A housing bubble in Canada: Is it possible? (Part 9 of 10)
Growing appetite for sub-prime mortgages
A Bank of Canada report dated December 10, 2014, indicated a growing appetite for risky auto loans and sub-prime mortgage loans—high-rate loans to riskier borrowers—in Canada (EWC). “About 35% of new, uninsured, mortgages lent by smaller federally regulated banks since the end of 2012 could be considered ‘non-prime,'” the report said.
“Sub-prime” is the concept that triggered the financial crisis in the US in 2008. Now, it daunts Canada.
However, it’s important to mention here that the share of sub-prime mortgage loans in Canada remains at roughly 5%. In contrast, at the peak of the housing bubble, the share of sub-prime mortgage loans in the US was nearly 24% before the crash.
Also, there’s the concept of mortgage insurance. It could save the day for the Canadian mortgage market.
Mortgage insurance in Canada
Mortgage insurance—or home-loan insurance—is an insurance policy that compensates lenders or investors for losses due to the default of a mortgage loan. Depending on the insurer, mortgage insurance can be public or private.
In the aftermath of the housing bubble in the US (IVV) (SPY), several insurance companies—like American International Group (AIG), MBIA (MBI), and Ambac—faced extensive mortgage defaults. The defaults increased their potential exposure to losses from credit default swaps, or CDS.
A CDS is a financial instrument. It’s used as a hedge against the risk of default by a mortgage-backed security, or MBS, holder. It’s similar to insurance. However, since there wasn’t a central clearing house to honor CDS defaults back in 2008, AIG had to be bailed out by the federal government. AIG had CDS insuring about $440 billion.
Canada’s case is a little different. By law, Canadian mortgages that have less than a 20% down payment must be insured. The CMHC (Canada Mortgage and Housing Corp.) is the government-owned housing agency in Canada. It’s fully backed by the federal government. The government also guarantees 90% of mortgage insurance offered by private-sector insurers.
Canada’s housing bubble differs from US in more than one way. We’ll discuss this in the next part of the series.
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