Measuring MortgageIt seems that every week someone is telling CMHC how to run its business. The latest advice comes from Ben Rabidoux, a well-known CMHC critic.

In the Globe and Mail last week, he suggested four changes to the country’s top mortgage default insurer. (Here is the story)

In some respects, he’s right on the money. In others, well, here’s another take…

Stack Of FilesBen’s Recommendation #1: Increase income documentation requirements on insured mortgages

The argument here is that CMHC asks for “far less” documentation than U.S. lenders/insurers. On a typical insured purchase with salaried income, the key documents required by American lenders include:

  • a credit report
  • verification of down payment
  • recent pay stub(s)
  • purchase & sale agreement(s)
  • appraisal

U.S. documentation not mandatory in Canada:

  • two years’ worth of W2 forms (i.e., Wage and Tax Statements)
  • verification of other assets via two months of bank/investment statements
  • verification of timely rent/mortgage payments (usually only for first-time buyers)

Canadian documentation not mandatory in the U.S.:

  • job letter

There are exceptions of course, but two of the key differences are that most Canadian lenders don’t make tax documents and proof of assets (not related to the down payment) mandatory for salaried applicants.

Canadian-US-mortgagesIn Canada, salaried income is validated in other ways and employers generally collect taxes at the source. Therefore, requesting tax documents from salaried borrowers would primarily serve to discourage income misrepresentation. But, if someone is willing to fudge a job letter or pay stub, they’re just one more bad decision from faking their tax documents.

As for proof of assets, Canadian lenders ask for it whenever it’s required to support an application. When other loan characteristics are strong, proof of assets generally becomes non-essential because lenders have other ways to judge solvency.

The argument for more documentation rests primarily on two points:

  1. It reduces fraud
  2. It reduces lenders’ incentives to look the other way when underwriting (a moral hazard in the case of insured mortgages).

But these arguments ignore the realities of today’s risk-averse mortgage environment. Specifically:

  • While “soft fraud” (i.e., document fraud for shelter) is all too common, defaults linked to this type of fraud are still minuscule. One non-bank lender we spoke with said it could count the number it sees on one hand. Hardcore fraud (e.g., organized criminals recruiting straw borrowers) remains a multi-million dollar problem, but again, the total amount of lender losses are too small to justify hassling millions of Canadians with excessive paperwork.
  • Regardless of whether a mortgage is insured, Canadian lenders have considerable economic incentive to underwrite diligently. (See this)
  • In the Guideline B-20 era, bank audits are not a rarity. And OSFI regulators are hyper-sensitive to loan documentation quality. (It’s notable that banks finance the vast majority of insured mortgages in this country. And numerous non-bank lenders also rely on bank funding.)
  • CMHC reviews individual lenders at least every six months to survey performance and track key metrics. Loan quality is monitored monthly. Arrears, negative credit score trends, and the rate that emili refers applications to live underwriters are just a few of the early warning signs CMHC monitors. On-site physical audits take place when CMHC feels that lender performance may be outside of its parameters.
  • When insurers analyze delinquencies, they compare lenders against one another. (“Early term delinquencies” get additional scrutiny.) No lender wants to rank near the bottom and all lenders are required to maintain full audit trails of their underwriting and documentation reviews.
  • Insurers can and do deny claims. But their ultimate power is restricting lenders who don’t heed their policies, which can be exceptionally costly for a lender. It can also affect that lender’s ability to obtain competitive mortgage funding going forward.
  • Underwriters—who generally prefer to remain employed—are held accountable for preventable defaults. Documents and underwriter adjudication are closely scrutinized when insurance claims are made.
  • Non-bank lenders are routinely audited by their funders, who don’t hesitate to come down hard on lenders who underwrite recklessly. Losing a key investor is a nightmare for non-bank lenders.

When it comes to document fraud, lenders know the stakes. They are continually getting better at fighting it. This is in addition to sophisticated fraud detection algorithms that CMHC runs on every application.

The point of all this is simple. Ample checks and balances are in place to ensure that bad documentation never triggers a Canadian mortgage meltdown. Squeezing more paperwork out of consumers would make the approval process unnecessarily onerous and not lead to any meaningful reduction in default rates…or taxpayer risk.

Provincial-Mortgage-RegulationsRecommendation #2: Reinstate the regional mortgage cap

CMHC’s public policy mandate is to “ensure that mortgage financing is available for a range of housing choices.” CMHC is tasked with broadening housing options for all Canadians, not just Canadians at a certain income level. Limiting home buyers to purchasing no more than an average-priced home in a given area is a purely arbitrary decision. The economic and social repercussions of such policy haven’t even been contemplated in Mr. Rabidoux’s treatise, and could easily outweigh the modest risk reduction.

Let’s also not forget: The price of a home being insured, by itself, is almost inconsequential when a mortgage is correctly underwritten. For example, a borrower buying a $200,000 home with a 620 beacon, 42% TDS and 5% down payment can pose a greater expected loss to a lender than a borrower buying a house at double the price with an 800 Beacon, 32% TDS and 10% down.

That said, most would agree that there should be some insurable loan limits. It’s probably not good public policy to insure purchases at double the local price. The question is, with urban sprawl, how do we define the “regional area,” such that communities outside the fringe are not penalized?

And where do you draw the line on price? Do we not insure homes that are 20% above the “average”? 30% above average? One standard deviation above the average?

This is an issue in dire need of perspective. Only 1 in 25 high-ratio mortgages is over $550,000 to begin with. Capping loan amounts further would only marginally alter CMHC’s portfolio risk. But more importantly, doing so would penalize working families. We’re talking about husbands and wives making $60,000 to $75,000 each, for example—not exactly top one-percenters.

Recommendation #3: Eliminate the second home program

This one is much harder to defend. Intuitively, it’s an unnecessary risk to back people who buy second homes with only 5% down. Moreover, as Rabidoux correctly notes, this program is abused.

CMHC-Second-HomeCMHC’s Second Homes product is such a small part of its portfolio it would not make major waves if it were eliminated. The most current data we know of is that 9% of Canadians own second homes, but the majority could put down 20% or more.

Recommendation #4: Increase transparency and oversight

Time for Transparency Clarity Honest Forthright ClockRabidoux is bang-on here. CMHC refuses to provide basic portfolio information like average down payment and average loan size on high-ratio mortgages. In this author’s view, there is no justification for withholding such information from the taxpayers who back CMHC. None. The excuse of shrouding it for competitive reasons doesn’t hold water (since insurers already know the general metrics of their competitors).

Rob McLister, CMT

  1. I propose CMHC increase its required credit score to 850, raise down payments to 50% and double its premiums. Let’s really screw those good for nothing first time buyers. I mean really, what do they do for the housing market anyway?

  2. Is anyone else sick of constantly hearing that defaults are low therefore there are no problems with current policy? The time to justify that argument is when the Ponzi scheme runs in reverse. I’ve heard Ben R in person and his #1 point in everything he says is “wait for houses to be flat or in decline, then everything gets exposed”. This is why he’s a great analyst, and you’re still a broker. According to all current news articles in BC, you have your “flat” market, so it shouldn’t be too long of a wait now. This industry is about to get Madoffed.

  3. Excellent article Rob. Thank you for bringing some real world knowledge and experience to this discussion.
    What I could not fathom from Rabidoux’s amateurish and poorly researched diatribe, was why he chose to pick solely on CMHC to lecture upon his version of “moral hazard.” Both Genworth and Canada Guaranty have substantial government backing as well.

  4. CMHC’s public policy mandate is to “ensure that mortgage financing is available for a range of housing choices.”
    Is that actually their mandate? All the statements I’ve seen for CMHC have been about affordable housing and the function of the housing market.
    From my point of view, the housing market functions just fine in large cities (plenty of liquidity and rental options), so allowing uncapped CMHC financing is counterproductive to that mission. Though there will be edge effects (e.g., if the cap is set to say $400k, then there may be no units available between $375k and $401k).

  5. They do have substantial government backing, but not as much as the CMHC, and the value of their insurance-in-force is maybe 1/3 or 1/2 of CMHC’s.

  6. Rob, this was such a well reasoned, well researched response. While most of us understand that CMHC needs some rethinking and tinkering with; this is the perfect response to Rabidoux’s half baked screed. I am sure he and Garth Turner are texting each other right now planning their next diatribe.

  7. What would our housing market look like without government intervention through CMHC? You know… how it used to be.
    I shudder to think.
    I’m glad we are all taking on the risk of housing collapse.
    When arrears rates start climbing, it won’t come in a stream. It will be a tsunami. Looking at arrears rates when anyone can liquidate an asset and make money is meaningless.
    On point #2. Do some research on the history of the CMHC. It wasn’t always the disaster-in-waiting that it is now.
    CMHC provides insurance to those that borrow fifty thousand dollars from their parents to buy a million dollar house.
    The ultimate joke will be why no one saw it coming.

  8. Rabidoux has been described as an “empty theorist” and I agree. He is an avowed real estate bear, vehemently anti real estate and anti homeownership. He has spewed so many ridiculous pronouncements and predictions about the real estate market, that they are nearly impossible to ennumerate. His former blog “The Economic Analyst” claimed in 2010, that the real esate market was poised for a 25-50% crash and that it was actually occurring “as we speak.” He has claimed that mortgage arrears are low because homeowners are using their lines of credit to make mortgage payments. No surprise to see the blog has now dissappeared, archives and all. I’d be embarrassed too. Total amateur.

  9. Thank you for this excellent article Bob:
    Regarding the 3rd point – Second Homes – I hope this program remains around so that I may help my daughter eventually become owner of her own home. This program will allow me to purchase a house on her behalf until she can take-over.

  10. I think everyone can agree CMHC today is not operating as it was originally intended to be. In regards point #2 my question is how can you expect CMHC/Tax payers to insure a $1MM mortgage for 95% LTV in an area, if the mortgage was conventional the LTV from a Financial Institution maybe 75%. In terms of LTV how can we expect CMHC/taxpayers to take on more risk than the FIs would on a conventional mortgage.

  11. “Is anyone else sick of constantly hearing that defaults are low therefore there are no problems with current policy?”
    No. What I’m sick of hearing are alarmists who reject the actual data, broadcast fear and live lives of frustration as they scorn the market’s strength. Do you know anyone like that, Concerned?
    “This industry is about to get Madoffed.”
    Right and I bet you said that in 2008
    and 2009
    and 2010
    and 2011
    and 2012
    and 2013
    If you keep saying it, maybe someday you’ll stumble on a big housing correction. Then you can tout how you saw it coming “years ago.”

  12. Name one major institution or corporation that has the same mandate or is operating exactly as it did 65 years ago!
    Did you know that before 1954, when The Bank Act was amended, banks were not in the mortgage lending business?
    This false harkening back to the ‘good old days’ is laughable and a complete red herring when it comes to the form and function of modern financial institutions like CMHC.
    Get real.

  13. My point was why should CMHC insure properties to a high LTV, when if uninsured they would require a higher down payment from most lenders. You are expecting CMHC to take on more risk than the lenders would.

  14. The bank act prevents FI’s from lending above 80% ltv. If this was not the case, the banks would be lending above 80%.
    CMHC is an insurance company, which means it’s function is to take on risk and charge a premium in order to offset that risk. So far, they have done so to the benefit of taxpayers and Canadian homebuyers.
    What I have never heard from the critics is a viable alternative mortgage banking system

  15. In another article on this site, CMHC losses were cited at 9 bps “over time”. That is $900 on every $1,000,000 insured. Premiums on high ratio mortgages vary from 100 to 275 bps (ignoring low doc programs) with the majority of that, in my experience, in the 200-275 rate class. Will CMHC ever have to open the kimono and show the Canadian taxpayer (who is ultimately on the hook) complete financials. If the average CMHC high ratio premium is 150 bps (I suggest this is conservative), revenue is $15,000/$1MM. How are they consuming the $14,100/$1MM that is not paid out in losses? Extrapolate that over the billons in underwritten mortgages….

  16. +1
    I must assume that Jon is not in the mortgage business. That is the trouble with all of these uninformed criticisms. People opine without knowing how the system actually works.

  17. just because the bank cant lend above 80% doesn,t mean that there aren,t lenders (institutional) in that space, and the risk premium is established.

  18. CMHC is a crown corporation and not just an insurance company. Even the IMF suggests that “Over the long run, the need for extensive government-backed mortgage insurance should be re-examined,” There are alternatives to CMHC with Genworth & Canada Guaranty. The government backs 100% of loans that CMHC insures and 90% for private corporations.

  19. Jim you assumed wrong, I’ve spent 11yrs arranging mortgages on both sides broker & Financial Institution and now work in a Corporate Office for a Financial Institution, so in that time I’ve arranged most types of personal mortgage financing with all different types of lenders so I can “opine” about a system & how it works. my point was about why CMHC/Tax payers take on more risk than lenders. Why should the Government back 100% of loans that CMHC insures and 90% for private corporations. To me this doesnt make sense why Tax Payers are expected to take on ALL of the risk for CMHC mortgages & not for private corporations.

  20. This may come as a surprise Jon, but when a CMHC mortgagor defaults, the CMHC pays the claim from its considerable reserves, which originated from mortgagor premiums. Not the taxpayer.
    The hair-on-fire, dime-a-dozen doomsday tax-payer bail-out scenarios proffered by fearmongers like Rabidoux (and apparently yourself) are well, just that.
    Maybe you should check out some squirrel recipes. Garth Turner might be able to help you.

  21. CMHC returns 100% of its profits directly to the Government of Canada, and hence directly contributes to deficit reduction.
    Genworth and Canada Guaranty, while they only enjoy 90% backing from the Government, contribute 0% of their profits back to the Government. In fact, Genworth Financial Canada is 57.5% owned by its parent, Genworth Financial in the United States. Genworth Financial Canada pays a quarterly dividend, in the last quarter 19 million dollars was repatriated to the US parent.
    Personally, I’d rather keep the profits here in Canada.

  22. Just to clarify, the taxpayer owns those reserves…and all insurance companies have lots of money until s^&t happens.

  23. Right and maybe we should shut down insurers like Intact and Aviva, just in case an earthquake wipes out the western seaboard. Because you know, s^&t happens!
    P.S. Yes, the analogy is valid. The government would bail out property and casualty insurers in a major disaster scenario.

  24. What risk to the taxpayers are they talking about. From a profit/loss standpoint, CMHC is a money making machine. They charge high premiums and default rates resulting in losses are almost miniscule.
    Open up the financials and see how much money/profit CMHC has made over the years, so I don’t know what everyone is worried about here.

  25. Recommendation #1 – I think that creating a requirement for people to provide more documentation related to a purchase of this magnitude is a minor inconvenience.
    Recommendation #2 – The goal of CMHC isn’t to make every house affordable to every person. It was originally intended to make housing affordable “for people who’s needs weren’t met through the marketplace.” and has significantly broadened its scope to include everyone.
    Recommendation #3 – You should never have been able to buy a second house with only 5% down.
    While the price of housing is increasing at astronomical increments, most people don’t consider mortgage underwriting an issue. The argument is that why fix something that isn’t broken. As in most industries, being proactive to mitigate or avoid potential problems is proper risk management. If lenders were not backstopped by tax payers things would be a lot different.

  26. You asked why CMHC should insure properties to a high LTV. The answer is, it’s the law. If you’ve been doing this for 11 years then how can you possibly not acknowledge that?
    I understand you don’t like the law but I don’t like driving only 100 kph on the Trans Canada Highway. Deal with it or petition parliament.

  27. “When arrears rates start climbing, it won’t come in a stream. It will be a tsunami…The ultimate joke will be why no one saw it coming.”
    No. The ultimate joke is that you actually think you can predict arrears rates.

  28. Here’s a note for everyone who wants big neo-con changes to CMHC. When housing prices correct, as they will someday; CMHC will experience a surge in defaults. CMHC will go to their reserves, stop raining profits down on the federal government and wait out the downturn until the housing market returns to good health. Same as they did during the last reversal in 1989 – 1990. End of story. The trouble with generational cycles (that’s what we have here: 24 years since the last big national market reversal) nobody remembers the dynamics except old trolls like me. It gets bad and then it gets better. The sky actually does not fall in. CMHC has made a ton of tightening changes over the last 3 years and more to come. CMHC can be tinkered with to make it a better operation but tearing it apart is just silly.

  29. #1 – It doesn’t matter what size the inconvenience is. Additional documentation is simply unnecessary because it wouldn’t reduce losses by any significant degree. It is pointless to hassle people for nothing.
    #2 – You are mistaken. CMHC does not serve everyone. There is a $1 million limit and only 4% of mortgages are over $550,000. Personally speaking, if my tax dollars are going to back the 96% of people with homes under $550,000 then my government should be willing to back my $999,999 purchase IF I am not a credit risk and IF I pay a proportionately larger insurance fee. Anything less is socialism and this country has enough of that already.
    P.S. There is a big difference between being “proactive” and being overreactive.

  30. I would be very interested to know who has described Rabidoux as an “empty theorist”. Google turns up nothing but this post on CMT.
    Your comments about the status of Rabidoux’ blogs are false. The blog is still online at (I have it open in another browser tab right now) and everything is still there — he has not taken it offline. He doesn’t post much anymore, but he is active on Twitter.
    My read on this CMT article is that, of Rabidoux’s four points, Rob has serious issues with no. 1, some questions about no. 2 based on where lines get drawn (geographic or value-based) but some agreement in principle, and general agreement on no. 3 and no. 4. So I don’t think Rob is as dismissive as your comment might imply. Again, just my read.

  31. Answer:
    I don’t suffer fools gladly.
    I value hands-on experience and knowledge over spin.
    I deplore sophistry, punditry and hyperbole.
    But most of all, I hate being wrong.
    Thus far, that’s not been an issue.

  32. thank you for this. very thought provoking.
    however, i do take issue with your logic on the first two recommendations.
    first, you seem to have an awful lot of faith in the checks and balances of the canadian underwriting process despite it being inferior to the US at least wrt documentation standards. can you honestly say this is a balanced and impartial view? i suggest that improving documentation standards is a valid point for a variety of reasons, not least of which is the fact that borrowers w/ self declared income are more likely to to have incomes positively correlated with the construction industry at large and are therefore more susceptible to losing income in any significant downturn in real estate. your notion that if they are going to do it they are going to do it anyway simply does not cut it from a risk management standpoint.
    second, your arguments against instating regional insured loan limts are not robust, in my view. the US has a very straight forward process for doing exactly which works generally fine. why couldn’t canada do something similar? again, this would be prudent risk management wouldn’t it?
    thanks again for sharing your thoughts.

  33. “From a risk management standpoint” there isn’t enough risk in the current system to worry about it. You’re asking whether a candle should be put out with a fire hose. Learn how lenders actually underwrite so you can gain some perspective.

  34. “US has a very straight forward process for doing exactly which works generally fine”
    Oh really now?
    How “fine” did it work from 2006-2009 when bad underwriting crashed US home prices 35%?
    That’s funny because I don’t recall Canada having a similar crisis.

  35. No need for hyperbole… going back to a required 25% down payment would be a very good thing that would reign in the excesses.

  36. How would I challenge the CMHC’s decision to deny me mortgage insurance? Is there a process in place for this or would it be a court battle.

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