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Why Canada isn’t heading for a U.S.-style housing bust

Reporter John Greenwood, of the Financial Post published the following interview with Ed Clark, Chief Executive Officer of TD Bank Group, explaining “why Canada isn’t heading for a U.S.-style housing bust”.

Q Canada’s housing boom has so far been good for the banks. It’s helped drive near record profits and enabled lenders to recover from the financial crisis. But now some critics worry that it could turn into a bust if the economy weakens. What do you think?

A I think the banks have been divided on this issue. We are not going to have a housing meltdown like they had in the United States. We haven’t been doing subprime lending like the United States, so we don’t have a whole population that bought houses in which it’s obvious that they will never pay back the mortgage. But I guess the way I look at it is, you can only leverage society up so far. It’s not very different from an ordinary person: “I’m sure I can borrow more money than I borrowed today, but could I keep on borrowing more money than I borrowed every year? Eventually I reach a point where I can’t keep borrowing more and in fact I have to start paying it back.”

Q Is the housing boom an unintended consequence of the measures taken by Bank of Canada after the financial crisis?

A Yes. They obviously thought it would stimulate housing but I think the fact that we got into this is an unintended consequence. [Bank of Canada Governor] Mark Carney gave a speech several years ago outlying this exact risk. The problem is that if you set key interest rates low, you have a tendency to have asset bubbles. So what do you do about that? [One option is to] try to use administrative means to lean against these bubbles and that’s what Canada’s trying, and I think that’s the right thing to do.

Q You said you don’t think Canada is headed for a U.S.-style housing bust, but there have been plenty of housing busts around the world, in fact many countries in Europe have had one.

A Yes, but I think [most were victims of] a combination of both low interest rates and poor lending policies. We had the advantage in Canada that the bulk of mortgage lending is done by regulated banks and those banks hold those mortgages on our balance sheet.

Q Yes, but about $600-billion of those mortgages are insured by CMHC, so banks like TD don’t have to pay the consequences if something goes wrong.

A There’s two categories of CMHC insurance, one is the social program where this is in a sense a government program and there is no question, that’s a higher risk program. The government is saying, we would like people to be able to borrow more than 80% loan to value, we think that’s a social good. When you do stress tests on that — which we’re able to do — it’s clear that in the case of a downturn, you’re going to suffer more losses [on those loans].

You then have a second portfolio, a big part of the $600-billion where the banks have gone to the CMHC and said, we would you like to insure our portfolio [of loans where the borrower has put down more than the minimum 20%]. CMHC makes money, huge money on that portfolio.

In one sense, the portfolio part subsidizes the social part, and it’s the part that people look at and say, jeez, the banks are getting a free lunch. No, they’re not. They’re paying for insurance that is highly, highly profitable for the government of Canada.

Q In the mid-2000s, before the financial crisis, a lot of banks, including yours, were predicting that we were not going to have the financial crisis and yet it happened. And now people are saying don’t worry, interest rates are gong to stay low and we’re not going to have a U.S. style housing bust. Can you help me understand that?

A I agree with [the] view that it’s very hard to run an economy with very low interest rates and not have asset bubbles. So if you’re not going to have asset bubbles, you’re going to do exactly what the government then did. And that’s start to lean against it and tighten up the rules and say, we’re going to just keep touching that brake to try to offset the fact that we’re running on an unusually low interest rate environment. So I completely agree with that… I think that [the government] so far got it about right. And there are people in my own organization that say they’ve gone too far and they’re going to risk pushing this over into stopping it too quickly. I haven’t seen evidence of that yet, so I think they’ve done exactly the right thing. But a year from now we could be having this discussion again if it turns out that having slowed it down, it then starts to speed back up again.

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Casey Ragan

“Toronto’s Condo Authority”

Toronto Condos and Lofts

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