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Moody’s Analytics calls it “mortgage meltdown math”, but the subsidiary of the ratings agency paints an ugly picture of what could happen to the Canadian economy if everything goes wrong in the housing market.

A report from Moody’s economist Brendan LaCerda says total outstanding credit to the non-financial sector is well above international averages with the government backing most of Canada’s mortgage insurance.

“Fortunately, the government’s finances appear healthy enough to sustain a large bailout in a severely adverse scenario,” writes LaCerda. “Canadians’ borrowing binge has put the economy in a precarious position.”

The non-financial sector includes households, non-profit institutions serving households and financial corporations excluding banks.

Moody’s says low interest rates have driven the demand for mortgages and homes and caused the increase in residential property prices. That has led to more expensive homes, forcing new home buyers to borrow even more.

“This cycle is inducing fears of a bubble. If a recession were to hit the economy, many households would find themselves with negative equity and reduced incomes, raising the spectre of a swell in non-performing loans as homeowners default,” the report notes.

The problem for the government is that although banks hold the loans, a little over half of all mortgages are insured by the Canada Mortgage and Housing Corp., which is 100 per cent backed by Ottawa. Two private companies, who hold the rest of mortgage default insurance market, are 90 per cent backed by Ottawa.

“Mortgage insurance is required for loans obtained with less than a 20 per cent down payment, which implies that the loans CMHC is insuring have a smaller-than-average equity cushion,” LaCerda states.

The analyst notes that the likelihood of a major downturn in the housing market is low and Moody’s Analytics own forecast shows that housing prices will slightly dip and then level off over the next year. “But supposing such a severely adverse scenario comes to pass, the ability of the government to absorb CMHC’s losses is worth considering.”

The report focuses on the rise of credit in Canada’s non-financial private sector and compares it to the international average. Based on data from the Bank for International Settlements for 42 countries, the average credit outstanding to the non-financial sector was 154 per cent of GDP in the first quarter of 2017, compared to Canada’s 217 per cent.

“Considering only the debt of households and nonprofits as a share of GDP, Canada ranks fifth highest in the world,” writes the economist.

The positives for Canada is it’s in relatively good shape compared to its industrialized peers with a debt-to-GDP ratio of about 79 per cent of GDP in the first quarter of 2017, says Moody’s.

“Even if CMHC realized a total loss on its more than $500 billion of insurance guarantees, which is nonsensical given the collateral value of the underlying homes, and the government completely bailed them out, its debt-to-GDP ratio would rise to about 105 per cent,” writes LaCerda. “Such an increase would raise Canada above the U.S. at 99 per cent but still keep it below many of Europe’s largest economies.”

In a scenario where all of CMHC’s insured borrowers made only the five per cent down payment and house prices fall 25 per cent, and all borrowers default, that would mean a 20 per cent loss of its portfolio and $100 billion government bailout. In that case, Canada would still have a lower debt-to-GDP ratio than the U.S.

“Government finances would face additional sources of stress during a severe recession, but the prior considerations do not even include the potential assistance from the Bank of Canada. On the other hand, a bailout for the private mortgage insurance would also be necessary. But their exposure is less than half of CMHC. A bailout of CMHC would be extremely costly and unpopular, but the rise in the government’s debt-to-GDP ratio would not put Canada on the fringe of the world’s economies,” the report concludes.

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The Ontario Securities Commission (OSC) said Monday that a survey it commissioned found 45 per cent of pre-retired homeowners in the province are relying on the value of their property increasing to fund their retirement.

“Owning a home is not a substitute for retirement planning,” said Tyler Fleming, director of the investor office at the OSC, which found homeowners without any retirement savings or plan are among those most likely to be counting on value of their home appreciating.

The survey found 76 per cent of Ontarians 45 or older own their home and among this group of homeowners, nearly 37 per cent say that they are relying on the value of their home increasing to provide for their retirement.

DBRS Inc. noted in a report out Monday that Canadian house prices are up about 230 per cent in the past decade but that wealth is far from a sure thing and the debt agency pointed out that in a span of less than six months prices in the Greater Toronto Area have plunged 31 per cent from their peak.

“Findings suggest a large number of Ontario homeowners, 45 plus (particularly pre-retirees) are replacing retirement planning with the belief that home equity gains will finance their retirement,” said the OSC, in its report. “This approach to retirement planning can be sustainable so long as residential properties maintain or increase in value. However, to the extent Ontarians 45 plus are overestimating their ability to finance their retirement using their homes, or if there is a downward pricing correction in Ontario’s housing market, a number of Ontarians 45 plus may be at risk of not meeting their retirement savings goals.”

The survey also found among those 45 plus Ontarians, who are not yet retired, 73 per cent own their homes — 38 per cent with a mortgage and 37 per cent without a mortgage. Among that group, 38 per cent have no investment savings.

The regulator said the research findings will be used to support the development of its seniors strategy, which the OSC has identified as a priority for its 2017-2018 fiscal year.

The survey was conducted between May 9 and 16, 2017 by Innovative Research Group and involved an online survey of 1,516 Ontarians, aged 45 and older. The results were weighted by age, gender and region using the latest Statistics Canada census data to reflect the actual demographic composition of the adult population aged 45 and older residing in the province.

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The Bank of Canada has already hiked the overnight rate twice this year, and many experts suggest even higher interest rates are on the way — but not everyone agrees when Canada’s central bank will make its next move.

BMO Senior Economist Robert Kavcic says another Bank of Canada move to increase the overnight rate, which influences mortgage rates, is “possible” this year but not the likeliest of outcomes.

“We’re kind of working on the assumption that they’re done until probably January,” Kavcic tells BuzzBuzzNews, predicting “a few more rate hikes in 2018.”

These would follow Bank of Canada hikes of 25 basis points in July and September that resulted in the overnight rate reaching 1 per cent, up from a historically low 0.5 per cent, where it has stood since 2015.

The Bank of Canada’s more aggressive monetary policy of late comes after seven years without a single hike. Kavcic suggests it is a result of “the economy getting back to potential.”

The hikes may pose problems for Toronto’s housing market, the BMO economist notes. Higher rates could extend and deepen Toronto’s home price correction, he adds, but says most markets across the country have been “very well behaved” and can handle an environment of higher rates.

Like BMO’s Kavcic, David Madani, senior economist for Canada at Capital Economics, doesn’t ignore the possibility of an October rate hike. But he offers another possibility as well — a scenario in which rates drop again.

“Given the potential for a disorderly unwinding of housing-related imbalances, we still think that this rate hike cycle is a gamble that might have to be reversed before long,” Madani adds in a recent report.

National Bank, Canada’s sixth largest bank, says the stage has been set for a rate hike in December.

“The bank wouldn’t want to be behind the curve,” Marc Pinsonneault, a National Bank senior economist, tells BuzzBuzzNews, outlining what spurred the first two hikes: the record-level rate of employment among prime-aged workers and the closing of the economy’s output gap.

The output gap compares potential economic output with its actual performance.

Pinsonneault says a home price correction in Toronto “won’t affect what the Bank of Canada does.”

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