Canada's Housing Bubble

July 19, 2011 Ian Lee Ottawa Citizen

After a half-decade of minority governments where many challenging and controversial issues were kicked down the road, the Government of Canada finally can tackle overdue problems.

One important policy field that must be re-examined in light of the 2008 financial crisis, and the U.S. housing bubble and its collapse, is the role played by Canada Mortgage and Housing Corporation in Canada in the rapidly appreciating housing market that some analysts argue is producing a similar Canadian housing bubble.

Indeed, the role of CMHC has been addressed by the CD Howe Institute, Fraser Institute and the Macdonald-Laurier Institute, each of which provided some compelling recommendations including privatization, that nonetheless, were perhaps too radical for a government committed to incremental change.

CMHC is the Godzilla of Canadian residential housing financing, established in 1946 by the Mackenize King Liberal government to provide inexpensive, low-rate mortgages with low down payments to returning veterans of the Second World War.

In 1954, the National Housing Act was amended to remove CMHC as a direct lender and instead it was mandated to provide default mortgage insurance to banks and other mortgage lenders for "high-ratio mortgages," advanced to consumers with less than the required down payment. Moreover, in the following years, the rules pertaining to down payment requirement, mortgage amortization, and income standards were modified from time to time, revealing that mortgage insurance policies are not etched in stone.

Today, CMHC mortgage insurance provides mortgage guarantees to banks and other mortgage lenders of approximately $500 billion or one-third of Canadian GDP, representing approximately 70 per cent of the mortgage insurance market.

Astonishingly, notwithstanding these enormous contingent liabilities and notwithstanding Canada's long prudent and internationally recognized record of vigorous regulation of financial institutions, CM-HC is not regulated by any outside authority such as the Office of the Superintendent of Financial Institutions (OSFI), as are all other federally incorporated financial institutions in Canada.

As CMHC is a "Crown corporation" owned completely by the Government of Canada, the CMHC insurance guarantees - which are liabilities of CMHC - are backed by the Government of Canada. Thus, Canadian taxpayers are liable for $500-billion to banks and mortgage lending institutions, in the event that Canada experienced a housing meltdown similar to the U.S. in 2008. The U.S. housing meltdown cost homeowners more than $6 trillion in losses and drove 20 per cent of homes into foreclosure. According to Gretchen Morgenson and Joshua Rosner in Reckless Endangerment, the housing crisis was driven by federal politicians who encouraged more and more lending to ever lower income people who could not afford a mortgage and produced "what happens when Washington decides, in its infinite wisdom, that every living, breathing citizen should own a home." The authors also assigned blame to Fannie Mae and Freddie Mac, two government sponsored corporations, that were the dominant firms in the secondary market of buying individual mortgages and repackaging them into bundles of mortgage-backed securities - so called "securitization."

The U.S. Congress - encouraged by aggressive lobbying and generous campaign donations by Fannie and Freddie to key congressional politicians - ensured that Fannie and Freddie were never adequately supervised and regulated. Due to enormous losses caused by the purchase and securitization of lowquality subprime mortgages, the U.S. government was forced to nationalize these two firms. According to the Congressional Budget Office, losses for Fannie and Freddie could cost U.S. taxpayers $389 billion.

Another important reason to modernize CMHC concerns its unfair and anticompetitive control of 70 per cent of the mortgage insurance market which violates the spirit of Canadian federal competition policy. CMHC has a dominant position as its guarantees are backed 100 per cent by the government of Canada while the private mortgage insurers are backed by a 90-per-cent guarantee. Due to the international Basel bank regulatory framework, banks as risk minimizers, seek out mortgages insured with a 100-percent guarantee, thus driving most business to CMHC.

The final and most important reason to modernize CMHC is to provide choice and competition to Canadian consumers, which will spur innovation and lower prices.

Canada can and should establish a subsidiary of CMHC for the sole purpose of issuing mortgage insurance. This subsidiary should be given a guarantee for 90 per cent of guarantees or liabilities, ensuring a level playing field with private insurance firms, as a first step in reducing the market share and thus exposure and liability of CMHC, the taxpayer of Canada.

As well, the Government of Canada must amend the CMHC Act to bring CMHC under the regulatory jurisdiction of OSFI, to ensure transparency, prudential financial regulation and a level playing field with private insurance firms.

Taken together, these changes will transform CMHC into a more transparent and efficient organization, operating on a level playing field with private competitors, which will significantly reduce risk to the Canadian taxpayer, bring CMHC as a regulatory outlier under the Canadian financial regulatory umbrella, and offer more choice and lower prices to consumers.

Ian Lee is a former mortgage manager with Bank of Montreal in the late 1970s and early 1980s. He is a professor in the Sprott School of Business at Carleton University and the former MBA director (2007-2010).