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Did the Government Overreact?

CAAMP issued a report Wednesday concluding that:

  • The “vast majority of borrowers holding (the) highest risk mortgages have considerable room to absorb interest rate increases.”
  • “…lenders and borrowers…have been highly prudent in the mortgage market.”
  • “…housing demand in Canada has been justified by the strength of the economy.”
  • “the degree of (mortgage) risk does appear to be extremely small.”
  • “…Canadian lending criteria are already tight enough.”

House price squeezeThose who side with CAAMP’s empirical evidence believe the government acted too hastily on Monday, when it created an over-reaching new set of mortgage restrictions.

CAAMP supports its position above with data from 85,500 insured mortgages that funded in 2010, mostly high-ratio purchases or refinances.

Here is a sample of its findings:

  • Assuming a 100 bps increase in fixed rates and a 250 bps hike in variable rates:
    • Under 1% of mortgages would have a dangerously high TDS ratio (i.e., over 45%)
    • This amounts to a scant 2,000-2,500 high-ratio borrowers among 13.4 million households, says CAAMP
  • Only 2% of borrowers approved in 2010 would not be able to qualify with a 30-year amortization today
  • 79% of borrowers have fixed rates and 21% have variable rates
  • Incomes rise by 2.5% per year, offsetting much of the payment increases borrowers experience
  • Each year about 2.5% to 3% of households are first-time buyers (350,000 to 400,000 people)

In sum, the “out of control” borrowers that housing critics have been warning about are a hairline fraction of the population.

Meanwhile, every other responsible low-risk borrower in the country now gets cash-flow management options (including longer amortizations and 90% LTV refinances) taken away.

By “low-risk,” we concede that 43 out of every 10,000 prime borrowers are behind on their mortgage by 90 days or more. That rate is at, or near, the lowest of any industrialized country. A 0.43% arrears rate is just 25 basis points from the lowest default rate of the past 20 years, and hardly indicative of any excesses.

Of course, arrears are a trailing indicator. So, go ahead and double them if you foresee high unemployment or another crisis on the way. (Arrears topped out at 0.45% in the last credit crisis). Either way, we’re still well below the highest Canadian prime default rate of the modern era (1.02% in 1983).

Economic-crisisTo exceed that level, we’d probably need extreme unemployment (remember, employment losses have the greatest correlation with mass arrears). Alternatively, we’d need a domestic economic crisis to substantially knock down home prices, putting hordes of people into negative equity scenarios. Funny enough, we just endured one of the worst global financial crises ever, and home prices went up.

The market’s biggest near-to-medium-term threat is probably rising rates. Depending on the extent, higher rates will put payments out of reach for a small fraction of the population. But, as CAAMP has shown, the huge majority of consumers can withstand sizable rate hikes.

As a side note, we would have liked to see CAAMP’s rate assumptions boosted another 1% (i.e., a 3.5% hike in prime and 2% increase in fixed rates). The current assumptions aren’t “worst case” enough. On the other hand, we doubt that rising rates alone would spark much more than a 1% default rate in any case—which would be considered a “controlled” rate by international standards.

As a parting note, it would have been interesting to see the data that policy makers used to justify these new restrictions. Unfortunately, the Finance Department doesn’t explain the logical details behind its mortgage policy. Its actions will have measureable economic consequences, but it chooses not to make Canadians privy to any quantifiable, default-related data that might support these sweeping changes.

If the government were confident in its research on this matter, it would make a clear case outlining the perceived risk factors with numerical evidence.  Its case would necessarily have to explain why highly responsible borrowers “deserved” to have mortgage options eliminated along with the higher-risk borrowers.

In the absence of these explanations, we can’t help but wonder which prompted these particular rules more: real data, or good old backroom politics.

Rob McLister, CMT