The Globe and Mail

Sometimes boring is a good thing.

International Monetary Fund economist John Kiff has spent the past few months looking at how mortgage markets in various developed countries weathered the financial crisis.

His conclusion about Canada's mortgage market: "boring, but effective."

It's a meat-and-potatoes mortgage market. Most Canadians opt for fixed-rate mortgages, typically five years. Half of borrowers have at least 80 per cent equity in their homes.

On the lender side, a clutch of institutions dominate the Canadian market. Mortgage brokers are rare. Most mortgages are held and serviced by the same institutions that offer the loans. Mortgages are typically backed by deposits and rarely turned into securities and sold off to anonymous investors.

And most notably, government policy is neutral when it comes to owning or renting, with no tax incentive to take on debt.

Banks have sweeping powers to tap mortgage holders' future wages if they stop making their payments, making Canadians more cautious about borrowing too much.

All this is, of course, is quite different from the United States.

Here, the system overtly encourages homeowners to borrow as much as possible by allowing them to deduct mortgage interest from their taxable income. The more interest, the bigger the deduction.

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The industry has responded with an endless array of exotic options and a proliferation of lenders eager to indulge Americans' appetite for debt.

"I'm supposed to be the financial products expert at the IMF and the selection of products here boggles the mind," Mr. Kiff, a former Bank of Canada official acknowledged at a recent forum at American Enterprise Institute in Washington.

We all know that Canada's housing market emerged from the financial crisis relatively unscathed. Not so for the United States and parts of Europe, where there have been more foreclosures, coupled with bigger writedowns and numerous bank failures.

The New York Times columnist Paul Krugman has concluded that what sets Canada apart from the United States is tougher regulation - regulation aimed at limiting systemic risk and shielding consumers. He said that's exactly what the U.S. needs.

"We need an independent agency protecting financial consumers - again, something Canada did right - rather than leaving the job to agencies that have other priorities," Mr. Krugman argued in his March 7 column. "And beyond that, we need a sea change in attitudes, a recognition that letting bankers do what they want is a recipe for disaster."

That may be partly true. But why did banks make such bad loans and investments? And why did homeowners overreach for bigger, more expensive homes?

Much of what happened in the U.S. housing market was ultimately consumer-driven - the overbuilding and the overborrowing.

And for that, Americans can blame policy makers, who for decades aggressively pushed homeownership as a national goal.

The incentives encouraged banks to overlend, and for homeowners to overborrow.

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The government, through mortgage lenders Fannie Mae and Freddie Mac, is continuing to backstop massive amounts of mortgage risk.

The irony is that there's no evidence U.S. policy has created more homeowners. The rate of homeownership in Canada and the United States was virtually identical before the crisis- at slightly less than 70 per cent.

And today, the rate is likely lower in the United States because so many Americans have lost their homes to foreclosure.

Sadly, in all this no one is talking about scrapping mortgage deductibility, which drains roughly $100-billion (U.S.) from tax coffers.

For most Americans, it's the biggest tax break they get.

And for the banking industry, it is the fuel that keeps the mortgage market going.

The tax break's many defenders argue that if the deduction inflates housing demand, its effect is already built into current prices. So removing it could destabilize an already shaky market and send prices tumbling.

Presumably, a gradual phase out would mitigate a price collapse. The more important question is whether the United States can afford to keep a policy that encourages homeowners to act recklessly and puts the financial system at risk.