Report: How Did Canada’s Housing Market Dodge the Bullet?

Given the relative stability of Canadian housing markets, many observers try to draw comparisons between the housing finance policies of Canada and its southern neighbor the United States.
[IMAGE] Why is it that the United States suffered through such a painful housing bubble and bust in the last decade, while Canada did not? Despite similarities in their homeownership rates and mortgage lending dominated by government backing, the fates of the two countries' housing markets took very divergent paths.

According to a report from the ""Center for American Progress"":http://www.americanprogress.org, a policy-driven think tank based in Washington, D.C., the answer, quite simply, lies in the sudden rise and expansion of an unregulated private securitization market here in the states.

The author ""of the report"":http://www.americanprogress.org/issues/2010/08/true_north.html, David Min, says, ""The answer, quite simply, is that Canada did not become enthralled with the laissez faire ideology that dominated U.S. economic policy making in the 2000s, and thus did not allow major gaps in its regulation of housing finance to develop.""

Both countries have a long history of government-supported mortgage lending. In America, this is primarily through the explicit government guarantees on mortgage-backed securities (MBS) provided by ""Ginnie Mae"":http://www.ginniemae.gov and the implicit government guarantee on the liabilities of ""Fannie Mae"":http://www.fanniemae.com and ""Freddie Mac"":http://www.freddiemac.com. In Canada, this support comes through guarantees on insured mortgages as well as significant levels of government-backed securitization, Min explained.

But here lies the difference. He says from 2003 to 2007, the United States experienced a sudden surge in the unregulated securitization of new, exotic mortgage products such as adjustable rate mortgages that reset after two years, with such features as ""teaser rates"" and ""stated income,"" no documentation underwriting.

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These exotic mortgages, which were often originated by unregulated nonbank lenders, were purchased by private-securitization conduits-typically sponsored by large financial institutions-and then packaged and sold as so called ""private label"" MBS, Min explains.

This mortgage financing channel grew tremendously, he says, and in lockstep with the housing bubble, rising from roughly 10 percent of the U.S. mortgage market in 2003 to almost 40 percent in 2006.

In contrast, Min points out that Canada's mortgage system did not experience such dramatic changes in its mortgage lending landscape. There, they saw very limited amounts of lending financed by private securitization and as Min calls it, its alphabet soup of ABS, asset-backed securities; CMOs, collateralized mortgage obligations; CDS, credit default swaps; SIVs, structured investment vehicles, and the like.

While private-label mortgage securitization saw large market share increases in the United States in the last decade, this financing channel remained a negligible source of mortgage lending in Canada, at less than 3 percent of the Canadian market during the 2000s.

Min also says there were far fewer incentives for unregulated private securitization in Canada than there were in the U.S. There, lenders had greater benefits through government-guaranteed mortgage insurance, while here they sought to reduce capital levels and raise returns on equity, which drove them to sell loans through unregulated securitization conduits.

The Canadian mortgage market is considerably smaller than in the U.S. Canada has a total population of about 34 million (larger than Texas but smaller than California), and total residential mortgage debt of slightly less than $1 trillion (as opposed to slightly more than $14 trillion in the United States).

For this reason, Min urges caution in drawing overly strong conclusions from the Canadian experience.

Nonetheless, he says there are some important lessons to be learned from Canada's aversion of the crisis, which could help to shape the future of housing finance in our country.

According to Min, ""The key lesson Canada appears to teach us is that regulated, government-supported mortgage finance leads to greater sustainability and stability than its unregulated, purely private counterpart.""