Writing in the Financial Post, Stanley Hartt argues that to avoid damage to Canada's banking sector, the Canada Mortgage and Housing Corporation should be weaned off government support. "Fiscal prudence demands a new approach to the Canada Mortgage and Housing Corporation," he writes.
Stanley Hartt, December 16, 2013
What began after the end of the Second World War as a government program to assist veterans reintegrating into peacetime society has morphed into a gigantic engine with a cap of $600-billion on its government-guaranteed insurance of residential loans. Fiscal prudence demands a new approach to the Canada Mortgage and Housing Corporation.
The recovery from the financial crisis has been slow and all of the indicators foretell tepid growth for the next few years, so interest rates will remain low. Our central bank gets to establish one benchmark rate for the entire economy, without differentiating among regions and industries. This means that Canadians are able to stretch their monthly budgets for shelter and aspire to more pricey digs than they could afford if rates rose substantially.
As a result, accumulated personal household debt grows as the face amount of mortgages climbs. And CMHC delivers a 100% government guarantee of claims against borrowers secured by residential real estate. Conveniently, this also assists banks with the capital they reserve against mortgage loans under Basel rules, because no capital needs to be set aside for an obligation of the government.
Two private insurers compete with CMHC, Genworth Financial Mortgage Insurance Company Canada and Canada Guaranty Mortgage Insurance Company.
These private mortgage insurers, in exchange for fees paid to the government, benefit from a 90% federal sovereign guarantee of the mortgage loans they insure. They also contribute to a reserve fund managed by the government. The 10% of insured loans that is not guaranteed by the government, however, attracts a capital charge under Basel rules, making it more expensive for a regulated lender to use the private companies on any given loan.
CMHC operates on a commercial, market-oriented basis and has earned huge surpluses which benefit the fiscal balance, but competition from the private sector insurers has kept fees at a reasonable level. What is of concern is the aggregate amount at risk for the federal treasury when times get tough, if a burst housing bubble were to cause house prices to fall to unsustainable levels for many borrowers.
In Australia, the government-owned Housing Loans Insurance Corporation was privatized in 1997. At the time, there were a number of private sector competitors which operated without any government guarantee at all. Although there is no legislative requirement in Australia for high loan-to-value mortgages to be insured, prudent lenders have insisted that loans exceeding 80% of the value of residences be insured. The Australian decision to privatize appears to have been based on nothing more than the fact that the mortgage market was operating efficiently and private sector mortgage insurance was well established, competitive, and available at reasonable cost.
In a privatization, certain aspects of the policy functions of CMHC (affordable housing and housing on First Nations reserves) would need to remain with the government. The mortgage bond securitization activities of CMHC should also be retained.
The sheer magnitude of CMHC insurance in force militates against an outright sale of the company. Dividing it into several pieces would only mean that there would not be enough potential purchasers who were not also mortgage lenders to create a viable auction.
Here is where the Australian example would be helpful: Australia did not, in fact, sell what are called "pre-transfer contracts" to the buyer. What the purchaser got was the origination capacity for new contracts. The pre-existing book remained the responsibility of the Commonwealth government and a management contract was entered into for the portfolio.
It would be foolhardy to expect that the Canadian practice of a 90% government guarantee for mortgage insurance issued by private sector insurers could be abruptly converted to the Australian model and reduced to zero. Because of the global rules regulating the capital of deposit-taking institutions, Canada's banks would be sideswiped in a particularly unhelpful way if deprived of the 90% back-stop they now enjoy for privately-insured mortgages. But once the standard was no longer 100% versus whatever the private sector mortgage insurers enjoyed, it would be possible to wean them from 90% to some substantially lesser number over a multi-year period, thus massively reducing the exposure of the federal government to housing market values.
Nothing would prevent the government from adopting the most robust set of rules and regulations to enable it to continue to monitor and influence the direction of market forces as regards sustainable residential mortgage borrowing and lending practices.
The licensing of new entrants would remain with the government and the Office of the Superintendent of Financial Institutions would continue to oversee their claims-paying ability with respect to mortgage insurance risks taken on.
The Australian example appears to offer the best way for effectively privatizing CMHC in a moderate series of prudent steps to extricate the federal government from this now quite adult and mature program which it instituted long ago with the best of intentions.
Stanley H. Hartt, Counsel with the law firm of Norton Rose Fulbright Canada LLP, previously served as Chairman of Macquarie Capital Markets Canada Ltd. and Citigroup Global Markets Canada Inc. This article is excerpted from the December issue of Inside Policy, the magazine of the Macdonald-Laurier Institute.