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Almost 200 U.S. banks have failed since early 2008, but not a single Canadian bank has. The delinquency rate last December for home mortgages in the U.S. was 9.47%, but only 0.45% in Canada. What explains this incredible difference? Read Mark Perry's fascinating article to find out, but here's a summary:
• Full recourse mortgages
• Shorter-term fixed rates
• Mortgage insurance
• No tax deductibility of mortgage interest
• Higher prepayment penalities
• No Community Reinvestment Act
• Much larger banks
• Less mortgage securitization
Canada has largely eschewed policies which encourage home ownership and insulate homeowners from the consequences of their purchase decision, yet Canada has a higher home ownership rate than we do. We could learn a lot of lessons from our northern neighbors when it comes to banking and home ownership.
UPDATE: I noted that an Australian pointed out many of these same issues way back in Oct. '08. The origins of our housing crisis have nothing to do with free markets; it's government intervention in free markets that screws things up.
Friday, February 26, 2010
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11 comments:
I love this post. It basically highlights everything we have done wrong in housing since the Great Depression.
Zero accountability and massive government meddling. Two ingredients for calamity.
This is actually a repeat of the past. During the banking crises of 20th centtury, especially after the Great Depression, Canada's banking system had a tiny fraction of the defaults suffered in the US. The reason, much freer banking system.
Those who fail to learn from history...
Funny you mention. I work for a Canadian company, and the mother of one of the partners is Miriam Varadi. She had a great interview on CBC about his very same subject!
http://www.youtube.com/watch?v=Rui-5U7D3pY
check out the video. some great insight.
Well, I agree but...
"less securitization" is the elephant in the room.
US lenders securitized debt and sold it to a rabidly hungry global capital market looking for yields.
The RMBS were rated AAA by Moody's, S&Ps, Fitch.
As long as lenders could sell RMBS, they would loan, and make money on the transaction, not on holding the mortgages. The lenders did not care who they lent to--the risk was sent downstream to RMBS buyers.
It may be a Canadian reg. that limits securitization. I don't know. Does anybody?
A needed reg? Maybe require issuers hire ratings agencies through a pool. That is, they do not pay the rater directly. When they pay directly, the pressure is on the rater to give a rating the issuer wants. In other words, hold your nose and give it a AAA.
As it stands, our capital markets have been damaged. Who will belive a AAA rating anymore? That means more perceived risk, and higher capital costs.
Interesting. I wonder why the Canadians did not make some of the same policy moves that ultimately were proved so wrong for US. Were they smarter? More boring and less creative? Or is there something about their political system that makes perversion of public policy for political gain less of an issue? I assume the Canadians are humans too. Along with identifying specific policies we could change, it sure might help to correct the political landscape that got us here.
Benjamin: I imagine that it will be a long time before people trust AAA ratings implicitly again. It will also be a long time before mortgages are securitized like this again. The bad thing about securitization is that it becomes difficult for the market to know what is inside and behind the securities for sale, and it is easy for the originator to stuff bad loans into the package. If originating banks were required to hold a significant fraction of what they securitize, this might help solve the problem.
randy: I think you're exactly right. Our problem begins and ends with politicians who always seem eager to do whatever sounds popular, regardless of whether it is a good idea or not. If we can't mend our ways, we deserve the politicians we get, and they will keep wreaking havoc on the economy.
Scott-
Yes, the market does correct. As you say, who believes the AAA anymore? But that is real market damage--capital becomes more expensive.
I must say, I am surprised that bond buyers have not set up their own credit-rating agency, and insist that bond sellers get rated by their agency, or no dice.
This is what free markets would evolve. Bond buyers could actually make a little money through their credit-rating work. Maybe a reg prevents this.
And, as it would be the bond buyers doing the paying, the rating agency would examine debt with a gimlet eye.
Maybe a huge opportunity out there for some bond-rating entrepreneurs?
You propose a reg that S&L's and banks keep a portion of their originations in-house. That is a reg, and not a market solution.
In general, I think we should first look for market solutions, than, as last recourse, look to reg solutions. The reg I like is that bond-rating agencies must be paid from pool of randomly chosen raters, or paid by buyers.
But, of course, if I say I like a reg, and you say you like a reg, then that guy behind a tree can say he likes another reg. Who has a leg to stand on? Obviously, we all believe in government regs on markets--and we know where that leads us.
Benjamin: excellent points you make. It reminds me that big bond buyers never rely on ratings to begin with. The only way to be competitive is to know more than the ratings agencies. The problem this time was that 1) the rating agencies didn't realize how bad things could get and 2) Fannie and Freddie were buying the bulk of the securities sight unseen. Fan and Fred really messed things up.
I could see enlightened originators selling their product by also announcing they were going to hold a big chunk of the stuff to maturity. That would reflect the proper workings of a market. I think we'll see things like this sooner or later.
Fannie and Freddie bought about one-third of RMBS issued in recent years, as I recall. They own 44 percent of all securitized homeowner debt now, but they used to be the only buyer...the private sector enlarged prior to the bust.
I have to say, there were classic free-market elements in this bust--and I don't think we should shy away from it. Just as capitalism is creatively destructive, it also has booms and busts. The nature of man. Each generation forgets the last's lessons.
BTW, I say it is time for housing to stand on its own two legs, along with US farmers, and we can dispense with Fannie, Freddie, the home mortgage interest tax deduction and the USDA.
If we want to help poor people, then we help people directly with a monthly. above-board stipend, easily understood by everybody, including taxpayers and people on welfare.
Trying to "help" people and farmers through convoluted housing and tax programs and food stamps and incredibly complicated ag programs is Rube Goldbergian-except Rube would probably take offense that his contraptions actually worked.
I guess by now you know I subscribe to "KISS" Keep It Simple Stupid.
Especially in government--the citizenry does not have time to oversee every federal program. We get hoodwinked. The more simple every program, the better we can understand it, and vote accordingly.
Nice blog post for reading and Thanks for sharing the wonderful article
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