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When the Canadian Housing Bubble Pops

Strong average loan/value ratios may not fully protect the country's banks.

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Although interest rates in Canada remain at all-time lows, there are now signs that the housing market there has lost some steam as a result of the efforts of the Canada Mortgage and Housing Corporation. Nevertheless, we maintain our opinion that the housing bubble will not significantly deflate until the Bank of Canada raises rates.

In the meantime, the Canadian banks argue that their loan/value ratios on residential loans are lower now than U.S. banks' were just before the bursting of the U.S. housing bubble; however, our review reveals that the average loan/value ratios of U.S. banks just before the housing collapse are similar to those we currently see on residential loans in Canada. More important, their distribution is eerily similar. Based on 10% incremental decreases in home values, it appears that the CMHC and the banks have significant risk of losses or impairment to capital levels.

Dan Werner does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.