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Moody’s says low interest rates have driven the demand for mortgages and homes and caused the increase in residential property prices. That has led to more expensive homes, forcing new home buyers to borrow even more.

“This cycle is inducing fears of a bubble. If a recession were to hit the economy, many households would find themselves with negative equity and reduced incomes, raising the spectre of a swell in non-performing loans as homeowners default,” the report notes.

The problem for the government is that although banks hold the loans, a little over half of all mortgages are insured by the Canada Mortgage and Housing Corp., which is 100 per cent backed by Ottawa. Two private companies, who hold the rest of mortgage default insurance market, are 90 per cent backed by Ottawa.

“Mortgage insurance is required for loans obtained with less than a 20 per cent down payment, which implies that the loans CMHC is insuring have a smaller-than-average equity cushion,” LaCerda states.

The analyst notes that the likelihood of a major downturn in the housing market is low and Moody’s Analytics own forecast shows that housing prices will slightly dip and then level off over the next year. “But supposing such a severely adverse scenario comes to pass, the ability of the government to absorb CMHC’s losses is worth considering.”

The report focuses on the rise of credit in Canada’s non-financial private sector and compares it to the international average. Based on data from the Bank for International Settlements for 42 countries, the average credit outstanding to the non-financial sector was 154 per cent of GDP in the first quarter of 2017, compared to Canada’s 217 per cent.