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More reforms needed at CMHC

Appeared in the Financial Post
Authors:
Release Date: April 26, 2012

The 2012 federal budget announced steps to protect taxpayers from exposure to risks in the residential mortgage market: enhancing the governance and oversight framework for CMHC, and introducing a legislative framework for covered bonds.

Enhancing governance and oversight is consistent with a 2011 IMF report that stated that since Canada Mortgage and Housing Corp. "is now one of the largest financial institutions in Canada and the key backstop to the housing market, it would be useful to undertake a review aimed at ensuring that CMHC has a modern and effective governance structure and supervision, and assessing the scope for further strengthening its risk management."

The Financial Post has reported that Canada's solvency regulator, the Office of the Superintendent of Financial Institutions (OSFI), may be given responsibility for supervision, and other prudent reforms may be in the offing. The question is whether the reforms will go far enough.

An optimal governance regime for CMHC will require structural change. CMHC not only provides mortgage insurance, but actively pursues social-policy objectives, namely affordable housing. Hence, the composition of CMHC's board of directors reflects that it is not simply a commercial insurer but has a broader social mandate. Splitting off CMHC's commercial insurance activities will be essential to achieving better governance.

The federal government has also been maintaining a $600-billion cap on how much insurance CMHC can underwrite. This cap will prompt CMHC to scale back its new activity, allowing its private market competitors to take up the slack. One insurer, Gemworth Financial, noted in its 2011 fourth-quarter conference call that it had plenty of capacity for 2012 and 2013, and that it may provide more portfolio insurance to key customers.

The potential shift of business to the private sector sounds like a very positive development on the surface. However, taxpayers are not off the hook, as a government guarantee exists for private insurers. Nevertheless, this development is positive in that the guarantees for private insurers are set at 90% as opposed to CMHC's 100% guarantee, and the capital of the private insurer must be extinguished before taxpayers are on the hook.

The government should also direct CMHC to establish a reinsurance pro-gram. The term "risk management" popped up 46 times in CMHC's most recent annual report, suggesting CMHC takes risk management very seriously. But a search of "reinsurance" reveals its complete absence. Reinsurance is the most common risktransfer tool used by insurers to manage risk. Private mortgage insurers use it, as does Export Development Canada, a federal Crown corporation with a significant export credit insurance business. CMHC could use this tool to advantage, for example to reduce its exposure to the Vancouver and Toronto regions.

Most of all, a plan for the federal government to exit the mortgage insurance business and cease providing guarantees is needed to eliminate taxpayer exposure. Australia exited the business without any adverse effects. In addition, a 2011 IMF study revealed that government participation in the mortgage market, including government provision of mortgage guarantees or credit, exacerbated house price swings and amplified mortgage credit growth during the run-up to the global financial crisis, particularly in advanced economies. The plan would inevitably have to be long term in nature because there would be significant implications for lenders that would need to address their regulatory capital.



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