Christie's Real Estate Team

CIBC World Markets – StrategEcon

Containing Contagion

CONTAGION - When an economic crisis in one country's bond or equity markets spreads to other countries which experience the same problems. The term comes from the more general definition of contagion, which is a highly transmittable disease.

Just how damaging contagion effects will be to credit and equity markets remains to be seen.  Funding billions of dollars in the overnight market may not be the “Greenspan put” that the equity market had hoped for. However it is a strong commitment the central banks are not going to allow accidents in financial engineering threaten the economy. The Bank of Canada was leaning towards another rate hike, but with recent activity it appears this theory will be sidelined over the next few months. Modest US growth and a firm Canadian $ will be seen as sufficient anti-braking inflation forces.

The housing market will continue to suffer in the US and US mortgage arrears will get worse as interest rate resets on adjustable rate mortgages peak later this year. Despite the sufferings of our neighbour’s to the south, Canada’s own housing market has demonstrated extraordinary resilience.  We have seen a slight ease during the first half of 2007 compared to the same time last year, but the decline is only a fraction of the damage suffered in the US. Resale activity remains robust in Canada and home prices in Canada are charging ahead at roughly 10% per year. Building permits suggest starts could be still heading higher if it weren’t for our shortage of construction workers (Western Canada). Canada is nearly at full employment in the construction industry, particularly in Western Canada. 

It is mentioned in the CIBC World Markets report that Canada “remains safely divorced from a US-Style mortgage fiasco that has battered financial institutions.  Subprime default rates in Canada are at less than 3%, 10 points below the US. It is expected this margin will only increase over the coming months. Canada has proven that our lending practices are more conservative than our neighbour’s to the south. Canadians tend to take on more manageable mortgages and we tend to take on fewer questionable borrowers.  Still the subprime mortgage market is barely 5% of mortgage originations (2006-2006).

CIBC World Market

What’s in the Pipeline?

“Market optimism is back. But if it’s based mainly on expectations for a fed rate cut, then the recent stock market recovery is on shaky ground”  The words subprime crisis cab be used to describe recent months and/or  more recently weeks.  Mortgage rate resets were the catalyst of the subprime mortgage meltdown, one that is far from over. Approx $850 billion worth of mortgages are due to be reset during 2007 and 2008. These resets will be peak come November and will start easing into 2008. Year-to-date only one third have been reset. Of these mortgages, 75% are securitized and 80% are subprime.  The bottom line is the subprime mortgage market in the US will continue to make headlines and get worse before it gets better.