The secret plan to break up the CMHC
Larry Smith delivers his warning about the state of Canada’s housing market in the kind of gruff, no-nonsense tone you might expect from a guy who’s seen it all before and said everything he thought he could in years past, back when people might have listened.
Canada Mortgage and Housing Corp., the country’s national housing agency, is finally on the path to being operated like a significant financial player which it has morphed into during the past decade.
A new chairman of the board, a soon-to-be unveiled chief executive and a new reporting structure that will overhaul its operations are the tangible indications of the fundamental changes playing out behind closed doors at the Crown corporation that have been set in motion by the federal government.
“It looks like we’re going to see the same problems [that I warned about] reappear and nothing’s been done to alleviate them,” said Mr. Smith, officially retired but still a professor emeritus at the University of Toronto’s economics department, specializing in real estate.
“I’m pretty disappointed,” is all he has to say of the fact that much of what he predicted more than 30 years ago about Canada’s taxpayer subsidized and precariously overvalued housing market has come true.
Back then he was a vocal critic of government policies that paved the way for a major expansion of the role of the public sector in the housing market — mostly through the Canada Mortgage and Housing Corp. (CMHC), the government-owned mortgage insurer.
In 1979, Mr. Smith was appointed deputy chairman of a federal task force set up to “study the potential for privatization” of the activities of the CMHC. The task force report, which was never released publicly according to Mr. Smith, came down squarely on the side of the free marketers.
The CMHC should “cease writing mortgage loan insurance, except in extreme circumstances when the private market cannot supply this service in remote areas,” the 130-page document advised. The report also raised troubling questions about the lack of transparency within the Crown corporation, making it difficult to properly analyze the financial implications of the insurance program.
It makes for an interesting read three decades later as the country gets set to contend with a potentially severe correction in house prices.
The Organization for Economic Co-operation and Development warned earlier this month that Canada is among the world’s over valued real estate markets, leaving it vulnerable to rising interest rates or unemployment. The comments come in the wake of similar red flags raised by policy makers such as former Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty.
Much of the discussion about what’s wrong with the housing market focuses on the CMHC, which now counts as one of the country’s largest financial companies, owing to its substantial portfolio of mortgage guarantees covering nearly $600-billion of outstanding home loans, roughly 30% of Canada’s GDP.
Critics say the CMHC is under-charging for its policies, which has opened the door for housing speculators and enabled banks to push the risk of default on hundreds of billions of dollars of mortgages onto the shoulders of government — bottom line, the CMHC is the primary cause of the bubbly market.
The CMHC has always denied this. It has taken the position that while the taxpayer is the one ultimately holding the bag, the risk of losses spilling over onto the government is actually miniscule because of the responsible manner in which business is conducted and the fact that the insurance premiums have been piling up year after year, contributing to a capital surplus of nearly $14-billion — more than enough to cover potential losses from any potential housing correction.
For the last few decades, the CMHC has managed to churn out regular profits, and of course it’s hard to argue with success. But the thing about housing is that it’s a market like any other, except that the cycles tend to last longer than most. And often the busts are painful.
You only need to go back to the late 1970s to see what a difficult housing bust looks like. By then, the period of prosperity characterizing previous decades had given way to rising unemployment and economic uncertainty. With job losses mounting, housing prices began to wilt and the pain quickly spread to the CMHC.
Launched in 1946 to help provide housing for soldiers returning from the Second World War, it administered a range of subsidy programs focused around mortgage assistance and social housing. Mortgage insurance was already a core function.
The CMHC’s annual report for 1979 paints a disturbing picture:
“The year saw a further increase in claims on the Mortgage Insurance Fund. Claims had started to increase in 1977, accelerated in 1978 and then more than doubled in 1979. All these claims resulted in the Fund acquiring real estate that could not be readily sold because of long-standing constraints on the Corporation’s real estate practices….”
“In each Annual Report from 1976 onwards, reference has been made to the diminishing viability of the corporation under present financial and legislative arrangements. Developments in 1979 reinforce the need either to change these arrangements or the explicit recognition of CMHC’s financial problems.”
Mortgage insurance claims arising from borrower default soared that year, leaving the CHMC with more repossessed homes than the cumulative total since it got in to the business in 1954. But the recession had only just got going. Interest rates, already stratospheric by today’s standards, started to move up, sparking more defaults and a further slowing of economic growth.
Soon the CMHC found itself administering tens of thousands of foreclosed homes across the country, an enormous portfolio that quickly became an administrative burden and a source of unforeseen problems. For instance, the organization was required by its mortgage insurance contracts to compensate banks following a default, but due to the explosion in defaults and tumbling housing prices that simply wasn’t possible. At one point, the CMHC had possession of more than 40,000 foreclosed homes. As a result, the mortgage fund became so depleted that the government had to step in on at least one occasion with emergency funding.
Then, as now, Canada’s housing market was partly supported by the arrival of new immigrants but as the recession ground on, immigration fell off, exacerbating the mess.
Indeed, the troubles were so severe that the funding deficit rose to nearly $800-million, leaving the CMHC technically insolvent.
To be fair, the CMHC was a different beast in those days. When mortgage insurance wasn’t enough, prospective home buyers could qualify for something called the Assisted Home Ownership Program (AHOP), where the CMHC covered part of the mortgage interest payments. And mortgage insurance itself was cheaper, partly because the fees charged to borrowers didn’t even cover the cost of administration.
Subsidies like the AHOP have long since gone by the wayside and mortgage insurance is considerably more expensive.
“In the late 1970s and early 80s, the mortgage loan insurance business was managed mostly on a cash basis and without a comprehensive capital management framework,” said Teresa Amoroso, a spokesperson for the CMHC. “As such it is difficult to compare today’s mortgage insurance business, which operates on a commercial basis, with the pre-commercialized activities of the 1970′s and 80′s.”
As well, she points out, the CMHC is today under the oversight of the Office of the Superintendent of Financial Institutions, the federal banking and insurance regulator. “CMHC currently has more than twice the minimum level of capital reserves as set out under OSFI guidelines.”