Back in 2007, Fannie Mae backed up $2.7-trillion (U.S.) of mortgage-backed securities with $40-billion of capital, or 1.5-per-cent equity against its overall exposure. At that time Fannie Mae stock was trading at $50 a share. Today it is 19 cents.
Just because these dots or facts are out there doesn’t mean that housing prices in Canada will fall 25 per cent or that CMHC will face any major financial problems in the years ahead. However, by connecting the dots, we can see a very plausible scenario that already unfolded with Fannie Mae and Freddie Mac that cost U.S. taxpayers an estimated $124-billion. If we had a similar scenario – and CMHC is now roughly one-tenth the size of the combined Fannie Mae and Freddie Mac – it is plausible that in a major real estate downturn, Canadian taxpayers would be on the hook for several billion dollars.
The biggest risk is likely with mortgage holders who only put 5 per cent to 10 per cent of equity down when buying a property. The reason I say this is that if house prices drop by over 10 per cent, everyone in this group will have negative equity in their homes. According to CMHC, 9 per cent of their loan book (or $49-billion) is connected to mortgages with under 10-per-cent equity based on current home prices. Remember all of CMHCs equity value is $11.5-billion (Canadian). Another 18 per cent of their loans are connected to mortgages with between 10-per-cent and 20-per-cent equity based on current home prices. This is another $108-billion of loans.
What happens if Canadian houses hit their ‘proper’ value, according to the Economist magazine, and decline by 25 per cent of their value? Every one of the $157-billion of mortgages noted above will be guaranteed by the Canadian taxpayer, and every one of those mortgages will be on homes with negative equity value.
When we connect the dots and look at the real risk, the time has come for the federal government to do the prudent thing and raise the minimum equity payment from 5 per cent to 10 per cent, and at least minimize the hit from the riskiest segment of mortgages insured by CMHC.
We can’t say we didn’t know, when the dots were right in front of us.
Ted Rechtshaffen is president and CEO of TriDelta Financial Partners, a firm that provides independent financial planning advice. He has an MBA from the Schulich School of Business and is a certified financial planner. He was vice-president of business strategy at a major Canadian brokerage firm.
Follow Ted on his blog at The Canadian Financial Planner.
