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Tyler Anderson/National Post

Tyler Anderson/National Post

Home buyers who can’t put up at least 20% of the cost of the house are required to take out insurance.

 

The numbers are staggering.

At the end of last year the Canadian banks had $494.4-billion of insured mortgages on their books, guaranteed by the Canada Mortgage and Housing Corp.

Another piece of telling data: As of the end of September the CMHC had guarantees on $541-billion of outstanding home loans — roughly equivalent to the Canadian federal debt and just shy of its government mandated $600-billion cap.

The sudden jump in demand for so-called “bulk insurance” on securitized home loans took even the CMHC by surprise. It acknowledged last last month that due to “an unexpected level of requests” it is establishing “an allocation process” (aka: sharp reduction) for big lenders so it can keep doling out insurance to average Canadians.

Meanwhile, the government led by Stephen Harper, which is deeply worried about runaway consumer debt, is said to also be leaning on the CMHC to curtail bulk insurance.

“There has been increasing speculation that upcoming legislation will not permit the use of CMHC insured mortgages as collateral,” said BMO Capital Markets analyst George Lazarevski.

Whether such a move will have the desired impact remains to be seen but it’s further evidence of the dilemma the government finds itself in as it struggles to rein in consumer borrowing without destabilizing an already frothy housing market.

The good news is that the Canadian real estate prices appear to have stabilized, according to the Canadian Real Estate Association.

In a report released on Wednesday, CREA said average prices in January were up less than 2% over the same period last year, with sales down 4.5% compared to December, the biggest monthly decline in 18 months. The findings suggest that the market may be headed for a soft landing, though experts say it’s still too early to say.

Home buyers who can’t put up at least 20% of the cost of the house are required to take out insurance. Banks can also take out bulk insurance on mortgage pools, a key step before packaging up the loans into securities for sale to investors.

Though there are a handful of private sector insurers, the CMHC is by far the dominant player. It also backstops 90% of the private sector guarantees.

As a Crown corp., the CMHC is an arm of the federal government, which is why bonds backed by CMHC insured mortgages can carry a higher credit rating than the institution that issued them.

This means banks are able to raise funding almost as cheaply as the federal government — an enormous competitive advantage at a time of rock bottom interest rates, when many foreign lenders are virtually shut out of funding markets.

Not surprisingly, Canadian banks are big fans of bonds backed by insured mortgages, selling a record $24.7-billion of covered bonds in 2011, up from $17.3-billion in 2010 and $2.8-billion in 2007, the year prior to the financial crisis.

Ottawa increased the mortgage insurance cap to $300-billion from $250-billion in 2004. It was boosted again in 2007 to $350-billion, and then to $450-billion in 2008. In 2009 it was pushed up to its current limit of $600-billion.

Part of the reason Ottawa has been raising the cap was to enable players to access funding in the wake of the financial crisis that began in 2008. While that storm is long over, the banks’ appetite has been undiminished.

Some critics worry that lenders are more focused on creating and selling covered bonds than on the ability of borrowers to meet their obligations on the underlying mortgages.

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Industry insiders speculate that the government may respond by prohibiting the used of CMHC-insured mortgages as collateral for covered bonds, according to Mr. Lazarevski.

Even if Ottawa takes that step it still doesn’t solve the bigger problem with consumer debt.

The root of the issue is that banks are public companies — with demanding shareholders — designed to pursue profit, and that’s exactly what they’re doing.

“As long as you’ve got a free, open economy, there’s really not much the government can do,” said Lawrence Booth, a professor at the University of Toronto’s Rotman School of Management.

The government has tightened mortgage rules several times, but when interest rates across much of the developed world are close to zero such strategies will only go so far.

“The fact is, what can you do with the banks?” asked Mr. Booth. “The banks are in business to make money. The Bank of Montreal  lowered their five-year rate [a while back]. All the banks had to respond otherwise they lose business. On the one hand this is good to help the economy. On the other hand [Bank of Canada Governor] Mark Carney is dead worried about the increase in household indebtedness.”

Canadian household debt to income is already sitting at a record 153%, greater in Canada than in the U.S. or Britain.

Finance Minister Jim Flaherty has tightened mortgage lending rules in several ways, but with limited effect as consumer debt held by the banks continues to grow at around 6%, well ahead of GDP.

The worry is that a spike in unemployment or interest rates could trigger a wave of defaults that would ripple through the broader economy. In a worst-case scenario, a major real estate correction could overwhelm the CMHC, leaving taxpayers on the hook.

“Of course taxpayers should be concerned,” said Finn Poschmann, vice president of the C.D. Howe Institute, a Toronto-based think tank. “You’ve got a situation where a big portion of the assets held by the banks are comprised of loans guaranteed by the federal government, which enables the banks to raise extraordinarily low cost capital. All the incentives line up.”

John Reucasse, who covers banks for BMO Capital markets, pointed out in a note to clients last month that the sector’s reliance on CMHC insurance has “increased significantly” and he warns that “should the CMHC ever require capital from the federal government… we expect banks could face higher taxes and higher premiums to fund losses.”

Outstanding mortgage debt stood at a record $1.1-trillion at the end of 2011, nearly triple what it was a decade ago, with most of the growth taking place since 2007.

About 50% of mortgage loans held by the banks are covered by the CMHC, representing about 22% of the Canadian dollar assets, according to the C.D. Howe Institute.

“The system is working the way it’s supposed to,” said another analyst. “These are public policies designed to support the financial system.”

The result is we have strong, profitable banks that are widely held.

“People have got to start thinking about their own ownership stake in the banks,” he said. “Look at any equity mutual fund, banks all in there, Canadian consumers have got to recognize they are all owners.”

 

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