Real estate prices are falling, and a U.S.-style collapse could cost taxpayers plenty

Could it happen here?


Could it happen here?

Christopher Judge is accustomed to turning heads in Vancouver. During the decade-long run of the cult hit TV show Stargate SG-1, which was filmed in and around the city, Judge starred as the muscle-bound alien Teal’c. But when the six-foot-three actor appeared in B.C. Supreme Court in mid-November, amid raised eyebrows from the galley, it was for a role he’d desperately hoped to avoid. Judge, who owns three luxury homes in B.C., faces foreclosure. He’d flown up from Los Angeles the night before to ask the court for time to get a new appraisal done on one of his properties, a West Vancouver home with stunning views of the city that he’d bought for $2 million in 2006. At the same time, one of Judge’s former co-stars on the show, Michael Shanks, is facing foreclosure on another sprawling West Vancouver home purchased in January for $4 million. “I was always told the safest place for your money is in the real estate market because it would never drop by 50 per cent, but that’s exactly what’s happened,” a congenial Judge said outside the court. “I watched the L.A. housing market fall and now I’m having to watch the B.C. market go down, too.”

But it’s not just two actors on the hook. Canadian taxpayers, through the Canadian Mortgage and Housing Corp., may ultimately have to make good for any losses stemming from their woes. That’s because mortgages on at least two of Judge’s high-end properties were insured by the government-owned agency. If the foreclosures go through, and the houses are sold at a loss, lenders could turn to CMHC to make up the difference. “This wasn’t some mom-and-pop homebuyer,” says one Vancouver real estate observer familiar with the situation, but who asked not to be named. “CMHC was never supposed to be in the business of insuring speculators.”

Like Fannie Mae and Freddie Mac, the two failed mortgage finance giants that were seized by the U.S. government in September, CMHC’s primary job is to encourage home ownership by making it easier for people to obtain mortgages from banks. And over the decades, the Crown agency did just that, helping millions of Canadians buy a place to call their own. Yet there’s growing evidence that CMHC’s lax policies in recent years ignited a housing bubble in this country in much the same way Fannie and Freddie did in the U.S. The Canadian mortgage industry may not have gone to the same extremes as in the States, and the subprime market was not as big, but experts say lending practices here were far more liberal than first thought. The question now is, will homeowners find themselves squeezed by huge debt loads and plummeting house prices? And if so, how deep will taxpayers have to dig to cover the losses?

In Canada, anyone buying a house with a down payment of less than 20 per cent must purchase mortgage insurance, which protects lenders in the event of a default. But starting in 2006 the CMHC, along with smaller private insurers, raced to loosen their standards. CMHC, with roughly 70 per cent of the market, kicked things off by offering to back mortgages with 30-year amortizations, instead of the traditional 25 years. As rivals like Genworth Financial fought back, amortizations quickly grew to 35, then 40 years. Meanwhile, mortgages could be had with no down payment whatsoever. At the time many in the real estate industry welcomed this competitive tit-for-tat, since it helped thousands of young Canadian families who would otherwise have been shut out of the market. To others, it was a sign Canada was headed down the zany path America’s mortgage lenders had taken. In June 2006, David Dodge, then governor of the Bank of Canada, fired off a gruff letter to CMHC CEO Karen Kinsley warning the new policies were “disturbing.”

When the full extent of America’s housing crisis became apparent this past summer, Ottawa slammed the door on extreme mortgages. As of last month, mortgage amortizations were limited to 35 years, while buyers must now cough up a down payment of at least five per cent. The flip-flop, which CMHC said it supports, is aimed at preventing a real estate crisis here. But critics say the clampdown came too late. In October the average resale price of a home in Canada’s major markets fell 9.9 per cent to $281,133 from a year ago, the fifth straight month of falling prices. “Given the highly leveraged situation of many homeowners, it is quite clear to me that we are not immune to what has happened in the U.S.,” says Moshe Milevsky, a professor of finance at York University. He says a five to 10 per cent price decline over 12 to 24 months could wipe out the equity of hundreds of thousands of Canadians who rushed to buy homes in the last few years. “Bottom line is, there are many Canadians today who own homes they should have rented instead. I’m afraid CMHC was responding to politics as opposed to prudence when they loosened their standards a few years ago.”

CMHC declined an interview for this article. In an email, the Crown corporation said it made it clear at the time that 40-year mortgages “were not for everyone.” The agency says its qualification criteria ensure that “only borrowers with the ability to manage their debts can access our products.” The agency didn’t reply to specific follow up-questions. But interviews with real estate agents, mortgage professionals and economists suggest many homeowners were able to qualify for large mortgages they might have trouble managing in the event of a downturn.

Take, for example, so-called liar’s loans. The term refers to mortgages given to people who can’t document their income. In America the practice was widely abused, since many borrowers simply lied when asked how much they earned. But such loans were available here, too. Last year CMHC trumpeted its new Self-Employed Simplified program, allowing those with no documented proof of income to obtain mortgages, provided they make a down payment of five per cent and have good credit. The result was that in some cases those borrowers with proof of income were at a disadvantage to self-employed workers in the same industry who had no documents at all, since the latter could overstate their earnings. “It got to the point that we could actually get a larger mortgage for somebody who couldn’t prove their income than somebody who could,” says Ajay Soni, a senior mortgage broker with Invis in Vancouver. “On the whole, Canada’s borrowing culture is more responsible than in the U.S., but in some cases risk assessment was thrown out the window.”

Some suggest that’s because Canadian mortgage lenders had nothing to lose. One problem that led to America’s housing crisis was that millions of mortgages were securitized and resold to investors. This meant the companies that originally issued the mortgages to consumers with poor credit histories had nothing at stake if the loans went bad. CMHC may have played a similar role here. “The banks could write as many mortgages as they wanted, subject to being able to get them insured by CMHC,” says one prominent economic analyst on Bay Street who spoke off the record. (Several of the people Maclean’s spoke to for this article expressed concern about reprisal from CMHC, which has come down hard on critics in the past.) “The banks knew they wouldn’t be on the hook.”

Now there are concerns the sudden drop in Canadian house prices, along with rising unemployment, are proving too much for some borrowers to handle. For instance, the number of foreclosure filings in B.C.’s Supreme Court between January and the start of November stood at 928, up 50 per cent from the same period last year. Foreclosure lawyers in B.C. and Alberta have had to hire extra staff to keep up with the workload. Gloria Vinci, a Calgary real estate lawyer, says she’s been astonished to find a large number of cases where homeowners have taken out as many as four mortgages on a property in the span of three years as housing values soared. “I don’t know if this is just the beginning or we’ve reached the peak [of foreclosures],” she says. “But with the massive increase in equity over the last two to three years, people have maxed themselves out.”

Some who borrowed heavily to pre-buy during the Great Canadian Condo Boom are also struggling. Scott Hannah, CEO of the Credit Counselling Society in Vancouver, has seen cases where buyers obtained mortgages to buy condos with no down payment. As the equity in their unfinished properties rose, they took out secondary loans to buy furniture. Now those buyers are underwater, and they still haven’t moved in.

Even in Toronto, where the market run-up wasn’t as big as in the west, some owners face problems. The number of homes listed under power of sale, which refers to repossessed properties, has climbed from 300 to 500 since the spring, says Jim Common, a real estate agent whose monthly newsletter tracks the sector. It’s a small fraction of the total active listings, but he expects the number to rise.

It can take months for the full extent of a collapsing housing market to be felt. For instance, some in the real estate industry point to the relatively low default rate on residential mortgages as a sign the market remains strong. According to the Canadian Bankers Association, the percentage of residential mortgages in arrears stands at just 0.28 per cent of the total market. But when the 1990 housing bubble burst, the national default rate was also 0.28 per cent, and it took two years before defaults peaked at 0.65 per cent.

If defaults rise, claims against CMHC could climb, too. The good news is that because the buck ultimately stops with Ottawa, the country should avoid a mortgage-fuelled banking crisis like the one that has claimed so many victims in the U.S. In fact, through CMHC the federal government plans to buy up to $75 billion worth of mortgages from the banks as a way to inject liquidity into Canada’s financial system.

But could taxpayers be left holding a massive bill? There’s almost no way to know. CMHC doesn’t divulge key information about its lending portfolio, which it considers to be competitive information. Even so, Nick Rowe, an economics professor at Carleton University, recently posted online a “back of the envelope” calculation of CMHC’s potential losses. Based on what is known about the agency’s $334-billion insurance portfolio and $7 billion in reserves, he argued CMHC could lose $9 billion if prices in Canada fall as much as they have in America. (U.S. prices have dropped 20 per cent from their 2006 peak, with some cities down 35 per cent.) By contrast, CMHC posted profits of more than $1 billion for three straight years, thanks largely to insurance premiums it charges homebuyers. Rowe admits his analysis is crude. But he worries CMHC officials may not have accounted for serious price declines when constructing their financial models, believing, as Fannie and Freddie did, a catastrophic economic event would never happen.

For what it’s worth, CMHC remains more optimistic about the Canadian market than some of the real estate industry’s most bullish proponents. On Oct. 30, CMHC predicted the average MLS selling price for this year will come in higher than last, and continue to rise in 2009 to $306,700. A week and a half later, the Canadian Real Estate Association predicted the average price of a Canadian home will end the year down 0.6 per cent to $303,900 from 2007, and continue to fall in 2009 to $297,600. “Somebody needs to work out what the losses for CMHC would be if house prices fell 20 per cent across Canada,” says Rowe. “We’ve got a rough idea of the national debt, and what the deficits are going to be, but there’s an item here that hasn’t been taken into account. There’s no question of anything going bust, but this is something we should know. It’s very clear who is on the hook here, and that’s the taxpayer.”

No one is saying this is all CMHC’s fault. Genworth, Canada’s second-largest mortgage insurer, moved in lockstep with its government-backed rival. Meanwhile, smaller U.S. mortgage insurers rushed into the Canadian market at its peak. (Almost all have since fled Canada.) And CMHC didn’t exactly hold a gun to the head of lenders, who were the ones actually doling out questionable loans at the outer limits of CMHC’s insurance policies.

Still, at the end of the day, CMHC isn’t a private company, which means taxpayers may have to write a sizable cheque if the housing market worsens. It’s happened before. Back in the early 1980s Ottawa had to bail out CMHC when thousands of homeowners defaulted on their mortgages and insurance claims skyrocketed. Much has changed since then, but it’s becoming clear that CMHC’s policies encouraged many homebuyers to jump into the market before they were ready. And the consequences of that could be far-reaching. “[The easy credit] dragged buyers kicking and screaming from the future to today and they were lent money whether they could afford it or not,” says Ozzie Jurock, a Vancouver real estate promoter. “The only test was whether they could breathe.”

With Rachel Mendleson


Real estate prices are falling, and a U.S.-style collapse could cost taxpayers plenty

  1. Excellent piece of information, well written and very informative.

  2. This should be on the cover of Macleans

  3. This should be on the cover of Macleans magazine

  4. Many people have been saying this for the last few years but were shouted down in favour of ‘let the good times roll’ thinking or saying Canadians were too smart to let it happen here, our banks are the best in the world blah blah blah — and now we may all pay the price bailing out the gullible and the greedy get away with it.

  5. how do i short CMHC? :-)

  6. I concure, this piece of information considering the economic and political climate, is a firecracker waiting to go off…

    CMHC sold out Canada to the banks, again. Great article Mr. Kirby, nice to see a portion of the media peddling information versus misinformation.

  7. What do you mean by the headline “could it happen here ?”

    It is well underway to happening here……..we are absolutely no different than the US real estate market in terms of lax lending practices or anything else.

    Denial of reality by the media due to RE industry funded advertising has to stop now.

    • What do you mean Carioca Canuck “no different lax lending”?
      Did we lend billions to people with no job, no income and no down payment?
      I don’t think so.

  8. Not even a year ago, Macleans towed the Realtor’s line about how the real estate market in Canada was just fine. I am not a reporter whose job it is to look into the facts all day long and yet I could forsee the market was destined to move downward dramatically. The 0 down 40 year mortgages that smacked of bad lending practices, the unsustainable increase in home prices, and the slumping American economy did not even formulate into Macleans equation. I am greatful I saw how poorly researched that article was and avoided buying. I pity the many people who read your article and will go into bankruptcy after following the advice.

  9. I agree that there are housing problems in Canada. However, as someone who splits his time about equally amongst the cities of Chicago, San Francisco, Boston, Toronto and Calgary, all that I can say is most Canadians have no idea what “collapse” means. I have seen price pressure in Canada, I have seen unemployment tick upwards but nothing – and I mean nothing – can prepare an average Canadian for the reality of the housing problem in the US. I have seen hundreds and thousands of homes ransacked and occupied by squatteres, Entire neighborhoods and indeed, communities have been lost.
    With regards to the banking system, I have never observed the same sort of unbridled greed and unchecked stupidity in Canada.

    Also, don;t kid yourself about US unemployment. There have been so many changes to the way that CPI,GDP and unemployment are calculated that the official numbers are essentially useless. Years of hedonic adjustments and rule changes have been designed to artificially depress the reality. I rely on others who calculate these numbers using the metrics that existed as they were BEFORE 1982 (eg. shadowstats). These people will tell you that US unemployment is actually closer to 14%. The thousands of homeless Americans that I see wandering the streets tend to confirm the number.

  10. Hahaha, the main stream drive by media (much like many politicians) is doing it again..inventing headlines to sell their rags..no wonder 99% of print media in North America is going bankrupt (look no further than the New York Times who’s stock can now be purchased for less than the price of their Sunday edition). This form of “bloody headline” drive by media has sadly become the “norm” and is accepted by those with a lower than average “financial IQ” making one wonder if there is something more sinister at play (such as social engineering-much like the “no house left behind syndrome” of the US) with the media playing more than a passive role.

    There are literally hundreds of “articles” and “reports” that completely disprove everything “theoretical” in this “National Enquirer” stylized “piece.” Stating “facts” and reporting the news is staggeringly different that “making” or “engineering” the news and worse having a hyper negative influence on markets whether they be real estate, financial, economic, military, political etc. How many times have you seen some ill informed “ideologue” Hollywood flavor of the moment screaming that the proverbial “sky is falling” and we should all get out of the way? It’s like Al Gore stating that he invented the internet when the only thing he ever invented was “man made global warming.”

    So, if you are as dumb as a bucket of wet hammers and love to be led around by some self important “gas bags” that are probably renting someone’s basement suite or for some ideological reason can’t fathom anyone wanting to own a home (God forbid in the evil suburbs) or more than likely living in some concrete coffin in downtown Toronto playing chicken little to all of their friends.

  11. Who already has had house wants the price goes up, and who does not have one wants the price goes down. The point is you can affort it, so buy it. you can not, just wait for a chance to buy it as now USA. I bet the real eatate will go down sharply after 2012 because baby boomer retirement wave

  12. I don't see this type of collapse happening. The reasoning for the sub prime collapse involved factors that just are not present here in Canada, including a more structured and accountable banking system. Recently the newer first time mortgage rate rules will serve to slow down the market, but also prevent those from overextending in my opinion.

  13. It all depends what exactly define collapse?

  14. Sex with hookers was removed from GTA after a complaint? Certainly not in the last game… http://en.wikipedia.org/wiki/Hot_Coffee_minigame_

    That's the top result for "GTA sex controversy" in Google. The sex in GTA is all implied, rather than being graphic. This allows it to keep a "mature" rating as opposed to an "adults only" rating, but having a graphic depiction of sex (like the Hot Coffee minigame) would have definitely bumped it to "adults only" which would have seen it pulled off shelves in stores, and sales would have plummeted.

    The quality of technology coverage on Macleans strikes me as generally being pretty poor and this article is more of the same. The whole thing is about how violent games might be funded, implying that this is somehow a bad thing, and instead of examining what's actually been done in Canada it just goes straight to the juicy stuff that's already been in the news, like the recent bit about MacKay putting his foot in his mouth (http://www.ottawacitizen.com/news/MacKay misfired video game assault/3492208/story.html), or the mistake about what was or wasn't removed in GTA.

    The only useful thing in the whole article is the little bit of information on how provincial governments choose to subsidize games, and even that is mostly valueless in the absence of context. How do these subsidies compare to say, subsidies for films or other media? And really, if you're so attached to making a point about violence, how many violent movies have Canadian taxpayers paid for in comparison to video games? What's the precedent?

    This whole article is lazy, and I really am bugged by it. Video gaming is extremely common (http://www.theesa.com/facts/index.asp) and it isn't just for kids. Why is violence an issue if the consumers of it are adults? This shallow, sensationalist treatment of the whole topic is frustrating.


  15. Actually, in GTA: San Andreas, if you properly went into the game files you could unlock a graphic sex game. But, you had to do things they developers never intended you to do and it was never really part of the core game.

  16. If they are referring to GTA4, the game was ported to PC and done by Rockstar Toronto. The idea itself in terms of game content come from their head bosses based out of either London or New York. But that shouldn't matter because of the game's content and where it was developed you should be in hoopla over. I mean if EA Canada was only developing NHL titles, the Canadian government would be ecstatic but in the end that's 1 title out of that studio per year. They wouldn't be maxing out the tatent they've hire.

    What I really want to address is this whole notion of taxpayer money going to help interactive entertainment development. If the Ontario government didn't put in the tax incentives to lure Ubisoft, we would have lost out to other US States, countries overseas who are getting into the this industry. This is the stepping stone in providing Ontario a fully function gaming hub industry that likely will lead to EA, Square, THQ, Sony, Microsoft, Nintendo, 2K, Activison to bring more jobs to the area. We are a state where we have numerous grads looking for work overseas, lets give them the jobs here. I'm tired of the old generation that thinks lets just produce cars as the backbone of our province industry. We need to facilitate the IT sector, software engineering, e-commerce, film and video and design sector. And I really believe the gaming industry can benefit this as a whole and help Ontario in this rough economy.

    • So here I had a nice, long reply and 'cause of one naughty word, I lose the whole thing on hitting the submit button.

      Summary version:
      Subsidizing a large industry like auto manufacturing has knock-on benefits as not only is the manufacturer kept in business, but so are all of their suppliers and other supporting businesses. Many "knowledge economy" jobs, on the other hand, don't provide the same kind of benefits and can be easily off-shored to places like India and China.

      Subsiding an industry like gaming, where workers are often treated like trash 'cause their employers know they're wanting to work their dream job and are accordingly willing to put up with poor wages and ugly conditions, may just be a complete waste of money. At the very least, I'm quite sure it isn't the solution you seem to think it is (Engineering? Sure. Video games? No.).

      …and there's yet another important point totally missed by the article.

      • Very true. However as a skilled trades man I can't help but fell bad for the lack of more IT jobs with good pay and working conditions, Well only one solution…..UNION!?!?!? That's why they keep making cars in Canada geek boy (JD2K)

  17. Canada is in EXACTLY the same position as the US. EXACTLY!!!!!
    Results will be the same.

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