Monday, December 14, 2009

Cleveland Fed: Comparison of Canada vs US housing markets

This research by the Cleveland Fed tries to figures out why the US housing market went bust and the Canadian market, whose appreciation was similar from 2000 forward did not. I thought the author was far too lenient on the US regulators more praising the Canadian regulators than shining the light on the US regulators. Regarding subprime in Canada vs US:

Perhaps the simplest story is that Canada was “lucky” to be a late adopter of U.S. innovations rather than an innovator in mortgage finance. While the subprime share of the Canadian market was small, it was growing rapidly prior to the onset of the U.S. subprime crisis. In response to the U.S. crisis, some subprime lenders exited the Canadian market due to difficulties in securing funding. In addition, the Canadian government moved in July 2008 to tighten the standards for mortgage insurance required for high LTV loans originated by federally regulated financial institutions. This further limited the ability of Canadian banks to directly offer subprime-type products to borrowers.

There are also several institutional details that played a role. The Canadian market
lacks a counterpart to Freddie Mac and Fannie Mae, both of which played a significant role in the growth of securitization in the U.S. In addition, bank capital regulation in Canada treats off-balance sheet vehicles more strictly than the U.S., and the stricter treatment reduces the incentive for Canadian banks to move mortgage loans to off-balance sheet vehicles. Finally, as noted above, the fact that the government-mandated mortgage insurance for high LTV loans issued by Canadian banks effectively made it impossible for banks to offer certain subprime products. This likely slowed the growth of the subprime market in Canada, as nonbank intermediaries had to organically grow origination networks.

There were monetary policy differences (interest rates were higher), regulatory differences (banks weren't getting away with the off balance sheet shenanigans and the regulators actually stopped them offering products, a novel concept to US regulators), structural differences (no Fannie or Freddie, much less securitization and little of that unregulated) and the basic mortgages in the two countries were different. The main mortgage being a 5 yr ARM in Canada means the tremendous drop in rates is buoying many homeowners without the need to refinance. Also I would bet their currency strengthening is also helping the household balance sheet by making imports cheaper. The other thing I would be very sure on, though I don't know how to check the data, is that debt load of your standard Canadian household during the boom years was much much less than US households. This was a credit bubble and looking at only one part of the whole bubble might lead you to some weird conclusions. It is also quite possible that Canadian home prices were undervalued in 2000 versus what I would call fairly valued for US homes and that would mean the overshoot to the upside was less of a bubble. David Rosenberg has more on what he believes to be the Canadian housing bubble here but I haven't gone through it yet.

Full Disclosure: I like hockey and the only stamps in my US passport are Canadian. So I might be a little biased to our Canadian friends to the north. But I do think their regulators and central bank got it much "less wrong" than their US counterparts. Though that is a very easy call to make.

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