We should privatize CMHC; Mortgage agency puts huge risks on taxpayer

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Appeared in the Financial Post

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 States.

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 market.

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 sales.

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 taxes.

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 business.

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.

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