Canada's Housing Bubble

Mar 10, 2010 edmontonhousingbust.com

In the last few years, especially in the wake of the housing bust and resulting financial crisis south of the border, we’ve increasingly heard about mortgage backed securities( MBS for short)… but many aren’t really familiar them, so I figured I’d offer up what little I know about them and promote a discussion that could perhaps serve to better inform all of us.

Until relatively recently, typically when a borrower takes out a mortgage, the bank/lender would hold the mortgage and collect the payments for it’s entire life… and it was a fairly good racket, as they were lending out the money at a higher rate of return then they paid to obtain it, making money on the margin. This is also why obtaining a mortgage gained a reputation of often being am evasive and unpleasant experience… as the bank would hold the mortgage for it’s full life, they wanted to make sure you’d be good for it.

Mortgage backed securities changed that, but I’m getting ahead of myself… first we should look at why MBS’s became in demand.

That is rooted in a topic we’ve discussed here many a times, that being manipulating of central bank rates to extreme lows. Without going off on too much of a tangent, this is largely tied to policy of former U.S. Fed chair, Alan Greenspan… whose one size fits all response to any economic problem was to slash the Federal Funds rate (ironically he’s an Ayn Rand acolyte, though the irony seemed to escape him). Anyway, fast forward to dot com crash, and Greenspan did away with the scalpel and just flat out started taking an axe interest rates.

Not only did that open the flood gates of liquidity (and fuel a lethal housing bubble)… but it also really threw a wrench into the gears of the fixed income crowd. While we don’t really hear much about them, there is A LOT of money in that crowd, and we’re not just talking about grandma and her shoebox full of savings bonds, these are everything from pension funds, mutual funds, university endowments, etc. You see, by slashing short term rates, it pulled down yields on all sorts of bonds and securities that this bunch invests in. Suddenly they found themselves unable to achieve their required returns buying low risk government bonds… and hence a big demand for AAA rated securities with yields higher than what government debt was paying.

And yep, you guessed it, MBS filled the gap. With just the right mix, some mathematical voodoo and a whole lot of negligence the rating agencies started rubber stamping these pools of mortgages with AAA ratings, and the fixed income crowd lapped ‘em up. You see, this was the real root of the “subprime crisis” in the US. Rather than lenders making sure borrowers would be good for the life of their mortgages, suddenly they only needed to make sure they wouldn’t default within 60-90 days (the period it took to get “securitized”), at which point it was someone else’s problem.

From there we kind of know the rest of the story… eventually anyone who could fog a mirror could get a loan… sooner than later they defaulted… which of course meant all that AAA rated paper floating around was discovered to be the shit it really was all along… and the house of cards collapses as everyone discovers that whatever they paid a lot of money for, isn’t worth a damn thing. Banks go belly up, housing collapses, and the very same perfect storm that created the bubble, now reverses and destroys it.

We here in Canada are not that bad off in that sense, as while we have also seen a big rise in MBS, all ours are backed by the CMHC… or more accurately, our tax dollars. So, rather than cost a ton of money AND bring down the entire financial system, it’ll just cost of a ton of money. I know, it’s hard to believe the successes of “conservative” lending is actually rooted in socialized losses (though I bet the irony escapes those fuckers too).

Anyway, I’m not saying that just cause the US housing bust was rooted in MBS, and that we also saw a rise in it, that we’re destined for the same fate… we’re destined for the same fate for entirely different reasons. Well, not entirely different, but somewhat different reasons. In the US the bubble was caused by lax lending standards resulting from demand for MBS and colossal regulatory failures… in Canada, it was lax lending standards being mandated and backstopped by the federal governments. You see, the symptoms are the same, but the disease was different.

So there you have it, my two-bit background/rant on mortgage backed securities. I’m not of the opinion that MBS’s are inherently good or bad, but I also don’t consider myself an expert on their ins and outs. If you want to read some more, Jonathon Tonge wrote a very interesting article on them last year that is worth a read.

Now lets take a quantitative look at their impact on Canadian lending.

Residential Mortgage Credit

Firstly, this is the total residential mortgage credit outstanding in Canada. What really strikes me with this first graph is how the curve has started to take off and go parabolic in the last decade. It’ll be interesting to see how the 2009 numbers compare when they are released in the summer. We can also note that while growth has continued nominally in chartered banks and credit unions, that it appears much of the growth has been from the MBS segment. To get a better idea of that lets take a look at the market share by segment.

Residential Mortgage Credit Market Share

Here we can really see how MBS have become a major force in the market recently. From their entry in 1987 through 1999 they only made up about 5% of the market, but in the last decade they have really taken off and now make up over 20% of the market…. taking that share from chartered banks and the other category (mostly “Trusts” and such).

Once again, I don’t know that this is inherently good or bad, it just is what it is… some food for thought perhaps.