Friday, April 3, 2009

Is Canada The Envy Of The World?

In 2006, while home prices in the US began to roll over, some wondered whether the phenomenon would spread around the world. Most scoffed. Seemingly every spot developed it's own "it's different here because..." story. The sentiments were well suited to a general dislike of the US around the world. Americans were looked down upon (and still are) as morons. After all, if 50% of such a vast country could elect a moron like Bush II - twice, what does that say about the country? So when the US housing market started to roll over in 2006 and subprime lenders started going belly-up in early 2007, it played right into the growing world pretentiousness. "There go those stupid yanks again - buying houses they can't afford. Is there a scam those folk won't fall for? Would ya pass the maple syrup Norma?"

Indeed, these sentiments were most prominent in Canada. Every market had it's own little reason why prices would continue rising while the American markets tanked. Vancouver had the olympics, the Prairies had oil, Toronto had an endless stream of immigrants, Montreal had the Habs. But most of all, it was well known that Canada didn't engage in "subprime lending." Our banks were the most conservative in the world we were told.

I write in the past tense. Most still believe this nonsense.

Then again, should we be surprised? After all, it took more than a year of falling home prices in the US for anyone to acknowledge the problem. Here's a quote from David Lereah, chief economist for the National Association of Realtors on October 25th, 2006:

“Considering that existing-home sales are based on closed transactions, this is a lagging indicator and the worst is behind us as far as a market correction – this is likely the trough for sales,” he said. “When consumers recognize that home sales are stabilizing, we’ll see the buyers who’ve been on the sidelines get back into the market, and sales will be at more normal levels in the wake of the unsustainable boom that we saw last year.”

Lereah has since admitted he was a shill for the industry and would say whatever they wanted him to say.

Sadly, vast numbers of Canadians are being led down the very same path.

A recent globe and mail article is titled "Canada Envy, Amid Global Meltdown."

Canada's banks are finally getting some respect.

Derided for years as meek and mild while banks around the world expanded wildly, suddenly the reputation of Canada's big lenders as prudent and sometimes downright boring has become an asset instead of a liability.

The reason comes down to a fundamental conservatism. From lending practices to bets on trading to financial reserves and takeovers, the Big Five banks have long tended to be more careful than their global peers. And when they did want to get aggressive, government and regulators held them in check.

That's a result of a conservatism not just among executives. That same approach extends to consumers, helping the banks sail along on the strength of their domestic lending businesses.

“You've got a more balanced cultural approach towards consumption and savings than we do in this country,” says Charles Dallara, head of the Washington-based Institute of International Finance, and a former managing director at JPMorgan Chase & Co.

In between the hubris, there is very little to back up this information. And upon further research, much of it just ain't so. Now it's easy to look at a Countrywide or Northern Rock and declare themselves more conservative. Just like it's easy to make fun of the disabled kid at school, or for Canucks fans to make fun of the Leafs. If the bar is set low enough, anybody can step over it.

The fact of the matter is that Canadian banks are no different than many of their international counterparts. They operate on the same fractional reserve system as every other bank. And just because their reserve ratios were 8 or 9 to one as opposed to 11 or 12 to one will not matter much when all is said and done.

And were they really as conservative as is commonly believed? A week after that Globe and Mail article, another one was published titled, "Canada's Dirty Little Secret." It shows what goes on in reality. As it turns out, there's an enormous sector of the Canadian lending business that has been making garbage loans, helping to drive up prices. A few excerpts:

“I didn't really have to show anything to borrow,” Mr. Goodyear said of his two remaining mortgages, both in default and totalling about $340,000. “I didn't have to show them my tax returns. I just said ‘This is how much I make.' I think I made 11,000 bucks.”

Mr. Goodyear is not alone. A Globe and Mail investigation into more than 10,000 foreclosure proceedings has uncovered a burgeoning subprime mortgage problem that many, including Prime Minister Stephen Harper, have insisted does not exist in Canada.

The number of subprime lenders who have initiated foreclosure proceedings isn't a surprise to anyone in the business, said Kap Hiroti, the owner of, one of the companies that tracks foreclosures and supplied data for this story. “It was almost as if the lenders didn't see the big picture,” Mr. Hiroti said.

The spread of subprime mortgages to Canada is one of the country's most poorly researched and misunderstood economic afflictions. Government agencies don't publish numbers on the scope of high-risk lending. Banks and other mortgage lenders do not disclose details about such loans, known in industry parlance as “non-conforming” loans.

As long as real estate prices soared, these lending high-rollers were comforted by the belief that losses on defaulted mortgages could be recovered by foreclosing and selling repossessed homes at a profit. Added protection for a small portion of these lenders came from aggressive U.S. mortgage insurers that were approved by the federal government in 2006 to compete in Canada... Home Trust is a federally regulated trust company, unlike competitors such as the U.S.-based GE Money and Wells Fargo that jumped into the Canadian market in mid-2000. Mortgage lenders that aren't federally regulated aren't required, like banks and trust companies, to use a government-approved insurer when the borrower has put down less than 20 per cent of the value of the home.

Asked what he was thinking when he took out another loan to pay off a smaller loan that he already couldn't afford, Mr. Goodyear replied: “Well, that's what runs what I do, but I shouldn't have borrowed more money. It was so easy to borrow money. You get in a bind.”

He continued: “Well, I'm sitting there, ‘Jeez, if everything works out'... I might have been able to do it. Just squeak by maybe.

“I thought maybe I'd have to sell, but I didn't think the market would take a tumble.”

I could continue. It's a very informative article for those interested. But most have read this story before. Usually out of the pages of a Sacramento or Miami newspaper. But now that prices have started falling in Canada and foreclosures are rising, the "dirty little secret" can't be contained anymore. Increasing supply and forced liquidations will be the big story this summer. Prime loans made by the big banks will start going underwater and the vicious cycle will take hold in Canada as well. It should be obvious, but there are still hucksters out there trying to make their last quick bucks before the whole thing comes crashing down - just as David Lereah now admits he was doing in the US.

From a recent article depicting the Vancouver market as "finding a bottom" we see quotes like this:

"People can see the value - and the value is phenomenal," real estate agent Lorne Goldman says.

Mr. Goldman says he had a house for sale last year on the city's pricey west side with an asking price of $2.4-million. The sellers were offered $2.3-million, but the buyer failed to complete. The same house is now on the market for $1.85-million.

"It's also very basic Real Estate 101," he adds. "There are people who are getting married, there are people who are married having more children, people being transferred into Vancouver from other cities. There are people who have inherited money who want a bigger house. The market continues, despite what is out there in the general economy. The fundamentals are there. People still need to buy groceries, and they still need shelter."

Let's look at the fundamentals for a moment. Once a year, issues an affordability report covering 265 urban areas in the anglosphere. In that report, Vancouver ranks 262nd in terms of affordability behind only Honalulu, and some coastal tourist areas in Australia. The median home price (including all condos, townhouses, etc) was $492,600 for Vancouver while the median household income came in at $58,400. This provides a median multiple of 8.4. Higher than that of London, New York, San Francisco or Sydney (although at peak prices theirs were just as high).

For much of the last century, the median multiple was around 3. This held true for smaller urban areas where incomes were typically lower and for larger urban centers where they were higher. The more cosmopolitan cities typically demanded a premium over the dirty industrial centres, as one could expect. But it was always a fairly common rule: 3x your income is what you can afford in a home. If you wanted something bigger or nicer, you had to save for a larger down payment.

Many will simply ignore this historical guideline because of what it means. And what it means is a crash of epic proportions in order to get back to that historical guideline. Such a crash is impossible, therefore the guideline must be wrong - according to their logic.

But that's not all. Not only are the "prices" portion of this historical formula in a bubble, but so are the "incomes." And with unemployment rising and wages falling, the denominator itself is taking a beating. Canada, as it turns out, is shedding jobs at an even faster rate than the US. For every two jobs lost in the US, Canada loses three on a per capita basis. Personal bankruptcies are skyrocketing. January bankruptcy filings rose 23.1% from a year earlier. Nortel has essentially closed its doors. Air Canada is on the brink of bankruptcy. Ontario's auto industry is on the fritz. And all of those commodity based companies whose offices are based in Calgary and Vancouver are cutting costs wherever possible. There may be bright spots, but the overall trend for unemployment is up. And this is putting downward pressures on wages.

When Lorne Goldman talks about "incredible values," he is either lying or he has no idea what constitutes "value."

Another common assumption given by the media is that Canadian consumers are far more conservative than Americans. Again, this feeds our superiority complex. We want to hear it. So they keep telling us its true. But it isn't either. The following chart shows the debt/income ratio for Canadians and Americans.

Canadians gorged on flat panel televisions, "vacation properties", boats, luxury vacations, granite countertops, and countless other things they couldn't afford. The culture of conspicuous consumption was every bit as prevalent in Canada as in the US.

For those that want to follow the Canadian market, Brian Ripley has a fantastic site providing charts updated monthly. Below is a chart of the Vancouver market. Ripley's baseline projection for prices is back to '05 levels, and likely back to '99-'01 levels. I can't think of a scenario where prices avoid the latter. Based on price/income ratios, price/rent ratios and just plain common sense, prices MUST fall that far.

So. Are Canada's banks the envy of the world? Or are they just lagging behind the rest of the world like the real estate and job markets were? When the aftermath of the continuing price declines shows up on their balance sheets, we'll learn in short order what a credit crisis really looks like.

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Anonymous said...


I couldn't agree more with your take on the Canadian sub-prime mortgage situation. I remember going to see a mortgage broker back in '05 when I was thinking of buying. Glad I didn't now for a number of reasons. Filling out the forms for income and assets/liabilities I was very honest and wrote down exactly what I had. I could have lied and got away with it easily. I was eventually approved for a mortgage much greater than I knew I could afford.

The sub prime mess in Canada is very real.

Matt, I enjoy your blog, and look forward to your posts. Keep up the hard work. Your insight into the global (and Canadian) economy is intelligent, and your writing makes it easy for the rest of us to understand the technicalities.
Many thanks to you.

olives said...

Won't we be embarrassed here in Canada when it becomes evident that we weren't so special after all?


This article is very timely and relevant. As I quote Cameron Muir, an economist, "Home sales are unlikely to fall much further..That being said we expect home sales not to decline much further."

If the Economy Seems Scaring You Away From Real Estate? It Shouldn't. You can Become 12-Month Coaching Client of Millionaire Real Estate Investor Peter Vekselman Today and Learn Exactly How These Hard Times Can Be The Launching Pad for your Real Estate Career.

Toronto Realtor said...

Nicely said, as a Toronto Real Estate Agent I see the statistics of the Real Estate Market daily and I can only agree with you. We hit the bottom and its a matter of time when the lines in most graphs will start going up. In March we still had a 7% drop in sales when compared to March 2008 but in February it was a 32% (!!!) drop when compared to the February of last year. So we see the Toronto Real Estate is recovering. I predict the month of April will be about the same as the last years in stats. Anyways, thanks for your interesting article, great read, keep it up.

Take care, Elli

Kap Hiroti Sucks said...

Great blog posting, but Kap Hiroti is also profiting from the mistakes of the non conforming loans in Canada. He sells the lists for $99 a month when someone can actually do it themselves for $8 plus $1/page. That's one heck of a premium.

I'm not sure if I should applaud him for his strict capitalism, or slap him for charging far too much for a list that people can get elsewhere.

Kap Hiroti said...

The interesting thing about blogs is the relative anonymity :)

The (BC) lists are compiled from public information obtained through the courts. Anybody can get the information, however it is not $8 plus $1 per page for the entire list. It is an $8 search fee PER NAME, plus $1 per page to photocopy the court documents. So when you have 100 foreclosure properties a week across the province, that is $800 per week just for the search fees, it does not include the time or effort required in sifting through 100 court files to find the information you require.

In my experience, people value their time and money so would rather pay $99 per month for the list than go to the courthouses on their own time & dime to get the information.


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