Canadian real estate markets top global bubble lists, but speculators still pile in. Global observers struggle to understand why, but they only need to look at the latest guideline from the Financial Consumer Agency of Canada (FCAC). The government watchdog for consumers recently released the Guideline on Existing Consumer Mortgage Loans in Exceptional Circumstances (Guideline), outlining their expectations for lenders. The Guideline notifies federally regulated financial institutions (FRFIs) they’ll need to pull out all the stops for those in over their head in debt—from proactively identifying stressed borrowers, to giving discounts on fees, and even lowering interest expenses.
Canadian Banks Make Lehman Look Like A Sunday School
Canada is home to the G7’s most indebted households, ignoring international agency warnings. Instead, various solutions to get more cheap credit to people were devised. When it wasn’t cheap enough, households began to borrow adjustable rate mortgages with fixed payments. These loans have fixed payments, but the amount applied to principal varies with the cost of interest at the time. If rates rise, less is applied.
The loans, not particularly popular prior to 2020, became the loan of choice as investors piled in. As rates began to normalize, less and less principal was covered. Sometime last year, many began to cover no principal at all— and not even the full interest. It’s called negative amortization, and about 1 in 4 mortgages now fit this description. Some aren’t expected to be paid back for 70+ years, despite the maximum length being 35 years.
One would assume this would lead to a regulator crackdown, but the opposite is appearing. They’re endorsing these moves, and even ordering them to go further. Speculators are getting the message loud and clear.
Canadian Mortgage Lenders Asked To Identify Over leveraged Borrowers & Make Accommodations
The FCAC is the latest regulator endorsing the reckless lending from lenders. FRFI are expected to develop procedures to identify at risk mortgage borrowers, including:
- Proactive monitoring and identification of early stress;
- A criteria for offering mortgage relief;
- Disclosure of information to the consumer to ensure express consent;
Once identified, the lender is to make accommodations to mitigate any risk, including:
- Waiving prepayment penalties;
- Waiving internal fees and costs;
- “Not charging interest on interest”;
- Extending amortization;
A lot of mortgage borrowers must have been hit with adverse circumstances, right? Not exactly, and the move will produce more risk than it mitigates.
Investors Are Consumers Too!
Canadian regulators are scrambling to help “households,” but who are they helping? Only a third of households have a mortgage, and less than a third of the balance is variable rate. The risk is also concentrated in recent purchases. Buyers prior to 2021 have significant equity and resources to mitigate most risks.
Recent buyers swimming in debt might sound like first-time buyers. However, low rate stimulus helped investors displace first-time buyers, warned the country’s largest bank. Investors also bought half the new supply created, concentrating on low priced homes. Those are the units first-time buyers typically seek out.
Speaking of budget-sensitive, first-time buyers—don’t expect the same red carpet rollout. High-ratio mortgages, geared to first-time buyers, are ultimately taxpayer backed. The head of Canada’s state-owned mortgage insurance company took a firm stance, warning they can’t/won’t honor insurance on extended amortizations. She’s apparently the only adult in the room.
On the upside, these mortgages typically have lower rates than uninsured loans.
To put it short, regulators are selling the public on consumer protection. Not exactly a lie. They’re just omitting the consumers they’re scrambling to protect are primarily investors.
Canadian Regulators Are Reinforcing High Home Prices, Creating Taxpayer Liabilities
Every move has a reaction, so it’s important to understand this isn’t an issue of special treatment. At this scale, during a housing crisis, it will produce huge liabilities for the economy. The two biggest are higher home prices and financial system risks.
Pressed by policymakers, Canada’s bank regulator admitted the extended amortizations bolster prices. Spreading payments out over a longer term is a great way to increase the credit capacity of home buyers. Anyone can afford any price if they’re never going to pay it off, and that means sellers can ask for more. They’re neutralizing the mechanics of higher interest rates. Ultimately that means higher rates are needed to balance the impact.
Extending amortizations keeps costs lower, helping boost profits for investors. It also reduces supply, since it skews the balance in favor of over leveraged investors. A bad investment is now a great one, since the state mitigated the risk for its comrades. Managing your risk feels like losing, since those consumers didn’t enter a risky trade assuming the state will fix it.
Moral hazard is the term for these circumstances, and it overshadows other problems. If the consequence for being overleveraged is special treatment such as lower costs, and longer repayment terms—what’s your takeaway? It sounds like a great deal to me.
The FCAC is the latest regulator to send the message that the only loser is a person not engaging in risk. Experts have warned that mitigating the housing downturn will increase the risk of a financial crisis. But those are the same experts that were ignored when they warned households are carrying too much debt.
At least they’re helping investors. Uh, Consumers.