The Macdonald-Laurier Institute (MLI) today released "Mortgage Insurance in Canada: Basically sound but room for improvement", a paper by University of Guelph Associate Professor of Marketing and Consumer Studies Jane Londerville. The study highlights an important flaw in this country's otherwise solid system of mortgage insurance and explains how to fix it. A flaw that harms home buyers by tilting the playing field unfairly and inefficiently in favour of the publicly-owned Canada Mortgage and Housing Corporation (CMHC).
Learn how more competition can be brought to Canada's mortgage insurance sector...read the key recommendations of the Londerville paper and review the whole paper.
Canada's mortgage insurance system gives our housing market a solid foundation. Home buyers who cannot make a 20 percent down payment are required to insure their mortgages against default and government, in turn, guarantees against a default on that insurance. This system encourages sound loans while protecting lenders, borrowers and the entire financial system from unreasonable risk.
It served us admirably in the recent financial crisis. But it has one important failing: it denies consumers benefits from full competition by giving the public Canada Mortgage and Housing Corporation (CMHC) an unfair advantage over private firms.
As a public entity, CHMC mortgage insurance policies are 100 percent guaranteed by the federal government. But the government has chosen to give private mortgage insurance firm policies only a 90 percent guarantee.
That means banks whose customers insure through a private firm must set aside some capital reserves against the remote possibility of default by the insurer, but not if they use the CMHC. Thus, rates of return are higher on CHMC-backed mortgages. And when profit margins are thin and banks are nervous about their capital reserves, as in the financial crisis beginning in 2008, it makes a major and harmful difference.
The policy contradicts the 2006 federal budget which sought to encourage greater competition within the MI sector. The decision to allow private competitors to the CMHC, beginning in the 1960s, has been fully justified by innovations in lending practices and reductions in mortgage insurance rates that have taken place especially since Genworth Financial Canada, the other major player, entered the market in 1995.
The failure of other firms to gain or maintain a foothold, and the sharp drop in Genworth's business after 2008, indicate that the unfair guarantee differential edge given to the CMHC is depriving consumers of the benefits of competition and discouraging new private insurers from entering the market.
The most plausible argument in favour of its special treatment is that the CMHC pursues other important social or environmental goals through its mortgage insurance business. But a so-called "cross-subsidy" of social objectives from the commercial operations of a public entity is the wrong way to pursue such goals. It deprives home buyers of the benefits of competition, it obscures accountability and it is unfair.
The key component of Canada's solid mortgage insurance system is the requirement that high loan-to-value mortgages be insured with significant government backing. The system can be improved by pursuing the move to a fully competitive model, wherein a CMHC MI spin-off competes on a level playing field under continued strong regulatory control of lending criteria. Removing the punitive differential in the guarantee rate would be a major step in creating a more homebuyer-friendly marketplace.