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Lessons from Canada’s Mortgage Market

Canada appears to have avoided the fate of its neighbor to the south for two reasons. First, Canada’s regulated lenders and financing channels were supervised fairly well, and were not allowed to jump into the exotic mortgage products that proved so disastrous in other countries (such as interest-only mortgages, negative-amortization mortgages, or “liar loans”). Second, Canada did not experience a massive influx of unregulated mortgage financing or lending.

But why did Canada not experience an influx of unregulated mortgage lenders and financing vehicles? At least one important reason appears to be the relative benefits provided to regulated Canadian lenders. Regulated lenders in the United States seeking to reduce their capital levels and raise their return on equity had strong incentives to avoid regulation and to sell their loans to securitization conduits.

In contrast, Canadian lenders benefited from government-backed mortgage insurance, which was only available to regulated entities. Because Canadian mortgage insurance provided capital relief, there was significant incentive for lenders to be regulated, and among these regulated lenders, there was little attraction offered by private-securitization conduits. As a result, Canadian lending was almost entirely well regulated, and so did not experience the deterioration in underwriting and risk analysis that characterized U.S. lending over the same period.

The key lesson Canada appears to teach us is that regulated, government-supported mortgage finance leads to greater sustainability and stability than its unregulated, purely private counterpart.

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