To View Lending For Property As Less Risky
A weekend topic on some writings starting with Cody Cain at Salon. “If you ask anyone what caused the devastating 2008 financial crisis, you’ll invariably receive the same answer: Wrongdoing by the Wall Street banks. This is no wonder because this explanation has been trumpeted everywhere. It’s all over the media, our politicians repeat it endlessly, and the current presidential candidates harp on it incessantly. So this explanation has now seeped into our public consciousness as the conventional truth. But there is a tiny little nagging problem. There just seems to be some very curious flaws in the case that simply do not seem to add up.”
“The problem with this analysis is that it ignores the fundamental essence of what a mortgage loan is all about. The bank lends not based upon the income of the borrower, but instead, the bank lends upon the value of the house. The collateral for a mortgage loan is not the borrower’s stream of income, it is the house itself. If the borrower fails to repay the loan, the bank’s primary remedy is not to seize the borrower’s income, but instead, the bank forecloses upon the house, sells the house in the market, and applies the sale proceeds to repay the loan. So any analysis of the riskiness of a mortgage loan must be based upon the value of the house, not upon the income of the borrower.”
“Income serves as a useful indicator of whether the borrower is likely to meet the monthly loan payments. But income does not determine whether a mortgage loan is fundamentally good or bad, only the value of the house does that. So income, no matter how badly misstated, could not possibly have caused the financial crisis.”
“In addition, incomes became less of a factor as a result of the housing bubble. As the bubble expanded, home values kept increasing. Year after year prices experienced double-digit increases. This attracted a stampede of investors, just like in every bubble. It wasn’t that the banks were negligently failing to consider the borrower’s income and concealing it, but rather, investors were not concerned about the borrower’s income when the value of the house was certain to increase. Thus is the nature of bubbles.”
From Dan Barnabic at MarketWatch. “The prices of real estate in major selected urban centers are still going up. But job growth and wages cannot keep up the pace, in fact, they lag behind very badly. Will the average American middle-class buyer be able to consider buying into already overvalued real estate in those hot-spot cities such as San Francisco, Portland, Seattle, L.A., San Diego, Denver, Miami, Atlanta, not to mention New York City? The simple answer is no.”
“One has to be blind not to see what is really coming. We are already in serious bubble, the fact that stakeholders such as real estate brokers and speculators, even existing owners of overvalued real estate deny in fear of losing their commissions and equities. And fear they should. We are now living in the market which is almost solely driven by speculators hoping to flip the properties for even higher prices to Chinese and other off shore buyers and some domestic naïve buyers, who just about forgot or don’t bother to remember the last devastating real estate crash of 2007.”
“The latest gimmick involving condo developers’ promises for guaranteed first and second year rental income has turned even ordinary folks into speculating investors. They are buying condo units and other types of real estate hoping to ride the wave of success by selling them later at a higher prices. Due to sheer number of such investors-turned-speculators, the market has now entered into in artificial state of (high) demand. At the first sign of an economic slowdown, the speculators will retrieve, bringing the buying frenzy to a hold.”
“Suddenly, everybody will realize there is no actual demand. In a resulting panic, many investors will dump their units onto the market, causing prices to plummet and wreak havoc in the process. The glut of available units for rent will become a clear signal to buyers that there is an oversupply of units on the market. When this realization sinks in, a downtrend in condo unit market will begin.”
Liam Dann at the New Zealand Herald. “The median price of an Auckland house has almost doubled since the bottom of the last cycle in 2009, in the depths of the global financial crisis. The boom has now spilt over into the regions, with places like Hamilton and Tauranga surging 26 and 23 per cent respectively in the past 12 months. The big problem, says economist Shamubeel Eaqub, is that we have a banking system designed to view lending for property as less risky than other kinds of lending.”
“‘Our banking regulation allows us to feed on the property market,’ he says. ‘Of all the debt that is created in New Zealand, more and more is going towards mortgages because mortgages are less risky according to our rules and regulations.’”
“As house prices soar, the size of mortgages has to grow with it. There is no easy way out of the cycle. If house prices fall, then highly leveraged investors and many home buyers will be left exposed. ‘When it happens it will be nasty,’ says Eaqub. ‘There is no other way to describe it. What we have built up is ugly.’”
“What happened to the US housing market in the global financial crisis provides a sobering example. But in New Zealand it could be even worse. One thing favouring the Nevada home owners — and those in many other US states — were laws that allowed them to walk away from a debt-laden house. In those states, if a property ends up worth less than the mortgage, the homeowner can effectively post the keys back to the bank and leave their debt behind them.”
“In New Zealand there’s no such escape: the debt stays with the borrower. ‘In terms of the chilling effect on the entire economy it’s much much bigger,’ Eaqub says. ‘In Vegas people had these enormous debts that they knew they’d never be able to pay back. In New Zealand people know they have to pay it back.’”
From Chris Sorenson at Maclean’s in Canada. “After years of pumping money into the country’s frothiest housing markets, Canada’s big banks are suddenly—and alarmingly—nervous about the debt-fuelled monster they’ve helped to create. In the span of a few days this week and last, several big-bank CEOs and chief economists let loose a flurry of warnings about surging home prices in Vancouver and Toronto, where it now costs an average of $1.5 million and $1.3 million, respectively, to buy a detached house.”
“Such remarks are a marked departure from the finance industry’s earlier nothing-to-see-here attitude. So why the sudden change of heart? It no doubt has much to do with Vancouver detached-house prices surging by 37 per cent in the year to this May, and Toronto’s soaring by a still ear-popping 15 per cent. Those sorts of gains are unsustainable and suggest investor euphoria—the always-dangerous ‘fear of missing out’—has firmly taken hold.”
“Yet, while Scotiabank says it voluntarily curtailed its mortgage business, it’s unlikely to pull back on the reins too hard for fear of losing market share to competitors and leaving money on the table.”
“So is there any way for Ottawa to cool sizzling housing markets like Toronto and Vancouver without putting others into the deep freeze? There may well be—and it’s already coming down the pipe. When Finance Minister Bill Morneau announced the latest changes to CMHC mortgage insurance last December, he also proposed forcing banks to hold more capital against mortgages in cities where property prices are high relative to borrowers’ incomes—like Toronto and Vancouver.”
“The policy shift, the finer points of which are still being hammered out by Canada’s banking regulator, would effectively make it more expensive for banks to lend in higher-priced housing markets, prompting them to either pass along the extra costs to borrowers or issue fewer mortgages.”
“A better option is raising qualifying interest rates for five-year fixed mortgages. While this would also have a nationwide impact, Craig Alexander, the VP of economic analysis at C.D. Howe and a former Toronto Dominion Bank chief economist, argues the risk may well be worth it. ‘If you purchase a home but can’t make the payments if interest rates go up by two percentage points, you probably shouldn’t be buying that home in the first place,’ he says.”
