The canadian housing market bubble

The banks are doing what the banks do best in this situation, make money for their shareholders.

The banks make money off the interest they charge for loans. Actually, they make their money on the DIFFERENCE between the rate that they pay (the prime rate) and the interest rate they charge for loans.

In times where interest rates are higher, small business loans prevail, because although business loans are fewer in number and lower in value, the higher margin on rates makes those loans more palatable.

In a low interest rate environment, the bank has to do two things to make money:
1) increase the amount of the loan (the principal) and
2) increase the number of loans.

This strategy only works if the two conditions are met. The first adds risk, while the second (appears to) reduce risk through (seeming) diversification.

The risk is further diminished by CMHC, which underwrites the principal of residential mortgage loans, so that in the event of default, the banks only lose the outstanding interest on the mortgage, not the principal itself, which the bank had to borrow at prime, anyway.

The point is that as the residential market rolls over, the banks will be well motivated to extend the terms on residential mortgages to “good” customers who have a history of making payments, to keep collecting that interest.

For “delinquent” clients, the banks will cut their losses, foreclose, and claim the insurance from CMHC. And CMHC only pays the difference between what the foreclosed property sells for, and the amount of principal remaining on the loan.

Also, the banks can’t claim insurance, if there is no mortgage insurance in effect, so anyone with a loan to value less than 80%, will be sure to get every opportunity to pay more interest, instead of being forced into foreclosure.

The interesting thing will be to see what happens to CMHC in a few years, when falling property values cause loan to value ratios to soar, from below 80% to above 100%. Will mortgagees be forced to buy CMHC insurance on renewals, in lieu of making large balloon payments?

You betcha. Who wouldn’t add $10k in CMHC premiums to their bill at renewal time (amortized with the principal at a profitable interest rate), if the alternative is to write a cheque for $100k to make up the difference at renewal.

It’s not that the banks will fail in the event of a housing crash, it’s that generations of homeowners will be bled dry by degrees, trying to keep up with their interest payments.

Interest payments being pure profit for the banks.

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