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CMHC – Canada’s Mortgage Mess

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CMHC - Canada's Mortgage Mess

By HardCoreValue, he can also be followed on  twitter.

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.

They say history repeats itself. I would have to agree. Canadians seem to think we are above the US in a lot of ways, hockey, income equality, and less divisive government. However, we are blindly missing the lessons that the US housing bubble showed us. As discussed last in a prior article, Canada is in the midst of a housing bubble. I tried to demonstrate that low interest rates have created a real estate bubble. Now, after looking more deeply into the the Canadian mortgage market, I have found a major culprit of how so much money was loaned out. The Canadian Mortgage and Housing Corporation.The CMHC is similar to Freddie Mac and Fannie Mae. They are federal housing programs that help people afford homes. CMHC dominates its market, “its mortgage insurance provides mortgage guarantees to banks and other mortgage lenders of approximately $500 billion or one-third of Canadian GDP, representing approximately 70 per cent of the mortgage insurance market.” Leverage is also spectacularly high at 25:1 (similar to the US before they were nationalized).This 25:1 leverage is extremely important since the CMHC is a crown corporation, the Canadian tax payer is on the hook for any losses. Therefore, if CMHC’s assets fall or liabilities rise by just 4% the equity in the company is gone and will need to be funded by Ottawa.

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.

Click here to read the prior article on Canada’s Real Estate Bubble 

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