Wednesday, February 1, 2012

Banks Max Out Their CMHC Credit Cards

Imagine the banks as drunken college students and the card is in mom and dad's name. The banks have been binging on CMHC insurance (insurance the banks themselves bought, not that purchased by buyers) and the $600 billion limit imposed in 2008 to deal with the crisis is soon going to be hit.

This is what creates a bubble, ever increasing debt. The next round of house price increases requires accelerating volumes of credit. Without that, the party is over. Imagine you just bought your house for 800k and you dream of selling it in 5 years for 1.2 million. That means total outstanding mortgage credit for the entire country of Canada will have to continue to grow by 8% per year. When the GDP is only growing by 3%. Total mortgage credit has been growing at nearly ~100 billion per year on a base of ~1.1 trillion, that is ~10% growth. If that continues, total mortgage debt for the country will be 1.8 trillion and GDP will be 2 trillion. How likely is that?

Setting a fixed amount of debt, even sky high already, will end this bubble quicker than anyone imagines. Prices are set at the margin on ACCELERATING debt. The accelerating part is critical. So keep an eye on the CHMC limit. It directly impacts that excessive credit issuance through securitization because securitization is not allowed without insurance.

The first house sold for less because of limits on credit will reset the price for that entire area. Multiply that by every sale. Then wait 6-10 months (if Australia is any precedent) for a general realization of what is happening to sink in, then watch the rush to the exits. If these 800k houses are going to lose 10% in a year, many more owners than normal are going to want out, because the loss is so large because the leveraged bet is so high. Because of sky high values, buyers are under threat to lose 200% of their of their cash investment if they only put 5% down. Suddenly the house doesn't look so dreamy perfect anymore, it looks like a giant battle ax hanging over the head of one's net worth.

And believe me, lots of people in California said: "I don't care whether the value goes down, I'll just keep making my payments and ignore what is happening." These people changed their minds. Being underwater means you are stuck. Trapped, even if payments are affordable because of your situation, is not a state humans particularly like living in.

CMHC backing fewer loans
Financial institutions are required to have mortgage-default insurance when a consumer has less than 20% equity. However, the banks have been seeking insurance on loans with even high downpayments — something not required by law — so they can securitize those bulk lending loans, thereby getting them off their balance sheets and reducing their capital requirements. In those cases in which the loans to value is less than 80%, the bank pays the insurance charge instead of the consumer.
One of the great myths of Canadian banking: We aren't making the same mistakes as the U.S. like securitizing mortgages. Right. You can't blow a bubble without excessive capital pouring into housing. In Canada that excess has been from securitization for more than the last three years. This isn't new.
“One of the things that has got them [to the limit] faster than expected is they are doing a lot of conventional insurance for lenders,” said one source. Just three years ago, CMHC had $450-billion in loans it was backstopping and had to go to the government to get that increased to $600-billion.
I really really hope CMHC audits every one of the claims from the banks. I fear they will be used as a bailout mechanism, like last time. Sadly.
CMHC gave no indication it would seek an increase in its limit.
Well, that would be something.

CMHC Insurance Limits: A Wake-up Call for Lenders
Mortgage default insurance is typically only “required” when someone with less than 20% equity gets a mortgage.

Despite that, almost three-quarters of CMHC’s outstanding mortgage insurance is low-ratio (i.e., 20% equity or more). That’s largely because banks have been buying portfolio insurance in gobs to insure against defaults on low-risk conventional mortgages.
Wait wait wait. Seriously. 3/4 of their book? Holy moly.
(Incidentally, the biggest bulk insurance customer recently has been Scotiabank, which reportedly had an abnormally large and predominantly insured $17+ billion mortgage-backed securities issuance in December.)
Wow, it's getting ugly out there folks. Be careful.

(If anyone knows what it costs banks in Canada to process a typical foreclosure, please drop a note in the comments. Thanks.)


jesse said...

Costs exceed tens of thousands. I've heard of cases approaching $50K before commissions on sale.

GG said...

Ouch. The round number quoted in the U.S. is 20k.

That is not insubstantial. And I assume the bank bears that cost, even with CMHC insurance?