The U.S. mortgage game: How should it change?

Some Canadians are feeling a bit smug about their nation's relative economic calm – there's no housing bubble bursting or financial giants failing, and the Canadian dollar is strong.

But the financial mess in the United States has caught the attention of our neighbors to the north. "Canadians are terrified that the US mortgage malaise will cross the border," notes Fred Langan, host of CBC's Newsworld Business News, a cable show in Toronto.

Their fear is probably unjustified. Canada's home-mortgage system differs widely from the US system. Its banks are well-regulated and far less troubled by risky mortgage-backed securities.

Those securities were the primary reason for the dramatic negotiations in Washington last week between the Bush Administration and Congress over a gigantic $700 billion bailout proposal. That money would buy up broken mortgage-backed securities and hopefully thaw frozen US credit markets. Without available credit, the US economy could plunge to greater depths.

Such a major recession would be a real concern for Canadians. The US is Canada's biggest customer. For one thing, Ontario factories make a lot of cars sold south of the border.

Because the US financial crisis is often blamed on the current mortgage-financing system, there is already talk, beyond the rescue package, of reforming the system to prevent a future crisis.

One major issue is who absorbs the risk on what is usually the biggest investment for a family – a house.

From 1975 to 2005, US house prices never fell, notes Karl Case, an economist at Wellesley College in Massachusetts. Over that 30-year period, a house initially priced at $100,000 rose, on average, to $650,000. In New England, that house would be priced at $1 million, and in California $1.6 million. Homeowners and investors began to believe that there were "no snake eyes on the dice," says Professor Case.

Then the gamble went awry. House prices dropped decidedly, and so the nation faces financial trauma.

Today financial institutions hold some $12 trillion in outstanding mortgages on single-family homes in the US. Because mortgages usually are 20 to 30 years long at fixed interest rates, banks and other financial institutions take the risk of inflation and changes in interest rates.

In Canada, most mortgages are short term, running about five years, with renewal often involving a change in interest rates and the size of payments. (That was the system in the US prior to the Great Depression in the 1930s.) In effect, the Canadian homeowner assumes more financial risk.

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