Interesting Piece on Canada

Canada: Land of the Free, an interview with Canada Finance Minister Jim Flaherty appeared in the weekend edition of the Wall Street Opinion Journal and was surprisingly interesting.  Here are some interesting tidbits:

Canada did not have a banking crisis in 2008 and, despite its vulnerability to U.S. economic weakness it emerged from recession in the third quarter of last year.

Mr. Flaherty was in New York this week talking up the Canadian economy at the consulate, where I cornered him for an interview. I started by asking him how his country avoided the mistakes that led to the housing and banking crisis in the U.S.

“One of the fundamental reasons is that Canadian banks, the lenders on residential mortgages, lend and hold,” he begins. “Someone getting a mortgage normally meets with a live human being in a bank branch and [the bank] will know something about the person before it makes the loan.” Banks don’t sell them, either, he adds; “there wasn’t that repackaging securitization—selling the loans—that happened a lot elsewhere.”

On the flip side, borrowers can’t treat their obligations lightly, as is too often the case in the U.S. “Someone can’t just walk away from a home with a mortgage,” Mr. Flaherty says. “They remain personally liable [for the loan] and that makes a big difference.”

He also points out that the Canadian tax code “does not encourage excessive risk-taking in home ownership because the mortgage interest is not deductible.” For “politicians [deductibility] has a lot of attraction. But it’s bad policy,” he says, because it encourages home buyers to take on more than they can handle. Instead Canadian tax law tries to reward home ownership by making the capital gain on a principal residence tax deductible. “But that’s at the end, not at the beginning of a real-estate relationship,” Mr. Flaherty says. This, he contends, tempers the appetite for risk.

“They are supposed to have a certain part of the market but they are not supposed to be a dominant player in the market,” Mr. Flaherty says. They do make sure that lower income earners have access to a roof over their heads, but that can mean rental housing. “It doesn’t necessarily mean encouraging people to have title to a house and to have a mortgage.” Even so, it is worth noting that Canada’s home ownership rate of 68% is roughly equal to the U.S.

Yet it wasn’t only that American home buyers took on too much risk. Many investors in subprime loans thought they were buying a sure thing and the quasi-government agencies known as Fannie Mae and Freddie Mac played no small role in encouraging that perception. How come the Canadian Mortgage and Housing Corporation (CHMC), which is the Canadian version of Fannie, didn’t do the same?

The CHMC is not a government-sponsored enterprise; it is, Mr. Flaherty says, “a government agency” and that means “we watch quite carefully what risks they take.”

The size and scope of the agency, moreover, is far less ambitious. Fannie, Freddie and the Federal Housing Administration had, in June 2008, more than 50% of the subprime borrowers’ market in the U.S. The Canadian government, by contrast, keeps CHMC on a short leash.

I believe that if the U.S. had the same set up, where Fannie and Freddie were government agencies, that would have only made things worse.  The contagion in the U.S. wasn’t the “long leash” of quasi-governmental status of Fannie and Freddie.

The contagion in the U.S. was the belief, by many including inflentials in government (Congress in particular), that low income borrowers should have title to a house.

It seems Canada decided not to alter the path to home ownership.  They kept the path to home ownership the same as it has been for decades.  They didn’t incentivize large home loans through the tax code and they didn’t make it easier for people to become home owners by lowering financial requirements.  To own a home, you had to demonstrate responsible financial behavior.

In the U.S., we altered the path.  We encouraged large home loans through the mortgage interest deduction.  We lowered borrowing standards.  We believed that home ownership led to responsible behavior.

In reality, we rewarded irresponsible behavior and we learned that home ownership did not cause to responsible behavior.  It seems we had it right decades ago.  Responsible behavior is the best path to home ownership.  Responsible behavior leads to home ownership, not the other way around.

4 thoughts on “Interesting Piece on Canada

  1. i dont trust the folks at the chmc any more than i do those at the fnma or the fhlmc.

    home ownership rate seems like a misleading statistic here. more interesting is the actual figure that ‘short leash’ implies.

    if the ‘financially responsible’ are meant to own ~70 percent of the houses, who owns the remainder? someone owns all of the houses.

    are we talking about having a government policy that subsidizes people that want to buy homes or one that subsidizes people that want to lend money to people?

    houses are far too expensive. perhaps that is due to the enormous ‘tax pool’ that governments see property owners as. if taxes were lower(or even non-existant) housing would be more affordable.

    • dave – I agree. I think Flaherty was partially correct in that they didn’t perverse the incentives for owning more home than you could afford. That’s why they didn’t have a mortgage crisis.

      Whether the CMHC is government or not is irrelevant. It’s all about the mental models guiding CMHC’s activity. T

      Had CMHC caught the same idea contagion (home ownership is good no matter what) as the U.S., they would have had a mortgage crisis.

      There are plenty of private banks in the U.S. that didn’t get crazy with lending to prove this out.

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