Crawl Across the Ocean

Saturday, December 13, 2008

Better Late Than Never, I suppose

The Globe and Mail posts a decent article on "How High Risk Mortgages Crept North"

It's really a pretty simple story. Used to be, government rules said that if you wanted to buy a house and make a down payment less than 25%, you had to get it insured by the government. The government required a minimum down payment of 5% (already lowered in 1990 from the previous requirement of 10%) and a maximum amortization period of 25 years and charged a fee to cover the increased risk from these low down payment loans.

The purpose of down payments and limited amortization schedules is to avoid situations where people owe more on their house than it is worth( in case of price declines) and generally to ensure that people who buy houses can actually afford them.

This system worked reasonably well for a number of decades.

Starting in 2006, faced with sky-high housing prices, home ownership rates well above long term norms and an economy overheating due to excess demand driven by fast-rising and unsustainable debt levels, the Conservative government*, in its wisdom, decided that the time was right to push housing prices and consumer debt levels even higher so that when the inevitable crash came, people and industry could get hit that much harder.

As part of this plan to ensure Canada was able to participate in the sub-prime debacle, three changes were undertaken:

1) The minimum down payment needed to avoid buying insurance was reduced from 25% to 20%

2) The maximum amortization period was increased from 25 years to 40 years.

3) The minimum down payment rule was removed for insured mortgages.

In the summer of 2008, finally listening to the various ministry of finance and industry voices that had advised against this folly, the government partially backtracked on these rule changes, limiting amortizations to 35 years and reinstating a minimum 5% down payment rule. Of course, these rules are still looser than they were in 2006, and these rule changes take effect after the housing bubble has peaked so they can't do much to limit the size of the bubble, and we've now got two years worth of mortgages on the books under the zero down payment rules, but again, like the Globe writing a good article on the housing industry, it was better late than never.

* To be fair to the Conservatives, I don't recall that any of the other parties opposed these rule changes much

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