OSFI’s Melessanakis Asks “Are Canadian banks equipped to handle a 40% drop in home prices?”; Mortgage Broker McLister Retorts “The idea of 40% price drops is ‘farcical’”

Previous failures of Canadian financial institutions were due to bad real estate lending and sharp falls in housing prices, and these can happen again, Vlasios Melessanakis, manager of policy development at the Office of the Superintendent of Financial Institutions, wrote in documents obtained by Bloomberg News under freedom-of-information law. …
“Canada is not immune,” Melessanakis wrote March 21 in internal notes responding to a posting on a mortgage-industry website. “Just because nothing happened in Canada in 2008 (a U.S.-centered crisis), does not mean that Canada is not vulnerable to a housing correction now.”
Melessanakis wrote his comments to colleagues in response to a posting on a mortgage-industry website, Canadian Mortgage Trends, that criticized proposed standards published by Canada’s top banking regulator on 19 Mar 2012.

Ottawa-based OSFI suggested requiring lenders to take “reasonable steps” to verify borrower incomes, establish standards for measuring borrowers’ ability to pay their debts, and limit the size of loans secured by the equity in people’s homes. The draft guidelines are based on mortgage-lending principles set by the Financial Stability Board, a Basel-based group that coordinates global financial rules.
“How many new lending ‘guidelines’ can the market bear before it breaks?” wrote Robert McLister, a mortgage planner who edits the website.
“The market may break because the fundamentals are not sound (i.e. overvaluation of homes), not because of OSFI guidance,” Melessanakis wrote in response.

There’s “no question” the proposed OSFI guidelines will curb demand and hurt housing prices, McLister said in an interview. “OSFI had good intentions here, but some of this policy is certainly misguided,” he said, when asked to react to Melessanakis’ comments.
McLister pointed to banks’ low arrears rates on mortgages as evidence more rules aren’t needed. Melessanakis wasn’t convinced.
“This can change fast,” he wrote in his notes. “Are the banks equipped to handle a 40 percent drop (what occurred in Toronto market in early 1990’s)? Need to stress test to find out.”
McLister called the idea of a 40 percent decline in housing prices across the country “farcical.” Such a decline is “not going to happen, period. But in some places like Vancouver, maybe Toronto, obviously you’re going to have greater risk there of price volatility,” he said by telephone.

OSFI’s guidelines suggest lenders limit home-equity lines of credit to 65 percent of the property’s value. The regulator also recommends that HELOCs be paid off over a specific amortization period, like conventional mortgages.
While McLister wrote that those rules “portend a big slowdown in HELOCs,” Melessanakis responded that the loans have “contributed significantly to growing overall household debt.”
“This is not sustainable,” he wrote. “If (or when) housing prices drop, households will be vulnerable,” echoing comments made by Flaherty and Carney.
Melessanakis also disputed McLister’s point that many of OSFI’s recommendations are already employed by “scores of lenders.” “Not all, and not on a consistent basis,” the OSFI official said. “There are some enhancements in lending practices that are needed.”

– from ‘Banks Not Immune to Housing-Related Failures: Corporate Canada’, Bloomberg, 15 May 2012

Forty percent off is a fair downside target, but we see it going lower.
The ‘farcical’ quote will be archived in the ‘Bull Hubris’ sidebar, for ease of future reference.
– vreaa

24 responses to “OSFI’s Melessanakis Asks “Are Canadian banks equipped to handle a 40% drop in home prices?”; Mortgage Broker McLister Retorts “The idea of 40% price drops is ‘farcical’”

  1. 40% drop ??? Preposterous the masses screamed ! Never in La La Land ! The message was just delivered loud and clear, it’s all over suckas.

    • In Vancouver, we’ve already done a quarter of the way. A couple more years and we’ll be there, and three more years and we’ll pass the -50% bar. I don’t see how we’ll be able to avoid that fate…

      • It will be sooner then four years I can assure that, because this time, not like in 2008, there is no interest rate buffer to restore confidence. http://i48.tinypic.com/6ezzp5.png

        Buckle up, it’s going to be a hard hard landing.

      • @CW, as I said below, my prediction is a -55% from peak to trough in Vancouver. I think Vreaa said between -50% and -66%.
        I believe by the end of this year, we’ll already be at -15% to -20% and slowly but continuously go down from there. Lots of people will try to catch the bottom all the way down, they’ll get slaughtered as well. RE speculation is like a drug, it’s really hard to get out of the addiction.

      • I’m just saying, we’re heading into the abyss with no rates to save us.

  2. 40% off the average is devastation. That means some neighborhoods can see more. Scary

    • My very own estimate is -55% from peak to trough in Vancouver. Yes, it’s going to be bloody on an epic scale. People just don’t realize yet what’s coming. There is no economy to support the current RE valuation here, and once the market crash, the economy will be in an even worse shape.
      Lots of people will move out of Province to find jobs, investors will avoid BC like the plague. All of a sudden, nobody will talk about lack of land but everybody will complain about the ghost condo towers… There writing is on the wall for those who just want to see!

    • Renters Revenge

      Plus the impact on the banks as indicated in the headlined article, that alone could be catastrophic for the general economy. Lending freezes up, businesses lose access to credit, people lose jobs, property tax revenue drops off a cliff, government cutbacks, etc, etc. It really is not going to be pretty.

  3. Thai-born Chinese Canuck

    Nationwide, yes, 40% drop is definitely farcical. But it won’t be farcical for Vancouver and Toronto. To me, a basement suite for $500K was unthinkable and shocking the first time I learned of it. Let alone the $900K in the west side. Unlike Asian countries, Canada is such a vast land mass when compared to its population size.

    • Agreed. This article is talking the national average. Vancouver is a whole different ball game. I’m pretty bearish on Canada RE as a whole and I think -30% is about as low as we will go. Vancouver? Who knows. That one could hit -60%.

  4. He said 40% across Canada. While I don’t think it is farcical, it is at least improbable.

  5. So the average house price drops from 1 million to $500,000 (by most bear estimates). I wonder how many would view that as a reasonable price to pay for a SFH? Especially in a bad economy?

  6. 70-85% when all is said and done.

  7. Well, in Detroit, you can buy a house for less than a car. So I suppose drops can go pretty deep. Does anyone know what average/median prices were at their height?


    I’m not smart enough to figure out what’s going to happen to Vancouver.

    • That’s so droll.

      In other news contradicting, “farcical”… our Quote ‘O TheDay!…

      “It happened twice in the last month. One [deposit] was $75,000 and one was a $20,000 deposit, the guys just walked away from it,” said Mr. Arora, who runs Oneflatfee.ca in Surrey, B.C. “They are going to wait it out. So they lost $75,000 and $20,000, but if the market comes down $150,000 on a $1.5-million house, that’s not uncommon.”

      [G&M] – Vancouver’s real estate swoon deepens


      Cue the “We told ya so’s!” – StageLeft

  8. Okay, so agree: if we’re talking about 40%-off nation-wide, I’d (like RD above) say that’s unlikely, but definitely not ‘farcical’ to contemplate.
    For Vancouver 40% is a highly probable size of price reduction, and we estimate highest probability is it’ll be larger (50%-66%, as noted above).

  9. Thai-born Chinese Canuck

    The more the risk is insured, the bigger the moral hazard. It is ironic but true.

    Check out this article about Fannie Mae & Freddie Mac.


  10. surprising finding people finding this surprising … more like … well, uhhhh !!! oop ack!

  11. This is another fine example of the feds trying to control every aspect of our economy. They engineered it up and are attempting the same going down. We should know within a year how successful they were.

  12. taking all bets.
    We will not reach 40% off in Vancouver. Any takers can e-mail me at centrinoblue@hotmail.com
    Please indicate (by way of your total wager) how confident you are of 40% discount. This is for total benchmark price including all property classes in the City of Vancouver (no suburbs).
    If I hear from one of you squawkers

  13. Gerry Beauregard

    Some historical perspective here: http://www.renthomas.ca/wp-content/uploads/2010/09/Canadas_Housing_Bubble.pdf
    I don’t know how authoritative it is, but it says that after the late 1980s Toronto bubble bursts, the “sale price for a standard condominium in Toronto dropped by, on average, 39%. All other housing classes were relatively uniform, losing approximately 27% of their value, with luxury condos losing slightly more, at -32%.”

    Given numbers like that, and what happened in the US, postulating a 40% drop across the market in Canada doesn’t strike me as farcical. Worst-case, perhaps, but not impossible.

    Peripherally-related: some people are so poor at math that they don’t realize that percentage increases and decreases cannot simply be added up. It takes a smaller percentage drop to wipe out a prior larger increase. Consider this: a 40% drop in prices corresponds to the undoing of a 67% price increase: (1 + 0.67) x (1 – 0.4) ~= 1.0

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