Sunday, February 7, 2010

Canadian Banks Want WHAT?

I'll admit, I read this and was mightily confused. The big 6 Canadian banks are lobbying the Canadian government to tighten lending standards in order to prevent a housing bubble. The big question is why?

Higher required down payments and shorter amortizations would curb housing prices by cutting the amount most Canadians could bid for a house.

Such changes would also mean smaller mortgages and lower interest payments over the life of the loan - in other words, less money for the banks.

Don't get me wrong, this would be a fantastic idea to reduce risk to borrowers by allowing them less leverage by raising down payments and shortening amortizations. After all, it's CMHC that has to insure any home purchase where there is less than a 20% down payment. These actions would reduce the risk to the government. It would also reduce the number of prospective buyers as people would actually be required to save for a down payment. This would be a catalyst for a Canadian housing price correction (among others, such as the HST, rising interest rates, etc).

But why do the banks care?

The bankers' effort is all the more notable given the unique structure of the Canadian mortgage business. Banks get the profits from mortgages with their decades of interest payments, but have little risk of direct loss because of mortgage insurance.

Consumers cover the premiums and, because most mortgage insurance is underwritten by CMHC, the federal government ultimately takes the risk.

They aren't assuming the risk, the taxpayer is. I'll propose a few potential ideas of why the banks might suggest doing this:

1) They're actually worried about the secondary impacts of a housing bubble correction, and it's impact on other types of credit (non-secured loans, lines of credit, credit cards). The article assumes this is the big driver as well:
It's not the potential of big losses on mortgages that scares banks, says Mr. Routledge of Moody's. But if there were a spike in foreclosures in Canada, as has happened in the United States, consumers would likely struggle to make payments on other loans that aren't insured, such as credit card debt. Such a situation would also likely cause a big economic slowdown.
As Canadian mortgages are recourse, homeowners can't walk, and as such people should put their payments towards their house first. Banks may be a little leery of the prospect of people defaulting on their non-secured loans in order to make their mortgage payments, which banks would have to take a significant loss on (in many cases 100%).

2) Public relations. Banks sense the coming backlash worldwide as the US and the G7 in general are proposing banking taxes. This may be a game of "look we're responsible, don't tax us". Banks may also prefer to have the government take the lead in potentially pricking this bubble (so they can take the blame), as opposed to letting (eventually) rising rates correct things.

3) Counterparty risk of CMHC. Just because we assume the banks have "no risk" in their lending models doesn't mean that's the case. It's just been transferred to CMHC. If the banks realize that CMHC isn't prepared for the coming defaults and isn't adequately capitalized, changes will come. Either the CMHC will have to raise mortgage insurance premiums, the government will have to assume CMHC's losses in the form of deficits (and tax increases), or the goverment may decide to remove CMHC's taxpayer backstop (removing the banks no-risk play). I'm sure banks don't want to see an end to their no-risk lending model, so it's in their interests if CMHC doesn't implode.

4) Falling home prices might actually increase demand for mortgages amongst credit-worthy borrowers that are currently priced out of the market by marginal high-risk borrowers.

5) Do the banks have prop trades shorting the Cdn housing market? I'm not putting my tinfoil hat on here, but let's face it, we've seen this behaviour in the US before, pimping the product you're selling, while quietly positioning yourself for the opposite.

6) They're just really nice corporations that aren't interested in their own profits.

Of the 6, I'd think 1 is the primary reason, with 3 being a reasonable concern on the longer-term, and 2 in the near-term. But if this is the case, how much exposure must the Canadian banks have in their non-secure loans to justify taking this step?

It will be interesting to see how this plays out, and yes, this is yet another catalyst for a Canadian house price correction.


  1. WSJ: Housing rebound in Canada Spurs Talks of a New Bubble.

    "The Bank of Canada warned in its December report that if interest rates increase as expected, by mid-2012 about 9% of Canadian households could have so much debt that they'd be "financially vulnerable."

  2. Good link Ben...

    Seems there is the odd smart person out there still.

    "Mr. Carrasco, the Toronto massage therapist whose condo rose in value by 40% in one year, says he's glad he sold when he did.

    "I think we're in a housing bubble," he says. "I'm going to put stuff in storage, rent cheap and buy again when prices come down."

    Here lies the biggest concern: "The 2009 price increase of more than 20% came as personal income in Canada fell nearly 1% "

    How long can that keep up?