Pacifica Partners’ Financial Post Weekly Column – Nov 19th 2009
For most of this year the markets have been discounting an economic recovery. That is, they have been in rally mode in anticipation that the worst of the economic crisis is over. While that is likely, all that is left for debate is how meaningful the recovery will be and if it is sustainable. The G20 countries have committed to not let their collective foot off the stimulus gas pedal until they are confident that the economy is on a sustainable trajectory.
As has been expressed before in this space, the distortions being caused in the markets by a weak US dollar are numerous. The floundering US currency has in turn lit a fire under the Canadian dollar. It is up almost 17% for the year and 24% since its lows last March. That has created a conundrum for the Bank of Canada. It was widely expected that the Bank of Canada would have begun raising interest rates by now.
However, some economic data has come in weaker than expected and even more so, the high Canadian dollar has kept the Bank of Canada on the sidelines. The central bank is well aware that if it chooses to raise rates now and thereby further strengthen the loonie, it might end up choking off the budding economic recovery.
There may be yet another concern that might be leaving the Bank of Canada in a quandary. It seems that Canada is gaining a new reputation as perhaps the “new kid on the block” when it comes to the excesses of overheated real estate markets. The real estate revival is being fueled by a wave of mortgage financing that some consider to be sub- prime in quality. In part, this is starting to resemble what we have seen in the US. While it is highly unlikely that we would see anything remotely resembling the experience of the US banks, the story does have some similarities that are disconcerting.
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Part of the responsibility for this trend is being put at the feet of the Canadian Mortgage and Housing Corp. (CMHC). This government entity is considered by critics to be the Canadian equivalent of Fannie Mae in that its practices are thought to be provoking a rise in lending that could spell trouble for the Canadian real estate market in the future. This practice was brought about in part by the directive of the federal government to CMHC to effectively “hit the gas” and ensure that mortgage credit was accessible. The theory goes something like this: banks can continue making extended amortization loans to provide prospective homeowners the ability to get into an overheated Canadian housing market because the default risk is being transferred to the CMHC (taxpayers) since it acts as a guarantor for the mortgage market.
According to data from the CMHC, the amount of mortgage credit on the books of the banks has been almost unchanged since 2007 even though they have been issuing an explosive amount of mortgage credit. The reason is that the banks are offloading the mortgages from their balance sheet through the securitization process. Essentially, this allows them to move the risk of default to the broader financial markets.
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