Canadian housing's trillion dollar baby
By Peter Diekmeyer • Bankrate.com

What a difference a year makes. Last year at this time, the Canadian housing market was in a deep funk. Fear stemming from the US sub-prime loan and economic crises flowed north. And locals, worried about their jobs and stock portfolios, battened down the hatches. Existing home sales plunged, as did average selling prices.

But just 12 months later, almost all of the numbers that were down are trending up again. And while no one knows just how long it will last, recovery seems at hand.

There are several reasons Canada's economy and its housing sector bounced back so quickly. For one, Asian economies, many of which never suffered as badly during the recession as the United States and Europe, continue to demand vast quantities of Canadians resources. Unlike the United States, Canada also benefits from the fact that its armed forces do not drain away between five and nine percent of its Gross Domestic Product (GDP) each year.

However, the biggest reason Canada has done so well is the relative strength and sound management of its mortgage and banking industry, which the World Economic Forum has rated as the soundest in the world. In fact, according to one forecast, that industry is about to get a whole lot bigger during the coming year.

Comparing the US and Canada
Last week, the Canadian Association of Accredited Mortgage Professionals published the fifth edition of its Annual State of the Residential Mortgage report. In it, Will Dunning, the organization's chief economist, predicted the mortgage market will surpass the $1 trillion mark by this time next year. That's almost as much as Canada's entire GDP this year.

A sound mortgage industry is a key component of a strong housing sector, which needs a steady supply of cash to fuel demand for its products.

However, according to one expert, while mortgage lending in Canada is big business, it is generally done far more prudently here than in the US. Canadian financial institutions did not fall into the trap of forwarding money to as many doubtful borrowers as did American financial institutions. This conservatism meant Canadian financial institutions generally avoided the huge write-offs taken by their southern cousins. They are thus now better able to maintain lending to consumers and most importantly to the small businesses, which create the lion's share of new jobs in the country.

"The incentives are different," says Paul-Andre Pinsonneault, a senior fixed-income economist at National Bank Financial. "In the United States, mortgage interest is tax deductible. That means consumers have a strong motivation to borrow money against their house to finance non-housing purchases such as automobiles and other durable goods."  For example, if an American takes out a car loan, his interest payments are not deductible. However if he borrows $40,000 against his house and then uses the cash to buy an SUV, he can save hundreds, if not thousands, of dollars in interest payments.

With those kinds of incentives to borrow and spend, it should come as no big surprise that Americans do just that. As a result, Americans tend to have far smaller equity stakes in their homes than Canadians do. For example, at the end of the second quarter, home equity as a percentage of total real estate value was just 43.1 percent in the United States compared to 67.79 percent in Canada.

Swimming naked
However, there is an old expression in finance: "it is only when the tide comes in that you find out who has been swimming naked." It turns out that when times were good, and house prices were rising, Americans somehow managed to juggle all of their payments yet at the same time keep consuming at a frenetic pace. But when times got tough, Canadian families benefited from a far better financial cushion, a key reason that default rates on residential mortgages stand at just 0.43 percent here, compared to 3.67 percent south of the border.

It's a lesson Canadians would do well to remember. Last month the average value of homes traded via the Canadian Real Estate Association's Multiple Listing Service rose by a stunning 22 percent compared to this time last year to $373,000. As a result, Canadians have become increasingly optimistic about their real estate investment prospects. Fully 40 percent of them expect that house prices will increase, more than double the total of those surveyed this spring. Only a small minority expect house prices to fall, and the rest expect prices to remain stable.

But before Canadians rush mindlessly to borrow more money to buy new properties, or to upgrade existing ones, they ought to keep in mind the benefits that a conservative financial attitude has brought them so far.

Peter Diekmeyer [http://www.peterdiekmeyer.com] is Bankrate.ca's economics columnist.