple $500,000) in capital gains on their primary residence TAX FREE.

Investments are subject to capital gains. Here we treat it as something special (i.e. different than a regular investment) - in that capital gains on primary residence is not subject to tax and it is somehow different than any other investment.

 

[Mot]

So it comes down to right leaning political policies of deregulating industries that cannot control themselves. Harper & Tories believe in deregulation. It's strange that people elect leaders to run their government who outright tell them they do not like government. The bad results of this kind of voting can be seen in the last 8 years of incompetence in the US.