Housing boom has legs: CIBC economist

Interest rates are not going to rise any time soon, says a leading housing market expert, but it’s incumbent upon homebuyers to ensure they can carry their mortgage even if rates rise 200 basis points.

Speaking before the Canadian Mortgage Conference and Expo in Toronto, hosted by The Canadian Association of Accredited Mortgage Professionals (CAAMP), CIBC senior economist Benjamin Tal made the case that rates will probably not rise until late 2010, which means the hot housing market in Canada, will likely continue well into next year.

“I don’t see the Bank of Canada raising interest rates well ahead of the U.S. because of the implications for the Canadian dollar. Can you imagine a situation where the BoC would raise interest rates, while the U.S. is neutral? The dollar would end up going to the sky. That’s exactly what the bank of Canada doesn’t want to see,” Tal told Advisor.ca.

“Therefore, we won’t see the switch the market is projecting; it very possible we won’t see a rise in rates until late in 2010 or early 2011. It will be longer than what the market is expecting. The situation in the U.S. clearly does not justify higher interest rates, not now and not anytime soon.”

U.S. time bombs averted

Eventually rates will rise. Tal argued the worst of the recession is over in the U.S., and discounted concerns over “four time bombs” related to U.S. debt, which market bears say will create another financial crises. Those four bombs are resets on Alt-A mortgages and Option Adjustable Rate Mortgages (Option ARMs), as well as concerns in commercial real estate and credit card defaults.

A large portion of the subprime mortgage crisis was caused by resets on teaser rate mortgages which renewed at higher rates that homeowners couldn’t afford. Many of these mortgages were sliced and diced and securitized in the debt markets, which caused a global systemic crash.

Similar concerns exist on Alt-A mortgages, which were sold at low teaser rates with a reset after the first five years. Tal points out most of the resets are coming due now, so the mortgages are resetting at the now historically low rates.

Option ARMs are little more problematic. These mortgages allow homeowners to pay interest only on their home purchase for set period. Eventually these mortgages reset and the homeowner must start making principle payments.

“Only 47% of the Option ARMs were securitized, which does not create the nasty side effects that subprime had. The huge portion that is not secured, which are on the balance sheets of banks, can be played with over time. It’s not really a mark-to-market shock. Not to mention that 50% of these mortgage contracts are for 20 years, not for five years.”

Tal adds, “The same goes for commercial real estate, which is mostly held by small banks. Already more than 127 banks have gone under in the U.S. this year, and I expect 300 to 500 to become insolvent over the next 12 months. Compare that to 10,000 banks in The Depression, and it’s not as serious a macroeconomic story.”

The primary factor that caused the subprime crisis — inflated home debt — seems to have dulled the impact of credit card bubble, Tal says.

“People turned to their houses as an ATM, you put debt on the house, instead of the card. We haven’t see a bubble in the credit card market and even if you allow for 11% unemployment, were talking about $90 billion [losses] in the U.S. credit card market, which is roughly what the banks are expecting.”

Not a bubble yet

There is growing concern that the low rates and the fast rise of home prices in Canada is causing a bubble, but Tal says this speculation is premature.

Tal says a combination of low rates and high consumer confidence, backed by a strong financial lending system, support much of the optimism in home buying.

“In Canada, consumer confidence is only 10% below the highs of 2007. In the U.S., it’s 50% below,” he says. “We have confidence and low external interest rates.”

His biggest concern is that homebuyers may have overleveraged their most recent purchase, and may not be able to afford the inevitable 200 to 300 basis point increase, which would mark a return to a “normalized” rate regime.

“I challenge the [mortgage lending] industry to come up with research to make sure we know what types of mortgages are in the pipeline,” Tal says. “We need to know how many people taking variable rate mortgages at 2.5%, who cannot afford financing a mortgage at 4.0 or 4.5%. If it’s a marginal number, then we’re not creating a bubble — we’re basically seeing monetary policy that is working.

“We have to make sure if you take a mortgage now, you have to be able to finance it 200 basis points higher after 2010. If you can’t, then you should probably buy a smaller house or don’t buy a house at all — that the prudent thing to do.”

Tal says he believes most lenders are running this basic risk analysis on prospective borrowers.

“I think everybody knows these interest rates will not last, even consumers understand this. That could be a reason why people are buying right now, this is a window of opportunity that will close in the not to distant future. I believe this will probably not close as quickly as people expect,” he says.

(11/23/09)