The CMHC: Canada\u2019s mortgage monster<\/b><\/p>\n
The CMHC is a driving force in the housing market. But critics warn its policies could fuel a U.S.-style meltdown.<\/p>\n
by Chris Sorensen And Jason Kirby on Wednesday, March 23, 2011 12:51pm<\/p>\n
David LePoidevin isn\u2019t the first person to suggest Canada\u2019s roaring housing market is headed for a U.S.-style crash. But he is a rare breed of money manager for daring to point a finger at the Canada Mortgage and Housing Corporation, the country\u2019s biggest mortgage insurer. In a fall 2009 note to his clients, LePoidevin questioned what was underpinning the country\u2019s skyrocketing home prices, aside from rock-bottom interest rates. \u201cThe stock market was sure not providing huge capital gains to the masses,\u201d he wrote. \u201cDid the banks all of a sudden open up the lending spigots? In fact banks have actually reduced the number of their mortgages held from the peak of third quarter of 2008. The smoking gun is the CMHC and its securitization policies.\u201d<\/p>\n
As mainstream economic commentary in Canada goes, it was damning stuff. And it provided ammunition to critics who argue the Crown corporation\u2019s policies have inflated a housing bubble. The CMHC is arguably the most influential player in Canada\u2019s $1-trillion housing market. Its main function is to provide mortgage insurance for prospective homeowners who put less than 20 per cent down on their houses, protecting the banks in the event of defaults. The CMHC also helps to spread risk by finding investors to buy CMHC-insured mortgages that have been pooled together into so-called mortgage-backed securities. All of this is guaranteed by the government.<\/p>\n
Almost immediately, LePoidevin\u2019s bosses at National Bank leapt to the CMHC\u2019s defence. In a letter to an Ottawa newspaper that had referred to the commentary, co-chief executive Ricardo Pascoe said the Vancouver portfolio manager\u2019s views were \u201cpersonal\u201d and \u201cdo not reflect the views of National Bank Financial Group.\u201d When reached by Maclean\u2019s, LePoidevin declined to talk about the public rebuke or the CMHC in general. A National Bank spokesperson justi\ufb01ed its actions, saying the company \u201cfelt that the commentary was treading on social and political issues.\u201d<\/p>\n
The apparent unwillingness of the country\u2019s sixth-largest bank to challenge the CMHC is curious given the role similar U.S. institutions Fannie Mae and Freddie Mac\u2014quasi-government agencies that securitized mortgages\u2014played in the U.S. housing crash. But it\u2019s far from unusual. Several other critics, including economists, realtors, lawyers and analysts contacted by Maclean\u2019s, say they have also been the target of attack. One bank economist who once publicly raised fears about a housing bubble says he didn\u2019t dare openly criticize the CMHC because of the agency\u2019s reputation for snuffing out dissent\u2014an allegation the CMHC denies. The economist spoke on the condition his name not be used.<\/p>\n
Even worse, the public knows next to nothing about what lurks inside the CMHC\u2019s books, aside from the smattering of details it releases in its annual report. And, unlike every other major insurance provider in the country, the CMHC doesn\u2019t answer to Canada\u2019s top financial services regulator. It falls under an amalgam of government acts and departments, including Finance and Human Resources, while also working with the Bank of Canada. Yet on specific decisions that dramatically loosened mortgage lending rules last decade, CMHC officials have testified they did so on their own with the approval and oversight of the CMHC\u2019s board of directors\u2014a board that includes a political consultant, real estate developers, a small-town lawyer and even the owner of a plumbing company\u2014though not one single economist or recognizable financial services professional.<\/p>\n
It all raises troubling questions about the agency, its oversight and, ultimately, the health of the country\u2019s frothy housing market, a key driver of the Canadian economy. And, as LePoidevin found out the hard way, asking hard questions seldom yields satisfactory answers.<\/p>\n
Since taxpayers, through the CMHC, and not the banks are ultimately on the hook in the event of a housing crash, a growing chorus of critics has been calling for more transparency and oversight, if not outright reform. Stephen Jarislowsky, a billionaire Montreal investor, says home prices are likely overvalued by as much as 20 per cent in some Canadian markets thanks to CMHC policies that encouraged banks to lend far too much money to people to whom they shouldn\u2019t have. The core problem, he argues, is that promoting home ownership makes for good politics in Canada, if not always sound economic policy.<\/p>\n
\u201cThe CMHC is influenced by the political process, just like [Fannie Mae and Freddie Mac] were in the United States,\u201d says Jarislowsky. He notes the average debt-to-income ratio of Canadian households recently surpassed that of the U.S. for the first time in 12 years. \u201cThe political folks are guaranteeing mortgages that the banks might never have made if they had to keep them on their own books,\u201d he says.<\/p>\n
At the end of 2009, the CMHC insured roughly $473 billion worth of mortgages (it expected that figure to rise to $519 billion last year, though updated figures haven\u2019t been released), which is nearly the entire mortgage insurance market in the country. The CMHC also assists the financial sector by buying pooled mortgages and reselling them to investors as bonds, giving banks and other institutions an immediate source of cash that they can re-lend. As of 2009, the CMHC had securitized $300 billion worth of mortgages. So critical is this function that Ottawa relied on the agency to prop up the country\u2019s big banks during the financial crisis, giving the CMHC permission to buy $66 billion worth of mortgages.<\/p>\n
It\u2019s a familiar-sounding story to American ears. \u201cThe Canadian government mortgage apparatus echoes uncannily our experiences down here with Fannie and Freddie\u201d says Jim Grant, author of the widely read Grant\u2019s Interest Rate Observer newsletter. \u201cCMHC has distorted the housing market by making homes, especially ones that are on the pricier end of the spectrum, more affordable and encouraged a lot of people to get in over their heads.\u201d<\/p>\n
Grant and other critics argue the CMHC\u2019s balance sheet looks strikingly similar to both Fannie and Freddie if you compare the mortgages the agency insures against its equity. Using the CMHC\u2019s 2010 forecasts, it insures $519.1 billion in mortgages against $9.9 billion in equity, which works out to around 1.9 per cent (although the CMHC says it has another $6.7 billion in \u201cunearned\u201d premiums that could be used toward future claims). By comparison, in 2007, at the peak of the bubble, Fannie Mae backed up US$2.7 trillion of mortgage-backed securities with US$40 billion of capital, or 1.5 per cent equity against its overall exposure. But the CMHC says its capital levels are double what the Office of the Superintendent of Financial Institutions requires of mortgage insurers (though the CMHC is not regulated by the OFSI). But such assurances in the absence of transparent disclosure offer limited comfort. As C.D. Howe researcher Finn Poschmann wrote in a recent report: \u201cParliament and the voters to whom it answers have no formal documentation of the way these exposures are calculated or managed.\u201d<\/p>\n
What bothers Grant is that the CMHC\u2019s government-backed guarantees encourage banks to feel they have less to lose if loans go bad. \u201cThe risk has been shifted, rather than reduced, from the stockholders and depositors of the big Canadian banks to the Canadian taxpayer,\u201d he says. And if house prices fall and borrowers get into trouble, the ripples would run far and wide. \u201cA sharp break in Canadian house prices would inflict terri\ufb01c damage to consumer con\ufb01dence, would hurt the Canadian labour market, and ultimately produce a lot of the unpleasant results that have been America\u2019s burden to bear since 2007.\u201d<\/p>\n
The CMHC argues such concerns are overblown. It points out that the Canadian mortgage system is fundamentally different than in the U.S. That\u2019s because mortgage interest is not tax-deductible, a relatively small number of mortgages are securitized, and lenders can generally go after homeowners who don\u2019t make their payments. The CMHC also points to Canada\u2019s low rate of mortgage arrears, currently less than one per cent. Finally, the industry never got swept up in the subprime lending trend, the CMHC says. \u201cWe don\u2019t have those products in Canada,\u201d says Pierre Serr\u00e9, the CMHC\u2019s vice-president of insurance product and business development. \u201cAnd if we did, CMHC certainly did not insure them.\u201d Lending weight to the CMHC\u2019s claims, a 2009 IMF report called Canada\u2019s residential mortgage markets \u201cboring but effective.\u201d<\/p>\n
Canadian lenders didn\u2019t go overboard with the sorts of gimmicky mortgage products\u2014loans with low initial \u201cteaser\u201d rates or so-called NINJA loans (no income, no job or assets)\u2014that got Americans into so much trouble. But it\u2019s not like they shied away from taking risks. For two years beginning in 2006, the CMHC offered insurance on mortgages with amortization periods of up to 40 years, nearly double the traditional 25-year period, and loans with zero down payments. The products were later reined in by Ottawa after the U.S. housing market tanked.<\/p>\n
The CMHC dove into such high-risk products largely without supervision. While the government had previously relaxed conditions for guaranteeing mortgage insurance as part of a plan to introduce more private sector competition, it was the CMHC\u2019s management and board that ultimately made the decision to go to 40-year amortization periods. In the same way, in 2007, the CMHC introduced a program for self-employed Canadians who have difficulty documenting their earnings to nonetheless obtain mortgage insurance by \u201cstating\u201d their income. While the program was restricted to borrowers with good credit ratings, one mortgage broker told Maclean\u2019s self-employed Canadians were able to get much larger mortgages than those in the same field who had documented incomes. Then, a year ago, the CMHC backtracked and significantly tightened its rules on stated-income mortgages.<\/p>\n
\u201cWe\u2019re allowed to operate and make decisions with regards to mortgage insurance products and policies within the [government’s] guarantee, and when we do so we advise the government of any changes,\u201d says Peter De Barros, a spokesperson for the CMHC. Still, the move to riskier mortgage products drew the ire of then-Bank of Canada governor David Dodge, who sent a letter to CMHC chief executive Karen Kinsley in 2006 warning about the dangers of throwing fuel on a hot housing market. \u201cA home purchaser is able to borrow at very low interest rates because you and I as taxpayers essentially guarantee that mortgage,\u201d Dodge said during an interview earlier this year on Business News Network. \u201cSo it\u2019s not at all unreasonable for us as taxpayers to say, \u2018Look, Mr. Borrower, you\u2019ve got to have an equity stake in this as well, so if things go really bad it\u2019s not all on the Canadian taxpayer\u2014part of it is on you.\u201d (Dodge declined to be interviewed for this story.)<\/p>\n
Critics say that, given what happened in the U.S., it\u2019s irresponsible to not have someone watching over the CMHC. \u201cThey are the only major \ufb01nancial institution in Canada not regulated by OSFI,\u201d says Ian Lee, an assistant professor at Carleton University\u2019s Sprott School of Business and a former bank manager. \u201cHousing is so huge and the consequences are just so large. It\u2019s not like they\u2019re deciding what to do about the price of ballpoint pens.\u201d<\/p>\n
So how much risk have taxpayers been exposed to? The CMHC doesn\u2019t reveal specific data about the credit exposure that it has taken on, other than to say it is manageable and in line with internal guidelines. As for the question of whether the CMHC\u2019s policies could contribute to a housing crash, the agency says there\u2019s no reason for Canadians to lose sleep. It says more than half of CMHC-insured mortgages have a loan-to-value ratio of less than 80 per cent based on the value of the original loan, and that the average equity in a CMHC-insured property is 45 per cent. \u201cThe mortgages are getting paid down\u2014as a matter of fact, we see that about half of our folks made extra payments, more than just the minimum required principal payments,\u201d says Serr\u00e9, adding that rising home prices have also helped improve the debt picture.<\/p>\n
But such aggregate figures don\u2019t necessarily provide an accurate snapshot of how homeowners are faring, according to Poschmann at C.D. Howe. Important questions remain unanswered\u2014like what is the geographic breakdown of its mortgages? Of those people with lower equity in their homes, what is the size of their mortgages? What classes of loans are they? What are their terms? \u201cYou can\u2019t come up with an independent assessment of exposures based on the information they publish,\u201d says Poschmann. \u201cYou can manage risks better with oversight and daylight, but right now we have pretty opaque books.\u201d<\/p>\n
While the CMHC says it has a sophisticated automated system to check creditworthiness of borrowers and property values, its biggest private sector competitor (which also has its mortgage insurance guaranteed by taxpayers, albeit only up to 90 per cent) nevertheless suggested during a 2007 hearing of the Senate banking committee that more than a third of all mortgages insured by the CMHC could be considered risky. Winsor Macdonell, the vice-president and general counsel of Genworth Financial, told the committee he assumed the CMHC\u2019s portfolio looks similar to Genworth\u2019s given that both provide mortgage insurance for the entire Canadian market. \u201cWhen I talked about our portfolio, 36 per cent are people with low or poor credit,\u201d he said. \u201cThose are the people who are at risk.\u201d Genworth declined to talk to Maclean\u2019s for this story.<\/p>\n
Serr\u00e9 declined to comment directly on Macdonell\u2019s remarks. \u201cI\u2019m not exactly sure what low or poor credit is,\u201d he says. \u201cBut I want to make clear that our mandate is not to get people into home ownership, our mandate is to provide the housing of choice. The last thing we want, as a government insurer, is to get people in a position where they can\u2019t manage their debt.\u201d For the sake of Canada and its fragile economic recovery, let\u2019s hope he\u2019s right.<\/p>\n
The CMHC: Canada’s mortgage monster<\/a><\/p><\/blockquote>\n