Taxpayers—through the federal government—face financial risk from the housing market primarily through the Crown represented by the Canada Mortgage and Housing Corp. (CMHC), which has historically held 60–90 percent of the mortgage insurance market in Canada.
The curbs put on the federal housing agency in recent years bring it closer to holding 50 percent of the market currently, according to Finn Poschmann, CEO of the Atlantic Provinces Economic Council.
The risk to the government—and the taxpayer—is clear given the state of the housing market. On Wednesday, Oct. 26, CMHC gave its most severe warning to date—a red alert—stating that many of Canada’s housing markets show strong evidence of problematic conditions—mainly being overvalued with prices accelerating.
What should be done with CMHC’s mortgage insurance business is less clear, however. Arguments vary from privatization to variations on an insurer of last resort role. CMHC’s mortgage loan insurance-in-force stood at $557 billion in 2013 and has come down each year since then; 2016’s plan is for $516 billion.
Conservative leadership candidate Michael Chong said in an Oct. 18 press release that privatizing CMHC is the “most important measure that can be taken to increase housing affordability for Canadian families.” It would also lessen the risk to Canadian taxpayers from a housing market crash.
Chong blames the increase in government funding for mortgage lending over the past 15 years for elevated home prices.
The late former finance minister Jim Flaherty suggested privatizing CMHC over the next 5 to 10 years back in 2012; however, that is not on the table for the Liberal government.
With the Canadian housing market overheating—led by Greater Vancouver up 54 percent in the last three years and having an average benchmark house price of $926,600—UBC business school professor Thomas Davidoff said it is wise for the government to reduce its risk, but that the insurance it provides should only be meant to be competitive in bad times.
In a very bad scenario for the Canadian housing market, where a private mortgage insurer is not able to pay its claims, the government will be inclined to bail out the insurer. But charging the appropriate premium to cover such extreme cases is harder to get right than just pricing plain old mortgage insurance, he says.
“One way to proceed is for government mortgage insurance to be expensive enough that it is only used in bad times,” Davidoff said. In this framework, the government overcharges for mortgage insurance, thus allowing private insurers to gain more market share.
“I think that would be the right step to reduce taxpayer exposure, while still making sure there is a transparent and easily priced mechanism for the government to be there in recessions,” Davidoff said.
And it’s better to charge a price for that presence, rather than “give it away” like the U.S. did with its implicit guarantees of Fannie Mae and Freddie Mac obligations, he said.
“The worst thing you can do is have a private sector company benefit from an implicit government guarantee,” Davidoff said about the two former U.S. mortgage giants. “Money does not even get made by taxpayers in the good times. It gets made by the shareholders. The losses are taken by the taxpayer in bad times.”
“Take being the buyer [insurance provider] in the downstate of the world; that is the advantage the taxpayers have in this model of public insurance,” Davidoff said. “Don’t be there at the top. Be there at the bottom is probably the best way to go.”
In any case, CMHC’s role in providing mortgage insurance should be dialled back, as it subjects the Canadian taxpayer to excessive risk in the case of a housing market crash, said Poschmann.
“There is no reason for the state to be directly involved in selling insurance,” he said in an email to Epoch Times. He says Chong’s privatizing CMHC’s mortgage insurance business suggestion “remains a valid end game.”
Poschmann argues that CMHC should be a government-backed reinsurer—insuring the private insurers against catastrophic risks that they cannot manage. “It would neither be practical nor reasonable, however, to suggest that CMHC vacate the insurance market immediately or entirely,” he wrote in 2011 while in a former role as Vice President, Research, with the C.D. Howe Institute.
Spreading the Risk
Following up on Finance Minister Bill Morneau’s Oct. 3 announcement of measures to tighten up the housing market, the federal government wants to find out if it would be a better system to require mortgage lenders to bear part of the losses on insured mortgages—thus reducing risk to the taxpayer.
Currently when homebuyers purchase mortgage insurance—a requirement if they can’t make a 20 percent down payment—the government winds up holding the bag since it guarantees the mortgage insurer’s obligations.
If the private sector takes on more mortgage risk, it will be incentivized to price the insurance accordingly and strengthen its risk management practices.
Sharing the risk of mortgage defaults with lenders also incentivizes them to have stricter underwriting standards.
Bearing the risk of mortgage defaults is not necessarily a bad thing for taxpayers, according to Davidoff. Losses can bankrupt a private company, but governments can run budget deficits and live to fight another day.
“Taxpayers have an ability to spread risk across generations that the free market or private market does not have,” Davidoff said.
Canadian mortgage arrears rates are quite low, at 0.28 percent. Arrears refer to all mortgage payments that are 90 or more days past due. CMHC’s arrears rate at the end of 2015 was slightly higher, at 0.34 percent, with the difference reflecting the “cherry-picking” of risks by private insurers.
“When people know that there will always be safe mortgages around, people are willing to lend for mortgages in good and bad times. So we know there will not be as bad of a housing market collapse as there would be if there was no government involvement,” Davidoff said.
“Ultimately the government is going to have some role in mortgage insurance. I think that the more transparent that role is, the simpler the product it has in place, the better,” Davidoff said.
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