An aerial view of housing in Calgary is shown.Jonathan Hayward
Finn Poschmann is president and chief executive officer of the Atlantic Provinces Economic Council.
The federal government is apparently once again batting around the idea of an insurance deductible for mortgage lenders whose insured loans go bad.
This will be popular among those who like the notion of forcing lenders to have "skin in the game." However, in the words of a November, 2015, Finance Department ministerial briefing note, it would have "potentially far-reaching impacts on lenders, borrowers and mortgage insurers."
That might seem like calm sentiment, but in permanent staff language, it says, "Here be monsters, Minister, but go ahead, and don't forget to write us when it all settles down."
The issues are simple. For several decades, Canada's chartered banks have dominated the residential mortgage lending market. And in our market, if a more-or-less creditworthy potential home buyer has less than 20 per cent for a home down payment, federal law says mortgage insurance is required. That has mostly been provided by the Canada Mortgage and Housing Corp., a Crown agency.
When a mortgage loan goes bad (in arrears for 90 days), the borrower is typically still on the hook, but the insurer must make good any lender losses on the loan. So, through CMHC, the federal taxpayer pays.
There are two private mortgage insurers in the domestic market. When one of their insured loans goes bad, they are fully on the hook, and the taxpayer is not. One wrinkle: If the private insurer goes bust, the federal taxpayer is back on the hook for 90 per cent of the face value of those insured mortgages.
This federal guarantee enables lenders and insurers to do business without prohibitive capital requirements that would otherwise be imposed by the Office of the Superintendent of Financial Institutions, in line with those required under the international (Basel) banking accord.
While that federal backstop enables the existence of private insurers, CMHC still historically held 60 per cent to 90 per cent of the market. This came to mean that federal taxpayers were directly guaranteeing a giant share of chartered bank assets – not a recipe for financial stability.
Accordingly, some of us pushed hard in the past decade, and successfully, for restraint in the growth of CMHC's insurance premium book, to create room for private insurers and investors to take on more risk.
To nudge that along, the federal government restricted the amount of mortgage insurance that CMHC could underwrite, and restricted growth in the amount of portfolio insurance – which covers bundles of otherwise uninsured mortgages that go into securitizations sold on to investors – so that CMHC now holds more like 50 per cent of the mortgage-insurance market. And we sharply raised the fees that CMHC charges lenders for guaranteeing securitizations, a profoundly market- and risk-oriented reform.
Amid this tightening, there has been some loosening, allowing the growth of mortgage-funding channels that don't carry taxpayer guarantees. Canada has now legislated a covered-bond framework, which allows lenders to create a pool of low-risk, uninsured mortgages that backstop covered-bond issuance on global markets, bonds that are further backed by the full faith and credit of the issuer. These are secure enough that when the Canadian Imperial Bank of Commerce went to market with them in July, the bonds were priced at a zero coupon rate and sold with a negative yield.
This kind of funding channel is relatively new to Canada, and it has room to grow if regulators let it, without taxpayer guarantees.
So where does an insurance deductible fit in to the mortgage marketplace?
The first answer is that it does fit most finance and insurance markets – just not the one Canada has built.
Hence those "potentially far-reaching impacts," some of which are predictable. We have to figure out who's on the hook for the deductible when the lender has sold on a mortgage through a securitization. That affects the market value of the security.
The second thing we know is that costs will go up. Bank capital requirements will increase, as will the costs of running a mortgage-lending business. This is what economists call a supply shock, and the result is that markets will clear at higher prices and lower volumes.
And potential borrowers will have less access to credit. Lenders and insurers will do more market-risk segmentation and less risk-sharing among their customers, which is no fun for those of us in housing markets where income levels are less stable. The regional impacts would not be pretty.
Canadians are right to worry about occasionally frothy housing markets, and about how much risk their government exposes them to. But we have tools to respond. Unless we have reason to believe these tools aren't up to the job, we might best defer on skinning the mortgage lenders.