A very Canadian housing slump

Prepare for long grind (but not a fire sale), says Stephen Gordon


Data from the housing market out today shows that sales were down 15.3 per cent in March compared to the same period last year. Given the events of the past decade, it is natural to worry about the possibility that Canada is headed for a U.S.-style housing meltdown. But I don’t see how that’s likely to happen. It’s far more probable that we’ll see the kind of housing slump we usually see in Canada: a long grind.

The reasons for thinking so are two-fold. The first is that Canadian mortgage underwriting standards are more conservative than they were in the U.S. Practices such as “liar loans” (where borrowers didn’t have to provide proof that they earned as much as they said they did), no-money-down mortgages or negative amortization (where payments didn’t even cover the interest on the loan) never crossed the border into Canada. To be sure, we weren’t entirely immune from the trend towards looser mortgage loan standards — the introduction of longer amortization periods of 30, 35 and even 40 years may have been followed by other “innovations” if the U.S. housing market hadn’t melted down when it did.

The other, related point is that Canadians simply don’t default on their mortgages the way Americans do. This chart graphs the percentage of mortgages in arrears by 90 days or more (Alberta is broken out for reasons that will become obvious in a minute):

There are several plausible stories that can help explain why this is. One might be the fact that high-risk applicants don’t get mortgages in Canada, so the ones who do are generally able to make their payments. Also, most Canadian mortgages are recourse loans, so people who default will find that their creditors are able to go after other assets and their wages. (This isn’t the case in Alberta. The spike in the early 1980s might have been associated with the arrival of the legislation making Alberta mortgages non-recourse, so there was a certain pent-up supply. See here for more on this episode.) Yet another possible explanation would note that Northern peoples place a special priority on making sure that they have shelter from winter.

Of particular interest is the case of the early 1980s, which saw the most severe Canadian recession since the 1930s and a spike in mortgage interest rates so sharp that people who renewed their mortgages during this time saw their payments increase by up to 60 per cent. Even in the face of all that, more than 99 per cent of homeowners outside Alberta did whatever they had to do to meet their obligations.

Now look at this chart from the New York Fed (hat-tip to Calculated Risk for this one):

U.S. mortgage delinquency rates started increasing when housing prices began to fall, two years before the recession. For many U.S. homeowners with non-recourse mortgages, there was simply no point in continuing to pay off a mortgage that was worth more than the house. This set off a vicious circle in which “underwater” homeowners dumped their houses on the market, which subsequently depressed housing prices even further, dragging even more households underwater and leading to even more defaults.

This chain of events seems unlikely to occur here: Canadian policymakers have spent the last five years scrambling to tighten mortgage rules. The key ingredients of a U.S.-style “fire sale” are missing. The most vulnerable people among Canadian homebuyers are investors who bought condos in anticipation of a sustained demand — students in Toronto, Vancouver and Montreal will be happy to learn that these investors will soon be looking for tenants as a way of generating revenue until they can find buyers.

All of this isn’t to say a housing slowdown will be pleasant, as anyone who remembers the previous busts can attest. In the current cycle, the housing market stopped being a driver of economic growth at least a year ago, and will likely become a drag on growth as activity in the construction and associated finance and real estate sectors slows. Stagnant house prices imply slower growth in household wealth, which in turn affects consumer spending.

Other factors can and may offset the real estate market slowdown. But even if they don’t, we’re not going to see a U.S.-style housing meltdown. It’ll look like a standard-issue Canadian housing slump.

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A very Canadian housing slump

  1. This isn’t the case in Alberta. The spike in the early 1980s might have been associated with the arrival of the legislation making Alberta mortgages non-recourse, so there was a certain pent-up supply.

    You got your history right? I thought AB mortgages were non-recourse, the default peak associated with the rising interest rates, as well as collapse of the world price for oil (and expectations for continuing low commodity prices which kills investment and hence employment).

    Then I thought they were made recourse, looks like around 1985, causing the collapse. Your link is too much effort to sign up etc to read and confirm.

    But, it does point out the need to look at regional markets (eg Vancouver/T.O.)

    • House prices in Calgary declined by 25% between 1981 and 1985. The price of oil also declined but nothing like the hit in 1986. By then the Calgary economy had been totally eviscerated by the National Energy Program and the $10/barrel price (down by 66% from its peak) did not make a whit of difference to Calgary house prices. The damage had already been done.

      • Industry job losses continued through 1985 and 1986 when things came to a standstill, and for years afterwards. You can’t pay the mortgage if you don’t have an income.

  2. I maybe wrong but I believe that non-recourse mortgages were in place long before 1980, possibly as far back as the depression years when Alberta went bankrupt. In 1985 one out of three homes in Calgary that changed hands was a foreclosure,

    Many mortgages were also assumable then. Dollar deals were rampant.

    • It was the runup in home prices due to the boom in late 70s, peak interest rates in 1981, then collapse in world oil prices. As I mentioned, I thought the change in legislation in mid 80s was in response to so many walking away from their mortgages in favour of the financial institutions- iow non recourse => recourse.

    • Yes, they were. But there was a change in the law around that time that made it easier to default. If you have access to JStor, try that link.

      • So I actually made the effort to read the JSTOR link and found no evidence of any changes in law that occurred, as you assert, only mentions that existing laws passed decades previously were upheld. AMHC had to refund some of the money collected because of this.

        AFAIK, this legislation is still in place. For a conventional mortgage (25% down, non insured), non recourse still holds true. I may be wrong, but at least I don’t have a problem admitting that.

  3. In the 1980s, Alberta’s economy slid into a recession. Property values declined dramatically. Mortgagors started to abandon their properties in unheard-of numbers because in Alberta, mortgagees were “restricted to the land.” Since judgments on the covenants were unavailable against individuals, many whose property values dropped below the amount owing on their mortgages simply abandoned their properties. “Dollar dealers” then arrived on the scene. These dealers would offer to assume the mortgages and take title to the property for a nominal sum. By selling to a dollar dealer, a mortgagor could walk away from his or her property and avoid the damage to his or her credit rating that a foreclosure action might create. The dollar dealers would assume ownership but make no payments on the mortgages, for the only remedies available to mortgagees was to foreclose and take the property. The dealers knew this process would take months, and in the interim they profited, generally by renting out the property.

    An additional factor contributed to problems growing in Alberta’s real estate market during the 1980s. Over years, the federal government had enacted several versions of the National Housing Act (S.C. 1944, c.46; National Housing Act, R.S.C. 1952, c.188 and National Housing Act, R.S.C. 1985, c.N-11) which enabled financial institutions to extend more credit to potential mortgagors. To facilitate home ownership and residential construction, high-ratio mortgages, insured by the Canada Mortgage and Housing Corporation (CMHC), were made available to the public.

    This combination of factors (actions on covenants being prohibited except against corporate mortgagors, the granting of high-ratio mortgages with as little as 5 or 10 percent down payment and the decline of Alberta’s economy) contributed to a flurry of foreclosures in the province in the 1980s. Throughout it all, Alberta continued to prohibit actions on the personal covenant to pay. But the provincial legislation could not limit the rights of mortgagees under mortgages created pursuant to the National Housing Act. Accordingly, actions on the covenant to pay could be pursued if the mortgage was a National Housing Act mortgage or the mortgagor was a corporation.

    • Thank you for posting this. NHA, CMHC, and AHMC all threw in different twists into the mix. The only common thread is that you can’t suck blood from a stone.

  4. Be cautious on ascribing too much influence to recourse. international borrowers and people who loose their jobs won’t care. Also, a different wird of caution. loosening standards can indeed cause prices to go too high, but that doesn’t mean that just because yiu don’t have loose standards that prices aren’t too high. Finally, using the spike in rates in the 80s as proof positive that an increase in rates now won’t have a horrible effect (ie as proof that recourse and tight standards keep a crash at bay) is not wise. Rates were high then because inflation — and hence prices and wages — were also increasing. The situation now is totally different, and many borrowers might get caught with declining prices, flat wages and yet payments that nearly double when rates get back to normal levels. Show me the balance sheet and income statement one borrower at a time, then roll it forward along the curve, adding a further upward shock for a faster recovery in the US, sustain that over time and I will show you a Canadian housing crash.

    oh….one more thing. as you sing the praises of the canadian mortgage market, beware that the vast majority or borrowers roll their mortgages every 5 years while US birriwrrs are sitying on fixed rate mortgages for as long as 30 years. when rates normalize you’re going to see a huge underperformance of Canadian houding relative to the US. watch.

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