Economics: Housing Market Differences

TORONTO, ONTARIO - National Public Radio's All Things Considered in the United States has been doing a series on the housing market in Las Vegas, Nevada. Some of the stories told in this series are a reminder of why the housing market in Canada is in much better condition than that in the United States, and offer some pointers for reform in the United States.

A variety of comparisons between the mortgage markets in the US and Canada have come out during the US crisis; one that does a reasonable job of balancing completeness and readability came from Marsha J. Courchane of Freddie Mac and Judith A. Giles of the University of Victoria. It would be futile to try to go in depth in a blog entry, but the basics can be covered here. The most striking difference is the median mortgage in each country. In the United States, the median mortgage has a 30-year term. In Canada, the median mortgage has a 5-year term. The US mortgage usually has a fixed rate for the full 30 years, the rate on longer mortgages in Canada generally shifts after a term no longer than five years and often as short as one year. In Canada, anything beyond a "conventional" mortgage of 20% down and a 25-year term (not fixed-rate) requires insurance, and which mortgages can be insured and under what terms are much more strictly regulated in Canada than they are in the United States (where insurance is often required, but on much less strict terms). The bottom line is that the risk falls much more strongly on the borrower than the bank in Canada as compared with the United States.

While much has been made of the NINJA (No Income, No Job or Assets) loan that existed in the United States not existing in Canada, it is possible to get what would be considered a sub-prime loan in Canada. However, because of all the regulation, those sub-prime mortgages amount to less than 5% of the Canadian market, as compared with 20% in the United States. Again, clearly the lender was taking on a lot more risk in order to create a mortgage in the US.

A further incentive to taking out a mortgage in the US is the mortgage tax deduction, in which the interest paid on a mortgage is deductible against income. That effectively reduces the cost of the mortgage, again allowing the borrower to become more indebted than would otherwise be practical.

All this might seem good for borrowers in the US, since they are shouldering less of the risk, but because of those more favorable terms, they are more like to over-extend themselves and default. Partially because of that possibility, more than half of mortgages in the United States are bundled together or otherwise securitized to effectively reduce risk for the bank. That amount is less than 20% in Canada. So, when the securitization process started to implode in United States, that had a much better bigger impact on the overall market.

What really came out in the NPR series, though, is the consequence of the reduced risk to the borrower. As up to half the homes in Las Vegas are now worth less than the remaining mortgage balance (they're "under water" in common parlance), a number of the borrowers are simply walking away from the residence and returning the keys to the lender. That's not legal in Canada. About the only way to get out of a mortgage in Canada is to declare bankruptcy. Again, the added burden on the borrower has led to a more stable market, and reduced crazy scenarios like abandoning a home.

If it is agreed that the greater stability of the Canadian housing market is desired in the United States--and that may be a big "if"--then it seems the principle of a solution is clear, if not the specifics. That principle is shifting the risk back to the borrower so they will only take loans they can actually handle.

Lest that seem like a recipe for reducing home ownership rates in the United States, recall that home ownership rates in Canada and the US are similar--in the mid-60% range. How can that be? Canada has tried to provide direct ownership incentives, working on the demand side of the equation by making more people able to afford a home, whereas the US has been effectively working the supply side by making homes cheaper through a mortgage tax deduction. It should be clear that these approaches are not equivalent.

Will the United States actually engage in such reform, phasing out the mortgage tax deductions in favor of direct incentives and making it illegal to walk away from a mortgage? It seems doubtful, but I leave the last word to Hugh Mackenzie, speaking last week: "If we don't see those two points addressed, then we have to assume they're not serious about solving the problem."