JULY 21, 2011
Another look at CMHC:
Canada Mortgage and Housing Corporation (CMHC) has finally released their 2010 annual report. There is a great deal of information in it, and I am trying to wade through it, but I thought I would take a moment and chart out the growth in CMHC insurance.
For those not familiar with this government entity, please check out these posts:
CMHC's stated mandate is to "...help Canadians access a wide choice of quality, affordable homes, while making vibrant, healthy communities and cities a reality across the country. CMHC works to enhance Canada's housing finance options, assist Canadians who cannot afford housing in the private market...".
In a nut shell, CMHC's approach to helping people access quality, affordable housing is to intervene in the mortgage market to ensure that riskier borrowers are able to get an artificially low interest rate. They do this by guaranteeing the mortgage so that in the event that the borrower could not pay, and if the house had lost value, the banks wouldn't have to suffer any loss on the loan. In other words, they transfer the risk from the banks to the Canadian tax payers in exchange for the banks giving interest rates that are lower than they otherwise would.
In a normal market, a bank might balk at giving someone with virtually no equity a loan for 30 years at many multiples of their income. At the very least they would ask for a higher interest rate to compensate for additional risk. Instead, property virgins can take the leap into home debtorship with rock bottom rates while putting very little of their own money at risk. Heck, if they take advantage of an offer like this, they will put none of their own money at risk. This is not how a normal market would work.
"But wait"..you may say..."if CMHC guarantees these mortgages, and if all it does is lower monthly payments and introduce more mortgage debt into the system, won't the unintended consequences be artificially high house prices?"
Why yes. I suppose it would. And it's the very reason why I have stressed numerous times that CMHC's mandate is inherently self-defeating.
CMHC is by far the most dominant player in the mortgage insurance industry...an interesting fact given that they are a government agency and there are private insurers willing to offer insurance in the market. And since they are a government agency, it means that taxpayers by extension are the ones backstopping these loans. We can debate how risky CMHC really is, but the much bigger question is why in the world do taxpayers have to face any risk if there are private entities willing to take the risk themselves? I have yet to hear a convincing argument on this one.
And while we're at it, perhaps an astute reader can answer one of these question from a previous post, which have not yet received any sort of answer:
In 2003, the maximum mortgage amount that CMHC would guarantee was removed. Why? We can debate whether or not we even need an entity like CMHC, but I think we can all agree that there is a huge difference between trying to help people who are down on their luck get into decent housing that they can own, and guaranteeing mortgages so that house horny property virgins can have 3000 square of granite, stainless steel, and glossy hardwood. Last I checked, the right to own such a dwelling was not enshrined in the Charter of Rights and Freedoms.
It should come as no surprise that mortgage debt has exploded since that time, both in nominal terms and when compared to GDP:
CMHC has maintained that mortgage insurance is extremely important to the healthy functioning of the housing market in Canada. And since the housing market has a huge impact on the economy, the government should be involved. Or so they say. Yet are there not more fundamental needs than guaranteeing the banks their profits? Food comes to mind. If the rationale for nationalizing a service is because it is important to us, when should we expect Zehrs, Loblaws, Metro, etc. to be nationalized?
Charting the growth of the monster...
With all of that as a backdrop, let's see if there is actually anything to be concerned about. Maybe I'm making a big deal about nothing. Let's not speculate.
Below we see the total amount of mortgage debt that CMHC insures. As of 2010, that total was roughly $520 billion. You can see how that total has grown over time.
Next we see the total securitization guarantees in force. Note that this is a subset of the chart above. However, we may also note that some have criticized the securitization process as being an inherent moral hazard. It was the securitization of mortgages in the US that allowed the predatory lending and fraudulent practices to thrive. This is not to suggest that this is happening here. It's not. However, we should also not gloss over the arguments against securitization, particularly that it encourages less stringent underwriting standards on the part of the banks who originate the loans, as they know there will be willing buyers in the secondary market and they can immediately recoup their capital while pocketing a fee.
Certainly I don't see anywhere near the issues the US experienced with their securitization processes, but should we be concerned about this?
Interestingly, the report indicated a total securitization guarantee in force of $397 billion at the end of 2010. Yet the planned guarantee in force for 2011 is $310 billion. I'm very curious how they plan to reduce their securitization guarantees in force by a whopping $80 billion in a year. In fact, I'm totally stumped. Any thoughts?
Now if we plot those same two graphs against GDP, we find the following:
My question is, how much is too much? As a nation, are we comfortable with the current exposure we have to the Canadian real estate market, particularly with fundamentals as shaky as they are? What about 50% of GDP? 100%? How much is too much? Where do we draw the line?
And with that, I have sent an email to Finance Minister, Jim Flaherty, asking this very question. At what point does the government get rightfully worried about taxpayer exposure to the Canadian mortgage market? For those interested in echoing my question and concern, Mr. Flaherty's email can be found below.