illustration showing piles of money flowing out of the windows of a house

Photography: Household debt has doubled since 2006 and, as a share of income, breaks new records almost every quarter. (Illustration by Matthew Billington)

Analysis| From Pivot Magazine

I See Debt People

They’re everywhere. But that doesn’t mean we’re headed for a U.S.-style mortgage crisis that will crush our economy

Runaway home prices and record household debt levels have been the most talked-about economics story of the last decade. Disbelief, and even fear, have dominated the discussion, and there’s widespread concern that this all ends badly for Canada. No doubt some scary statistics are backing up these fears. Home prices in Vancouver have doubled in the last nine years. Prior to the recent pullback in Toronto, prices had doubled in six. Household debt has doubled since 2006 and, as a share of income, breaks new records almost every quarter.

These statistics paint a picture that’s eerily similar to the U.S. prior to 2008-’09. Recent price declines in Toronto even raise the spectre that we’re past the tipping point on our way to a U.S.-style crash. But are we?

While that comparison might be obvious, it is not the full picture. Beyond prices and debt levels, Canada shares far fewer similarities with the U.S. than you might think. And this becomes very apparent when you look at just one measure: credit quality.

Readers may recall that the root of the U.S. financial crisis lay in the spread of subprime mortgages—ultimately, home prices were driven by borrowers taking on mortgages that they fundamentally could not afford. When those borrowers inevitably began to default, the wave of losses that hit the banks acted as the trigger for the financial crisis.

The severity of that crisis owed to a number of factors, from the widespread use of derivatives to lax regulation, but those low-credit-quality mortgages were the heart of the problem. So the trillion-dollar question for Canada is: do we have that same problem?

Thankfully, likely not.

Data from the Canadian Mortgage and Housing Corporation (CMHC) show the opposite is true: the credit quality of borrowers is actually getting better over time, not worse. Among the mortgages that CMHC insures, the share of borrowers that are considered to be high credit quality rose from 66 per cent in 2002 to 88 per cent in 2017. Conversely, the share of low-credit-quality borrowers considered high risk fell from 17 per cent to just three per cent over those years.

3%: Share of low-credit-quality borrowers considered high risk by CMHC

Part of this shift is due to the dozens of changes made to mortgage rules in the last decade by the CMHC and the federal Department of Finance—such as making income testing more stringent, and limiting mortgage insurance to homes selling for less than $1 million. These changes ultimately made the system safer, but did so by systematically limiting the ability of borrowers to take on debt. Higher-priced homes became the exclusive arena of those who didn’t need mortgage insurance (i.e., they could come up with a 20 percent down payment), while everyone else was pushed into lower price brackets, or out of the market entirely.

Not surprisingly, most new mortgages in recent years have been uninsured as prices have continued to increase.

But even on that side, data from Equifax for every mortgage it covers (which, they say, is the vast majority) corroborate that credit quality is improving across the country. Data from the end of 2012 to the beginning of 2017 show that the share of borrowers with either “very good” or “excellent” credit scores rose from 81.4 per cent to 84 per cent, with an even larger increase among new mortgage borrowers, from 77.5 percent to 82.4 percent. Again, these increases come at the expense of those with mediocre or poor credit scores.

So how do we reconcile that home prices have been bid up beyond what most Canadians can afford, yet those who are doing the bidding appear to be in increasingly better financial standing?

It’s possible we’re not getting the whole picture. There are still plenty of ways credit risk can have crept into the system. Lower-credit-quality borrowers could be falsifying their income or assets to appear to be higher-quality borrowers, for example. Let’s also not forget that recent regulations have likely pushed riskier borrowers “off the grid” toward non-regulated lenders and others that don’t report to the likes of Equifax. So there could be risk out there, just not directly in the core of our financial system.

Interestingly, that’s part of what distinguishes Canada from the U.S. If our largest financial institutions are less exposed to losses if and when mortgage defaults start to pile up, then even a housing crash won’t hit our economy as severely as it did America’s. Nearly every U.S. bank had some losses related to subprime mortgages. The failure of those that were more exposed was what transformed a severe housing downturn into a full-blown crisis.

There’s an alternative interpretation—it’s harder to swallow, but pause to consider it. What if we don’t have a housing problem? What if this is simply what houses are worth now?

That would mean Canada may not be on a crash course to economic disaster, but it would also mean that homes may never be affordable to those who are already priced out.

In that case, fear may be exactly what we should all be feeling; not of the inevitability of a correction but of the fact that, on their way to becoming world class, our cities stopped being the bastions of equal opportunity we like to think they are. That may be what Canada is now. And that might be the scariest thought of all.