In 2006 the federal government changed the rules on CMHC insured mortgages from 10% down 25 year amortizations to 0% down and 40 year amortizations; they were in effect copying the reckless lending policies of the US. The only difference was who carried the risk. Our banks were actually well insulated from any potential losses because the government took on all the high risk mortgages through the CMHC. This was and currently still is a major subsidy to the banking, construction, and the real estate industries.
When the US housing bubble burst, Finance Minister Flaherty backtracked in 2008, and in an attempt to save face, altered the rules to 5% down and 35 amortizations. Had he done the right thing in light of the financial train wreck south of the border he would have reversed the government’s prior 2006 changes.
Then, with lax lending rules, a perfect storm began to brew. In 2009 the Bank of Canada introduced emergency interest rates to stave off a recession. By doing so it encouraged people to borrow and spend, which they did. However, what our politicians chose to ignore was the fact such low interest rates and lax lending rules increased purchasing power exponentially, especially if a buyer included rental income in their mortgage application. A further tightening of mortgage rules was desperately needed.
This unprecedented housing boom and economic recovery has been fueled solely by debt. A massive credit expansion that is unsustainable by any measure. We only need look to the US to see the hangover effects of a drunken debt binge. Now Canada, faced with a credit contraction is about to repeat history. It’s disappointing that we learned no lessons from the US housing debacle. History should never have to repeat itself so soon.
A brief look at the numbers tells us exactly where Canadians fare with respect to household finances.
• Credit card balances are up 458% in 11 years.
• Lines of credit grew 820% from 1999-2010
• Residential mortgage debt is up 142% in 11 years
• Debt to disposable income is over 147% and climbing
• 1 in 5 Canadians is currently struggling to afford their homes despite emergency level interest rates – what will happen with a modest increase?
• Unemployment in Canada is 8.2%, not including discouraged workers
• The real unemployment rate is 12.1%
With mounting government deficits, a winter Olympic tab to pick up, and unrealistic budget forecasts, we are going to be faced with issuing government bonds in a more and more saturated market. We can all expect government cutbacks and higher taxes to curb these amounts of overspending. Nonetheless, bank interest rates have already begun increasing and the Bank of Canada has indicated its priority is to keep inflation in check. Now that core inflation has taken off expect Bank of Canada Governor Mark Carney to begin a return to non-emergency low interest rates. Purchasing power will be significantly reduced at the beginning of interest rate increases.
To top that all off, Flaherty announced that April 19, 2010 would see another round of mortgage rule changes. Now buyers would have to qualify based on the posted 5 year fixed rate or enter into a 5 year fixed mortgage. Rental income used in the qualification process will be reduced from 80% to 50% and real estate investors not living in the home will need a minimum of 20% down.
BC and Ontario are also introducing the HST July 1, 2010.
All of this explains the massive 20%+ year-over-year run-up in housing prices despite the lack of increases in household incomes. Many people fearful of being priced out of the market or buying with higher interest rates are desperately trying to get in while they still can. Unfortunately, far too many people think they’re the shark in this historic feeding frenzy. As expected, those with vested interests are refusing to call this a housing bubble. Realtors, bankers, newspapers, politicians and even homeowners are taking part of pumping up this market.
This is a perfect storm for a housing bubble.
The saddest part is that many people have banked on real estate in their retirement planning as their only investment. Real estate is volatile and illiquid. Over the next decade we can add to that the retirement of the baby boomer generation and their cashing in of real estate. The results will become a liquidity nightmare. As our Canadian train wreck unfolds many would be retirees will wake up to suddenly find themselves in an extended career they didn’t see coming.
Solomon Nordine, BBA, MBA
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Solomon Nordine is the owner and president of Complete Accounting Solutions. Mr. Nordine is a Fellow Public Business Accountant (FPBA) and a United States Accountant.