HINT: It begins with "K" and ends with "rugman" (pdf).
Mr. Krugman states that Canada’s advantage has been in being stricter about limiting bank leverage, and that’s true. But he then blames Reagan-era deregulation for the “dangerously interesting” US banking system and suggests that the wild American banking mustangs must thus be broken to the regulatory bit.
The thing is, in his Keynesian enthusiasm, he is neglecting the most important qualities of the Canadian financial system, the things that really made the difference and account for the fact that we didn’t have a US-style housing collapse and have to bail out our entire banking system. The stuff he cites in his column is all correct, as far as it goes, but it’s just the feathers, not the chicken.
(Here's the Google Quick View if you don't like the pdf.)
Excellent article, but it barely touched the true root of the Canada-US difference: sustained crazy low central bank set interest rates in the US. Canada's central bank was more conservative, and while rates were too low, they weren't so epically off-target as they were in the states. On a side note, Brazil's ultraconservative central bank raised rates to 13% at the height of the boom and that has much to do with the shrinking poverty. Central bank policy is far more important than the welfare reform conservatives make too much hay of.
This article should put another nail in the "Socialist Canada vs Free-market America" mindset of many US and Canadian conservatives. America has been a LOUSY paradigm of freedom and capitalism more specifically. Canada at least pays for its socialism or at worst borrows for it. America at best borrows for it and at worst puts off the obligation until the future (SoSec, Medi) so it doesn't even appear on the balance sheet! America is credit card socialism, with a military-industrial complex to boot.
The US should eliminate the mortgage interest deductibility, I stated that even before the mortgage meltdown. Too many people think something that is deductible means it's free. Of couse that couldn't be further from the truth.
The roof over your head is the worst investment vehicle possible. It's not liquid whatsoever. Besides, if it went up 100k in the past 5 years, odds are every other house went up 100k in the past 5 years as well. Your net worth has gone up, but that's about it.
Rental property is a different story, but people generally don't buy rental property for the appreciation on the property. It's more about the revenue generated from rent. This actually stabilizes house prices. Unfortunately socialist ideals such as rent control in Manitoba put a serious choking to rental markets. There's a reason why we have such low vacancy, investment in the residential rental market is very low.
Harry Reid, Nancy Pelosi and Chris Dodd are responsible for this entire mess!
Obama is an ACORN entity.
Yeh...that tax deductible mortgage interest is bad. NOT!
Canadians sure love to be double taxed!
RFC, how does that equate into double taxation?
[quote]The roof over your head is the worst investment vehicle possible. It's not liquid whatsoever. Besides, if it went up 100k in the past 5 years, odds are every other house went up 100k in the past 5 years as well. Your net worth has gone up, but that's about it.[/quote]alan
Alan,
The issue of liquidity is in fact the problem; it was made Liquid by Mortgage companies... People were encouraged to take out the appreciation value by re-mortgaging to market value & pocketing the cash. Some people actually started from a clear title and assumed a new mortgage every two years (something like a reverse Mortgage for us oldies)
In Arizona the typical mortgage in trouble is almost twice the value of the home...financial planers are now advising clients to walk away, unethical given that the home owner pocketed CASH every time he upped his Mortgage.
Q: What Could Be Duller Than A Canadian Bank?
A: Dr. Dawg's Blog. It's like the Special Olympics, but without the wit.
Since we don't have it here, I had never considered the effect of tax deductable house payments. The man makes a lot of sense.
Three years to go and the house is mine! lol
Good article, but I'd mark it "incomplete".
Yes, mortgage interest deductibility is a factor. Your house has gone up $100k? Great, take out a 2nd for $50k at 5%, which is an effective rate of 3% after tax. Pay off all those 20% credit cards, and buy yourself a new car. Free money!
But far, far, far more important is the fact that Canadian banks kept their skin in the game whereas US mortgage brokers slipped out of it as soon as possible. This is what happened in the US: a mortgage broker, like CountryWide, would write, say, 100 mortgages on $250,000 homes. These would be bundled together and sold to a Wall Street investment bank (IB). That $25 million bundle would be sliced and diced into various parcels - e.g. a "senior" tranche that supposedly had the highest safety, but paid the lowest interest, a "junior" tranche that had middling safety and paid a higher rate, and an "equity" tranche that had no safety but paid the highest rates of all. These tranches would be sold to pension funds, smaller commercial banks (CB), etc., all of whom were searching for higher yields since the "normal" bond market was paying a pittance, thanks to "Easy Al" Greenspan.
Now, slowly and carefully, let's see who holds the risk. CountryWide, among others, was generating billions of dollars of mortgages each month (I believe at the peak, that one firm generated over 25% of all the new mortgages in the US that year). They would spin those new mortgages into a package and sell it off to an IB for a small profit (1-2%). At that point, CountryWide's risk was ZERO; the IB now owned the obligation, and CountryWide had received all the capital it had loaned out, and then some. (Note that with the curious US custom of "points", people paid a fee of 1-2% on the original mortgage as well; for example, to get a $250k mortgage, the person would sign for $250 + 2 points, or $255k total.) Within a month, CountryWide could generate a 3% return on their money, have their original capital back, and have ZERO NET RISK. No wonder they tried to give mortgages to anyone with a pulse.
What happened at the IB's? Same thing basically, it just took a few weeks longer to convince the pension funds and CB's to buy what the bankers at Goldman Sachs and others gleefully referred to as "toxic waste" internally, but "AAA rated" to their customers. (And the brokers pocketed billions of bonuses for doing so.) After the package had been sold to the customers, what was the IB's risk? ZERO, again. They'd received their money back, and then some. The incentive for both the mortgage brokers and the IB's was exactly the same: lather, rinse, repeat, as often and as quickly as possible. At 3% per month, CountryWide was making over 40% on its original equity each year. Neither cared about the credit quality of their borrowers because NEITHER WAS GOING TO HOLD THE BAG.
So who was left holding the bag? The pension funds and the CB's, as usual. They're the ones who woke up one day to find their "AAA" bonds were essentially toilet paper.
Contrast that to Canada. All the big banks own almost all of their mortgages. They have a vested interest in making sure: 1) borrowers aren't getting in over their heads to start, 2) that there's a cushion for the bank in terms of money loaned vs. property value (i.e. the downpayment), and 3) that the bank has clear title to the property in the event of trouble. Those are the primary reasons that Canadian defaults are so low, and we don't have a "subprime" crisis; our banks didn't make "subprime" loans.
Simple solution to the US problem: make any mortgage originator, including 2nd, 3rd, or "home equity loans" hold at least 50% of the principal until maturity or payout. Watch lending standards rise overnight. That single change, with or without changes to interest deductibility, would ensure more prudent lending going forward, and reduce the possibility of another housing "bubble" to virtually nil.
RFC might be operating under a mistaken assumption. In Canada your primary residence is tax free when it is sold, unlike the US where its capital gain is taxed when you either buy a house of lesser value or do not purchase another house (on death or otherwise)
In the Us you are still paying for the house with after tax money, its just the interest you get to deduct. It sets up a perverse incentive to carry as much debt, as opposed to equity, in the house as you can cash flow.
In Canada, the interest on a loan for a second property/investment property is tax deductible but the gains are taxed (like any other investment). The irony is the rates of home ownership are essentially the same, just the US inflates its market, and the physical size of its housing stock and or land owned, by providing a tax incentive to do so.
finally, it is an enormous drain on the treasury, and it doesnt acheive any higher rates of home ownership. So the free market US subsidizes home ownership with perverse results. Proof again the government should avoid these things.
I didn't read the article, I'm just waking up and getting my caffeine.
Does he make a passing reference to the subprime mortgage issue?
I think that there is an important distinction between the situation in the U.S. where banks were forced to give mortgages to unqualifiable people who wouldn't get them here in Canada.
The housing bubble was caused by the subprime mortgages more than any other single factor.
Our banks have not had the problems because Canada has not had the housing colapse that the US did. As a Canadaian I would not get too cocky as what ever can not continue won't.
http://www.thestar.com/news/canada/article/755588--vancouver-is-the-most-expensive-housing-market-in-the-world-report
When the housing markets correct the loan write offs will come.
Kevin... did you notice the cities listed have a propensity for a particular political party?
When I got a mortgage back in the early '90s the contract specifically stated that in the case of a default that the borrower would be on the hook for the difference between what the bank resold the home for and the monies owed on the mortgage.
The wording in the contract was designed to overcome the spate of mortgages that were basically walked away from here in Alberta during the NEP where borrowers would sell their homes to friends for $1 and then declare bankruptcy.
Mr. Koza's article is good, but he's not entirely correct on the deductibility of mortgage interest in his example of a house bought for $250,000, but now with a $750,000 mortgage. Only the first $100,000 of mortgage principal in addition to the balance of the initial loan carries interest that is deductible. So, for example, if the homeowner had borrowed $200,000 to buy that home for $250,000, paid the mortage down to $180,000, and refinanced for $350,000, only the interest on the first $280,000 would be tax-deductible.
Why wouldn't I like the PDF?
What's with lords of the universe Google and their PDF viewer? I am confused.
What's wrong with the PDF, I like PDF okay, I am not sure if I like Google. They are are getting scary. They are moving into everything like Obama.
It's not safe or conservative lending/credit policies that will save our currency/economy. We still have a debt-issue monetary system which has unsecured reserves based in other currencies. When the currency supplies of your reserve funds are inflated by over printing, your own currency is effected. This is what is happening to bretton woods economies now.
Canada will not escape if there is further US or global currency collapse because we foolishly are hooked into the whole rotten Bretton Woods arrangement. We gave up our economic sovereignty to do it and all we got for our sacrifice was endless peak and valley economic cycles, a depreciating currency and an intractable national debt caused by Keynesian spending in low business cycles.
We'd be foolish to get in deeper by surrendering all our economic sovereignty to a new G20 deal that puts our national economy and our currency in the rapacious clutches of the IMF.
It's time the loony stood as it's own currency standard. Issued by government and backed by tangible resource reserves. It would rid us of the need for centrally planned/controlled economy and Keynesian-collectivist government spending. It would free this nation to seek its economic potential. We need to realize that these people we sit across the table at G20 meetings are NOT our friends and benefactors - they are our competators. We don't need to give them the power to meddle with our currency.
I read the article and it is just demo/socialist/obamist spin to lay the blame of the Clinton mortgage bungle on a republican....any republican.
Oz and Fly have it pretty well pined.
FTA:
I’ve always had difficulty getting my head around policies designed to “make homes more affordable” which in practice make homes more expensive by bidding up their price. . ."
I have the same problem.
People have been talking about record low interest rates making homes affordable. They don't make homes more affordable, they just push some of the profit from the banks to a previous homeowner or builder.
I would like to know how our current "record low" interest rates will still have been a good thing when people go to renew their mortgages with less than 20% of the principal paid off over the next 5 years, rates are suddenly double what they are now and homes are worth less as a result.
An earlier comment of mine seems to be held up in moderation, so here goes, including the old one plus some other points:
RFC might be operating under a mistaken assumption. In Canada your primary residence is tax free when it is sold, unlike the US where its capital gain is taxed when you either buy a house of lesser value or do not purchase another house (on death or otherwise)
That was true in the US until the mid-1990s. Now, the taxpayer is entitled to an exemption of U$250K (if filing as single) or U$500K (if filing as joint; I don't know what happens in the case of a married couple filing separately); above that amount, gains are taxed as capital gains. There are some other qualifications in terms of how long you've lived in the house, but the simple version is that if you lived in the house for two years as your primary residence before selling it and you haven't used the exemption in the current year or previous calendar year, you get the exemption. I've done it twice myself, although, unfortunately, for amounts much smaller than the exemption.
Also, not all interest on home mortgages is tax-deductible. Interest on the original mortgage is deductible to the extent that the original mortgage doesn't exceed U$1 million. Any debt secured by the house after that point is deductible to the extent that it doesn't exceed U$100K. So if, as in the linked article, a taxpayer bought a home for $250K and borrowed $200K, interest on the $200K would be tax-deductible. If the taxpayer paid the mortgage down to $180K and re-financed for a new mortage of $500K, only the interest on the first $280K of debt would be tax-deductible.
K Stricker,
Excellent question, yet when I was lending in the late 80's and early 90's we qualified people only on the three year rate, even if they were taking less than a 3 year term.
I believe the banks lately have been qualifying based on 5 year rates. At least the smart ones are. And I agree with you that downpayments need to be no less than 10% (if it is insured) and ideally is 20%.
Nothing wrong with buying less than your dream house as a first house...but unfortunately thats what it has to be now, young couple buying some 3200 sqft home to start! Ridiculous.
If thats what people want then fine, just dont expect the taxpayer to subsidize, or protect you or your lender.
I would add one more difference between Canada and the US that explains Canada's superior financial position. To my knowledge, the Canadian parliament has never pressured its banks into lowering their loan criteria in order to increase minority home ownership. Paul Krugman, Barney Frank and most Democrats will never mention that.
To add to RSP's comment: Jimmy Carter implemented the 1977 Community Reinvestment Act in the US, which basically forced the banks to give loans to people who wouldn't normally qualify for mortgages. The risk was heightened and leverage increased by Clinton's 1995 revisions, which allowed banks to package up the CRA loans and sell them on the secondary mortgage market.
I'm no big fan of Bush's fiscal policies, but in 2003 the administration did try to put some control on all this, but it was shot down by the Democrat-dominated Congress.
I think Canada could still go down with the US and the rest of the world, but our banks didn't experience that kind of government interference.
I think Canada could still go down with the US and the rest of the world, but our banks didn't experience that kind of government interference.
~Seanstr
Yes, we could and probably will.
On the bright side, though, we'll go down last and come up first.
Additionally, I'm looking forward to socialism finally getting the discrediting it deserves.
People are still depending on the Nanny welfare state to make everything okely dokely and they're in for a long awaited wake-up call.
I can already smell that coffee brewing.
Yum.
"[It] seems to me that our hypothetical US homebuyer, let's call him Joe House, was exhibiting perfectly rational economic behaviour. Joe was responding to incentives put in place by the US government."
Lest we get too carried away with ourselves up here in the Great White North, this item caught my eye today in the National Post:
http://www.nationalpost.com/news/story.html?id=2605456
"The rules... allow people to continue to be involved in tobacco growing, even though they collected a quarter-million dollars of taxpayers' money to do something else."
Seems our tobacco grower, let's call him Joe Tobacco, was exhibiting perfectly rational economic behaviour. Joe was responding to incentives put in place by the Federal government.
Seems our tobacco grower, let's call him Joe Tobacco, was exhibiting perfectly rational economic behaviour. Joe was responding to incentives put in place by the Federal government.
~JJM
Wow! As many as 100 tobacco growers who had successfully farmed tobacco all their lives opted to continue what they had already been doing all their lives and take a no strings attached government handout out of $275K.
That's just the same as the 100s of thousands of Americans who, having never owned their own house before because they were bad with money, took government guaranteed loans to buy a house they couldn't afford to buy before their subprime loan.
Well, maybe not exactly the same.
Maybe not even similar actually.
Not similar in scale or situation or even overall result after I pondered it awhile.
Was there a tobacco bubble I missed?
Maybe the tobacco growers were a discriminated minority?
The larger point which the AIMS article makes is that nation's which make foolish policy decisions, will pay the piper. The US' extremely foolish decisions re the housing market ( 0% Fed interest policy, FNMA buying 0 down mortgages, no doc mortgages, mortgage interest deductibility, etc, etc.)have brought extremely severe repercussions. The perverse incentives Congress established by pandering to the National Assoc. of Homebuilders, the Realtors, and, most of all the prospective American homebuyer, have created a self-perpetuating problem that may never be fixed, but will instead recur in another few years.
America will profit by studying, and emulating the many sound features of Canadian lending which make their model sustainable, and obviate the need for taxpayer bailouts of credit addicts, whether they be homebuilders, realtors, or homebuyers.
Assuming the government sector does not grow relative to the rest of the economy, the free-market strengths of the Canadian economy ( rational, unsubsidized risk-taking, lower corporate income tax rates, a sober, skilled workforce ) will afford Canada the opportunity of significantly greater economic growth in the near and long term, as more and more firms establish in Canada to sell into the US market, and overseas markets. As an earlier post intimated, Canada, does not need to look to the G20, or elsewhere to sustain its prosperity. It has all the necessary ingredients of growth, and rising incomes, if government stays at the periphery.
our built in minority (Canaduh) has difficulty buying houses because there is no split title on reserve lands. no title , no caveat, no way of holding the morgagee accountable. no mortgage.