U.S. crunch may mean higher borrowing costs

CanWest News Service
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The credit squeeze in the United States has wreaked havoc in financial markets south of the border. Long-established investment banks have gone bankrupt or been swallowed up by competitors, the country's largest savings and loan has collapsed, and mortgage giants Fannie Mae and Freddie Mac were taken over by the government.
And while Canadian banks are unlikely to suffer the same fate, Canadians have not gone unscathed. The most pronounced effects: The 22 per cent drop in the S&P/TSX Composite index since the end of August, and the rising cost of borrowing money.
The key factor in the financial crisis in the U.S. was sub-prime mortgages, Bob Gorman, chief portfolio strategist at TD Waterhouse said. As these mortgages default, banks have less cash coming in, and less cash to lend out.
But while about 10 per cent of U.S. mortgages are sub-prime - and at the housing peak, 40 per cent of new mortgages were lower quality - in Canada, sub-prime mortgages are "a tiny, tiny percentage, maybe two per cent," Gorman said.
"So we've never had the same underlying issue, and so we don't have the same liquidity constraints.
"But what you do have is a certain spillover effect."
With less money available for loans and increased concerns about the risk of lending money, investors want a higher return, Gorman said. That means banks have to pay more when they borrow, and those costs are passed on as higher interest rates.
"And that is probably the single biggest change in the Canadian marketplace," Gorman said. "But it pales in comparison with what you see (in the U.S.)."
Yet those who want to borrow still should be able to. But some may choose not to.
"Because naturally enough, if you're a little more concerned about your job in a more fragile economy, you're going to want to be sure you've got some breathing room," he said.
Feisal Panjwani, a senior mortgage consultant with Invis, says credit is still available for anyone with a credit score of 600 or more, and that minimum score hasn't changed. But the cost of borrowing has gone up.
Homeowners can choose between two types of mortgages - a variable rate based on the prime lending rate (which is the Bank of Canada's overnight rate, plus 1.75 percentage points), or a fixed-rate mortgage which is set by the lenders.
A year ago, a homeowner could get a variable mortgage at prime less as much as 0.9 of a percentage point. But in the past few months those discounts have been disappearing, and almost all variable mortgages are now at prime, Panjwani said.
Banks who have outstanding discounted variable mortgages "are making very, very little if (they are) not in a loss position," Panjwani said.
In the last few weeks, five-year fixed mortgage rates have also gone up.
Panjwani looks at the best discounted rates for his clients, rather than the posted rates. A few weeks ago, the best discounted rate was 4.99 per cent, he said. Now the best rates are between 5.45 and 5.85 per cent.
Added liquidity - making more money available for loans - could ease some of the pressure on rates, BMO Capital Markets deputy chief economist Douglas Porter said in an interview.
"The problem right now is that there is a lot of uncertainty, and there is a lack of trust even amongst the banks of the world," Porter said. "And they're very reluctant even to lend to each other, and basically the credit process is being gummed up."
Recently, added liquidity came from two sources. The U.S. government voted to approve a $700-billion bailout plan in which the government would buy bad loans held by financial institutions and give the institutions much-needed cash in return. And the Bank of Canada announced it would boost liquidity by accepting a wider array of collateral for loans.
If money stays tight, causing the rate of inflation to fall below the Bank of Canada's target of two per cent, the bank could also choose to lower its overnight rate, directly affecting variable mortgage rates, and indirectly affecting shorter-term fixed-rate mortgages, which usually move in the same direction as the overnight rate.
But "that's heavy artillery that [the Bank of Canada] is trying to save until it is really needed," Porter said.

Organizations: Bank of Canada, Fannie Mae, Freddie Mac S&P BMO Capital Markets

Geographic location: United States, Canada

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