Monday, March 16, 2009

The "subprime" dilemma

House of cards
The Globe and Mail article from yesterday got me thinking about our subprime mortgage situation in Canada.

Some people say it's just as bad as in the US, but they aren't talking about truly subprime as much as they are about effectively non-prime or non-conventional lending

On the other extreme, a lot of people had been saying we don't have them here, so, it was only a US problem.

That isn't true, we had, and still do have them. Now, it is important to note that they were not as common here, at least so far as the quote, unquote, subprimes went. As the article mentioned, in the US during their run-up they made up about 22% of the all mortgages, whereas here in 2007 they only made up about 7%.

I've spent a couple days digging for numbers online, and haven't been able to come up with much if any hard numbers on those subprime loans. As good as I could find was in that article was their quoting Benjamin Tal as saying their were about 85,000 of them in 2006... and this would jive with the aforementioned 7% figure and CMHC reporting there were 1,220,765 mortgages issued in 2006.

So, as far as an apples-to-apples comparison goes, "subprimes" were only about one-third as prevalent north of the border, as they were south of the border.

The problem in Canada was that we had several other "innovations" that were efffectively doing the same thing... they just kept lowering the bar and caused a rapid expanding of the pool of potential buyers.

At the beginning of 2006 in Canada, to buy a home one had to be able to (a) pay it off in 25 years or less, and (b) have at least a 5% downpayment.

In March of 2006 it was decided you could take 30 years, and you could borrow that 5%, so effectively you no longer needed a downpayment.

By June, you could take 35 years, and pay interest-only for the first 10.

And in November of 2006, the coup-de-grĂ¢ce, the 40 year amortization was introduced.

So, over the course of nine months, the lending standards had went from requiring you to have 5% down and pay your home off in 25 years... to requiring zero-down, you can take up to 40 years to pay it off, and you don't even have to put a dime toward equity for ten years.

And those 40 year amortizations were some kind of popular too. TD Bank, Deputy chief economist, Craig Alexander in an April 2008 interview said that by a year after their being introduction, 37% of all new mortgages issued were 40 year, as were 9% of outstanding mortgages.

Even more telling, he quipped,

"About 60 per cent of first-time buyers are opting for a 40-year mortgage"

So 60% of first-time buyers we either borrowing more then they would have qualified for, or would not have qualified for a mortgage, in 2005.

Needless to say, the buyers pool was increased just a tad by these lending innovations.

As you probably know, late last year the government axed those 40-year amortizations and re-introduced the need for 5% down after seeing the negative effects the lax standards produced during their two year run.

While it was certainly not the only contributing factor to the run up in prices we saw here in Edmonton, and really all across Western Canada, they definitely added fuel to the fire.

The timing certainly looks suspiciously similar to the time frame of the price explosion here in Edmonton, but as I've said before, there were many factors in that perfect storm... though I still think it's safe to say we quite likely wouldn't have reached the extreme heights we did had lending standards not been eased like they were.

That's not to say the US didn't have 40 year amortization, they actually brought them in first back in '05 IIRC... and they still do offer them. Though they didn't seem to quite catch on the way they did up here.

While clearly not a perfect comparable to subprimes, I don't think it's a stretch to label them as non-conventional... another non-conventional comparison other for 40 year mortgages, are the Alt-A mortgages in the US. For the unfamiliar, Alt-A's are kind of in the middle ground, they aren't quite as bad as subprime, but aren't quite as good as prime. Subprimes not quite as ugly sister, if you will. So, something of an apt comparison to our 40 year mortgages.

Alt-A's often get lumped in with subprimes since that's the word most are familiar with, but we are starting to hear more and more about them as some are expecting they are the next time-bomb to go off in the US housing crisis.

Last year Alt-A's made up 67% of the non-prime mortgages in circulation, or about 10% of all mortgage debt. During the peak of the US housing boom, Alt-A's made up 15.4% and 17.7% of all new loans made in 2005 and 2006 respectively. At the same time, subprimes made up 21.6% and 21.7% in those years.

Collectively, Alt-A's and subprimes accounted for 37.0% and 39.4% of all loans made in 2005 and 2006... sounding eerily familiar to that figure cited for the marketshare of 40 year mortgages a year ago?


So, a subprime by any other name may not be a subprime... but I don't think it's much of a stretch to say we had eerily similar figures when it came to non-prime or non-conventional lending during our respective booms.