Finance Minister Jim Flaherty has recently floated privatization of the government-owned Canada Mortgage and Housing Corp. CMHC has a mandate to promote home ownership and, among other functions, provide insurance against defaults by borrowers on their mortgages. Mr. Flaherty thinks mortgage insurance is a business “that we’re in that we don’t need to be in.”
About 70 per cent of mortgages in Canada are insured and the government provides a 100 per cent guarantee of mortgages insured by CMHC. The corporation is required to operate with a reasonable rate of return and remits its annual profit to the federal government.
Two private mortgage insurers also compete with CMHC, covering roughly 30 per cent of insured mortgages. These private insurers have a government guarantee for 90 per cent of their liabilities, for which they pay premiums and are required to contribute to a reserve trust.
We want a competitive financial sector. Some private involvement in mortgage insurance may provide competitive discipline and choice. But fully privatizing mortgage insurance is wrong for at least three reasons.
First, if CMHC were privatized, it’s not clear that mortgage insurance would be competitively priced. The resultant oligopoly would have incentives to hike rates, and there’s no certainty that a monopoly wouldn’t result.
Second, private mortgage insurers would have tremendous leverage and could resist measures to curb risky behaviour. Private insurers could hold the Canadian housing market hostage.
Third, and most important, the taxpayer would remain on the hook. Even if CMHC is private, the government would still pick up the tab if it goes bust. The private insurers simply resell their government guarantee and tack on a profit margin. Privatizing CMHC just creates another layer while the government remains the ultimate insurer.
The risks from housing to the whole economy and ultimate government guarantee are exactly why CMHC needs to stay government-owned.
If Canadians can learn anything from recent U.S. experience, it should be that housing markets affect the economy as a whole. When a housing bubble bursts, the shockwave blows through the financial system. Central banks have a limited tool kit of relatively blunt instruments to curb excesses and restore balance. Government intervention in mortgage borrowing is necessary to restrain bubbles in advance.
Both Bank of Canada Governor Mark Carney and his predecessor David Dodge emphasized that housing policy is a key complement to monetary policy. To deflate housing bubbles, CMHC is a scalpel compared to the economy-wide sledgehammer of raising interest rates.
Organizations from the Financial Stability Board to the International Monetary Fund praise CMHC as a lynchpin of Canada’s financial stability (albeit calling for improved governance and risk management by CMHC). If CMHC were private, “too big to fail” would be a laughable understatement.
A home is most families’ major asset (and a mortgage their largest debt), so home values shape how families borrow, consume and save. How many baby boomers have you heard say that their home is their pension? Housing prices don’t just ebb and flow with economic ups and downs. To take one economist’s phrase, “ housing IS the business cycle.”
As the U.S. experience underscores, taxpayers are on the hook if private insurers go bust. The housing market is simply too important for economic stability. A privatized CMHC would still have an express or implied government guarantee. Just like Fannie Mae and Freddie Mac, it would pretend to be a private corporation but know that the government would step in during a pinch. Such a “heads I win, tails the public loses” approach is the exact perverse incentive for risky lending – what economists call “moral hazard” – that we want to avoid.
Proponents of privatizing CMHC – like the Fraser Institute , the MacDonald-Laurier Institute and private mortgage insurers themselves – point to Australia. All of the Australian mortgage insurers are private, they say, and there has not yet been a housing crash down under. Those proponents fail to mention the still-elevated arrears on Australian mortgages and the credit rating downgrades that face its private mortgage insurers.
Governments must be wary of intervention for its own sake, but governments should step in where the market fails to achieve an economically efficient outcome. J.P. Morgan may have been the “lender of last resort” in 1907 , but no one would suggest privatizing the Bank of Canada today. We need a government-owned (if reformed) CHMC to curb excesses in housing. Too often in the financial system, the invisible hand likes to roll the dice, fuelling speculative bubbles and the risk of financial collapse. Like musical chairs, everyone has fun until the music stops.
Grant Bishop has an MA in economics from UBC and served as an economist at a Canadian financial institution. He is currently a law student at the University of Toronto.