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A decade after the housing crisis, Australia and Canada hope to avoid a repeat

Just before the U.S. subprime meltdown triggered a global financial crisis, housing markets in the U.S., Canada, Spain and Australia appeared similarly overvalued. Ten years after the crisis, each market offers lessons in the diverging paths followed since.

Why housing prices crashed in some countries but appreciated in others hinges on traditional economic fundamentals as well as the structures of housing finance systems. While the causes and effects of the 2008 financial crisis will be debated for years to come, some trends have emerged. Housing markets that crashed experienced a crush of speculative activity, and a drop-off in homebuyer interest triggered a collapse in home prices. Meanwhile, overvalued housing markets that persevered through the crisis featured more consolidated housing finance systems dominated by a small number of lenders that answer to stern regulators.

Lessons learned

Housing finance systems for both the U.S. and Spain feature significant government involvement. U.S. home buyers can take advantage of 30-year, fixed-rate mortgages, a unique product by global standards made possible by Fannie Mae and Freddie Mac, quasi-public entities forced into taxpayer-funded conservatorship as part of the 2008 crisis. In Spain, the country's constitution guarantees citizens a right to housing, a mandate that led to extensive subsidies for a class of "protected housing." Combined with regulation on rental leases, the nation has high homeownership rates and a limited rental supply.

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In both Canada and Australia, the government is less involved in housing finance although regulators maintain an active role. Lending standards in the two countries never loosened to the extent seen in the U.S. For example, negative-amortization or pay-option loans — mortgages in which the borrower does not have to pay for all accrued interest, resulting in a growing balance each month — never gained traction.

"There was a different regulatory structure in Canada. And maybe even more important, there was always a more conservative culture in the Canadian financial sector," said Robert Hogue, a senior economist for Royal Bank of Canada.

Unlike the U.S., where Fannie Mae and Freddie Mac enable long-term, fixed-rate mortgages, most borrowers in Canada and Australia have to rely on variable-rate mortgages. Analysis from 2009 put the share of variable-rate mortgages in Australia at 85%. The Canadian market is dominated by mortgages with fixed-rate terms that expire after five years, although the mortgage is amortized over 25 years. As interest rates appear to be on the rise, homeowners with variable-rate mortgages could face a jump in housing payments.

Homeowners in Canada and Australia could be in a particularly tight bind if home prices start to decline. Both countries have seen continued price appreciation, reaching levels above the U.S. peak on a price-to-income basis. In an attempt to cool their heated housing markets, regulators in the two countries have taken aim at underwriting standards and foreign investors.

In December 2014, Australia's principal banking regulator informed depositories that it would apply additional scrutiny to high-risk mortgages, such as those with little equity or interest-only payments. And in April 2017, the provincial government in Ontario, home to Canada's expensive Toronto market, implemented a 15% tax on foreigners speculating on real estate. British Columbia and its Vancouver market have a similar measure.

"Everyone learned from the U.S. experience," Hogue said. "You can't ever let up from a supervisory perspective."

The U.S. housing crash also illuminated the dangers of risk layering. Risky components of mortgages, such as self-reported income, low down payments or junior liens, do not make for an inherently dangerous product. However, when the risks are combined in a single loan, the results can be toxic.

"It's like calling a sports car dangerous. It's a question of: 'Are you going to drive it at 200 miles per hour on a rainy day?'" said George Ratiu, a research director for the National Association of Realtors.

With those lessons in mind, Canada's regulators require that lenders stress test borrowers to ensure they can afford a mortgage with an interest rate 200 basis points above the contract rate.

Hogue said he thinks the measures to cool the heated market could work. Barring a recession, he expects regulators to successfully usher the nation’s housing market to a smooth landing, a term for stabilization after rapid appreciation.

Back to fundamentals

Amid the crisis' aftermath, the U.S. housing market experienced a robust price recovery. By 2013, the national index was up double digits on an annual basis, surpassing the rate of appreciation in Canada.

Analysts attribute the return of such appreciation to supply-demand dynamics. Homebuilders essentially ceased building new homes while the U.S. continued to grow demographically and the jobs market recovered.

"Beginning in about 2012, we started to have a mismatch between the growth in demand and the slow rebound in supply so we've seen home prices appreciate significantly," said Michael Fratantoni, chief economist for the Mortgage Bankers Association.

Additionally, government programs in response to the crisis focused on keeping delinquent borrowers in their homes, further limiting supply. And banks that did foreclose on homes were not interested in becoming real estate management companies, selling foreclosures by the thousands on the cheap. That encouraged a new business model from some private equity giants: single-family rentals. The result was a constrained supply of detached, single-family homes for sale in a recovering economy.

"The regular ebbs and flows of people being delinquent and putting up their homes for sale didn't materialize in the normal course," said Guy Cecala, publisher of Inside Mortgage Finance.

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The Spanish housing market's decline was not as rapid as the American experience, but the housing market has languished and has not recovered since the crisis. The U.S. market was well into its an appreciation rebound by 2012 with 5% year-over-year growth, a year in which Spain was still at the depths of its housing recession. Nonperforming loan ratios followed a similar course, peaking in 2013 at a level above the U.S. and remaining high through 2016, checking in at roughly triple the U.S. ratio.

Price declines have been so severe that the Spanish government has backed off its subsidy programs; local news reports show that free-market housing is now available at lower prices than the government-protected housing. New builds under the program have fallen off a cliff: In the last 12 months ended September 2017, the most recent data available, there were roughly 4,350 government-protected units built, compared to about 81,000 units built in the 12 months ended September 2009.

Exotic financial instruments and aggressive mortgage underwriting deployed in the U.S. might have played a significant role, but consideration of the U.S. recovery and a global view of the financial crisis serve as reminders that supply-demand fundamentals ultimately drive markets. Whether Canadian and Australian housing markets can successfully transition from rapid appreciation to a stabilized norm could hinge on the ability of borrowers with variable-rate mortgages to refinance in a rising-rate environment.

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