Skin in the Game

The government’s guarantee of mortgage default insurance “subjects Canadian taxpayers to large, ill-defined risks.”

Source: C.D. Howe Institute Policy commentator, Finn Poschmann

“As long as the government insists on backstopping the risk of high ratio mortgages with taxpayers’ money, banks simply won’t have any skin in the game.”

Source: Fraser Institute Director, Neil Mohindra


Measuring RiskA contingent of vocal critics, like those above, have charged Canada Mortgage and Housing Corporation (CMHC) and the government with taking undue risks on the taxpayer’s dime.

They paint an alarming picture of Canadians being forced to bail out insurers when homeowners default en masse.

Many of their arguments center on the inherent risk of the underlying borrowers. (In partial defense of these critics, affordability and debt ratios have indeed become stretched among limited segments of the population.)

Yet, those we talk to with an inside view of mortgage underwriting question how overblown and one-sided the risk debate has become. By one-sided, it means that legitimate counter-arguments are not making it to the mainstream press in proportion to the negative charges being made.

There is ample evidence to suggest Canadian mortgage risk is well in check. Here are just a dozen such reasons why:

  1. The #1 reason is that Canadians pay their mortgages…through thick and thin—through up markets and down markets. Canada’s default rate (fresh off the presses from the Canadian Bankers Association (CBA) is 0.42%. That means just 42 out of every 10,000 prime mortgagors are behind on their mortgage payments by 90+ days. The all-time high in modern times is 1.02% in 1983. Canada’s arrears rate has remained at, or near, the lowest arrears rate in the world. That’s been true throughout multiple business cycles, including 2008-2009, one of the worst global recessions and housing cycles in memory.
  2. By and large, Canadians with mortgage insurance have considerable equity. 71% of insured mortgages are low-ratio, says TD. That means there is generally significant leeway if a borrower defaults and insurers have to liquidate the property. 87% have at least 10% or more equity, according to CMHC in 2010.
  3. Canadian mortgages are full recourse. That means, if you default, you can’t thumb your nose at the lender and turn in your keys. In most provinces, insurers or lenders will get a judgment to collect any deficiency once they liquidate your property. As a result, strategic defaults (as made popular in the U.S.) are not in the borrower’s favour here.
  4. Canadian lending standards are stringent and carefully monitored by governmental agencies including the Finance Department, Office of the Superintendent of Financial Institutions Canada (OSFI), provincial regulators, and the Bank of Canada.
  5. Debt has risen sharply, but so have assets. Canadians’ asset values “more than swamp the size of their debts,” says BMO economist, Sal Guatieri. As per the Montreal Gazette: “Average household net worth has risen to an impressive six times the size of disposable income.”
  6. Canadian insured mortgages entail a much smaller risk of payment shock than in many countries, thanks to artificially high government-imposed qualification rates, as well as the predominance of 5-year fixed terms. (That said, the risk of payment shock has gone up thanks to the government restricting homeowners’ ability to reset their amortization back to 35 years at maturity. Amortization resets are a last resort strategy for homeowners when rates rise and improved cash flow is required.)
  7. Default insurers are multi-billion dollar enterprises that insure to make a profit. They do assume risk, but that is precisely their business. They get paid well for what they do. In fact, default insurers get paid well enough to build reserves that are 150%-200% of government guidelines, and in CMHC’s case, return billions in profits to taxpayers (thus reducing each and every person’s tax burden). If insurers mismanage risk, they bleed losses and the axe comes down on management. Apart from certain competitive pressures (which make them marginally less conservative), insurers are motivated in every conceivable way to write good business.
  8. Canadian mortgage underwriters are incentivized to avoid undue risk. Underwriter compensation, for example, is frequently linked to low arrears levels. One lender we spoke with last week gears 30% of its underwriters’ bonuses to arrears. (Keeping one’s job is another good motivator for an underwriter.) In short, you can bet every penny that underwriters, as a whole, are strongly encouraged (read, “required”) to approve quality deals.
  9. Insurers perform regular, significant and thorough quality assurance (QA) auditing of every approved lender, from the smallest monoline, to the biggest banks in the land. These audits ensure underwriting standards are being met and due diligence is being properly performed (including employment verification, income validation, asset checks, etc.)
  10. Canada’s rules on proving income are conservative compared to many countries. Unlike our American cousins who loved to rubber-stamp their NINJA (No-Income-No-Job-or-Assets) mortgages, Canadian fulfillment personnel actually look at a person’s documentation and call their employer to verify job status (imagine that!). Even standards for insured stated-income mortgages, which comprise only a small ratio of Canadian loan volumes, are relatively cautious. Insurer sources state that defaults on stated-income mortgages are well-contained, making these products amply profitable.
  11. Insurers are regularly required to stress-test their portfolios, using inputs like extreme unemployment or rapid and unexpected interest rates hikes. These tests include government-mandated hypothetical scenarios designed to “break” the insurer. The results are then reported back to the federal government.
  12. Banks do have skin in the game. In fact, one might say they have pounds of flesh in the game.

Let’s talk a bit about point #12. Critics charge that lenders have no risk in writing bad loans because the government (with taxpayer backing) covers all their costs when borrowers default. That is unequivocally untrue.

There is a major misconception on this point, even among widely-quoted analysts. Neil Mohindra, recent author of a broadly disseminated and critical report from the Fraser Institute, told us: “I am not aware of any costs that mortgage insurance does not cover.”

That is, by no means, an affront to Neil. He was very gracious and helpful in responding to our questions. It’s merely a commentary that certain realities about our industry are beyond the purview of outside analysts.

CMHCAnother case in point was the hubbub that occurred when the media learned that CMHC’s total authorized insurance jumped to $600 billion in 2010. Little did some realize that billions of this cap was earmarked for portfolio insurance (i.e. ultra-low-risk insurance on low-LTV mortgages).

The point is, too many commentators make influential judgments on Canada’s default insurance system without considering its checks and balances.

Lenders are, by no means, Scot-free when they sell an insured mortgage. Here is a sampling of very real costs that mortgage insurance does not cover:

1. When a borrower defaults, lenders are stuck with:

  • Originator compensation costs (often exceeding 40-100 basis points)
  • Hedging costs (often $500 to $1,000 or more depending on the rate hold)
  • Underwriting labour and expenses
  • Labour and expenses for recovery and collections
  • Channel support, marketing, and other client acquisition costs
  • Administrative and servicing labour and expense (TD Bank notes that: “Even with an insured mortgage, the lending institution manages the mortgage, directly handling payment collection, foreclosure, and sale of the home, where applicable.”)

2. Lenders must fork out higher portfolio insurance premiums when default rates are abnormal

3. Higher defaults raise capital costs, which shrinks or eliminates profit margins (Xceed Mortgage showed everyone just how thin insured lending margins have become). Non-bank lenders with above-average defaults, for example, may find it impossible to secure the cost-effective financing required to sell off mortgages to investors.

4. Once ratings agencies (S&P, Moody’s, Fitch, etc.) catch wind of default problems, you can bet they’ll downgrade that lender, which has costly repercussions.

5. High defaults are blasted by equity analysts. That tends to have a decidedly negative impact on a lender’s share price.

6. Most mortgages are held on lender’s balance sheets. Only 29% of mortgages are securitized, according to TD. (See Mortgage Market Primer) Now more than ever, lenders are closely scrutinized. They want only performing loans on their books.

7. Cross selling is a huge profit driver for most lenders. Customers who default cost lenders multiple lost opportunities for revenue in other areas.

8. Similarly, when a lender takes back a person’s home, that lender can kiss goodbye any and all referrals from that customer.

9. Defaults tie up a lender’s capital. The lost-interest revenue can be considerable when calculated over an entire portfolio of arrears. Non-performing mortgages also cannot be financed. Therefore, lenders must keep them on the balance sheet, which entails carrying costs.

10. Customers who default on their mortgage often default on other debt with that lender. This raises lender risk further because lenders are not insured for non-mortgage products (like credit cards, lines of credit, car loans, etc.).

The reality is, Canadian mortgage lenders have a long-term perspective, largely because they bank on retaining quality clients. (For lenders, the second mortgage term is far more profitable than the first term.)

George-Hugh-INGING Direct’s Head of Mortgage Origination, George Hugh, says, “As a bank, I’m not interested in your money for the short term.”

“I don’t look at insurance as offsetting risk. It mitigates risk…but doesn’t offset it. We have valuable relationships with the insurers and we are partners. We don’t view them as a venue to offset risk.”

Defaults are especially feared today because lending profit margins are so tight. Hugh cites a 60-basis point gross spread on some mortgages, which is razor-thin by historical standards. Hugh estimates that lenders must swallow up to 15 basis points in costs that insurers don’t reimburse upon default.

Another key point is that most defaults happen in the first year after closing. “After 6-9 months of payments, underwriting is irrelevant,” one insurer executive told us. Things like unemployment, illness and marital splits then become the primary risk factors.

This 6-9 month default window is a key point because lenders’ costs cannot be recouped that fast. Costs are instead recovered over five years in many cases. As a result, most people who default give the lender little chance to recover its non-insurable costs.

Canadian-Mortgage-Default-InsurersBased on data we were provided by one insurer, bad underwriting is simply not a material risk factor. 70% of that insurer’s defaults occurred when a borrower lost his or her job. Second in terms of impact, were losses from home price declines associated with economic shocks. A distant third, were large rate increases.

Many will look at all of these factors and think, “If Canada’s system isn’t broken, why are people rushing to fix it?” The fact is, additional regulations should be welcomed if they abate risky segments of the market. On the other hand, tinkering with the $2.78 trillion residential real estate market, which represents 1/5 of Canada’s entire economy, has its own serious risks.

Moreover, we can never forget the utility that government housing sponsorship affords us on a national level. Yes, real estate values have been magnified by government support of housing. (Some people love that home prices have been strong and some people hate it.) The benefits, however, include materially lower mortgage rates, added stability in the real estate and mortgage funding markets, added tax revenue, housing research, and vital programs for low-income, rental, senior citizen, new immigrant, rural, and self-employed borrowers…to name just a few.

In fact, in 2008 “over 40% of CMHC’s total business was in areas, or for housing options, that are less well served or not served at all by the private sector mortgage insurers,” says TD. Funding these programs is incredibly expensive and made possible, in part, by CMHC’s considerable mortgage insurance revenues.

Despite the strength of our housing system, that doesn’t mean we shouldn’t strive to make it better.

Ideas-to-improve-mortgage-insuranceHousing critics have proposed various ideas to improve Canadian mortgage finance, and some deserve a further look. Here are a few:

  • Adopting legislation to further support covered bonds
    • Covered bonds are backed by insured or non-insured mortgage assets and by the full faith and credit of the financial institution sponsoring them, as opposed to securities that rely fully on the government’s guarantee.
  • Encouraging insurers to use risk transfer mechanisms to manage exposures, where appropriate
  • Augment reserve requirements
    • Mohindra writes that mortgage insurance is prone to “catastrophic levels of losses.” Internationally speaking, he is right. In Canada, risk levels are far lower. Several years ago when CMHC had a deficit, “$200 million was injected” by the federal government, says Mohindra. (Since then CMHC has significantly bolstered its reserves and underwriting systems.) Contrast that $200 million with CMHC’s $7.3 billion in profits to taxpayers last decade + billions more in additional tax revenue. TD estimates that mortgage defaults “would have to increase by three- to four-fold to compromise the profitability” of CMHC’s default insurance program. (see: Mortgage Market Primer)
  • Subjecting CMHC to OSFI oversight and regulation
    • Presently, CMHC is not under OSFI’s watchful jurisdiction, as are private insurers. A single centralized regulator for all insurers seems intuitively sensible. It eliminates any regulatory advantages and helps ensure all insurers have equal, full, and transparent disclosure requirements.
  • Reducing CMHC’s government guarantee from 100% to 90%, like its private competitors.
    • Mohindra says that a “10% deductible might be enough” to encourage more prudence when lenders underwrite CMHC-insured mortgages.
    • This would certainly level the playing field between insurers, because lenders would no longer have to set aside extra capital for privately-insured mortgages. (See: Mortgage Insurance in Canada: Make it more competitive)
    • An across-the-board 90% guarantee would also mitigate the perceived risk from investors who buy non-CMHC-insured mortgages (this risk premium raises the cost to lenders who use private insurers). We saw how powerful this difference can be during the credit crisis, when private insurer market share plummeted.
  • Higher standards for riskier loans.
    • This is where the government could have got it right, had it consulted the industry further and not succumbed to the bank lobby and one-sided media accounts. By higher standards, we mean tougher qualification criteria for insured mortgages where LTVs and/or debt ratios are high. It does not mean thoughtless blanket regulation that affects impeccably-qualified borrowers and risky borrowers simultaneously.

Despite all the debate and disquieting headlines, Canada’s mortgage insurance system has earned respect worldwide, and for good reason. Scotiabank says: “The structure and micro economic foundations of the Canadian financial system are much different than in the U.S. and the U.K. (as just two examples) and work to limit the downside risks to the household sector.”

Canadian housing emerged from the credit crisis with hardly a scratch. While we do have a measure of housing risk in this country, every mortgage system has risk. What’s more important is that our country has a lending system that incentivizes underwriting and borrower prudence. At the same time, the regime we employ must allow maximum flexibility for deserving low-risk borrowers.

Rob McLister, CMT

  1. Wow. Big article! Good point about stock prices dropping if arrears go up. You know the banks aren’t going to let defaults affect their beloved share prices.

  2. My head is swimming with delight thanks to all your good counter-points and it’s nice to read a balanced, well-researched point of view. Might be your best post ever. Good job.

  3. Last time I checked, it was the U.S who didn’t have what Canada/CMHC had, and the U.S went into the worst recession since the great depression.
    Who ever wrote the article has no idea about finance and the current history of the market. I guess you were proven wrong in the recent recession.

  4. Long article. And yet you never address the only questions that matter. And I put you them as a former employee of the mortgage-backed securities division of Bear, Stearns:
    Why am I on the hook for anyone else’s mortgage insurance?
    Why is the State carrying risks that should be borne by private lenders?
    And why, if the risks are minimal, can they and are they not being met by the free market?
    You cite a list of “benefits,” such as lower mortgage rates. Well yes, if we *subsidise* mortgages by backstopping them, then rates will be lower. But why should we do that? Regarding “adding stability”–see my CV above.

  5. David, have you ever thought of what might happened if the insurers were all private? It is well known in the industry that private insurers typically take on much more risk than CMHC. Opening the door to just private insurers is a sure recipe for disaster even if those insurers are “governed” by rules and policies in Ottawa…The chance of a housing collapse is remote in Canada due to overall solid prudent practices in Canada on the mortgage front. If you want to see a housing collapse let the private insurers take over and when home prices plummett then you’ll have some ticked off tax payers.

  6. The US recession was caused by a complete lack of underwriting standards and blind securitization. Based on your post it is obviously you that have no idea about history and mortgage finance.

  7. Are tax payers really on the hook for the insurers? if you look at on average they collect say 3,500(on a 200k mortgage at 85% LTV) and with only <.5% default rate; I really doubt we are. This is one of the very few profitable business' the gov't is involved in. I also doubt that they see many claims from lenders unless it is a severe case of negative equity.

  8. Well said Sean. As a taxpayer I’m very pleased with my return on the CMHC mortgage insurance business. The risk is definitely worth the upside any way you slice it and we should continue to invest in it any way we can.
    As for the bank’s “skin in the game”, they have a big liability/expense that has not been discussed here: fraud losses. I once heard that a mortgage lender’s exposure to fraud loss exceeds their exposure to credit loss. As I understand it, in this country, fraud losses do not have to be reported to the authorities (i.e. the RCMP) by the banks, unlike in the U.S., where fraud must be reported and becomes public record. So who really knows how much of a 60bps net margin is wiped out when a bank gets quietly ripped off… I have no doubt the banks make great profits, but I would not go so far as to suggest they “have no skin in the game”.

  9. The argument that “defaults are low in Canada” is somewhat meaningless… who would default when house prices keep rising? Isn’t that precisely how everyone gets consolidation loans?
    Also – almost all of these mortgages are approved by emili the CMHC robo-approver… how is that not that same as “rubber stamping”?
    5 Million approvals, most in 7 seconds or less! A rubber stamp would be slower than how CMHC approves these loans!

  10. Maybe, instead of a conversation between homeowners and other homeowners and how all these rules are so bad for the first time homebuyers and everyone else in the market, how about you actually talk to some well informed potential first time buyers? A lot of us are fed up with the current outrageous price of homes and have made the connection that easy access to credit have priced us out of the market for now. Only until the market reverts back to a normal position will it make sense for us to buy. In the meantime continue with all your useless banter and business biased articles and we will wait for a more sane market to emerge.

  11. This used to be a blog site that at least attempted to offer mortgage advice and help to the first time home buyer (while representing the biases of the broker industry of course). Now it’s almost all broker industry flag waving. Not too much talk geared to the first time buyers these days… Anyone want to discuss the “smith maneuver”? Anyone?
    Me thinks he does protest too much. If the broker channel believes in these arguments, let it be the one to front the “skin” here without the CMHC’s insurance or assistance.

  12. Are you kidding Frank?
    This blog site is awesome! I’m CEO of http://www.TDMP.COM. Check it out. I oversee the largest portfolio of “Smith Manoeuvre” clients in the country. Ask me any SM question you can dream of. You came to the right place for such answers.
    P.S. SM is not suited to first time (high-ratio) homebuyers. You need to wait until you are in a conventional mortgage.

  13. What’s your point? If you want something, earn it. Don’t whine to others expecting sympathy. The rest of us work hard for what we have and live within our means. If we can’t afford a house we rent, move, or find a way to make a better living. Housing policy isn’t designed for the lowest denominator. If you have a problem with that then improve your situation and take personal responsibility.

  14. Stats
    You overlook important details.
    That five million transactions are over the last 15 years. Just because emili is automated means nothing. Automated underwriting actually generates fewer defaults than manual human underwriting. Regardless, most applications are manually reviewed by the lender before being sent to an insurer.
    Defaults have stayed low for more than 50 years. We’ve had a lot of economic shocks and recessions in that time but somehow people keep paying their mortgages.

  15. Every once in a while someone posts something like this here. I don’t blame them – I felt like that too while I was trying to buy my first home. But in reality, blaming the CHMC for housing prices is kind of like blaming ice cream for making someone unhealthy – there are so many other factors that contribute to someone’s overall health. Same for housing prices. Easy connections make for poor answers.
    The CHMC is always the easy target – the bogeyman for those without a house, the saviour for those for whom it helped into the market. It’s easy to point to finger and say “This is the reason prices are so high! Everyone else is buying with 5 percent down and 35 year ams!” when in it’s always much more complex than that.
    Without the CMHC prices might be a bit lower. Housing affordability, however, would still be off the charts, particularly in places like Toronto; the ‘sane’ market you’re likely expecting would still be eluding us.
    I encourage you to wait; that’s what we did, waiting for a house that was priced within our means. Housing prices will likely decline over the next ten years, however the price-levels that some people expect of the market will be a long-time coming…if they ever arrive.

  16. Is this article a manifesto, an invitation to debate or an act of frustration?
    You’re lobbying in the wrong area.
    Undoubtedly the government is aware the ranks of mortgage brokers and alternate lenders are largely populated by former big-6 bank employees.
    To expect the government to accept you as a champion of the consumer or a impartial thinker on economic efficiency is not sensible.
    Push for alternate lenders to have better access to capital. That’s where you should make your bed.

  17. Interesting and long post. I’d like to throw a few thoughts in.
    1) It’s mentioned that historical default rates are low, but I question the value of that info. We’re at all time highs for debt load and price to income ratios for housing. Very different circumstances.
    5 & 2) Rising debt and assets at the same time is a common feature of a bubble, and if the bubble bursts the asset side can drop very quickly (as can equity levels). Makes these point irrelevant.
    8-12) Here’s the important points, and why I believe we haven’t seen a market crash like other economies. While standards have been eased from the traditional 20% down, 25 year amortization, the reduced standards are still being enforced. Places like the US threw caution completely to the wind.
    Personally, I wish the government hadn’t abandoned the 20%, 25 year standard. It wasn’t broken, so why fix it? Prices and debt loads would have been lower without that unnecessary change, and at worst we would have seen a bit of dry spell for the housing market and level prices or modest reductions.
    Instead I see more significant damage to the market, though certainly not US style given the diligence being maintained. There will be a drought of qualified buyers, but not a glut of unqualified buyers.

  18. Most bubbles (whether housing or tulips) follow a sequence of psychological stages – enthusiasm, greed, denial, fear, capitulation and then despair.
    Lately there has been a change of tone in discussions on the housing market. The media, various think tanks, and the government have begun to seriously consider the possibility of a housing bubble.
    In response to these recent developments, it seems like many in the market are beginning to tip further from the denial phase into the fear phase (if we are indeed in a bubble).
    The next year will be telling of which direction we are going.

  19. While the first time buyer segment is certainly important for the broker channel (brokers originate more than half of first time buyer mortgages), it is not the only segment we’re involved in and expecting this blog to cater almost exclusively to first time buyers makes no sense. The mortgage market in Canada is very complicated. I just love how this blog isn’t limited to one particular segment and covers everything including the financial aspects behind the mortgage market that the majority of applicants aren’t aware of. It provides them with quality information as well so that they can make informed decisions.

  20. >> What’s your point? If you want something, earn it.
    I love this response.
    People that bought when housing was at a reasonable level looking down their noses at those who are having trouble affording twice what they paid in inflation adjusted dollars.
    My wife and I would be approved for almost a million dollar house, but yet we don’t buy. I don’t like to throw my money away (cue someone’s response who has never done the math that renting is throwing money away).

  21. Second in terms of impact, were losses from home price declines associated with economic shocks.
    There you hit the nail on the head.
    I think we can all agree that housing is in for a correction (not a collapse, mind you). It happens quite regularly in Canada. Early eighties, late eighties, mid nineties, and now we’re at the top of the heap again.
    So unless are arguing that “it’s different this time”, we are in for a corrective period.
    At the same time, never before have so many people had so little equity in their homes. In all previous corrections, the vast majority of even first time home buyers had 20% or more equity, so as you say, default rates never went very high.
    During this previous run up, we saw extreme credit loosening at the same time (which is why the run up has gone on for as long as it did). The average for first time home buyers is now ~7% down payment. So what happens when we encounter the normal corrective cycle? This time we will have far more owners in negative equity situations than ever before, and as you say, that is the second biggest driver of default.
    It’s not all as neat as it seems. In the US home equity levels were very close to ours before their crash and looked very healthy as well ( ).

  22. Frank, I’m a consumer in the first term of my mortgage, and I browse this site every day. There’s no better way for a consumer to get the advantage than to browse an industry-focused blog.
    Kudos Rob!

  23. Private insurers in Canada are backed by the government to the tune of 90%. CMHC is backed 100%
    The private insurers they take more risk than CMHC is that they have to carve out a market niche in order to have a business.
    The Canadian people are on the hook no matter what.
    Thanks for coming out.

  24. The role of the CMHC has drastically changed in the past 10 years and its balance sheet is now much larger.
    During that period housing prices have been increasing nationwide.
    It is easy to make money insuring an asset class (like real estate) when the prices are increasing. A rising tide lifts all ships.
    The proof in the pudding comes when one has completed one full price cycle (half up and half down).
    I work in catastrophe insurance, and we made a lot of money in the 1990’s. It was easy money. We lost all that profit (and then some) in 2001 with the 9/11 catastrophe.
    If the CMHC had such a profitable book of business, I can GUARANTEE you that private insurers would be clamouring and complaining about it and demanding that it should be opened up to the marketplace. (ie private insurers who are not required to be 90% backstopped by the CMHC/Federal Gov’t)

  25. .> Without the CMHC prices might be a bit lower. Housing affordability, however, would still be off the charts
    Any evidence for that conjecture?
    I’d say there’s pretty strong evidence of the role of CMHC in the house price runup. One of the biggest runups in history ( ) coincides with CMHC’s loosening of credit standards through the 2000s.
    Let’s be clear, I don’t think CMHC is useless, I just think we wouldn’t have a problem with house prices if they had left their standards where they were up to the end of the 90s.

  26. “not suited to first time (high-ratio) homebuyers”.
    This shows the problem we have in the Cdn housing market today. It is assumed that all 1st time buyers are high-ratio buyers..and for good reason..because they are.. due to high home prices overall and lack of ability to put down payment enough to cover 20% limit.
    I agree with sentiments of others above me in that many buyers are priced out of the market due to high prices.

  27. Funny how some people assumed I was in a poor situation. Actually I’m doing exremely well and could easily qualify for an outrageous mortage right now. However, in today’s environment, especially with interest rate soon to be on the rise, qualifying for a mortage and affording that mortage in the future are two completely different things.
    I’m sorry if I came across as a little harsh in my earlier post (I actually quite enjoy this site), but there are a growing number of potential first timers that are thinking like I am. Housing has definetly gone above the threshold that is considered healthy. The issue I take is when people disregard the fact that easy credit and low rates have risen prices. Of course they have. Would they be extremely cheap without CMHC or low rates? Of course not. People still value places to live and there will always be home purchasers. But they would be an awful lot lower than they are now. Here in Regina houses have more than doubled over a span of 3 years. Is it because of lack of supply? No. So obviously this means there are other factors at play. Conicidentally it happened around the same time as standards were relaxed.
    Don’t get me wrong, I definetly think the government should play a role in the housing industry, however they have far outstepped those limits they should have stayed below. Hence the new rules.

  28. Absolutely – a rising economy in the early 2000s, then the recent drop in interest rates, the increased use in lines of credit (particularly HELOCs) increasing the availability of capital, the reno boom, the move back to the cities of young professionals, early boomer investment in real estate (beyond their immediate homes), high rental costs (relative to the carrying costs of a mortgage, particularly at the low rates these days), the first bunch of millenials/Gen Y buying houses and often skipping long-term rental/the starter home stages, traffic and the complete lack of permanent rapid transit expansion in some major cities (particularly Toronto.)
    Many many things happened over the 2000s. The CMHC insuring of low-downpayment buyers definitely had an impact. But it is just one of many things that changed the landscape of housing in Canada (for better or for worse) – it is the easiest to wag a finger at.

  29. I copy Gord’s comments. There is no equal to CMT for presenting the “rest of the story” on industry matters. This story in particular is brilliant.

  30. Tomas, The article is a statement of facts intended to correct a number of fallacies. We advocate for what we believe is in the consumer’s best interests, primarily: knowledge and responsible choice. Take that for what you will…

  31. Hey Sandy,
    Sorry about this but here goes…
    The model works when the market goes up but doesn’t when it goes down.
    In 2008 distribtutions were cut to mutual funds distributing return of captial to paydown the mortgage.
    Loans have to be prorated down every year meaning a 8% distribution means say a $100,000 loan may only be good for a $92,000 deduction the next year.
    With captial gains dividends (which taxes must be paid) this offsets a lot of the tax deductions made.
    I have a lot more points, but I will wait for Sandy’s reply.

  32. Some great comments here!
    Like welfare, or UI, CMHC should only be giving people a helping hand per it’s original mandate.
    That means helping people in true need find clean, affordable, and safe but modest housing.
    Instead, CMHC has turned into a massive gov’t tool to juice the economy by encouraging renters to buy before they have saved a meaningful deposit, and to allow people to buy more house than they would otherwise.
    By stimulating prices through artificially inflated demand, CMHC has actually made it harder for all first time buyers to find clean, affordable, and safe but modest housing – unless they take on a huge, CMHC guaranteed, high ratio mortgage.
    Thus, from a social policy perspective, today’s CMHC is a failure. Banks and mortgage brokers may love it, but socially progressive Canadians should be very concerned and demand an overhaul.
    As for skin in the game, of course the banks, the buyers, and all other willing participants in CMHC insured transactions will have some skin in the game. But how did an unwilling participant – the taxpayer – end up having the most skin in the game?

  33. ….and do we blame CMHC for rising house prices AROUND THE WORLD? that chart looks pretty much the same in many developed countries. How do we blame CMHC for THAT?

  34. Taxpayers are unwilling participants? CMHC is a failure??? Says who? A handful of anti-housing extremeists?
    People who write things like that have minimal comprehension of housing finance and its enormous benefits. Or they want home prices to crash so they can afford a nice house at the expense of other homeowners.
    Either way, you need to educate yourself.

  35. Hi Brian. No apology required. It’s very nice to hear from you – it’s been years!
    I will happily indulge you in this conversation as long as you play nice :) In the interest of disclosure, I think readers should know that prior to the market crash of 2008, Brian and I worked cooperatively to advise SM and TDMP clients.
    To your points: You state:
    ” the [borrowing to invest] model works when the market goes up but doesn’t when it goes down.”
    I could not agree more. All leveraged investors must believe that the stock market will generally move upwards over time. In fact, it can’t just go up a little, it must also beat your cost of borrowing over the long term. If you can ignore short term market fluctuations (e.g. 2002 and 2008) and you borrow at the bond rate to invest in the stock market, your primary objective should be to profit by the spread. The spread in real returns between the bond market and the stock market, in the U.S., over the last 138 years has averaged 5.04% (including the crash in 2008). Tax benefits, like making your mortgage tax deductible, should really just be considered a bonus unique to Canadian homeowners….although “make your mortgage tax deductible” is a really cool marketing message! Anyone wishing to verify these statistics or study the concept should read the book Lifecycle Investing by the Yale professors; Ayers and Nalebuff.
    On Return of Capital (ROC) mutual funds – again I must agree with you. Return of principal to an investor will result in a prorated erosion of interest deductibility on related investment loans. In the broader picture, ROC distributions do not provide a tax advantage over dividend distributions. The math is complex, but the tax result is basically a wash, unless of course, dividends are your only source of income in which case the dividend tax credit will actually make dividend income preferable to ROC. ROC mutual funds are highly popular in SM and TDMP strategies because they make the monthly cash flow from investments consistent and predictable – which is helpful when you use them to make mortgage pre-payments.
    So far so good! It seems that I agree with everything you say Brian. Perhaps we can make this a more heated agreement if you have other points…
    Really great to hear from you after all these years! Sandy

  36. Hello all,
    Interesting debate on the role of CMHC..
    The argument that I often hear from people supportive of the CMHC is that securitization and mortgage insurance have driven down the cost of borrowing- making housing more affordable and allowing more people to enter the market.
    Although clearly, a lower cost of borrowing does make housing more affordable in the short-run, this is not the case in the long run (total mortgage servicing costs as a % of disposable income have not improved since the early 1980’s, despite interest rates dropping from 20% to 5%).
    What it has done, is allowed a run-up in household debt relative to income, and left homeowners much more susceptible to cashflow problems should there be even a small change interest rates.
    Although mortgage loan insurance and mortgage securitization programs are not the only reasons for lower interest rates, they have had a hand in creating a housing market that is much more vulnerable to economic shocks.

  37. There are thousands of insurance companies worldwide that have never had a catastrophic loss. The fact that your insurance company was mismanaged is no reflection on CMHC, Genworth or Canada Guaranty.
    CMHC’s profit is plain to see. Look in their annual reports. You don’t have to speculate on it.

  38. So I’m a schadenfreude, uneducated, extremist? Ad hominem attacks are flawed and just plain sad. Looks like you need the education.

  39. You’re probably right that we’re due for a correction but there is no evidence that defaults will be higher than the last major correction.
    Interest rates were over 20% in the early eighties. That led to one of the worst housing markets ever. Peoples’ equity was secondary to their ability to pay their mortgage. Banks don’t forgive your payments just because you have equity.
    Try this. Compare two mortgages:
    A] One with 20% interest, a 25-year amortization and 20% equity
    B] One with 3.75% interest, a 35-year amortization and 7% equity.
    Do the math. You’ll be surprised how affordable homes are today, even if rates go up a few points. Don’t forget to account for growth in income.

  40. Hi Brett
    I know what you mean. I’m fed up with the cost of a Porsche 911 Turbo. I’m hoping the government will impose rules to make it easier for me to afford a 911 Turbo because, as a first-time car buyer, I feel like I am entitled to one.

  41. Put things in perspective. If foreclosures were 3% and all of CMHC’s reserves were exhausted, you might be on the hook for maybe a few hundred bucks? Big deal. Try paying 1/2% more for your mortgage and see what that adds up to. That’s what you’d pay without the government supporting our mortgage market.
    BTW, the Leafs have a better chance of winning back-to-back cups than Canada has of seeing a 3% foreclosure rate.

  42. Pete, I think $30b would probably be close to the worst case scenario for the CMHC, and I agree that is only $1000 per Canadian.
    But you if foreclosures reach 3%, one can safely presume that housing prices will have declined substantially. A 15 to 25% correction in the values of ones home would amount to substantially more than that.
    For those that think this is unlikely to the point of science fiction? Well. Maybe you are right. I hope so.
    But given what has happened in many countries, I think that it merits careful monitoring and discussion. Which is why I find it so concerning that so many find any consideration of the possibility to be so absurd. It is a similar demeanour to those in the US and Ireland 5 years ago.
    ps, As a Torontonian, I think the Leafs are an embarrassment, and I think any real hockey fan should boycott them and all their merchandising until they and their ownership show some athletic and professional pride.

  43. My apologies if you’ve taken offence.
    My actual point is that alternate lenders / mortgage brokers don’t exist because of consumer choice and knowledge. They exist because of vibrant alternate lenders and an accomodating CMB securitization system.
    Don’t complain too much. Look what happened to pharmacists, chartered accountants and CREA in 2010 when the government tired of them.

  44. Three percent of CMHC’s $473 billion in insured mortgages is just $14.19 billion. CMHC’s reserves and deferred premiums would cover this with no loss to the taxpayer.
    Keep in mind that this example uses 3% of all CMHC insured mortgages. In reality, 7 in 10 CMHC insured mortgages are low ratio and there is no way 3% of those would default. Therefore, even this $14 billion figure is overstated.
    As many others have said, we do not have a risk problem in Canada. Any risk we do have is negligible and offset by the billions in premiums that CMHC generates.

  45. Mark,
    You’re responding to something I didn’t write.
    I said I think that a worst case scenario would be the range of $30b loss to the CMHC.
    But I didn’t say that I thought that 3% foreclosures was the worst case scenario. The 3% figure was quoted by you as one scenario, (presumably extreme in your mind) where the cost to a taxpayer would be only a few hundred dollars. I quoted that to point out that if foreclosures hit 3%, one can presume that prices have declined and at 10 or 20% (or more) this would affect many people much more than a “few hundred” dollars (especially since their mortgage will have not declined similarly)
    With respect to your comment that there is “no way” 3% of those would default, that is a unfounded statement which has been disproved
    by the experience of many other countries which similarly thought there was “no way” that could happen.
    The following graph shows US foreclosure rates going from a steady 1% over the past 50 years pre-2007, to a current rate of 5%.
    You are correct that “many others have said that we do not have a risk problem in Canada”. But so what. Many others have said the opposite.
    To be clear, the risk is not only the potential claims to the CMHC. The risk is also the possible effect of inflated mortgages purchased to pay for inflated houses, and then the house price declines. This would have a serious effect upon our economy (see Ireland, Spain, US, and others).
    Fingers crossed that it won’t happen. But I respectfully suggest that belittling an intelligent review of the situation reflects poorly upon your confidence in the status quo.

  46. Banks and Private mortgage insurers always pick low hanging fruit and serve populated cities well. Remote Kitsault BC, Tignish PEI or a farm in Chaplin SK?, not so much. What about newly arrived immigrants who have little assets but good income, work hard and want to live the dream and own a nice home? Without CMHC or any government backed mortgage insurance, all would likely be S.O.L.
    What many don`t appreciate is how committed and successful the Staff and Management at CMHC is to serving and including “All Canadians” in implementing their mandate. That is something you cannot put a price on but if you have to, the price to the taxpayer is $0 plus Billions in dividends and paid taxes to boot!
    Canada is not the U.S., Spain or Ireland nor has the economic crisis unfolding that these countries are experiencing so let’s be thankful for that and stop comparing ourselves?

  47. Oh…I never thought of looking at it like that.
    So we are a different country.
    And we haven’t currently experienced their current misfortune.
    Therefore you conclusion is…
    It is impossible for us to experience their misfortune at any point in the foreseeable future (for reasons unexplained), and the topic merits no further discussion.
    Well. I can’t argue with that logic. )))

  48. Hi Dave,
    If you find it of interest, the differences between the Canadian and American mortgage systems have been discussed on CMT at length. The search function will return several results to that effect. Many of those differences have been reiterated in this story above as well.
    Canada’s sensible housing finance standards do not immunize it from a housing correction, but they do considerably reduce the odds of a US-style correction.

  49. Rob,
    Many of the excesses in the US market that are blamed for their housing problems were not similarly present in other housing markets (Ireland, Spain) which have had similar problems.
    I don’t think the issue is US vs Canada. But rather, Canada currently vs Canada before the expansion of the CMHC in the last dozen years.
    For me, it comes down to two metrics.
    -the price-to-income ratio, and -the cost of ownership vs the cost of renting.
    When I look at those two metrics, it is very difficult to not conclude the housing in Canada is overpriced, and due for a 20-25% correction (likely over a period of 5 years)
    When I look in more detail for when those metrics moved out out of balance, I keep coming back to the CMHC.
    Anytime I mention those two metrics, most of those who think a 20% price correction is impossible either become very quiet or tell me to stop talking about it.
    I’d be DELIGHTED for prices to remain stable or continue to increase. But I don’t see how it is possible.
    My 2 cents.

  50. Hard of hearing or just too busy thinking up some witty retort? Sorry for my tardiness in not explaining. Some of us do have day jobs and I thought the point made had already been covered well by other contributors in past.
    Yes, we are a different country to US, Spain or Ireland for a host of reasons debated extensively on this site. (Solid financial market,cdn$,immigration,economy. Low unemployment, inflation and sound lending practices to name a few.
    “Impossible” to follow the same economic path?, no but highly unlikely in many’s professional opinion and is supported by solid economic numbers and not gut feeling or whatever Mr. Garth T says. I pity the fool!
    If you think otherwise, let’s hear it, but please use credible data and comparisons or at least make it entertaining and include other unrelated housing and economic data like Summer Inuit Igloo prices or Bangladesh mud hut’s during the rainy season. We are all ears….

  51. As I wrote just above you:
    “For me, it comes down to two metrics.
    -the price-to-income ratio, and -the cost of ownership vs the cost of renting.
    When I look at those two metrics, it is very difficult to not conclude the housing in Canada is overpriced, and due for a 20-25% correction (likely over a period of 5 years)”
    Our price to ownership is now more than 5-to-1 (compared with 3 or 3.5 to 1 historically). And most properties rent for substantially less than the cost of ownership.
    I don’t think anyone denies the factual accuracy of the preceding paragraph.
    If someone can tell me why these metrics don’t indicate a coming price correction, than I welcome that explanation.

  52. I honestly don’t know if the accurate metrics you quote indicate a price correction. Do you? But in professional life, I am always careful to not base business decisions on limited trends lines and probably why I have a Board and Regulators to keep me in line. Don’t want to look stupid!
    Many investors got burned in 2000 with the .com fallout because investors ignored P/E ratios. Today, many experts price Facebook @ $50B+ or $100 per member? Is FB valuation overpriced? Maybe because I am certain the page that I rarely use is worth $100 to them but maybe others FB page is worth $200 to them and their market strategies.
    There is one interesting fact that I would like to pass along to the CMHC blame gamers. UK house prices have tripled in 20yrs, doubled in 10, even after accounting for recent price corrections and the UK market does not have a CMHC government insurer. hmmmm!!!!

  53. I think we can both agree that there are many factors which influence housing prices. Opening up the discussion to comparing all the different countries of the world will likely stretch our little blog discussion, but I’ll respond to the UK situation
    In the case of the UK, they don’t have a CMHC equivalent, agreed. But they do have short term mortgages, similar to Canada and different from the US long 30 year terms. This makes both the Canadian and UK markets very susceptible to short term financing costs, (ie 2 to 5 year mortgages). With the drastic drops of late, this has buoyed purchasing power.
    The UK’s prices have increased 3x in nominal terms over the past 20 years, but closer to 2xin real terms (net of inflation) (similar to Canada). They are currently at a similar multiple to income of 5:1 as per Canada.
    The below article (bearish) comes form the same source that was recently authored a paper on Canada’s market that was quoted last week. It references the 5:1 ratio.
    Some graphs from a UK housing bear site.
    Mortgage Rates
    Housing Prices
    In summary, wrt the UK, my read is that the short term mortgages rate decreases has helped them in the same way it has helped us. In contrast, in the US they’ve not benefited similarly, as their 30 year rates remain at approx 5% (versus the 2% to 4% that has emerged recently for the UK and Canada).
    wrt to Price-to-Earnings, for Facebook. Dunno. But wrt to housing, if first time buyers can’t afford housing, then that will place downward pressure on prices. And if investors can only turn a profit due to speculative increases, and not based upon rental revenue, then that will suggest that either rental rates must increase, housing prices must continue to increase, or investor will be divesting from the asset class.
    The fact is that we’re at a historical high for housing prices in Canada, and a historical high for a % of home ownership amonst our population.
    No-one knows for certain what will happen. Such is economics.
    We can agree to disagree, but as I continue to look at the fundamentals, it continues to bode for price decreases. Unpopular though this makes me at cocktail parties.

  54. Actually I think Garth Turner has moved on from igloos and mud huts. He’s now comparing Canadian housing to cardboard lean-tos in Brazil’s Favelas and Tahitian grass shacks in typhoon season.

  55. Home prices aren’t governed by price-to-income or mortgage-to-rent ratios. Home prices are set by what people can afford. The ratios you mention are high by historical standards but actual affordability (as measure by total debt service) has not deteriorated much in 20 years.

  56. If someone can tell me why these metrics don’t indicate a coming price correction, than I welcome that explanation.
    here it is:
    average rents and incomes go up and average house prices flatten.

  57. Easy. That is exactly the point. (almost)
    Rents and incomes need to catch up to house prices, and eventually they will(5 years? 10 years? 15 years?)
    But what magical force will keep house prices static until that catch up finishes.

  58. Tim,
    Actually, everyone who provided these products in the market place had the same fate.
    Indeed, the worst case scenario that was modeled for a loss of life catastrophe was 2 747’s colliding (a loss of 800 lives). It was unfathomable to consider something worse. In the same way that US house price models only allowed for annual price increases of 0% and higher. The effect of a price decrease was not modeled, because it was considered impossible.
    Similar rent vs own calculators can be found all of the Canadian finance/media internet, with no option for modeling a price decrease.

  59. JP,
    The ratios indicate what people can afford, although I full admit that decreasing mortgage rates can support affordability while rates remain low.
    But even with the current low mortgage rates, as a general rule it is cheap to rent than to own. Most rental net cap rates are at approximately 2.5-3.5% (scarcely higher than inflation).

  60. Dave, I see what you are saying but the ratio’s you mention do not indicate what people can afford. In simple form, the 5 C’s of credit are the qualitative and quantitative measures used by both FI’s and Mortgage insurers like CMHC to assess credit. (character-capacity-capital-collateral-conditions)
    From my experience, rents, even in non-rent control Provinces like AB often don’t move in lock step with housing price appreciation and probably for various reasons like employment gains, immigration, migration, variations in rental stock, maintenance and utility costs to name a few.

  61. Sandy,
    The big problem I see with (ROC) is also, the distribtion of captial gains, interest income and dividends which is taxed. In 2008 these clients who had their distributions cut which means more money out of pocket to support the loans. Yes, this is offset somewhat by deduction of the other funds but years later the clients are still underwater. Only double digit returns will get them at a break even point.
    The 5% returns is mainly reinvested dividends (which of course taxes must be paid by the funds or out of pocket. Returns in the market come in short bursts and can disappear quickly. Factor in inflation and the real returns are small or even negative.
    One reason one has to be careful is the amount of debt in the US,Europe,UK and yes even in Canada there is no time is history to compare this amount of debt.
    A good example of how real estate overwhelms stocks is Japan. This story is getting played out in the US. In Japan companies like Sony, Toyota etc. have returned (nikki 225) -30% over 10 years and over 15 years $10,000 would be worth about $4800.
    My thoughts are the “plain Jane SM” is a more conservative way to go and of course only for the right people.

  62. Home prices go up when demand overtakes supply. When that happens the only other thing that matters is the cost of carry (aka. affordability). Rents and prices-to-incomes are almost meaningless because they don’t affect affordability.

  63. “Rents and price to income are almost meaningless”?
    I’ll just shake my head in disbelief that you wrote that, and agree to disagree.

  64. StatDude is actually right. Buyers don’t think about ratios when they purchase a home. All they think about is “Do I want a house?” and “Can I afford a house?”

  65. Fix,
    That is a simplification. They don’t just think about those two questions.
    Using that logic, every person would simply buy everything which they “want” as soon as they can “afford” it.
    But buying one thing we want, means we can’t buy something else we want.
    So a consumer looks at the utility they will derive from a specific purchase, and compares it to other options.
    Options like the greater affordability of renting versus owning. Options like vacations, or investing in other asset classes, etc.
    And in purchasing real estate, one also considers (or should) the likely resale value, and the effect of variables such as mortgage rates on current affordability.
    My original reference to ratios was a macro-economic reference, and I agree that there will be many individual differences. A high price to income is irrelevant if one has $1m cash in the bank. The price to income metric simply shines a light on the fundamentals of the current market.

  66. People don’t “need” to buy homes. They can rent instead. Prices go up because people “want” to buy homes.
    When people ask themselves if they “want” to become homeowners they may consider some of the things you mention. However, people don’t sit there and do marginal utility calculations. Home buying is mostly emotional and people aren’t that scientific.
    Most people just want to know if they can afford their “dream house” given their other monthly obligations. Over the long run, assuming reasonably constant demand, home prices will rise when affordability gets better and fall when affordability gets worse.
    The new amortization rules just kicked a leg out from under the table of affordability. Expect prices to drop as a result.

  67. Dave,
    1) Regarding the ratios you use, I understand that one of the underlying premises that the price-to-income ratio should remain somewhat the same throughout the history. Does it take into account the dynamics of the population growth and aging and changes in the job market?
    1) I agree with StatDude that a fair number of people who were on the border of affordability did not necesserely make completely rational decisions. The euphoria of rising home prices and several years of brainwashing by the RE and mortgage brokers did form a public opinion that home ownership was important as an indication of the wealth and status.

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