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Editorials Canada, the U.S. and the weaning of the mortgage markets

Fannie Mae’s logo at its headquarters in Washington. REUTERS/Jonathan Ernst/Files

JONATHAN ERNST/REUTERS

Both Ottawa and Washington are taking steps to reduce their roles – and the risks to taxpayers – in propping up their respective mortgage markets. The moves signal a welcome return to saner mortgage policies that will force banks to shoulder more of the responsibility for the risks they take, at a time when the Canadian housing sector is showing renewed strength and the U.S. market finally appears to be on a firm recovery track.

At the height of the global financial crisis in 2008-09, the Canadian government intervened in the mortgage market in an effort to keep credit flowing and the economy rolling. Now, Ottawa is endeavouring to return to a more normal state of financial affairs by limiting protection for lenders. Something similar is afoot in Washington, where officials are still struggling to clear the rubble remaining from the spectacular collapse of the U.S. subprime mortgage market and the bursting of the housing bubble in 2007, which triggered the worst financial crisis and economic slump since the Great Depression.

President Barack Obama outlined his proposals this week for an overhaul of the U.S. system that would effectively put government-controlled mortgage finance giants Fannie Mae and Freddie Mac out of their misery and leave Washington mainly as a backstop in cases of catastrophic risk and to preserve access to long-term mortgage financing. Although the revamped market will require "a limited government role," he declared that "private lending should be the backbone of the housing market."

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Unlike many of Mr. Obama's initiatives, this one reflects bipartisan congressional support for similar proposed legislation being cobbled together in the Senate. But in a country where the private mortgage market essentially ceased to function and banks have been loath to write new mortgages unless Fannie Mae or Freddie Mac absorbs the risk, it will be tough to wean the market off heavy government support. Since 2007, about 90 per cent of mortgages issued in the U.S. have been acquired or guaranteed by Fannie and Freddie. These were publicly traded enterprises whose debt was implicitly guaranteed by government. Washington was forced to take over both these insolvent companies in a $187-billion (U.S.) bailout in 2008, and officials have been debating what to do with them ever since.

Ottawa has a much easier task in reducing its mortgage-backstopping role. Canada Mortgage and Housing Corp. is now limiting guarantees available to banks and other lenders on mortgage-backed securities. It's a sensible decision. Housing is in the midst of a strong rebound, as historically low mortgage rates offset more restrictive mortgage-insurance rules brought in last year in an effort to cool an overheating market. Even in a calmer market, officials rightly worry that too many homebuyers don't have a sufficient financial cushion to weather even a slight – and inevitable – rise in mortgage rates down the road. By limiting its role as guarantor, Ottawa is signalling that it wants banks to accept more of the risk.

CMHC has notified banks, credit unions and other mortgage lenders that they will each be restricted to a maximum of $350-million of new guarantees this month under its National Housing Act Mortgage-Backed Securities program. Lenders have embraced the conversion of loans into securities with the Crown corporation's backing as a nearly risk-free way to obtain funds from a broad range of investors. That, in turn, has enabled them to write more mortgage loans at a lower cost. But federal Finance Minister Jim Flaherty worries that extremely low mortgage rates, accompanied by generous public backstopping of loans and mortgage-backed securities, are giving homebuyers and lenders alike a false sense of security. A serious reversal in housing could saddle taxpayers with hefty costs and spread considerable pain across the general economy.

In the spring, Mr. Flaherty took the rare step of publicly criticizing some banks for cutting rates even more to gain a competitive edge. He has also reduced the degree to which taxpayers would be on the hook if the market turns sour and defaults climb. So far this year, the Minister has announced restrictions on the banks' ability to buy bulk insurance from CMHC, and he ended the use of government-backed insurance on securities sold by the private sector. Last year, Ottawa told banks they could not use insured mortgages in covered bonds, another type of security backed by pools of mortgages.

All these changes have been designed to transfer more risk to lenders. There will be grumbling about higher costs, which the banks will undoubtedly pass on – yet another step in returning the mortgage market to something resembling normality and forcing both lenders and customers to exercise more caution.

In the U.S., attempts to reform mortgage financing are fraught with political and financial problems, despite a consensus that the current system has to go. Washington relied for years on the two government-sponsored mortgage behemoths to carry out uneconomic housing policies. Now, the government wants banks to take back their traditional role, but what will the politicians do if they balk at financing long-term mortgages at low fixed rates or steer clear of areas they believe pose higher risks of default?

A sensible proposal has surfaced in the Senate. It calls for a mortgage-insurance scheme that would operate much like deposit insurance, with mortgage investors putting a big chunk of their own money on the line in exchange for the government protection. That way, taxpayers wouldn't be on the hook for another costly bailout.

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In any case, both Washington and Ottawa are heading in the right direction, signalling a sharp reduction to their extraordinary intervention in vital markets and putting the risks back where they belong.

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