Historical article note: This article was originally published on 2019-05-09. Rates, policies, home prices, statistics, product names and qualification standards reflect the environment at that time and may have changed. This archive is for historical record and general education only. It is not mortgage approval, investment, legal or tax advice.
The Governor of the Bank of Canada made comments on mortgage policy on May 6 and revealed some ideas for improvements to mortgage policy. According to him, Canada's current strict mortgage policies are commendable. He credited the tougher mortgage guidelines, which brought in interest-rate stress tests, for working as they were designed.
Recently, some people have forwarded negative news about Canada to me for comments, and I have replied with a 'haven't seen it' approach. This inevitably reminds me of the period after April 20, 2017, when the stock price of a Canadian publicly traded mortgage financial company plummeted, causing some commotion. Later, Buffett invested in this troublesome company but sold its stock in less than two years. From Buffett's actions, it seems that he went all out when others were fearful, but he did not hold it long-term, likely due to a lack of confidence in the management. Two years later, people began expressing concerns about the Canadian economy again, worries about Canadian debt issues, and distrust of the real estate market, but the degree of concern is much less than before, and the reasons for pessimism are increasingly far-fetched. Friends who ask for my opinion are probably trying to understand the country they now live in after immigrating, as the situations described in the chaotic news are sometimes not about Canada at all. Many of the news writers are just fulfilling tasks assigned by their bosses related to page views and clicks; the authenticity of the content has nothing to do with the authors. People who like pessimistic news can go to anonymous forums like BBS to indulge themselves, where commanders of empty air and fanatical netizens gather day and night to collect and organize articles about the sky falling and the earth cracking. In anonymous spaces, everyone is entitled to freely express their pessimism about Canada and in-depth analysis of reasons for not buying property other than being unable to afford it. I have lived in Canada for ten years and have never seen a single article about the Canadian economy written by a non-Canadian that is positive or optimistic. There are two reasons for so much pessimistic news: sensational headlines attract readers to click and read; and the writers do not understand Canada.
Canada safely weathered the 2008 subprime mortgage crisis, and was less affected than Europe across the Atlantic. Why? Have you lived in Canada for many years and understand its real estate financial system? If you want to avoid being swayed by others' emotions and discern the truth from false information, you need to seriously understand the country you live in. Much of the knowledge-based information, once understood, benefits you for a lifetime and will no longer allow 'entertainment' news to deceive you. Below, I will introduce Canada's real estate financial system. There is no need to use this knowledge to educate Air Force generals or online trolls—you cannot wake someone who pretends to sleep; when they can afford a house, naturally, they will retire.
01 Mortgage Default Insurance Company CMHC is the Anchor of the Mortgage Financial Market
As early as 2014, Canada's only state-owned real estate financial company CMHC (Canada Mortgage and Housing Corporation) conducted a detailed comparison of housing finance safety between Canada and the U.S., titled Comparing Canada and U.S. Housing Finance Systems, explaining in detail the characteristics of Canada's real estate financial system. Comparison brings awareness, and the result showed that Canada's mortgage financial system is more conservative and more stable than that of the U.S.
CMHC is a Canadian Crown corporation, playing a huge role in safeguarding the security of the real estate financial system and providing ample funds for real estate finance. In contrast, prior to the subprime mortgage crisis, the U.S. “Fannie Mae and Freddie Mac” were private institutions. CMHC not only underwrites loan default insurance but more importantly 'oversights' mortgage asset securitization, injecting a continuous flow of funds into mortgage lending. U.S. financial regulation has multiple authorities: federal regulation of commercial banks is through the OCC, FDIC, and the Federal Reserve, while banks registered in each state are regulated by state governments—for example, the regulatory authority of Bank of China New York branch is the OCC/Office of the Comptroller of the Currency, while Industrial and Commercial Bank of China New York branch is regulated by the New York State Department of Financial Services. Canadian financial institutions, including commercial banks and trust investment companies, are all regulated by OSFI with uniform regulatory standards. The U.S. federal government directs 'Fannie Mae and Freddie Mac' to help low-income people become homeowners through lending, but in Canada, no government or financial institution supports low-income people in becoming homeowners. In home buying, everyone is equal, with no subsidies or preferential treatments that take from the rich to give to the poor.
In Canada, if the down payment is less than 20%, federally regulated financial institutions are legally required to insure the mortgage against default, which means that the risk of a mortgage with a down payment of less than 20% is borne by the state. In the United States, the law does not require mortgages with less than 20% down payment to have default insurance, but unless default insurance is purchased, the 'two housing agencies' will not acquire such mortgage loan assets.
02 Canadian commercial banks would rather not make money than lend recklessly
The quality of mortgage assets in the United States and Canada is the biggest difference between the two countries in terms of real estate financial security. Taking the second quarter of 2014 as an example, the delinquency rate of Canadian mortgages was 0.28%, while the delinquency rate of U.S. mortgages during the same period was as high as 2.31%, eight times that of Canada. Even today, the mortgage delinquency rate of Canadian commercial banks remains quite low. According to the CBA statistics from the Canadian Bankers Association, the mortgage delinquency rate of the six major banks was still 0.24% in December 2018.
03 The methods of handling debt after mortgage default are beneficial to banks
If Canadians default on their mortgage, according to Canadian law, banks have the right to recover all of the borrower's personal property until the borrower declares personal bankruptcy, with only one provincial exception, namely, "full-recourse" loans. Under U.S. law, due to consumer protection, banks can only recover mortgage debt from the property itself. If the property is sold and there is still a loss after repaying the mortgage, banks cannot pursue the borrower's other personal assets. From this perspective, although the U.S. protects consumers, it poses a significant risk to the financial security of the country's real estate. This is also an important reason for the high mortgage default rate in the United States.
04 No subprime bonds
In the United States, financial institutions that engage in subprime lending have a market share of nearly one-fourth, while in Canada, financial institutions that offer subprime mortgages have a very low market share, only about one-twentieth.
Ordinary consumers react negatively to the term 'subprime' mainly because of the shadow of the 2008 financial crisis. The spread of 'subprime' loans worldwide had tremendous impact, which required certain conditions. One of the key conditions was that 'subprime' loans could be securitized and sold globally, and whether a large-scale default occurred on the corresponding mortgage loans. Looking at the institutions handling mortgage-backed securities in the US and Canada, Canada is very conservative in its business processes. It can be said that in Canada, 'subprime' loans could not possibly be turned into bonds, let alone threaten the world. The only company underwriting Canadian mortgage securitizations is Canada Housing Trust, a wholly-owned subsidiary of CMHC. There is no institution in Canada underwriting subprime mortgages, and therefore no subprime mortgage-backed securities exist.
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Canada's 'subprime mortgage' market is originally small, and it cannot be securitized, which has laid a solid foundation for the safety of Canada's real estate finance.
The subprime mortgage crisis in the United States was caused by consumer ignorance, fraud by mortgage brokers (forging documents), and the greed of lending financial institutions. In Canada, mortgage security issues are concentrated in a very small number of financial institutions that condone forged documents. It is believed that the capital market will correct such greedy behavior. The regulatory body for the mortgage brokerage industry in Canada is the provincial finance departments, and inadequate supervision has exacerbated the risks.
I have worked in mainland China, Hong Kong, and New York in the United States, and have personally experienced the Hong Kong financial crisis and the U.S. subprime mortgage crisis. I have full confidence in Canada's real estate financial system. I have seen countries and practices that are conservative regarding financial security, but I have never seen a country more conservative and stable than Canada. CMHC is a state-owned enterprise; the government lets them take on risks and serve society, similar to another state-owned enterprise, the postal service—just serving the country well, the state doesn’t expect the enterprise to make a profit. However, although CMHC is conservative, it is well-managed and achieves huge profits every year. I mean huge, not merely breaking even. In May 2018, CMHC announced its 2017 revenue, paying as much as 4.7 billion to the government as dividends. In the federal government’s 2019 budget, it proposed providing 1.2 billion in subsidies over the next four years for first-time homebuyers. Online, some people were screaming, 'Taxes will go up again!' This shows ignorance of Canada’s mortgage financial system. For CMHC, spending this amount of money is nothing.
05 High homeownership rate + high proportion of owned housing rights = very few people are forced to sell their homes at low prices
The Canadian real estate market itself is safer than real estate finance. According to the 2016 census results, the homeownership rate in Canada was 67.8%; according to the Canada Mortgage and Housing Corporation, Canadian homeowners have an average net home equity of 70%, which is the home value minus the mortgage balance. These two 70% figures determine that in Canada's secondary housing market, sellers always remain in the driver's seat. In 2008, the world experienced a severe subprime mortgage crisis, but Canadian real estate prices withstood the severe test. The reason lies in this: Canada's financial system is extremely conservative; Canadians have a homeownership rate close to 70%, so when housing prices fall, sellers, holding up to 70% net equity in their homes, are unwilling to be forced to sell at low prices. For Americans, the mortgage interest on their primary residence can be deducted from their annual income tax, so many American households voluntarily maintain high mortgage balances. In Canada, mortgage interest on primary residences is not tax-deductible; without tax incentives, Canadians, from a tax perspective, also aim to pay off their primary residence mortgage as quickly as possible.
Many people question and do not believe that Canadian real estate is so vibrant. The population is much smaller than that of the United States, GDP is much lower than that of the United States, and even income taxes are higher than in the U.S. So why are houses worth so much? The intrinsic value of Canadian real estate lies in safety, conservatism, stability, and resistance to decline. Recently, I attended an event hosted by BMO Securities. The keynote speaker, Brian Belski, is BMO Bank's Chief Investment Strategist. He confirmed that over the years, Wall Street has consistently shorted Canadian bank stocks. These people believe that Canadian real estate is in a bubble and that the banks can't be okay. And the result? Those who shorted have consistently suffered losses. Brian previously worked at Merrill Lynch in the U.S., and he knows the financial systems of both the U.S. and Canada inside out. Watching these short-sellers be so arrogant, like moths to a flame, must also be a kind of work enjoyment.