Get your head around this - Big Six banks urge Ottawa to tighten mortgage rules
The heads of the country's six largest banks have privately told policy makers that they fear the wide-ranging economic fallout of a U.S. style binge-and-collapse in housing. To head off any chance of that happening, they are willing to accept tighter rules on mortgages that would slow the real estate market, even though it would mean forgoing some short-term profits from giving out ever bigger mortgages as home prices jump.
That's right - in Canada bankers are asking for more regulation.
Before we get into the detail of the article a quick primer on why Canada is not in the same mess as the US (at least yet).
Housing:
- In Canada mortgage interest is not tax deductible (this limits how much you can borrow).
- If you primary house goes up in value and you sell, say for a gain of $100,000, that gain is tax free.
- A large chunk of mortgages are held by the banks that issue them. And 40% of bank loans are mortgages.
- Any mortgage with a loan above 80% of the value of the house must have "mortgage insurance" (which costs money and makes big mortgages more expensive). Most of this mortgage insurance is provided by a government agency (called CMHC).
- Currently to get mortgage insurance you need a minimum 5% down payment and a maximum 35 year amortization.
Banking:
- Canada has 6 major banks which form the vast majority of the banking industry. In essence all these banks are too big to fail.
- These banks are very profitable, but do not pay obscene salaries or bonuses (at least in comparison to US banks).
- The banks are heavily regulated. A few years two sets of banks tried to merge and the government forbid it. So Canada still has 6 big banks, not 4. There is a limit to too big - and the government controls it.
- The small number of banks does make for a very efficient system (though perhaps with less choice). Debit cards are used heavily and fees are very low compared to the US where clearing is far more complex.
Government:
- From the mid 90's to recently the Canadian federal government ran budget surpluses. It is only with the onset of the recession that it now runs large deficits. If you are a Keynesian this is how things should work (surpluses in good times, deficits in bad), unlike in the US where it is big deficits in good times and bigger deficits in bad.
- Just as in the US it was the "conservatives" that came in and cut taxes and did not reduce spending, setting the stage for bigger than necessary deficits.
- It is easier to get things done in the Canadian system. No messy Senate, or heavily "influenced" congresspeople to deal with.
Back to the banks on housing:
In their discussions with the finance minister the banks asked for something quite extraordinary. They wanted to see mandatory down payments of 10% and a maximum mortgage amortization of 30 years. Pretty amazing, eh? The banks wanted to make it harder for people to get mortgages (and to keep everyone on the same playing field with regards to terms - which can be done in the Canadian system).
So why would the banks want to see these changes?
- Because they actually hold a lot of the mortgages, so they would be responsible to some degree if there was a housing crash (although the first losses would be picked up by mortgage insurance.)
- Because stable mortgages are a great but boring profit stream (almost no risk).
- To stop "less constrained" competitors entering the market. By asking for strict rules they would make it harder for new entrants to offer "US style" alphabet soup mortgages, which of course are also far riskier. So the banks would rather take less profit (but secure profit) than risk big gains or big losses.
- They want people to keep paying off their other loans. The banks fear that with less restrictive mortgages their customers might take on too much debt and then may have trouble paying their other loans.
Wrap-up:
Interestingly in this case it is the Conservative government that is objecting to raising mortgage standards. Imagine that.
Following the financial crisis the Canadian banking model deserves a look - heavily regulated banks, that are allowed to be profitable, but are kept boring and less risky.
The mortgage market too provides some lessons. Given similar home ownership rates in Canada and the US it seems obvious that the aggressive promotion of home ownership is NOT required. It is not necessary to have subprime/pickapay/teaser mortgages to have a healthy housing market. These artificial stimuli only serve to distort the market in the short term and destabilize it in the long term.