Saturday, December 18, 2010

Canada Mortgage and Housing Corporation

Some issues to do with the Canada Mortgage and Housing Corporation (CMHC) came up in the comments on my last post. I got some interesting information, and thought I would dig deeper. The key question relates to the extent to which the CMHC looks like Fannie Mae or Freddie Mac.

Here is what CMHC does, and these slides, by Virginie Traclet at the Bank of Canada, summarize what is going on in the Canadian housing market. The key features of interest are the following. First, CMHC insures mortgages. There is also one private mortgage-insurer that has been in the business since 1995. In Canada, a mortgage must be insured if has a loan-to-value ratio greater than 80%. Essentially all mortgages are originated by private lenders, predominantly chartered banks. Second, the share of insured mortgages relative to the total has increased from about 20% in 1990 to 50% or more currently. This seems to be due to the fact that CMHC has become more aggressive in relaxing the terms of insured mortgages. For example, loan-to-value ratios of up to 95% are permitted in some cases. Third, after 2000, CMHC became increasingly engaged in securitization. You can find the details here. The first table here shows that securitized mortgage lending (NHA MBS in the table) has grown to about 25% of the market. The mortgages in securitized loan pools are essentially all insured mortgages. Fourth, CMHC issues debt that looks much like agency debt.

Thus, there are ways in which the activities of CMHC look like those of Fannie and Freddie. CMHC issues its own debt, it puts together mortgage pools and issues mortgage-backed securities, and it guarantees those securities. Further, as with Fannie and Freddie, the activities of CMHC have grown substantially in recent years. However, there are some critical differences:

1. CMHC is a Crown Corporation. It is owned by the government, and therefore its activities ultimately are reflected on the federal government's balance sheet. A critical problem with Fannie and Freddie is that they were spun off as private corporations, but with implicitly government-guaranteed debt. Fannie and Freddie, as has been amply demonstrated, are subject to a standard too-big-to-fail moral hazard problem, by virtue of their private profit motive coupled with implicit government insurance.

2. A 5% down payment on an insured mortgage might seem risky, particularly in a volatile real estate market like Toronto's or Vancouver's. However, a mortgage lender in Canada has more recourse than is typically the case in the U.S. They can go after the borrower's other assets in the event of default.

3. CMHC is not regulated by the the Office of the Superintendent of Financial Institutions, (OFSI), but claims to adhere to OFSI regulations. If that is true, that is a good thing, as OFSI is notably conservative. OFSI also regulates the chartered banks and the insurance industry. As proof that OFSI is serious, note that there have been only two small chartered bank failures since the 1920s, and there were none during the recent financial crisis. A key problem with Fannie Mae and Freddie Mac was lax regulation, in particular weak capital requirements.*

Of course the proof is in the pudding. Traclet's slides give you the summary of the Canadian experience during the financial crisis. In spite of CMHC's incursions into what might appear to be dodgy lending, nothing bad seems to have happened. This doesn't mean that what CMHC is up to is a good idea. Indeed, some of what I said about Freddie and Fannie in my previous piece applies here. If Canadians want to redistribute income to the poor (and believe me, Canadians know a lot about redistribution) there are better ways to do it than through government participation in credit markets. This piece is coming out of a noted right-wing Canadian think tank, the Fraser Institute, so take it with a grain of salt, but I'm sympathetic.

*Note the correction here. See the comments below.

5 comments:

  1. Incidentally, CMHC is not regulated by OSFI. My understanding is they voluntarily follow some of OSFI's guidelines, but are under no requirement to do so. The department of finance, and through the department the prime minister, plays the CMHC's fiddle. Not the regulator. A vote hungry PM can bend the CMHC to accomplish whatever vote-gathering housing policy he desires.

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  2. JP,

    Yes, you're right. Apparently CMHC was incorporated under the CMHC Act, not the Insurance Act, so it's not subject to OFSI regulations. For what it's worth, here is some reassurance, from an interview with the CMHC Vice-President:

    "CMHC is subject to stringent government oversight, including annual independent financial audits, special examinations every five years and periodic reporting requirements to Parliament in accordance with the Financial Administration Act (FAA). Ernst & Young LLP and Auditor General of Canada jointly audit CMHC accounts.

    CMHC maintains capital reserves and premium reserves for future losses in accordance with guidelines set out by the Office of the Superintendent of Financial Institutions (OSFI), Canada’s mortgage insurance regulator. In fact, CMHC maintains capital reserves that are twice the minimum required by OSFI.

    In addition, CMHC is governed by a Board of Directors and currently reports to Parliament through the Minister of Human Resources and Skills Development, the Honourable Diane Finley."

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  3. So do you think more stringent government oversight of mortgage brokers in the U.S. would reduce the likelihood of defaults in the U.S.? Because the VP's quote above seems to suggest that stringent government oversight helps prevent the type of lending that leads to large scale defaults and then bank failures like we see in the U.S.

    If that is the case, does the conservative argument in the U.S. Congress for deregulation (or at least blocking more regulation) seem counterproductive?

    -just a voter

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  4. I'm interested in seeing what comes out in the FCIC report. The mandate of the commission is to help us understand what the financial crisis was about. Presumably it will suggest some fixes, but in any event I'm assuming that the idea will be to go from there to specific reforms. We have already had some reform in the Dodd-Frank act, which was a mixed bag. You're right that all that seems to be on the mind of the Republicans on the FCIC is less government - get rid of Fannie, Freddie, and CRA. In my opinion there is nothing wrong with that, but I think there are other improvements that we could make that would involve more regulation, not less.

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  5. Hi,

    This is the marvelous post that I have come over after huge searches. I am really thankful to you for providing this unique information about CMHC. Thanks....

    ReplyDelete