Sunday, June 24, 2012

A Response to the Mortgage Industry and those who think Flaherty's actions were Foolish.

There are some who are already starting to blame Flaherty for the housing correction- even though it started a year ago in Vancouver and has not yet started in Toronto. The complaints from the mortgage industry over his efforts to tighten lending have been very loud. The reply to these complaints is a simple one.

John Hussman, a first rate money manager, had it in in his recent commentary. It actually came from Angela Merkel, the Prime Minister of Germany and one of the few politicians who 'gets it'.

German Chancellor Angela Merkel explained the entire situation in five words: "Liability and control belong together." This is a profound phrase, because it also summarizes how the U.S. got into the housing crisis - the government deregulated the banking system and abdicated proper control, while still assuming the liability through deposit insurance and other government backstops. Liability without control leads to disaster.

It is an obvious concept. If you accept liability for a transaction, you must also have full control over it. To put it simply, if you agreed to co-sign for a friend/ sibling etc on their mortgage, you would want to set the term, watch his/her finances carefully, make sure they paid in time so forth.

What the US had which was such a catastrophe for them, was a deregulated lending market ; zero down, money back, teaser rates, document-lite loans etc and yet the Government was taking all the hits via Fannie and Freddie.

This has been one of the major flaws of the current market driven, deregulation capitalism that we have, but I will discuss that further in another post. 

We had exactly the same situation in Canada. The banks and lenders were getting ever more 'imaginative' to get people into over-priced housing and passing the risk onto the Government.

Rather late in the game Flaherty has realised that to transfer the liability to the tax-payer he MUST exercise some control. Maybe he understood what Angela said. Of course there are people complaining. Some are calling it a folly. Where does it say in the Charter of Rights, that we have a right to borrow more than a sensible lender would lend us WITHOUT tax-payer insurance??

Where does it say that you have a right to buy your high leverage multimillion dollar house and if you default the tax-payer, many of whom have decided to rent and live more modest and prudent lives, have to pick up the tab?

To the mortgage industry I would say, I understand your anger and concern, but you have had over a decade of excellent returns even as the risk to Canadians and the Government has become more precarious.

Eventually everyone who feeds from the public trough has to pull away (or be pulled away) some time.   Some very wealthy doctors in Ontario are learning that, civil servants in Ottawa are learning that and others will in due course.


  1. Excellent commentary and almost spot-on.
    A big point missing, however, is that a great deal of the stupidity in lending in the USA was not at the time backstopped by the government at all, that came later. Instead it was "insured" by entities such as AIG who didn't have anywhere near the capital required to cover the liability.

    If I enter a contract that everyone knows I don't have a chance of fulfilling it's called fraud, when they do it they get bonuses and then a bailout when TSHTF. Fraud was rampant on all levels, and no-one has been charged. There is sworn congressional testimony from a high-ranking risk compliance officer at Citibank that in 2006 60% of their mortgage didn't meet all-ready loose underwriting standards and in 2007 it rose to 80%.
    That is called criminal fraud, and with the ratings agencies compliance it rises to racketeering. Very serious jail-time, yet not a single charge, just a chorus of "whocouldanode" and "no laws were broken".
    All that was without the explicit government backstop, so the basic premise of your post is flawed. Putting the foxes in charge of the henhouse is enough, the farmer doesn't have to sign a waiver.

    1. I think we could argue for ever about the many factors that caused the US debacle. There were many. Foremost amongst them IMO was the lack of oversight coupled with deregulation and implicit Agency liability assumption. The agencies owned or insured an enormous 56% of all mortgages written in the US or $5 Trillion+ when the government stepped in and took them over.

      Note our own CMHC is now at $600 Billion which is the same per capita.

      As to the fraud at AIG and the Big banks. I totally agree. No deregulation + incentivize risk + no oversight = huge losses. The assumption of these losses by the US government was IMHO criminal. Hussman says as much. The factor that no one at AIG has been taken to court, not Cussano, not Greenberg not the risk manager or board even though they clearly must have known that they were writing more credit default policies than they could cover is a sad reflection on our crony capitalism. The rich and well-connected rarely get nailed for their msideeds.

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  3. Fish, I think you meant to say No regulation + ... in the 3rd paragraph above. You have No deregulation. (If only...)

    1. Quite right egg. I got carried away!

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