The US mortgage mess was relatively simple. In essence, there was a breakdown between the risk and reward of a loan. Traditionally, banks were careful to only select good borrowers that would likely repay their loan. However, financial intermediaries broke this relationship. The loans were pooled together issued a rating using historical data and securitized to investors. The bank didn’t care about the strength of the lender since they didn’t retain ownership of the mortgage. In addition, government sponsored entities (Freddie Mac and Fannie Mae) amplified the problem since the implied federal government guarantee reduced the cost of the mortgage to an unrealistic level. The only way the system could continue was higher housing prices. And we all know how that turned out.
There is no doubt that the CMHC is an extremely important financial institution however it is surprisingly not regulated by the Office of Superintendent of Financial Institutions (OSFI). Instead we have to rely on a biased board of directors that “… is actively engaged in overseeing appropriate mitigation strategies.” This lack of an independent regulator is extremely concerning, given the billions that tax payers could be on the hook for. We simply have to trust that the CMHC internal risk system are adequate.
“Risks related to homeowner mortgage loan insurance are assessed through CMHC’s state-of-the-art automated underwriting system, emili. Incorporated within emili are borrower, market, property, and fraud risk assessment models.”
The cutely named ‘Emili’ is likely similar to US software programs that placed too much weight on historical data instead of taking a long term flexible view. The massive overvaluation in Canadian housing prices and a tiny 4% equity ‘cushion’ is a recipe for disaster. Canadians should wake up and demand the government reform the CMHC to reduce the potential liability on tax payers and more quickly reduce the housing bubble. Recent measures announced such as reducing the length of mortgages, are not enough. The biggest risk is not just CMHC’s future business but past transactions that created this massive organization. It might not be pretty and it’s certainly an ugly political subject, but the failure to reform the CMHC would be a far worse outcome.