Canadian Borrowing Gone Mad: A Look at BMO's Misguided Balance Sheet Theory and the Keep on Dancin' Market Share Theory of Toronto-Dominion

Theory has it that Canadian banks are in far better shape than their US counterparts. If so, it's primarily because the Canadian Central Bank (Bank of Canada) has assumed nearly all the default risk on Canada's massive property bubble.

Is that supposed to make everyone stand up and salute the Loonie?

One key point that has recently come into the spotlight is Canadian citizens are not in better shape than their US counterparts. All those going "rah rah" over the Loonie, might be advised to consider some of the following articles.

Canadians warned to rein in borrowing on cheap money before it's too late

Bank of Canada governor Mark Carney issued a staunch warning to Canadians about the perils of cheap borrowing Monday, just as fresh data suggested household debt-to-income ratios have jumped to record highs.

"Household debt levels are at unprecedented levels relative to income — the level of vulnerability of households remains high," Carney told a news conference after a speech in Toronto.

Statistics Canada said Monday the ratio of debt to disposable income rose to 148.1 per cent in Canada in the third quarter — a close to five point jump — slightly ahead of the U.S. ratio of 147.2 per cent.

TD Bank chief economist Craig Alexander said it was natural that the government would explore ways to constrain borrowing, but said he also does not believe the situation has reached a crisis.

Apparently TD Bank chief economist Craig Alexander thinks it's best to wait until there is a crisis to do anything about it.

No doubt Alexander is a big believer in the Greenspan methodology of dealing with bubbles after they burst even though we have already seen the disastrous results of such complaisance.

Here's another good one from up North: Consumers warned: 'brutal reckoning' ahead

Bank of Canada governor Mark Carney issued another stern warning Monday on Canadians' appetite to take on record levels of household debt, which some analysts took as a signal he is set to raise interest rates as soon as the economy improves.

"Cheap money is not a long-term growth strategy," Carney said. "Low rates today do not necessarily mean low rates tomorrow. Risk reversals when they happen can be fierce: the greater the complacency, the more brutal the reckoning."

In Ottawa, Finance Minister Jim Flaherty said his government could tighten mortgage eligibility rules for a third time, if required, to keep credit growth in check.

Based on conversations he's had with banking executives, "there is no reason for extreme concern right now," Flaherty said. "But there is a reason for concern. So if it is necessary, we will toughen up the mortgage rules some more."

What's with this "no reason for extreme concern right now" nonsense? The Canadian property bubble is of epic proportion.

Flaherty too, appears to be a proponent of the Greenspan theory that bubbles can only be recognized in hindsight.

Blue Ribbon Complacency Awards

The blue ribbon for complacency goes to the Bank of Montreal for Debt picture not so bleak

Statistics Canada released data Monday showing that Canadian household debt has risen to 148 per cent of disposable income. The eye-popping figure is all the more alarming considering it's the first time since the 1990s that Canada's ratio has been higher than that of the U.S.

Alarm bells rang everywhere from the Bank of Canada to the Finance Department on Monday, and Canadians were urged to tighten their belts and prepare for a time of austerity.

But a closer look at the numbers indicates the picture might not be so bleak.

"The continued laser-like focus on debt overshadows the other half of the balance sheet," BMO chief economist Doug Porter said Monday.

Namely, Canadians are borrowing. But they're also saving, and they're worth more than they used to be.

Balance Sheet Theory Madness

Porter's statements are exactly the same kind of silliness we heard in the US regarding the central belief "massive debt is OK because it's supported by rising asset prices".

It was bad enough that anyone believed such nonsense a few years ago before the US property bubble blew sky high. That such beliefs still have proponents at the highest level of Canadian banks now seems rather amazing.

It just goes to show just how firm the belief "It's different here" is in Canada.

When housing prices crash, and especially if the stock market goes with it, what's left of Porter's "Balance Sheet Theory" will look something like a moldy slice of 3-year-old Swiss cheese.

Banks Won' Lead The Way

Toronto-Dominion Bank chief executive officer Ed Clark says Banks won't lead way on fixing debt problem.

If policy makers want Canadians to stop borrowing too much, it’s up to Ottawa, not financial institutions, to force a change in behaviour, says one of Bay Street’s longest-serving senior bankers.

Toronto-Dominion Bank chief executive officer Ed Clark acknowledged Canadians’ alarming debt levels, but said the issue is a matter of public policy and would be best resolved by a tighter government rules on residential mortgages.

In an interview with The Globe and Mail, Mr. Clark said that no bank wants to be the first to impose stricter requirements on borrowers out of fear that it will suffer a major loss of customers to rivals. Personal banking “is a highly competitive industry,” Mr. Clark said. “If we said ‘Look, we’re going to be heroes and save Canada from itself, and we’ll impose a whole new [mortgage] regime on everyone else,’ the other four [large] banks would say ‘Let’s carve them up.’ ”

Mr. Clark said it is impossible to expect any bank to crack the whip on borrowers because “market share loss is perceived as a strategic loss, not just a numerical or dollar loss.”

Dance Until The Music Stops

Clark sounds like he's a big believer in the Chuck Price Music Theory best described in retrospect as "Keep dancing until you dance out the door".

Flashback July 10, 2007: Quotes of the Day / Top Call

Chuck Prince - Citigroup CEO

No End Soon to Buyout Boom: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing".

Mish reply.

If ever there was market arrogance, the statements by Chuck Prince says it all.

In an interview with the newspaper, Prince said the boom will eventually end, but will continue for now because markets have plenty of liquidity, despite turmoil in the U.S. subprime mortgage market. He denied Citigroup was pulling back, the newspaper said. "When the music stops, in terms of liquidity, things will be complicated," he said. "But as long as the music is playing, you've got to get up and dance. We're still dancing.

Prince added: "The depth of the pools of liquidity is so much larger than it used to be that a disruptive event now needs to be much more disruptive than it used to be. At some point, the disruptive event will be so significant that, instead of liquidity filling in, the liquidity will go the other way. I don't think we're at that point.

My comment at the time was "I leave it to you to decide whether or not this is the 'last dance'".

Flashback November 02, 2007: Music Stops for Chuck Prince

The party is over and the music has stopped for Chuck Prince. His last dance is a two-step out the door. Citi's Prince Plans to Resign.

Moral-Hazard Position of Bank of Canada

Toronto-Dominion's CEO does not give a damn about fundamentals, about acting on their clients' interests, or for that matter acting on shareholder interests. Clark's only concern is in not losing market share to the other Canadian banks until the whole mess blows sky high.

Canada's banks clearly don't care what happens as long as they can pass the trash to the Bank of Canada, the Canadian equivalent of Fannie Mae.

Clark's statements, as well as statements made by the chief economists of BMO and Toronto-Dominion, put a spotlight on the decidedly stupid moral-hazard mess the Bank of Canada has gotten itself into by backstopping mortgages of Canadian borrowers.

But hey, look on the bright side. The music is still playing. In memory of Chuck Prince, Keep on Dancin'

Addendum:

I said Bank of Canada in a couple of places where I should have said CMHC.

Here are a couple of corrections from Canadian readers.

"RP" Writes ....

Quick corrections here Mish. Mortgages in Canada are guaranteed by the CMHC, which is a crown corporation equivalent to Fannie Mae. Anything less than 20% down requires this insurance, so that's the source of the Canadian banks' "health". The loose lending standards were set by the current "Conservative" government, a few months after they came in office. We had 0 down, 40 year mortgages insured by the government for a couple of years. Now it's officially 5% down and 35 years, but every bank will lend you the downpayment. The government also insures mortgages for rental properties.

Similarly, "MS" writes ....

Hey Mish,

One inaccuracy that should be corrected. It's the CMHC (Canada Mortgage and Housing Corporation) that serves as the equivalent to Fannie and Freddie, not the BoC. The CMHC insures mortgages for below market rates, and the major banks pass along their loans to them.

The Conservative government ordered the CMHC (a crown corporation) to insure some $300 Billion in additional mortgages during the crisis - nearly double their previous holdings. It is this that has buoyed the Canadian R/E market since then. Banks don't worry about credit worthiness, because the CMHC will take it anyway in order to meet their quota.

"Moi" Writes ....

Mish you are one of the few Americans that seem to "Get It". So many of the other US financial writers talk glowingly about how sound Canada is financially and how the Canadian banks did not take part in the risky lending practices that the US banks have taken part in. This is complete and utter BS!! The Canadian banks are doing the same sort of zero down or variable rate mortgages it's just they have none of the risk to worry about. 600 Billion dollars worth of that mortgage risk is held by the government of Canada thanks to the Canada Mortgage and Housing Corporation (CMHC). There are cash back mortgages every where in this country. In other words come up with your measly 5% down payment and the bank will give you 5% back. So here in Canada we proudly brag about how we do not have zero down mortgages, we just call them by a different name. Also, if you do not have 5% to put down no problem. All of the banks will loan you money to by an RRSP (IRA), you can than cash that RRSP to be paid back later and use that as your 5% down payment. Voila, zero down mortgages.

The Canadian Association of Accredited Mortgage Professionals came out last month with their "Good News" annual report last month. Just like the Real Estate Industry, all news is good news. Take a look at the numbers. At these absolutely rock bottom interest rates:

100,000 mortgage holders would be in trouble with any rate move.
350,000 mortgage holders would be in trouble if rates only go up less than 1 percent.
250,000 mortgage holders would be in trouble if rates went up between 1 and 1.5 percent.

So, if interest rates which are at Century lows went up a measly 1.5 percent, 700,000 mortgage holders in Canada would be in trouble. What if they went up 2 or 3%? It would be mortgage Armageddon in Canada. This is how precarious our housing market. The following link gives you just one tiny example of why Canadian housing is a house of cards that could topple at the slightest touch.
http://whispersfromtheedgeoftherainforest.blogspot.com/2010/05/pardon.html

http://www.theglobeandmail.com/report-on-business/canadian-mortgage-debt-tops-1-trillion-for-first-time/article1789172/

5% or more cash back mortgage:

http://www.tdcanadatrust.com/mortgages/5_cashback.jsp
http://www.rbcroyalbank.com/products/mortgages/cash-back-mortgage.html

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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