Canada's Mortgages Not Like The USA

Canada’s Mortgage Market is NOT Like the U.S.

A Report from Scotia Economics – Part 1 of 2

We're fielding client inquiries about risks facing Canadian housing and - more importantly - mortgage markets. The following points summarize some key thoughts that we’ve made over time. The bottom line is that we do believe there to be considerable downsides to the Canadian housing market, but that comparisons of Canadian mortgage market prospects to the U.S. experience are off-base.

1. Debt growth over the full cycle

Much is being made of the fact that Canadian debt growth relative to incomes over recent years has been on par with the U.S. experience.  Ergo, one is led to conclude, Canada must face similar stresses to its own housing and mortgage markets.

Nonsense. One must look at the full cycle and use the right measures. Recent Canadian debt growth reflects the unleashing of pent-up demand from the 1990s. Canada’s recession in the early 1990s was more severe, and the effects were longer lasting by way of how long it took housing markets and the consumer sector to get back on their feet. The U.S. recession of the early 1990s was comparatively mild, and the economy rebounded faster such that U.S. debt growth over the long-haul has exceeded debt growth in Canada. The effect has been for the U.S. to outpace Canada on growth in total household sector liabilities relative to incomes throughout the past two decades.

2. Leverage - night and day comparisons

Canada’s ratio of household debt-to-income is much lower than the U.S. Despite its popularity, however, this is the worst way to look at leverage since it compares total debt amortized over decades to a single year’s after-tax income which is a stock-to-flow comparison that most economists avoid. One doesn’t take out a mortgage on January 1st with the expectation of having to pay it all back out of the current year’s income by December 31st, so why make the comparison?

The best way to judge the full cycle’s influences upon debt growth in Canada versus the U.S. is to look at where the two countries stand today on leverage on the household balance sheet (i.e., debt as a share of assets). This must be done by making adjustments to ensure comparability of Canadian and U.S. household sector balance sheet data. In Canada, total debt as a percentage of total assets sat at 20% as at the end of 2007. The U.S. ratio is about 26% (chart). By corollary, Americans have used nearly 30% more debt to purchase assets than Canadians. Clearly, Americans and Canadians have different debt tolerances.

3. Canadian mortgage markets are fundamentally healthier than the U.S.

a. Canada’s subprime market is small (5-6% of outstanding mortgages) whereas the U.S. share peaked at about three times that. As a share of originations, 20-25% of new mortgages in the U.S. were subprime over the 2004-06 period. So Canada isn’t anywhere near as exposed to the products that caused most of the damage in U.S. housing markets.

b. Not only is Canada’s subprime market much smaller, but it isn’t even really subprime per se. Canada's subprime market is more like the U.S. near-prime market, whereas the U.S. subprime market often lent to borrowers with extremely impaired quality.

c. Adjustable rate mortgage (ARMs) resets also caused many of the problems stateside, but those resets occur much more suddenly in the U.S. By contrast, the closest Canadian product parallel is the variable rate mortgage, but they get constantly repriced so that people aren't caught off-guard years later. Furthermore, in Canada, some variable rate products adjust the principal, not the payment. On balance, the shock effect from payment resets in Canada is nowhere close to what has caused much of the problem in the U.S.

d. Canada’s mortgage equity withdrawal market isn't like the U.S. We've seen secured home equity lines of credit (Helocs) grow in Canada as a way of withdrawing equity, but nothing like the U.S. withdrawals picture. U.S. homeowners’ equity has been in free-fall with mortgage debt growth outpacing housing assets since the early 1990s. Canada, by contrast, retains much higher homeowner equity, and while it may have reached a plateau, the figure has risen in recent years while the U.S. position has deteriorated.

e. Mortgage interest is deductible against taxes in the U.S. It generally is not in Canada. That creates vastly different incentives to leverage oneself in the two markets.

f. The nature of the products has been very different in Canada versus the U.S. Examples of Canadian innovation like long-amortization mortgage products are absolutely nothing like Ninja mortgages. Mortgage innovation was needed in Canada, but has been relatively more conservative.

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