How Canada Avoided a Housing Bust

Canada avoided the collapse in housing prices that devastated American homeowners and the U.S. economy, thanks to tighter financial regulations, the lack of subprime lending and securitized mortgages. Foreclosures are rare.  As a result, Canadian real estate steadily appreciated while property values in Florida, Arizona and other hard-hit American markets tanked.

According to James MacGee of the Federal Reserve Bank of Cleveland, The United States’ and Canada’s “Monetary policy was very similar in both countries from 2000 to 2008, but housing prices rose much faster in the U.S. than in Canada. This suggests that some other factor both drove the more rapid appreciation in U.S. prices and set the stage for the housing bust.

And what is that other factor?  Canadians are a bit plodding: 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.  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.”

Relaxed lending standards in the United States, highlighted by the rise in subprime lending, played a vital role in creating the housing bubble. This weakening of standards led to an increase in housing demand.  Mortgages were frequently given to people who were likely to have trouble making payments.  Extending credit to risky borrowers helped fuel the housing boom and set the stage for the resulting surge in defaults and foreclosures, which were a big factor in the housing bust.  Additionally, according to the Case-Shiller Index, house prices in the United States from 2000 through 2006 appreciated at a rate nearly double that of Canadian residential real estate.  In contrast with the United States, Canadian house prices continued to appreciate until late 2008, and are now nearly 80 percent higher in value than in 2000.

MacGee said “The potential risks of increased household mortgage debt depend critically upon its distribution across borrowers. To see how the distribution of mortgage debt has changed, we examined the distribution of the ratio of the outstanding loan to house value (the LTV) of borrowers.  A high LTV implies that a small decline in the house price would leave the owner with negative equity.  Negative equity is problematic as it removes the option for a homeowner who is unable to meet their mortgage payments to sell their home to repay the mortgage.”

Canadian home prices are leveling off in 2011, though, with an overall decline of 0.9 percent anticipated for the year.  A home worth $100,000 will likely decline by $900 in 2011.  In some areas, home prices might actually increase while other areas might see prices fall two or three times as much. The Canadian Real Estate Association (CREA) expects a 7.3 percent decline in home sales in 2011.

“Canadians are debt-averse,” said Kevin Fritz, a Canadian who recently purchased a home and made a 40 percent downpayment. This is an attitude that is partly cultural and partly shaped by banking practices and regulations designed to keep people out of homes unless they can clearly afford them.  “People here don’t leverage.”

“It is a regulatory structure in Canada that created the Canadian mortgage system, and it was a regulatory and political structure in the U.S. that created the U.S. mortgage system,” said Ed Clark, chief executive of TD Bank.  “The irony is…that one of the primal causes of the crisis was the U.S. mortgage system.”

In an interesting aside, more Canadians are finding housing bargains in Florida, and today account for eight percent of residential sales in the state.  Doug Flood, who relocated to the Sunshine State from Toronto in 2008, now runs a business that helps his fellow Canadians find the home they want.  “There’s clearly a perfect storm.  If you’re Canadian, you’ve got very low interest rates at home if you want to borrow against your house.  You’ve got a foreign exchange par, dollar-for-dollar.  And prices down here that are 40 to 50 percent lower than what they were five years ago.”