Lexpert Magazine

LEXPERT MAGAZINE | JANUARY/FEBRUARY 2017 61 | IN-HOUSE ADVISOR: MORTGAGE REGULATION | to retain capital on their books in order to cover the risks of any uninsured mortgages they might be stuck holding. So they rarely underwrite uninsured mortgages. Says Feldman, with the government planning to force more risk onto lenders, the better capitalized a mortgage lender is, the better it can absorb that additional risk: "at leads you to say the bigger banks are capitalized more sufficiently to absorb the extra risk." Not so, though, for smaller financial institutions such as credit unions and trusts, who may feel they have insuffi- cient capital to do that. For his part, Stikeman's McElheran says he's seen indications that the big banks are somewhat more receptive to taking on more of the risk. "To a certain degree it would be in their interest to take on more of the risk if their competitors aren't able to," he says. "And if they take on more of the risk, they are going to charge more. And that is where you are going to see pres- sure on [interest] rates." TAPPING ON THE BRAKES All this regulatory activity by the federal government shows that, unlike US regula- tors before the subprime crisis, Canadian authorities are carefully watching the hous- ing sector and sensing that a significant crash that could hammer our economy and financial system is far from implausible. Maybe someone in the finance depart- ment read the worrying paper that Craig Alexander, now Senior Vice-President and Chief Economist at the Conference Board of Canada, co-wrote in 2015 when he was Vice-president, Economic Analysis at the C.D. Howe Institute. In that paper, enti- tled "Mortgaged to the Hilt: Risk from the Distribution of Household Debt," Alexan- der and economist Paul Jacobson found a "significant minority of Canadians" have taken on a "high degree of financial risk" through primary mortgages. eir analysis determined the percent of Canadian homeowners with a mort- gage-to-disposable-income ratio in ex- cess of 500 per cent climbed from three per cent in 1999 to 11 per cent in 2012. "at is far from the majority of Cana- dians, but it does represent half a million households," they wrote. By and large, few Canadians default on mortgages, even in difficult times. But those Alexan- der wrote about are the wobbliest of the many dominos in the housing market. If interest rates inch up a percentage point or two, or if job losses spread beyond what we've seen in Alberta, those home own- ers could trigger a cascade of mortgage defaults and a housing price freefall of 40 per cent or more. In October, the CMHC — for the first time in the Crown corporation's 68-year history — issued a "red" alert for our na- tional housing market. "High levels of indebtedness coupled with elevated house prices are oen followed by economic con- tractions," Evan Siddall, CMHC's CEO, warned in a Globe and Mail article pub- lished October 17, the same day that new federal mortgage rules came into effect. "e conditions we now observe in Canada concern us." So, says Alexander, the real question now for the Canadian government when it comes to our overvalued housing market is how to address the imbalance: "e meta- phor I like to use is, imagine you are driv- ing down the highway and all of a sudden the road has become very icy. So now there is risk. e one thing you don't do is slam on the brakes, because that is likely to cause the very accident you are worried about happening. So the government of Canada has been taking an incremental pace in terms of tightening policy. "So what do you do in that risk-filled environment when you are driving on icy roads? Well, stop pushing on the accel- erator, and maybe you just gently tap the brakes. In a sense, that's what the govern- ment has been doing." And in Alexander's backseat driver view, even if mortgage bro- kers and alternative lenders have to feel a bit of pain in the short term, it's still well worth it to avoid the kind of pain Canadi- ans would suffer in a real estate crash. REAL POSSIBILITY Robust financial regulation spared Canada from a real estate crash following the financial crisis. But that doesn't mean we're immune Last October, the Canada Mortgage and Housing Corp. put Canada's hous- ing market on red alert for the first time in its 68-year history. CMHC said it was "finding strong evidence of problematic conditions for Canada overall. Home prices have risen ahead of economic fundamentals such as personal disposable income and population growth, resulting in overvaluation in many Canadian housing markets." Many believe Canada is immune from a US-style housing crash. History and statistics, however, say otherwise. Market disconnect: From January 1, 2009, to September 1, 2016, the average Canadian home price rose 78 per cent, according to the Canadian Real Estate Board. During the same period, according to tracking site Zillow.com, US home prices increased just nine per cent. Appetite for risk: Household debt — including credit cards, mortgages and other loans — as a percentage of disposable income has accelerated. In 2011, it was 150 per cent. Today it's 165 per cent, according to analyst Hilliard MacBeth, increasing Canadian vulnerability to mortgage defaults. Bank failures a reality: There have been 43 financial institution failures in our history, mostly in the 1980s and 1990s. The good news is that no depositors have lost money since the Canada Deposit Insurance Corp. was created in 1967. Expensive homes a target: The federal government's new mortgage eligibility stress test required for prospective homebuyers with less than 20 per cent to put down will push homebuyers out of the market for more expensive residences. A family with an annual household income of $80,000 and a five-per-cent down payment would see purchasing power fall from $505,000 to $405,000. IN HOUSE INSIGHT

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