canada bird housesFlickr / Sue Richards
Canadian Finance Minister boasts about crony capitalist bailout of collapsed mortgage lender. But his assumptions might be wrong.

"Just like I said, a back door bailout in exchange for something down the line. Very very dirty," tweeted Bay Area short-seller Marc Cohodes in response to Canadian Finance Minister Bill Morneau's gloating about the government's role in the bailout of Home Capital Group.

Home Capital Group is Canada's largest alternative mortgage lender. It focuses on new immigrants and subprime borrowers that have been turned down by the banks. It had been melting down ever since revelations of liar loans surfaced in 2015. Liar loans don't exist in Canada's clean housing market. They're a US thing. By April this year, Home Capital was collapsing as a run on its deposits crushed its funding sources. A very onerous and controversial funding package was arranged in all haste to keep it afloat, as the industry - and as we now know, the Canadian government - worried about contagion.

The Canadian housing bubble is sitting on needles, and everyone knows it.

On June 22, when Warren Buffett's rescue of Home Capital Group became known, its shares, after having already soared over the prior days, soared another 27% to C$19, having tripled from their crisis low in late April. But since that propitious day, its shares have fallen nearly 30%.

Buffett, of course, didn't buy the shares in the market as normal investors would have had to do. His firm Berkshire Hathaway bought shares directly from Home Capital, giving it a 38% stake, and thus diluting all other shareholders. Berkshire Hathaway also extended Home Capital a C$2-billion loan.

"Many eyebrows were raised when the oracle of Omaha, Warren Buffett, rode in on his white horse to save Canada's largest alternative lender, Home Capital Group," wrote ever vigilant Steve Saretsky at Vancouver Condo Guide today.

"Many believed it was a backdoor bailout, engineered by the Canadian Government," he said. "It seems our wildest conspiracies have been vindicated, by the Canadian finance minister himself."

During an unguarded moment in the interview with BNN, Morneau prided himself of the arrangement. But first he explained just how crucial Canada's housing bubble is to the government: "I expect for the entire time that I'm in the role of Minister of Finance - the entire time we're in government - we're going to stay closely focused on this," he assured his citizens. "We want to make sure people's big investment… is safe and secure as best we can," he said, even as the government is trying to cool the housing market.

And then Morneau got to Home Capital Group and let this slip:

"We obviously wanted to see a private-sector solution for Home Capital. The company seems to have found itself an approach that will be successful. I will say that it was probably not a coincidence that the Prime Minister and I were in Seattle meeting with Warren Buffett a few weeks before Warren Buffett came in and decided to make an investment in Home Capital.

Crony capitalism?

"We certainly didn't talk about that file, but we talked about the Canadian market, we talked about the strong economy that we were seeing, and I think as he moved forward that was a positive thing for Home Capital and certainly good for our market."

Asked if the conversation also discussed Canada's housing market, he said:

"I believe we did talk about our view that while the housing market was rising at an unsustainable pace that Canadians have generally seen very low rates of walking away from their homes. So that's a little different than the US situation."

He's talking about "jingle mail" during the US housing bust. But he might be mistaken in his logic about Canadians being a lot different from Americans when it comes to walking away from mortgages.

So here's some useful info for Morneau: Only 12 US states have non-recourse mortgages, where lenders are barred from going after homeowners beyond the collateral (the home) and where homeowners can "walk away" from their mortgage.

The remaining 38 states and the District of Columbia have recourse mortgages where lenders may obtain a "deficiency judgment" to recoup the mortgage debt beyond the value of the collateral. Thus, the vast majority of states are recourse states. Of the big four states, only California is non-recourse. New York, Texas, and Florida are recourse states.

In Canada, two provinces are non-recourse - Alberta and Saskatchewan. The rest are recourse. Similar as in the US. And as in the US, defaulted homeowners in Canada can seek protection from creditors in bankruptcy court.

The main difference in the "Canadians-won't-walk-away" theme trotted out endlessly by Canadian housing bubble and banking advocates and by the government is that the US had a massive housing crash during the Financial Crisis and Canada did not.

Instead, Canada's home prices experienced a brief dip before the bubble resumed with renewed vigor. Homeowners don't walk away from mortgages when prices are soaring; when push comes to shove, they can always sell the home and pay off the mortgage. The walk-away issue arises only during a sustained housing crash, when the proceeds from the sale of the home - if it can even be sold at all - fall far short of paying off the mortgage. That's what happened in the US.

Canada is now uniquely primed for a housing bust, perhaps more so than any other country in the world. And if home prices crash - another US thing that cannot happen in Canada - the theory that Canadians will not walk away from their mortgages and will not let their banks hang out to dry will be sorely tested. Read… Can a US-style Housing Crisis and "Jingle Mail" Hit Canada's Banks?