Home prices have doubled over the last decade, propelled by low rates and easy mortgage terms. But as the U.S. experience proved, soaring property values can come with an ugly downside. The Globe and Mail examines the foundation of Canada's historic real estate boom in a series.
The governor of the Bank of Canada was getting angry.
It was a sweltering afternoon in July, 2006, and David Dodge was meeting with executives at Canada Mortgage and Housing Corp. in Ottawa, in search of the answer to a pressing question: Why were they lowering their standards in such a reckless fashion?
As Canada’s largest mortgage insurer, federally-run CMHC is a gatekeeper to the housing market, influencing who gets to buy a home and who doesn’t. For decades it has sought to make it easier for people to enter the housing market, but it has also enforced some strict rules, requiring home buyers to make minimum down payments and pay off their mortgages in 25 years.
Now CMHC was abandoning its old ways. It was starting to allow more exotic kinds of mortgages, similar to what lenders were offering in the United States – 35-year loans, and loans on which the buyers had to pay only the interest at first, giving them low monthly payments at first but saddling them with more debt down the road.
To Mr. Dodge, these were irresponsible moves that would encourage some people to borrow too much or jump into the market before they were ready, creating new risks for the economy. “This is a mistake,” he told CMHC brass bluntly.
Lower mortgage standards were going to cause already-frothy house prices to inflate even more – an “excessive exuberance,” the governor called it – as buyers rushed in, borrowing greater amounts of money and purchasing bigger homes than they could otherwise afford.
“This is absolutely not the appropriate thing to do,” a frustrated Mr. Dodge told the meeting.
CMHC president Karen Kinsley defended the changes, arguing that the mortgage insurer wasn’t getting lax, and that borrowers would be as closely scrutinized as ever. But she had other concerns. For months, competitive pressure had been mounting on the Crown corporation to bring in more business.
Created in 1946 to help returning Second World War veterans find homes, CMHC had morphed over the years into a multibillion-dollar goliath that fuels bank lending and housing demand by insuring riskier mortgages, especially those in which the buyer has only a small down payment. Without that insurance, many more people would be shut out of the real estate market, unable to get a mortgage from a chartered bank.
It has also been a lucrative venture for the government. But that business was now being eroded as a result of the arrival of aggressive U.S. insurers into Canada.
The American companies were willing to do things CMHC had never done. Some were even backing “zero-down” mortgages in which the buyer borrowed every dollar needed to pay for the home.
It was a race to the bottom, and CMHC was playing along. “We didn’t lead it … As we lost market share, we would follow what the American companies were doing,” said former CMHC chairman Dino Chiesa. With money available and the economy booming, home buyers streamed into the market and prices soared.
Mr. Dodge’s warnings didn’t cause CMHC to change course. But later, convulsions in the U.S. economy would. The bursting of the American property bubble showed that a rapid rise in home prices and household debt, built on a foundation of low interest rates and easy mortgages, could be a toxic combination. When the boom ended, it left a legacy of failed banks, foreclosed homes, recession and government debt.
It is a path that Canada is trying to avoid after a period in which home prices have risen much faster than incomes – faster than any other decade since the 1950s. To afford those houses and condos, Canadians now hold nearly $1.2-trillion of mortgage debt, nearly three times what they had in 2000. Households have almost $1.65 in debt for every $1 in after-tax income, the highest since Statistics Canada began keeping the data in 1990.
And in the process, the federal government has been taking on bigger risks as well. The federal government now backstops some $800-billion in mortgages, mostly through CMHC, the equivalent of almost half of Canada’s annual economic output.