For most of this year the markets have been discounting an economic recovery. That is, they have been in rally mode in anticipation that the worst of the economic crisis is over. While that is likely, all that is left for debate is how meaningful the recovery will be and if it is sustainable. The G20 countries have committed to not let their collective foot off the stimulus gas pedal until they are confident that the economy is on a sustainable trajectory.
As has been expressed before in this space, the distortions being caused in the markets by a weak US dollar are numerous. The floundering US currency has in turn lit a fire under the Canadian dollar. It is up almost 17% for the year and 24% since its lows last March. That has created a conundrum for the Bank of Canada. It was widely expected that the Bank of Canada would have begun raising interest rates by now.
However, some economic data has come in weaker than expected and even more so, the high Canadian dollar has kept the Bank of Canada on the sidelines. The central bank is well aware that if it chooses to raise rates now and thereby further strengthen the loonie, it might end up choking off the budding economic recovery.
There may be yet another concern that might be leaving the Bank of Canada in a quandary. It seems that Canada is gaining a new reputation as perhaps the "new kid on the block" when it comes to the excesses of overheated real estate markets. The real estate revival is being fueled by a wave of mortgage financing that some consider to be sub- prime in quality. In part, this is starting to resemble what we have seen in the US. While it is highly unlikely that we would see anything remotely resembling the experience of the US banks, the story does have some similarities that are disconcerting.
Part of the responsibility for this trend is being put at the feet of the Canadian Mortgage and Housing Corp. (CMHC). This government entity is considered by critics to be the Canadian equivalent of Fannie Mae in that its practices are thought to be provoking a rise in lending that could spell trouble for the Canadian real estate market in the future. This practice was brought about in part by the directive of the federal government to CMHC to effectively "hit the gas" and ensure that mortgage credit was accessible. The theory goes something like this: banks can continue making extended amortization loans to provide prospective homeowners the ability to get into an overheated Canadian housing market because the default risk is being transferred to the CMHC (taxpayers) since it acts as a guarantor for the mortgage market.
According to data from the CMHC, the amount of mortgage credit on the books of the banks has been almost unchanged since 2007 even though they have been issuing an explosive amount of mortgage credit. The reason is that the banks are offloading the mortgages from their balance sheet through the securitization process. Essentially, this allows them to move the risk of default to the broader financial markets.
Recently, the president and CEO of ING Direct Canada stated that he is seeing Canadian habits resemble those of US and European nations during their housing booms. The level of equity in Canadian homes is surprisingly low as more than 50% of all mortgages issued this year are longer than the 25 year range that has been the usual option for borrowers.
Taking this altogether, should rates rise over time, many Canadians might wonder what they have gotten themselves into. The chart above shows that Canadian income growth has not kept pace with the level of mortgage credit and now exceeds Canadian income. This also raises the question about whether or not the federal government can reverse its directives to the CMHC to open the credit spigot given the fact that many households are holding well under 10% equity levels in their homes. If however the Bank of Canada moves too fast in correcting this loose credit situation, the housing market could start to freeze up once again. If it does nothing, we could quickly confirm that the recent housing market surge is in fact the making of a bubble and bubbles are generally known for only doing one thing.
It seems that rather than simply expressing concern about this issue as we have seen thus far, the Bank of Canada might be tempted to follow its words with actions and send a shot across the bow of a surging Canadian housing market.
<!-- Facebook Badge START -->Mark Fidgett | 604-273-2002
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An independent Mortgage Specialist associated with the Verico Mortgage Network.
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