This week, Hurricane Harvey offered another little lesson in market forces. It's a lesson that helps us think about Canadian real estate.

Market theory tells us that people who wanted to protect their property from the hurricanes and floods that plague the Gulf Coast should have had insurance.

The fact is, only about 20 per cent in the Houston area did, says Robert Hunter, an insurance expert with a U.S. consumer research group.

"All these people taken out in boats, they have a second problem: They have no insurance," he said.

Financial risk-taking

Market theory also tells us that, like Texas homeowners, Canadians buying into the current housing market understand the risks they are taking.

If interest rates rise, they know they will have to find more cash to pay their monthly mortgage payments. The alternative is they will lose their homes.

Many Canadians try to squeeze every penny out of their finances to buy their dream home, even though they risk being surprised by rising interest rates. (Chris Wattie/Reuters)

The example from Hurricane Harvey demonstrates the difficult choice for the Office of the Superintendent of Financial Institutions, or OSFI, the Canadian regulator that has taken the lead in trying to take the froth out of Canada's housing market.

Public statements from Canada's biggest banks show they have come around to the idea that a market free-for-all may be dangerous for already overheated housing. Bank of Montreal chief economist Doug Porter has announced that Toronto was a bubble, and we've popped it.

OSFI isn't so sure. It has floated additional rule changes that could go into effect later this year.

This week, a report from TD Economics chief economist Beata Caranci gives a qualified stamp of approval to OSFI attempts to cool the market.

TD: Soft landing

As the title of the report, Navigating a Soft Landing, implies, TD expects the increasing layers of rules imposed by various levels of government to calm but not crash the market.

Not everyone in the Canadian real estate industry has been so accepting.

As CBC reported last month, some in the property business, including Grant Thomas, founder and partner with The Mortgage Group, would be happy for the government to butt out.

"The government has been intrusive in our industry in the last three years, and they continue to be so at a rate that is probably unnecessary," he said. "I'm not overjoyed whenever the government involves itself in business."

Bank of Canada governor Stephen Poloz has warned about the potential impact of uninsured lending. (Chris Wattie/Reuters)

For OSFI, the problem appears to be that parts of the industry, anxious to keep the boom alive, are working their way around the regulator's first attempt to discipline the market.

Under the initial rules that kicked in last October, anyone who wanted to borrow more than 80 per cent of the purchase price of a home — in other words, those with a down payment of less than 20 per cent — would have to prove they could afford an increase in borrowing costs of two percentage points, a so-called stress test.

Those people, with what's called a high ratio mortgage, must also buy mortgage insurance that protects their lender if the borrower defaults.

But there was more evidence this week that the first stress test is not working. A report from the Canada Mortgage and Housing Corporation out yesterday shows the number of insured mortgages is declining following the rule changes in October.

Uninsured homes don't just hurt the owner financially when disaster strikes. The economic impact can hit the entire community and governments must step in with relief. (Adrees Latif/Reuters)

Perhaps people with low down payments are putting off buying a house, but there are signs something else is happening.

Rather than paying the mortgage insurance and submitting to the stress test, some borrowers are topping up their down payments with loans from unregulated lenders.

Such lenders include mortgage investment corporations that have traditionally offered second mortgages. Or they can be the bank of mom and dad.

That's why OSFI now wants to restrict official deals between regulated and unregulated lenders, called "bundling." The regulator also wants to apply the two per cent stress test to borrowers who ostensibly have more than a 20 per cent down payment.

In Houston it appears many homeowners were willing to take a risk on losing everything rather than buy expensive insurance. In Canada, the pressure to buy a dream home in an overheated market means some buyers are willing to squeeze every penny out of their finances without leaving a pad to protect themselves from rising rates.

It may be that interest rates will never rise. Before Harvey, perhaps it was reasonable for homeowners to assume Houston would never flood. Now there are fears houses will be abandoned and parts of Houston will never recover.

In the Canadian case, a continued property boom followed by a sharp fall as pinched homeowners run for the exit could crack Canada's economic recovery.

The free market analysis would say they take the risk, they pay the price. But when disaster strikes, it's not just the individuals who take the risk that suffer.

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