Canada Mortgage and Housing Corporation (“CMHC”) has created what could be called a mortgage insurance empire. With a book totaling $526B in 2015, that book alone was larger than Canada’s fifth largest bank and exceeds 1/3 the total all outstanding residential mortgages in Canada. This coverage is sold through banks, credit unions and other lenders. Mortgage insurance, primarily, lets buyers with small down payments into the game.
The Department of Finance (Canada) recently sought public input on the way that credit default risk may be shared between CMHC and the originating lenders. CMHC now assumes 100% (with some exceptions). They touched a nerve with proposals for ‘Lender Risk Sharing’. The banks and credit unions have objected to change. But light being shone on the mortgage insurance program (and the related securitization activity) also illuminates the paradoxes.
FIRST, the primary beneficiaries of this program are the banks and other lenders. Our cultural obsession with home ownership and the ‘right’ to have a home, obscures the reality. The mortgage insurance program lets lenders book billions in loans that would otherwise not qualify. That $500B in loans generates a yield of @3% or $15B annually in easy money.
SECOND, the mortgage insurance program and the securitization activity have grown substantially since the turn of the century, from @$200B to over $950B. This is all government (read taxpayer) guaranteed. The securities activity includes mortgage backed securities and Canada Mortgage Bonds. While the rationale is that CMHC is facilitating and stabilizing residential mortgage financing, the growth since 2007 suggests strongly that government was using these programs as stimulus tools to help recover from the great financial crisis of 2008. With this kind of financial engineering, the government did not ‘go into debt’. The debt burden was instead shouldered by modest income households. And the recovery was, and remains, heavily reliant on the real estate sector and these borrowers.
THIRD, while CMHC has ‘helped’ home owners it has also made good use of the monopoly market power it has; CMHC is essentially the only provider of these services. CMHC annual reports boast of the billions of dollars paid to government as ‘tax’, and also report substantial retained earnings (@$17B in 2015). No other government insurance scheme is required to pay ‘tax’, only the one that services lower & middle class households. CMHC guarantees are a profit center, generating almost $4B in 2014, and almost $2B in 2015.
FOURTH, the concerns about excessive levels of household debt in Canada are directly related to the promotion of mortgage insurance. The concerns have been raised by the Bank of Canada, the OECD, and the Bank of International Settlements. It is simple minded to think of mortgage insurance as just a ‘good thing’. Many households appear to be over extended and may be really squeezed if rates rise or employment prospects dim. Only recently has government tightened qualifications for applicants.
FIFTH, the mortgage insurance program allows people with little savings to buy a home. That brings new buyers into the real estate market, increasing market demand. The result of increased demand is price inflation as buyers compete. Mortgage insurance also contributes to our ‘affordability crisis’.
SIXTH, government does not want too many lenders claiming on the guarantees when the borrowers default. Government is conflicted insofar as a market correction, or bursting of the housing bubble, might help make housing more affordable for many Canadians, but might also leave many insured borrowers with ‘negative equity’. So government has a stake in appreciating real estate values, which continue to outstrip inflation and income growth.
This is a quick overview of the bigger picture. Most credit unions only appreciate the mechanics; a member can get a loan and a home, a loan can be booked, and almost all the risk is borne by CMHC. Indeed, lenders may become addicted to such a sweet arrangement, but is it sustainable? Is the allocation of the debt fair? Is the higher cost of housing for future generations acceptable?