No U.S.-style housing market meltdown for Canada: CIBC

A new report released by CIBC World Markets found that a U.S.-style housing meltdown is not likely to occur in Canada. Benjamin Tal, deputy chief economist at CIBC argues that there are fundamental differences that set the Canadian market apart from the U.S. market.

While many economists have pointed to record high levels of Canadian debt, Tal argues that the debt-to-income ratio in Canada is not a “serious analytical tool.” A number of countries with comparably higher debt-to-income ratios than Canada did not experience a housing meltdown as the U.S. did. Rather, Tal proposes, Canadians should consider the speed at which the debt-to-income ratio has been growing. Over the past three years, the debt-to-income ratio in Canada has been rising at half the speed than the rate at which the debt-to-income ratio rose in the U.S. in the three years leading up to the housing crash.

Strong growth in indebtedness in the U.S. was partially fueled by speculative activity in the housing market. Tal argues we have seen far less of this in the Canadian market. Furthermore, in the decade leading up to the crash housing starts in the U.S. exceeded household formation by nearly 80 per cent. On average in Canada over the past decade this gap has only been 10 per cent.

Another key difference between Canada and the U.S. is in the quality of mortgages. The distribution of credit scores has not changed drastically in the past four years in Canada. Whereas in the four years leading up to the recession in the U.S., the proportion in the “risky category” rose by more than 10 per cent and made up 22 per cent of the overall market.

In the U.S. in 2006, non-prime mortgages accounted for no less than 33 per cent of originations and close to 20 per cent of outstanding mortgages. One third of mortgages taken out in the U.S. in 2005 and 2006, before the drop in prices, were in negative equity position. No less than half had less than five per cent equity making them highly exposed to even a modest decline in prices.

In Canada however, the negative equity position is zero and only 15-20 per cent of new originations have an equity position of less than 15 per cent. Tal estimates that the non-conforming market is currently at around seven per cent of mortgage outstanding, which is well below the over 20 per cent seen in the U.S. before the crash.

The reset of no less than $2 trillion of mortgage debt in 2006 and 2007 was no doubt the trigger to the U.S. housing crash. Such a potential trigger does not exist in Canada with mortgage rates likely to rise gradually, which will allow borrowers to adjust over time.

The recent slowing in sales activity will likely be followed by price adjustments across the country. However, the Canada of today is very different than a pre-recession U.S. Tal’s argument is compelling. Fears of a U.S.-style of meltdown happening in Canada tend to oversimplify the current state of the Canadian housing market.