Home Capital is the first domino to fall

"There is never just one cockroach in the kitchen," Warren Buffett said.

If you believe that, it's about to get much worse for a Canadian mortgage originator, if not the entire industry, and possibly Canadian housing in general.

A run is underway on a Canadian company called Home Capital. Investors are pulling out money and shares have plunged to $6.45 from $26.00 at the start of the month. They fell 65% yesterday after Home Capital took out a line of credit with interest rates as high as 22.5%.

The company gives loans to home buyers. The run came after Canadian regulators said problems with false loan applications were blamed by management on other things.

To recap: Canada has strict rules on mortgages. Liar loans are rare because mortgage lenders are forced to use tax returns for income. So if you want a loan and say you made $100,000 last year, that needs to be the number on your tax return. Since no one would want to pay extra tax just to get a loan, it's a good safeguard.

But evidently it's not infallible. The loans came to Home Capital from mortgage brokers and allegedly, those brokers were submitting false documents and no checks were performed. The company seemed to learn of the problems and stopped working with certain mortgage brokers. Business declined. Instead of disclosing the problems they found, they blamed a fall in business on things like seasonality and competition. That's where they mislead investors and it's why they have been charged by regulators.

But the broader market isn't worried about the misleading, it's worried about what other cockroaches are in the kitchen. Or about other fake mortgage applications.

A more-systemic worry is that all the alternative lenders could lose access to capital, which would mean home buyers would lose access to loans. That would mean fewer buyers for Canadian homes and just like that, house prices could drop.

Other lenders in the sector are out with statements saying their businesses are different -- no cockroaches here, they say.