Canada's conservative approach to mortgage finance could provide model for U.S.
TORONTO -- When he bought a home last week with a 40 percent down payment, lawyer Kevin Fritz didn't see the transaction as particularly relevant to the debate over global financial stability.
But consider: With U.S. home sales and prices still shaky, Fritz bought in a Canadian market that already has rebounded beyond pre-crisis levels. Without the key tax advantages available to U.S. home buyers, he amassed as much as possible for the down payment, and he expects to pay off his 15-year mortgage with the same bank that gave him the loan -- a rarity in the United States, where finance companies typically resell mortgages.
"Canadians are debt-averse," said Fritz, an attitude that's part cultural and part shaped by banking practices and regulations designed to keep people out of homes unless they can clearly afford them. "People here don't leverage."
As President Obama and other Group of 20 leaders gather in Toronto to continue the debate over ways to avoid future financial crises, they have a ready-made example in Canada, where a quaintly old-school approach to mortgage finance helped their host country avoid the worst of the recent turmoil.
"It is a regulatory structure in Canada that created the Canadian mortgage system, and it was a regulatory and political structure in the U.S. that created the U.S. mortgage system," said Ed Clark, chief executive of TD Bank. With the United States now leading a discussion on how to increase the stability of the financial system, he said, "the irony is . . . that one of the primal causes of the crisis was the U.S. mortgage system."
Canada, as a major U.S. trading partner, did not escape unscathed from the global downturn. The country also suffered a recession, and its Conservative-led government intervened with tens of billions of dollars in extra spending to boost the economy.
But the experience here was dramatically different from the United States', and it offers a study in how policy, regulation and consumer behavior combine to create economic conditions that allow homeowners like Fritz to enjoy steady price appreciation, while their U.S. counterparts suffer through years of uncertainty. Despite hope that an economic recovery is taking hold in the United States, sales of new homes in May hit a record-low annual pace of 300,000, undercut by the expiration of a buyer tax credit.
Heading into the crisis, banks here were under stricter rules, forced to set aside more capital than U.S. firms and managed with a more conservative bent. Government agencies such as the Canada Mortgage and Housing Corp. hewed closely to policies in which they supported the housing market by offering mortgage insurance, but unlike Fannie Mae and Freddie Mac in the United States, they were never expected to encourage homeownership as a social or economic end.
Canadian tax law is neutral: Interest on mortgage payments is not deductible, a fact that encourages home buyers to make larger down payments and avoid withdrawing equity. The banks themselves expect to hold on to the mortgages they make and collect the interest. Most loans allow interest rates to be reset after five years, and most also carry prepayment penalties -- rare in the United States.
The result is a market that appeared sluggish when the U.S. property bubble was inflating but "has been rational" throughout, said Craig Alexander, TD Bank's chief economist.
"Fundamentally, what we have seen is the Canadian housing market responding to the dynamics of supply and demand," Alexander said. He contrasted that with a U.S. housing market driven by loose lending standards and by Wall Street demand for mortgages to be bundled and sold as securities: "The mortgages made in Canada are mortgages that banks are quite happy to keep on their balance sheets."
Subprime mortgages in Canada accounted for only about 5 percent of the loans originated by local banks during the housing boom, compared with more than 20 percent in the United States.
And while U.S. housing has remained sluggish, the Canadian market is showing so much life that the Bank of Canada recently raised interest rates and regulators have taken other steps to temper demand -- for example, tightening mortgage qualification rules.
Pamela Alexander, managing director in Canada for the Re/Max real estate firm, said her brokers complained when those actions were taken.
"I said: Be happy it is happening," she said. "It will be short-term pain. But it means a long-term market."
Some of the principles underpinning Canada's performance are now gaining greater acceptance among other G-20 countries -- raising capital standards for banks, for example, and being more careful in managing risk. But it may be hard for other governments to replicate the attitude of Canadian consumers.
In the three years since she graduated from college and got a job with the Ontario provincial government, Caralie D'souza, 25, has been saving steadily to buy a condominium in downtown Toronto -- but won't until she is sure she has at least 20 percent to put down and gets the right price.
"It is important to get on the property ladder," she said. "I have been saving since I was a kid."