Guest Post: Primer #4: CMHC- The Enabler To Canada’s Housing Addiction
Submitted by Ben Rabidoux of Financial Insights
Primer #4: CMHC- The enabler to Canada’s housing addiction
In our primers, we’ve now covered some of the important concepts that will be
referenced frequently on this blog, namely deflation,
bubble, and the significance of mass
psychology in financial events. This primer will add on to the primer on
the Canadian housing bubble and give some insight into what has enabled this
bubble to reach such significant proportions.
It is not possible to understand the Canadian housing bubble phenomenon
without understanding the role of CMHC (Canada Mortgage and Housing
Corporation) in mortgage lending. First, a bit of history.
CMHC was created in 1946
(the known as Central Mortgage and Housing Corp.). The mandate of CMHC was
to administer the National Housing Act and the Home Improvement Loans Guarantee
Act. Essentially it was created to provide soldiers returning home from war
with access to affordable mortgages.
Today, CMHC describes their role as follows:
“Canada Mortgage and Housing Corporation (CMHC) is Canada’s national housing
agency. We are committed to helping Canadians access a wide choice of
quality, affordable homes, while making vibrant, healthy communities
and cities a reality across the country. CMHC works to enhance Canada’s
housing finance options, assist Canadians who cannot afford housing in the
private market, improve building standards and housing construction,
and provide policymakers with the information and analysis they need to sustain
a vibrant housing market in Canada”
It’s the bold part of this statement I want to focus on. We will see shortly
that the mandate to ‘(help) Canadians access…affordable homes’…by…’enhancing
finance options’ is a self-defeating mandate. CMHC works by acting as the
guarantor for any mortgage where the purchaser is unable to pay a specified
amount as a down payment (20% for residential properties). Essentially CMHC
guarantees the full value of the loan so as to protect the lending institution
in the event that the buyer defaults on their mortgage and the bank is unable to
recover the full value of the loan by selling the home. Consider an example:
Imagine a homeowner buys a $200,000 home with a 5% downpayment, leaving a
mortgage of $190,000. Since the homeowner does not have the required 20%
downpayment, they pay a CMHC insurance fee and CMHC guarantees that they will
cover any losses so the bank can be assured of a profit. A year later the
economy sours, the homeowner loses their job, and real estate falls by 10% (I
know real estate only goes up, but just use your imagination). The home is now
worth $180,000 but the bank has lent $190,000 leaving them with a 10K loss.
Seeing as how we embrace capitalism some strange system
where we guarantee private banks a profit at the expense of taxpayers, we can’t
allow that! How else can the bank CEOs get their fat bonuses. So instead the
bank waddles up to CMHC and ask for the difference. CMHC obliges and promptly
hands over the 10K.
As I touched on in an earlier
post, any time the government steps in to guarantee things, they actually
defeat their own purpose. In this case, let me ask you whether or not CMHC has
been successful in helping to keep the costs of homes affordable? Let me
refresh your memory of how affordability currently measures here in Canada (and
this is with record low interest rates):
So what is really going on here? A more appropriate wording of their mandate
might be, “To provide artificially cheap mortgage rates for borrowers who may
not otherwise qualify for such rates and to ensure that the banks have no
reservations about lending to said individuals”. In this respect, they are a
resounding success. In a mortgage market free of government manipulation, a
lending institution would carefully consider what interest rate to charge a
person. They would take into consideration their credit worthiness, payment
history, and down payment since negative equity is one of the important
determinants of default rates. Now imagine two people came in to a bank.
One with a FICO score of 800 (excellent credit) and a down payment of 25%, the
other with a FICO score of 650 (average or slightly below average credit) and a
down payment of 5%. In a normal, functioning mortgage market, who should get
the lower rate? If you were asked to lend money to one of them, which would you
choose? If you did decide to lend money to the less credit-worthy person, you
would ask for a higher interest rate to compensate for the increased risk. And
so it should be. The effect of the CMHC guarantees ensures that both
individuals get the low rates, one of which would be an artificial, manipulated
You may ask, “why hasn’t CMHC spurred a bubble before now?”
Excellent question. To answer that, let me walk you through some key events that
have greatly changed the mortgage market landscape in Canada.
In 1954, the federal government expanded the National Housing Act to allow
chartered banks to enter the NHA lending field. CMHC introduced Mortgage Loan
Insurance, taking on mortgage risks with a 25% down
In 1999, the National Housing Act and the Canada Mortgage and Housing
Corporation Act were modified, allowing for the introduction of a 5%
down payment – a change launched as a five-year pilot in 1990, extended
and finalized in 1999 – removing a significant barrier for first-time home
buyers. Yes….imagine the injustice of actually having to SAVE to purchase a
home, as all the generations prior had done.
In 2003 CMHC decided to remove the price ceilings limitations. That is, it
would insure any mortgage regardless of the cost of the home.
These two developments had the effect of increasing the outstanding mortgage
balance in Canada by 125% between 2000 and 2009. Thanks once again to Jonathan
Tongue for compiling the chart.
In 2007, CMHC allowed people to purchase a home with no down payment
and ammortize it over 40 years. This was changed back to a 5% down
payment requirement and a maximum amortization of 35 years in late 2008.
In an effort to prop up the real estate market in 2008 (when affordability
nosedived and the economy soured), the Harper government directed the
approve as many high-risk borrowers as possible and to keep credit
flowing. The approval rate for these risky loans went from 33% in 2007
to 42% in 2008. By mid-2007, average equity as a share of home value was down to
6% — from 48% in 2003. This resulted in a shocking 9% increase in household
debt between June 2008 and June 2009, the only such increase during a recession
in Canadian history.
I have long maintained that the net effect of these policies has been to pull
demand forward, particularly in the past few years, and to raise home ownership
rates to artificially high levels. In Canada we are currently at the highest
home ownership rate in our history, hovering around 70%. How many more people
can buy? CMHC has been absolutely pivotal in getting many new individuals into
the market, but have massively skewed prices in the process.
So just how much does CMHC insure and what is the risk to taxpayers? In
March 2010, the Fraser Institute released a study
highlighting the risks to taxpayers and suggesting a privatized mortgage market
structure similar to the one Australia uses. This study confirmed that the
taxpayer risk from a housing collapse is greater in Canada than elsewhere. It
notes that a stunning 90% of all insured residential mortgages in Canada are
covered by the CMHC. This amounts to an estimated $480-billion (now no doubt
over half a trillion) for which Canadian taxpayers would be on the hook if the
housing market tanked (although any loss would obviously only be a fraction of
Those who have payed CMHC fees may protest that it won’t be taxpayers on the
hook, but that their fees will cover future losses. Perhaps. Bust consider
that standard loan fees reach a maximum of only 3.3% of the total loan value.
Not much of a cushion. As you can see in the following chart, the standard
premium for a non-traditional down payment (such as this
ridiculous offer….gotta love our ‘conservative’ banks) is 2.9%, plus a 0.4%
surcharge if it is amortized over 35 years.
It’s not hard to see that CMHC is the crutch supporting a wounded housing
market. It has had a role analogous, though not identical to the one played by
Fannie Mae and Freddie Mac in the US. See how things turned out for them.
Canadians are on the hook for a significant amount of debt and it is absolutely
my belief that we will pay up in the next few years. Government interventions
in free markets can have the effect of propping up demand over the short term.
But free market principles will win out over the long term. In the case of our
CMHC-aided housing bubble, the long term is now here.
Cheers and blessings