As the world turns…and the bubble expands

A tiny news story this week confirmed a column I wrote a few weeks ago about the real estate bubble developing in Canada – quoting none other than Finance Minister Jim Flaherty, the man responsible for creating it.

In my Oct 24 column I detailed Canada’s own sup-prime mortgage scandal (see “Canada’s sub-prime mortgage time bomb in the right hand column) pointing out that Canada Mortgage and Housing Corporation (CMHC) had become the biggest sub-prime lender in the world – putting Canadian taxpayers at risk of huge payouts for defaulted mortgages (CMHC will own $500 billion by the end of next year – making it a bigger financial institute than all the banks except RBC).

Such warnings about a possible real estate melt-down have been repeatedly dissed by the Harper government which created the bubble to make itself look good in terms of economic policy. But now the Bank of Canada is voicing concerns, pointing out Canadians’ average debt is now 142 per cent of annual income – an all-time record. (In 1990 Canadians were carrying $88.60 in debt for every $100 of income.) That forced Flaherty to blink: “We certainly want people to be careful and there’s lots of money being lent, and I do ask Canadians to be mindful of the fact that interest rates will not be low indefinitely.”  While the language sounds moderate, it is the equivalent of screaming from the roof tops for free-market zealot Flaherty.

And it’s not just the mortgages themselves,  as many home owners have followed in the path of their US cousins (many now living in their cars) who used the equity in their homes to spend on other consumer goods. It isn’t clear how much of the so-called signs of economic recovery is based on this mirage.

Yet, while warning Canadians about cheap money, the government is at the same time boasting at the WTO (go the site and search for S/FIN/M/58) about its banking system and sound mortgages: “Canadian households generally had relatively smaller mortgages and the system had not had the same sort of exposure to sub-prime components of lending that might be found in other markets.”  This is patently false. The majority of mortgages insured by CMHC are sub-prime and the value of the average mortgage is equal to 7.5 times annual income – compared to 5 times in the US when their bubble burst.

The Bank of Canada has an idea of just how bad things are. According to its calculations, the percentage of mortgage holders whose yearly interest payments exceed 40 per cent of their annual income could reach 10 per cent by 2012 (the ten year average is just over 6 per cent). That 40 per cent figure identifies mortgages that are at high risk of default.

Do the math: 10 per cent of $500 billion in mortgages insured by CMHC by the end of 2010 means the federal government could be on the hook for $50 billion in defaults. That amount would be paid to the big banks despite the fact that in lending this money they took absolutely no risk themselves. What do they care which citizen’s pocket the money comes from – the right pocket of people still solvent, or the left pocket from which they paid their taxes?

The legions of people now buying homes they clearly cannot afford are being driven to this potential disaster from two directions – both generated by the sub-prime madness. First, people sensible enough to realize they should be renting cannot find rental accommodation because developers aren’t building apartments any more –  condos and single family units are so much more profitable.

So the tight rental market drives them into the home-buyers market they tried to avoid. And when they get there they find deals that must seem to be too good to be true – because they are. Mortgages at 2 per cent, but on houses whose prices have been driven through the roof.  These purchases represent the myth of the affordable mortgage. This is what CHMC was established to do in 1949. But all those people who purchased no-down-payment and/or 40 year mortgages in 2007 didn’t get affordable housing – they got hooped. A 40-year mortgage [on a $350,000 home] lowered their weekly payments by $73 but will cost an extra $254,000 in interest than if they had opted for 25 years.

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