The following is an insightful article written by Barry Lebow
So far, we in Canada have escaped the mortgage default problems that are causing major financial problems in the United States and have escalated to cause problems in money markets around the globe. People in the U.S. are walking away from their obligations and some good-sized lenders have gone out of business. The problems were started by a real estate blight, a real economic cancer known as subprime financing.
A little reality check on a default in a mortgage: depending on your province, a default in a mortgage can result in a power of sale, a foreclosure or a judicial sale. The cancer is what can happen to an area where defaults are too frequent.
Having experienced three major downturns during my four decades in this industry, the problem starts simply. A mortgagor goes into default and the lender takes control and puts the house on MLS in “as is” condition. A buyer looks at this as a way to buy below market value and to get a foot into the neighbourhood. According to the law, a mortgage lender selling under a power of sale action must get the maximum price possible and there can be no such thing as a bargain price. In a foreclosure, the lender owns the property and can blow it out for whatever they can get. Human nature, though, trumps a textbook concept anytime. Buyers know that they are buying “as is” and that alone establishes that they are buying with some risk, a home inspection notwithstanding. So, a house under default sells for below the market value prevailing in the neighbourhood.
One house or condominium unit will not disturb a market but based on what is happening across the United States and what we experienced in Canada just a decade ago, one mortgage default becomes two and three and then they are rampant throughout an area. People who have worked hard, met every mortgage payment and have solid equity in their homes start to see their equity erode as the prices for mortgage default properties starts to set new market prices and hence market value in their areas. (Note that market price and market value are not always synonymous). Poor lending programs, geared to bring in abundant loans to a greedy lending institution, contributes to a loss in value for thousands of decent people who are victims of plain greed by mortgage lenders.
Think that the subprime problem is only an American dilemma? How about the world financial funds that bought stocks in subprime mortgage markets? Stock prices have taken a downturn. A major French banker halted withdrawals from three investment funds, while German banks clubbed together to bankroll a 3.5-billion euro ($4.83 billion) rescue to cover IKB’s potential losses and stem what financial regulator Bafin warned could snowball into the biggest banking crisis in Germany in more than 75 years. The European Central Bank has injected almost 100 billion euros into its money supply because of one factor – a bunch of people who never should have been given credit and had no concept of financial maturity defaulted on their subprime mortgage. As I write this, about 250,000 mortgages are now in default and that number is climbing.
Frankfurt-Trust shut one of its ABS funds to stop panicking investors from withdrawing any more cash. Despite not having any subprime investments, it came under pressure after many worried investors demanded their money back.
The butterfly effect: a butterfly in Africa flaps its wings and that sets off a motion that escalates until it creates a hurricane in the Caribbean. Well, the first subprime default has escalated into a hurricane that is cutting a swathe of destruction through many American communities with secondary but fierce winds spreading around the globe.
As reported by Bloomberg, Standard & Poor’s may cut its ratings on $913.9 million of U.S. mortgage securities backed by Alt A loans because of rising delinquencies and losses that may “exceed historical precedent.”
The Canadian Association of Mortgage Professionals (CAAMP), in a recent press release, tried to assure the public that Canada is not headed for the same fate as in the U.S.; it pointed out that there are many factors that have made the Canadian mortgage scene “a picture of health.”
Average house prices rose by about 10 per cent in both 2004 and 2005 and a further 11 per cent in 2006. Canadians remain optimistic about housing markets. For all of Canada, only nine per cent of consumers surveyed expressed negative opinions about the prospects for house prices in their community. When asked, “Is now a good time or a bad time to buy a new home in your community?” the most positive responses were given in Atlantic Canada and Ontario. The most significant jump in positive responses was seen in British Columbia, where it moved from below national average in the fall of 2005 to almost in line with the average this fall. Alberta had the most negative outlook, where many consumers considered their local housing markets over-heated.
The survey, Consumer Mortgage Choices in a Changing Market, contains a wealth of additional industry data including consumer response to new mortgage options, the age distribution of mortgage holders in Canada, popularity and rates of different mortgage terms, and anticipated mortgage renewals. For a full copy of the survey, visit: www.caamp.org.
In my own view, the subprime lending parameters in Canada are more restrictive than the American practices and better judgment is in place here. We have allowed for longer amortization periods and other options but people with the kind of poor credit and poor work history that easily found loans in the U.S. could not qualify here. The subprime lending market must be kept in check and not allowed to loosen its controls.
Thankfully, Canadians as a whole are generally more educated and more sophisticated than our friends to the south. Cooler heads here should prevail because cooler heads were already in control. Think of being in a car and you see a crash ahead of you. You can take control, apply the brakes and hope not to slide into the debris ahead of you and pray that the guy behind you does not skid into you.
We are fortunate as we can be smug watching the American crash and having the foresight to apply the brakes before we go into a skid. Remember one major factor – people follow herd instincts. The subprime losses are grossly overstated and people are acting on fear and hence the stock market has losses. There is no true basis for this fear. Although 250,000 mortgage defaults may seem high, you must know this one major fact – there are 44 million mortgages in the United States and only about 0.6 per cent are in default. Given those numbers, one should not lose much sleep, because the American mortgage market is stable. Heck, only about 13 per cent of the entire U.S. mortgage market is subprime and most of those are not in default.
Get some sleep, this will pass. Compared to the savings and loan crisis in the U.S. years ago, this subprime media frenzy is a tempest in a teapot.
Starting in real estate in 1968, Barry Lebow calls himself a real estate professional as he wears different hats as an appraiser, arbitrator, Realtor and educator. He is CEO of Lebow, Hicks Ltd. a long established appraisal and consulting firm and CEO of the Real Estate Training Institute, a training company for Realtors. He recently opened his own boutique brokerage, Senior Agent Inc. Realtor. (416) 781-5504; email firstname.lastname@example.org ; website www.negotiator.ca .