Jay Bryan
Sun
As Canadians read alarming headlines about overstretched U.S. homebuyers threatening that country’s financial system, they can keep one comforting thought in mind: It’s simply not happening here.
The term “subprime,” once an obscure bit of financial jargon, has become a staple of business news reporting over the past few weeks.
It refers to those with marginal credit who have nevertheless managed to participate in a huge American residential real estate boom, thanks to lenders who stretched lending standards to the limit and past.
Now, these shaky mortgages are going sour, just in time to hit the U.S. economy when it’s slowing.
Canada has its own economic strains, and if these housing problems take down the stock market or the U.S. economy, we’ll certainly feel some pain.
But not as much as our neighbours, largely because mortgage and housing markets, which are fundamental to the financial position of consumers, look quite solid in Canada.
Benjamin Tal, an economist at CIBC World Markets, has kept a close eye on the mounting stresses evident in the U.S. mortgage market and has come to two key conclusions.
First, there’s no excuse for anybody to be surprised at the troubles in the U.S., which could be predicted months ago in much the same way as the arrival of a freight train that’s already visible on the horizon.
Second, there’s no parallel in Canada, whose mortgage lenders remained safely stodgy even as those in the U.S. went wild in a speculative market where it seemed impossible to lose money — until the market crumbled last year.
Says Tal: “They really pushed the envelope. We didn’t even touch the envelope.”
Some of the worst excesses exploded in the overheated market that arrived in 2004: Interest-only mortgage loans that required no repayment of principal; “liar loans” that didn’t require borrowers to provide proof of income; and option ARMs — adjustable-rate mortgages that let borrowers forgo payments, piling new debt on top of the original amount.
A particularly widespread abuse was the offer of ultra-low “teaser” interest rates — including to those with poor credit — that could be reset as much as several percentage points higher after two or three years.
Obviously, any already stretched borrower would be unable to withstand a huge jump in interest payments, but by the time the defaults began, these mortgages had usually been packaged into bond-like securities and peddled to other financial institutions.
Tal was among those warning of the coming wave of mortgage problems last year. Five months ago, he noted the huge wave of adjustable-rate mortgages that climaxed in 2004 and 2005, as housing prices peaked, would have their interest rates reset upward beginning in the autumn of 2006, leading to two years of severe stress on borrowers.
How severe? Well, the value of mortgage loans now being reset is $2 trillion (yep, 12 zeros) and Tal’s estimate is that mortgage payments on these loans will jump by an annual average of $35 billion to $40 billion through late 2008.
This alone isn’t enough to tank the huge U.S. economy, but it’s plenty stressful to those exposed to this large chunk of loans. And if the stresses trigger problems in broader financial markets, all bets are off.
But for once, Canadians can be happy to be boring. Many of us might have been happy to take one of these free-lunch mortgages with a hidden bellyache, but our banks didn’t let us.
That helped keep household debt from exploding as it did in the U.S. (up nearly 70 per cent in the past four years versus 40 per cent in Canada.)
For example, subprime loans make up 22 per cent of new mortgages in the U.S. versus just five per cent here. Interest-only mortgages, a product that can help a borrower stretch her borrowing to the limit, amounted to 20 per cent of new loans last year in the U.S; but only one per cent in Canada.
One result: House prices didn’t explode here because the ultra easy money to finance a bubble wasn’t available. So it’s a little like 2001, when the collapse of the tech bubble brought a recession in the U.S. but not in Canada, largely because we didn’t have a big tech sector.
Today, real estate accounts for 31 per cent of U.S. household assets, much of it financed by shaky loans. It accounts for just 21 per cent in Canada, and only a tiny percentage of mortgage loans is of dubious quality.
