The quest to trim government exposure to mortgage risk continues. In a speech Friday, CMHC head Evan Siddall said the country’s No. 1 default insurer may start offloading some risk to lenders.
“…We are evaluating a range of ideas on future improvements to our housing finance system,” he said, “including risk-sharing with lenders to further confront moral hazard, future sandbox changes if housing markets are to become less stable, and increased capital requirements.”
That may mean that CMHC will eventually make lenders pay a deductible on their default insurance claims.
If such a system were implemented, it would naturally trigger the question of benefit versus cost. And the answer to that question is debatable at best.
The benefits of a deductible system are clear. Lenders would underwrite slightly more conservatively, reducing potential defaults.
The downsides are just as clear. Lender costs, especially those of smaller lenders, would climb due to the deductible and due to a resulting increase in funding costs. This latter effect would stem from mortgage investors assigning new risk premiums to insured mortgages, since they would now be relying partly on the lender’s own credit worthiness (as opposed to just the government’s and/or insurer’s). Lenders’ funding costs would also likely increase as a result of higher regulatory capital requirements.
If lenders passed those added costs to consumers, as is foreseeable, Canadians would immediately pay more for mortgages. Rates could conceivably rise 10-20 basis points or more, sucking thousands of dollars from the pockets of Canadian families. That, of course, must be weighed against the reduced risk of a housing crash.
“…The greatest store of personal wealth in Canada is residential real estate,” Siddall said. But with mortgage lenders already exhaustively regulated and arrears just 11 basis points from the all-time low, it’s fair to wonder if CMHC has a fix looking for a problem.
CMHC is eyeing these changes with as much concern for its future housing exposure as for its present exposure. The reason government backs housing finance is to “assume the tail risk,” explained Siddall. For this role, taxpayers have been compensated “to the tune of $18 billion in profits from CMHC” since 2004.
In his speech he added: “…I am pleased to report that our stress testing confirms that CMHC would survive a 2008-2009 U.S.-type housing and financial crisis, if that were to occur in Canada.” That implies Canada’s current system is strong enough to withstand a 33% national price collapse. In the U.S. crisis, this was combined with default rates approaching double digits on insured mortgages, a fate barely in the realm of possibility north of the 49th.
CMHC says it’s keeping a close eye on the heartbeat of our housing market by watching for
- overheating of demand in the housing market;
- acceleration in house prices;
- overvaluation in house prices; and
- over-building in the housing market.
“As a risk manager…we aren’t overly worried about a housing bubble at this point in time, based on what we know.” Yet if “price growth remains strong or accelerates…we may need to look to macro-prudential counter-weights to avoid excesses,” he warned. “As I said, we are currently evaluating them.”
That may rattle mortgage industry executives, but Federal Finance Minister Joe Oliver has assured markets that these are longer-term initiatives (see this Bloomberg story).
“We’re looking at things, but we’re not going to be doing anything dramatic,” Oliver told Bloomberg. “We don’t see the need for it…You don’t want to cause the very thing you are trying to prevent.”
Rob McLister, CMT