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Canada mortgages, banks untouched by U.S. pitfalls

TORONTO – Maybe Canada has something to teach the U.S. about housing finance.

One in four U.S. homes is thought to be worth less than the mortgage being paid on it. One in every 492 U.S. homes received a foreclosure notice in November. For the fourth year running, analysts are speculating on where the bottom is for U.S. real estate.

No such worries up here in Canada – yet its system of mortgage finance gets little attention in the U.S.

Not a single Canadian bank failed during the Great Depression, and not a single one failed during the recent U.S. crisis now dubbed the Great Recession. Less than 1 percent of all Canadian mortgages are in arrears.

That’s notable given that the recent U.S. economic turmoil was triggered by a meltdown in mortgage finance, forcing an unprecedented government rescue of Wall Street investment banks and the collapse of more than 300 smaller banks as the housing sector went bust.

How did Canada avoid all that?

“This sounds very simple, but one of our CEOs has said we are in the business of making loans to people who will pay them back,” said Terry Campbell, vice president of policy for the Canadian Bankers Association in Ottawa.

There’s a certain amount of apples to oranges when comparing the mortgage finance systems. Canada’s population last year was estimated at 34.3 million, while the U.S. population now exceeds 307 million. The U.S. economy is the world’s biggest; Canada ranks ninth.

Canadian banks were recently named the best in the world by the World Economic Forum, but they’re a much smaller universe of lenders – 71 that are federally regulated, compared with more than 8,000 U.S. lenders insured by the Federal Deposit Insurance Corp.

Even so, there’s plenty to learn from Canada’s conservative regulatory regime. It requires more rigorous loan underwriting standards and much bigger set-asides by banks for potential losses during market downturns.

Canada also lacks a big tax write-off for the interest that borrowers pay on their mortgages. They get a capital gains tax exemption on any profits on the sale of their primary residence, and that’s it. Yet the rate of home ownership in Canada is equal to or greater than the U.S. rate, and the lack of mortgage-interest deductions leads Canadians to swiftly pay down their mortgage debt.

“I’m not aware of any disparagement of the Canadian model or dismissal of the Canadian model. There are some interesting features to it,” said Stuart Gabriel, a finance professor in the Anderson School of Management at the University of California, Los Angeles. “They’ve insisted all along on the more rigorous mortgage underwriting, and because of that never found themselves originating subprime and no-doc mortgages … some very basic items such as stringency of underwriting seem to go a long way.”

Canada doesn’t have an equivalent to Fannie Mae or Freddie Mac, which purchase mortgages from banks and pool them into bonds. The argument for Fannie and Freddie is that they take loans off a bank’s books, freeing them to lend more.

Canada has no such secondary market for mortgages, yet it hasn’t hurt the ability of its banks to lend or significantly raised the cost for borrowers.

Canadian mortgages aren’t nonrecourse loans; homeowners can’t simply walk away from their mortgages. Even if they lose their home, they still owe their mortgage debt.

“You mail your keys into the bank here and guess what, you are not off the hook,” said Gregory Klump, the chief economist in Ottawa for the Canadian Real Estate Association.

Lessons from Canada could prove useful. Fannie Mae and Freddie Mac have been in government conservatorship since the summer of 2008. The Obama administration must unveil its roadmap for how and when they’re to be moved out of government control.

By July, the administration must establish the new Consumer Financial Protection Bureau, whose chief functions will include policing mortgage lending and defining suitable mortgages.

The issue of mortgage-interest deductions probably will come up this year when Congress debates deficit reduction. A blue-ribbon National Commission on Fiscal Responsibility and Reform late last year recommended a serious scaling back of the U.S. mortgage-interest deduction as a means of raising more revenue and lowering deficits and debt.

In some ways, the U.S. is already adopting big parts of the Canadian model.

“I think the U.S. system may be eliminating certain types of loans. … I think we’re seeing greater emphasis on down payments,” said Jay Brinkmann, chief economist for the Mortgage Bankers Association.

Lenders, he said, are shying away from second mortgages. And there are greater demands for private mortgage insurance, even on refinanced mortgages.


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