How Canada’s largest banks contributed to the housing bubble. 3 billion


After leading his 148-year-old institution to a record quarterly profit of $3 billion, Royal Bank of Canada Chief Executive David McKay gratified some Bay Street reporters with rare interviews the other day. He had just completed another clinic in the art of making money by guiding his institution to a record quarterly profit. Amid a flurry of zeroes, there is no better time for a banker to put themselves in the spotlight than they are right now.

Population Rate of Toronto (largest city of Canada)

The rate of population increase in Toronto is not sufficient to support the city’s inflated housing costs.
From the looks of the headlines, it would appear that the writers were either unimpressed or disinterested in what McKay had to say about the banking industry. He made headlines by discussing the real estate market in Toronto. When asked about Canada’s big-city housing bubble not too long ago, Royal’s chief executive was quite upbeat about the situation. In 2015, McKay stated,

“We feel optimistic about housing,” even though other agencies, including the International Monetary Fund and the Bank of Canada, have warned of potential difficulties. He has taken on an anxious tone. He warned the Financial Post about a “rather dangerous mix of drivers” that are driving up prices, one of which is the wealthy international purchasers that Vancouver drove away with a 15% tax the previous year to bust its property bubble. When asked about the housing market in his hometown,

McKay stated, “You’re seeing 20% house-price growth in a place where you shouldn’t see that much.” “It raises some concerns. That can’t keep going on forever. As a result, I think that we have reached the stage where we must examine the kinds of measures that we

McKay Statement

As McKay stated practically the same thing to the Globe and Mail, we have every reason to believe that the intervention was premeditated. The Toronto Real Estate Board must have been annoyed by it because on March 3 they released a report stating that the average selling price of a detached property in the Greater Toronto Area was $1.2 million in February.

This represents a 32.5% increase over the same month a year prior. In a press release, the president of the board, Larry Cerqua, elaborated at length on how the extraordinary price gains had nothing to do with global plutocrats seeking havens and practically everything to do with limited supply and strong demand, especially from people looking to buy their first house. In the absence of scientific proof, the provincial administration and municipal governments have, up to this point, avoided implementing a tax on purchases made by individuals residing outside of the country, according to Cerqua (though on Thursday Ontario indicated it might consider a foreign buyers tax after all).

Citing a recent survey of his members that suggested international buyers accounted for only 5% of demand, Cerqua added that “the solution to strong rates of price growth and related affordability concerns lies not with taxing foreign buyers more, but rather with addressing the supply of homes available for sale, or lack thereof.” [Cerqua] “the solution to strong rates of price growth and related affordability concerns lies not with taxing foreign buyers more, but rather with addressing the supply of homes available for sale, or lack thereof.”

Bringing Cerqua to justice could be entertaining, but there’s not much sport in it. Given that the heads of Canada’s banking oligopoly rarely open themselves up to public scrutiny, we will continue with McKay. The Big Six are the lifeblood of a banking system that prioritizes real estate over investments with higher returns, such as business loans. They actively promoted the low-interest, post-crisis mortgages that have contributed to Canada’s ranking as one of the world’s most indebted nations.

There is a plethora of research that supports this claim. The Bank for International Settlements (BIS) in Basel, Switzerland, recently released a new set of figures it views as indicators of financial stress. Canada is the only country whose domestic banking system sparked red lights on three of the four “early warning” signs monitored by the BIS.

The ratio of private credit to GDP in Canada is currently at 17.4 percentage points, second only to China’s debt-to-GDP ratio of 26.3 percentage points. (When the credit-to-GDP ratio rises above 10%, the BIS becomes concerned.)

Property prices in Canada are 11.6% above what the BIS estimates as a trend, one of the largest such discrepancies globally. The numbers also make one wonder if the Canadian economy would collapse under even a modest increase in interest rates of 2.5 per cent. Even though it’s highly unlikely, the BIS nonetheless loves to do the math to see if a country can afford its debts. The alert went off only in Canada, China, and Turkey.

In a sane universe, we might count on banks to assist in stifling the housing frenzy that has put Canada in this precarious position. Charles Calomiris and Stephen Haber, writers of Fragile by Design, a widely lauded international history of the relationship between politics and banking, claim that before the early 1950s, Canada’s largest lenders showed little interest in real estate. The situation shifted, however, when William Lyon Mackenzie King, in the wake of World War II, established the Canada Mortgage and Housing Corp. to guarantee the building of new houses for returning veterans.

A banker’s blood boils at the thought of risk-free lending. To participate in the postwar construction boom, the banks successfully lobbied the government to amend their charters in 1954. Consolidation that led to the current oligopoly began in 1992 when they were permitted to purchase the trusts that had benefited from CMHC’s backup in the beginning.

For the first time in November 2015, mortgage holdings at Canada’s chartered banks topped $1 trillion on a monthly average basis. According to the latest recent numbers from the Bank of Canada, the total reached $1.07 trillion in December, continuing its steady increase. That is more than twice as much as the chartered banks set aside for commercial lending.

What effect the new Canadian mortgage restrictions could have on the “shadow banking” industry?
Because banks funding to new enterprises is now obviously something worthy of special notice, on Thursday every major financial institution in the land banded together to create a $500 million fund to give loans to entrepreneurs.

The stock price of Royal has increased by almost 36% since this time last year, suggesting that the company’s CEO is doing a good job. So we shouldn’t celebrate him for taking on someone like Cerqua. McKay identifies several “hazardous triggers,” including foreign purchasers, ultra-low interest rates, a shortage of supply, and speculators.

He seems to have forgotten about himself and his peers at the other major banks. McKay tries to deflect blame for Bay Street’s part in creating the bubble by pointing the finger at foreign investors. With the publicly owned CMHC covering the majority of any losses, banks have been piling on mortgages.

Too jaded? Put it to McKay. You might remember hearing about the “short Canada” plan a few years ago. Seeing the events in Canada, some US investors were reminded of their home crisis. Looking at the banks’ massive mortgage portfolios, they concluded that they might profit by betting that financial giants like Royal and Toronto-Dominion Bank were about to fail.

Moreover, financial institutions’ stock prices declined for a time. McKay travelled to the Big Apple in 2015 to deliver a message to the financial industry. In a room full of financiers, he claimed that the speculators who predicted that his bank would suffer greatly from a wave of defaults were unaware of how finance operates in North America. The initial loss is covered by government-guaranteed insurance, which is a point he stressed repeatedly.

Economists use the term “moral hazard” to describe a situation in which one party engages in a risky transaction because they know their losses will be compensated by someone else, and that statement is one of the clearest articulations of this concept you will ever read. Before the financial crisis, a subtle form of moral hazard had already begun to play out. No one trusted the United States government when it said it wouldn’t bail out the banks,

So financial institutions like Lehman Brothers Holdings Inc. continued operating as if they had nothing to lose. In contrast, Canada’s moral hazard is written into legislation and norms that govern CMHC. Simply said, we don’t have nearly enough conversations about it.

Even while I have my suspicions, I can’t bring myself to label McKay a hypocrite. He is merely following the established norms and doing what he is paid to do, which is to maximize profit for his stockholders. In contrast to the United States, which suffers from recurrent financial meltdowns, that system has so far been able to avoid such crises. Hundreds of millions of dollars have been generated for the federal government by CMHC’s insurance offerings.

McKay and the other oligopoly members may not be hypocrites, but they are an obstacle to progress. They have done little to deflate the housing bubble on their own and have instead called for government regulation of sensible home-lending practices. Although though Canadian bankers regularly participate in price wars to keep their portions of the mortgage market, they regularly stress the necessity of fiscal stability. Once again, they are taking this action since the risks involved are minimal for them. A bank executive who does not maximize the use of risk-free revenues runs the danger of losing his or her job.

Things we don’t know about Canada’s housing market are numerous and concerning.
Canada has been working on minimizing moral hazard in mortgage financing for years, and they may finally be close to succeeding. Bill Morneau, Canada’s Finance Minister, stated in October that he would consider legislation to force mortgage lenders to bear a larger portion of the loss in the event of a default. Morneau suggested charging creditors a deductible-like sum or a percentage of the overall loss. The Treasury Service is now fielding questions from the general public on this issue.

But, the banks are fighting back. In response to McKay’s proposal to impose a tax on foreign buyers of property in Toronto, the Canadian Bankers Association urged the government to find an alternative that would have less of an impact on the financial services industry. Royal and the other large banks are represented by an association that has proposed allowing private mortgage insurers to purchase reinsurance or allowing the banks to issue more of a type of bond that combines house loans into single securities.

In theory, these changes could lessen the burden on Canadian taxpayers in the event of a mortgage failure, but they would do nothing to lessen the incentive for Canada’s largest banks to actively market mortgages. When banks plead with Canada, will they pay attention? While we won’t know for sure until the budget is released on March 22, it’s important to note that the new multi-bank-backed growth fund launched this week is a political creature born out of a meeting between bankers and Morneau in December and has all the makings of a “sorry” for inflating the housing bubble.

Bankers like McKay are getting nervous about the debt monster they helped build, but not nervous enough to stop feeding it. The incentive to continue artificially inflating the housing market is still too high, even though the rest of us will bear the brunt of the collapse.


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