Based on the frequency of reporting in the media, it seems
that many people are increasingly worried that a housing bubble
could develop in Canada. On Feb. 8 The Wall Street Journal even
published an article suggesting that home sales and prices in
Canada might have risen too quickly following the recent
economic downturn and that this could create the conditions for
a housing bubble similar to what occurred in the United
Policy makers worried about this should pay attention to a
recently published study by the Fraser Institute which suggests
that government intervention in the mortgage insurance market
is unnecessarily exposing Canadian taxpayers to enormous
financial liabilities in the event of a collapse in the housing
The extent of the potential taxpayer liability is
staggering. The Canadian government is heavily exposed in the
mortgage market because 43% of all residential mortgages (or
roughly 90% of all insured residential mortgages) are backed by
the government through the federally-owned Canada Mortgage and
Housing Corporation (CMHC).
As of 2007, the total value of the mortgages insured
directly by the CMHC was approximately $350-billion. More
recent statistics estimate that CMHC currently has about
$480-billion of insurance in force due to rising prices and
This means that taxpayers are potentially on the hook for
almost a half trillion dollars if the housing market were to
collapse and require the government's full backstop.
Recent events in the United States are a warning for
Canadians about the disastrous effects of misguided public
policies in mortgage and housing markets and the real exposure
of taxpayers when governments guarantee mortgage financing.
Through successive waves of legislation over many years, the
American government interfered in the U.S. mortgage market
through legislation that encouraged financial institutions to
issue mortgages to high-risk groups for social reasons. The
U.S. government also signaled an implicit public guarantee
against financial failures by directing government sponsored
enterprises (GSEs), similar to the CMHC, to buy and securitize
mortgages for high-risk borrowers.
In the wake of the recent financial crisis, American
taxpayers are now facing an enormous future liability to pay
for the government bailout of the financial industry. Not
surprisingly, Americans are not happy about this.
Canadian taxpayers could face a similar liability because
our government is so heavily involved in the mortgage insurance
market through the CMHC.
The Canadian mortgage insurance market is dominated by the
CMHC because the crown corporation enjoys regulatory advantages
not available to private-sector companies. As a result, several
private-sector mortgage companies have withdrawn from offering
mortgage insurance in Canada in the last few years.
The most significant advantage of the Crown corporation is
the 100% taxpayer-funded guarantee of its financial obligations
compared to the 90% guarantee on private insurance. The
difference in this guarantee means financial institutions
insured by private insurers face stricter capital requirements,
making it harder to compete against CMHC.
The CMHC also enjoys easier and less costly access to
capital, exemption from regulation (including the costs
associated with supervision by the Office of the Superintendent
of Financial Institutions), less financial reporting and
disclosure requirements, and exemption from provincial income
Our government should reduce taxpayer exposure by allowing
the private sector to take full responsibility for insuring and
securitizing Canadian residential mortgages. This includes the
complete privatization of the CMHC's mortgage insurance
For real world inspiration the feds should look to
Australia's example. Like the U.S., Australia had its own
sub-prime debacle in the 1980s when a state government
securitization agency created a program to fund mortgages for
low-income borrowers. The program was a disaster and prompted
taxpayer losses close to half a billion Australian dollars.
Once the Australian state governments exited the mortgage
securitization market, the private sector became active in
securitizing residential mortgages.
The Australian federal government also exited mortgage
insurance through the privatization of its mortgage insurer.
Home-ownership rates in the period following the privatization
showed no adverse effects from the lack of government
involvement in mortgage finance. In fact, the proportion of
Australian homeowners relying on mortgage finance increased and
housing quality improved.
By contrast, the Canadian model has the majority of risk
concentrated with government, and therefore the taxpayer
liability is much greater in Canada than in Australia. By
privatizing the CMHC or removing its unfair regulatory
advantages, the market would likely be more pluralistic with
multiple mortgage insurance providers serving Canadians. This
would be similar to the Australian model of mortgage financing,
which has been highly successful in achieving home ownership
outcomes and has produced a stable mortgage market, but has
minimized taxpayer liabilities during financial crises.
There are also other reasons why the government of Canada
should be immediately seeking ways to minimize risk to
taxpayers. The huge costs of bailing out the mortgage finance
industry will constrain the policy freedom for governments to
implement tax cuts and other policies to reverse economic
downturns. Government financial guarantees also have a moral
hazard effect, encouraging riskier lending because the costs of
failure are shifted from the lender to the taxpayers.
Research on the Australian experience shows that a market
for mortgage insurance can operate effectively without any form
of government guarantee. In order to lessen the taxpayer
exposure and reduce the likelihood of a Canadian mortgage
crisis, the government should emulate Australia and allow the
private sector to take total responsibility for insuring and
securitizing Canadian residential mortgages.