Yikes! Flaherty agrees with me…

It’s a bit unnerving to find that one of the country’s most zealous free market high priests might actually be agreeing with me. That’s what first struck me when I read the  headline this morning informing Canadians that “Flaherty warns mortgage rules may change”

That statement – contained in a yet to be broadcast interview with CTV – set off a wave of indigestion on Bay Street as the banks suddenly imagined the gravy train slowing.  Flaherty suggested that he might increase the minimum down payment (now at a near-zero 5%) and reduce the maximum amortization period – now at 35 years. These two easy money features of Canada’s mortgage market have had the effect of distorting the economy and driving household debt-to-income ratios through the roof: now at 142%, an all time high.

It has also driven house prices up when they are going down in virtually every other developed country – but particularly in the US and UK.  Housing is becoming more and more unaffordable and a big portion of the much-touted “consumer spending” recovery is being financed by high-risk home equity loans.

Flaherty denied, in another interview today, that there wasn’t a housing bubble – “right now.”

Last week the bank of Canada pointed out that by 2012 some 10% of Canadian mortgages could be in danger of defaulting if interest rates went up – which they will do at some point. Given that CMHC insures virtually all Canadian mortgages, that 10% default figure would represent a hit to the public purse of some $50 billion – 10% of the $500 billion the housing corporation will have in its asset pool by the end of next year.

The other elephant in the room? All these mortgages are securitized – that is, bundled into Mortgage Backed Securities (MBSs) and sold as highly rated bonds. (If this sounds familiar, it should – this was the scenario for the global MBS meltdown). Check with your financial advisor (assuming you have any money to get advice on) to see if any of your mutual funds have them. Anecdotal evidence suggests the whole sector is infested with these dangerous “financial instruments.”

When the bubble bursts it won’t just be over-extended home owners who hit the wall. Hundreds of thousands of investors are holding these risky investments thinking they are holding bonds. It will be a very nasty surprise – and an inexcusable failure of the government to protect consumers.

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