Why mort­gages that work in Canada wouldn’t work in the U.S.

The Times Herald (Norristown, PA) - - LOCAL - By MICHAEL HILTZIK

Those of us who write about the hous­ing mar­ket and the virtues of the 30-year fixed home loan - as we of­ten do - can cal­i­brate our watches by how long it takes a reader to re­spond as fol­lows:

“Hey, Canada doesn’t have 30-year fixed mort­gages, and their hous­ing mar­ket’s do­ing just fine!”

Usu­ally about a nanosec­ond.

That’s true. Canada doesn’t have fixed 30-year mort­gage terms. But that’s not the only dif­fer­ence be­tween the U.S. and Cana­dian mort­gage fi­nance sys­tems, by a long shot.

To be­gin with, the Cana­dian sys­tem is con­sid­er­ably more cred­i­tor­friendly than the United States. In Canada, lenders typ­i­cally have full re­course in cases of de­fault, mean­ing they can at­tach all of a bor­rower’s as­sets, not only the house.

In the United States that’s not per­mit­ted in 11 states, in­clud­ing Cal­i­for­nia, and fore­clo­sure pro­ceed­ings are com­pli­cated even in the other states.

The stan­dard mort­gage in Canada isn’t the 30-year fixed, as it is in the United States, but a five-year mort­gage amor­tized over 25 years. That means the loan bal­ance has to be re­fi­nanced at the end of five years, ex­pos­ing the bor­rower to any in­crease in rates that has oc­curred in the in­terim. Pre­pay­ment penal­ties for bor­row­ers hop­ing to ex­ploit a de­cline in rates, on the other hand, are very steep.

This looks as if it’s a clear win for banks, which are min­i­mally ex­posed to in­creased rates and pro­tected from pre­pay­ments. But Cana­dian mort­gages are also por­ta­ble - if you move be­fore the five-year term is up you can ap­ply your old mort­gage to your new home. (If it’s a more ex­pen­sive home, you take out a new loan for the ex­cess.) That re­stores some of the bal­ance in the bor­rower’s fa­vor.

The short term of Cana­dian mort­gages al­lowed them to be funded from lo­cal short-term bank de­posits at re­tail bank branches. The mort­gage-lend­ing sys­tem in Canada to this day re­sem­bles the Amer­i­can bank­ing sys­tem up to the 1970s, when dereg­u­la­tion took hold and placed fancy, risky and care­less lend­ing at the center of the busi­ness model. (By the way, mort­gage in­ter­est isn’t tax-de­ductible in Canada, so there’s no in­cen­tive to over-bor­row.)

That may be the sin­gle most im­por­tant fac­tor dis­tin­guish­ing the U.S. and Cana­dian sys­tems. Cana­dian banks haven’t had a free ride in reg­u­la­tion like their Amer­i­can cousins. Mort­gage terms are very closely su­per­vised, as are the safety and sound­ness of lend­ing banks. The Cana­dian sys­tem re­quires, and in­cen­tivizes, banks not to sell their loans but to keep them on their bal­ance sheets. That fac­tor alone dis­cour­aged Cana­dian banks from of­fer­ing the kind of wild, who-gives-adamn mort­gage struc­tures that in­fected the United States. It also pre­vented the ero­sion of un­der­writ­ing stan­dards seen here.

Se­cu­ri­ti­za­tion reached 40 per­cent of the mar­ket in the United States by 2007. In Canada, it never ex­ceeded 3 per­cent.

The idea that the U.S. gov­ern­ment med­dles in the mort­gage mar­ket more than Canada’s is dead wrong. The truth is just the op­po­site.

Yes, the U.S. backs the con­ven­tional 30-year fixed loan through Fan­nie Mae and Fred­die Mac, its gov­ern­ment- spon­sored home loan firms. But the gov­ern­ment-owned Canada Mort­gage and Hous­ing Corp. has an even greater in­flu­ence over that coun­try’s mar­ket.

It ac­counts for some 70 per­cent of all mort­gage insurance, which is re­quired on all loans cov­er­ing less than 80 per­cent of the home value and guar­an­tees the en­tire mort­gage.

The Cana­dian reg­u­la­tory sys­tem sim­ply didn’t al­low the de­vel­op­ment of ex­otic mort­gages de­signed to cre­ate loans for sale that had to be dressed up by fraud­u­lent ap­praisals and fla­grantly bogus credit rat­ings.

Put all th­ese fac­tors to­gether - tighter reg­u­la­tion, lit­tle se­cu­ri­ti­za­tion, less bor­row­ing, etc. - and you come close to an ex­pla­na­tion for the dif­fer­ent ex­pe­ri­ence with delin­quen­cies and de­faults in the two coun­tries. In the U.S., de­faults peaked at about 5 per­cent of all mort­gages, and ex­ceeded 20 per­cent for those dereg­u­lated sub­prime loans. In Canada, de­faults soared in 2008 and af­ter, just as they did in the U.S. But they topped out at about 0.45 per­cent of all mort­gages.

But Amer­i­can bankers won’t like that. They won’t like height­ened med­dling in their bal­ance sheets by a gov­ern­ment agency that can’t be bought, or lim­its on how clever and de­ceit­ful they can make mort­gage terms. They’d love to be rid of the bor­row­er­friendly 30-year fixed mort­gage, but also rid of reg­u­la­tions that would pre­vent them from pil­ing on to bor­row­ers in so many other ways. They don’t want an im­proved sys­tem in the U.S., just one that’s bet­ter for them. Heads they win, tails we lose.

As it was in the 1930s, the 30-year fixed mort­gage is one of the few bank­ing prod­ucts that un­ques­tion­ably fa­vors the Amer­i­can bank­ing cus­tomer. We do away with it at our peril.

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