I think this article is an interesting counterpoint to Coxe's comments about what excellent regulators Canadians have been.  If what is in this article is true, I have my doubts about the Canadian miracle, though it does seem like the banks will avoid the fallout.

 

Monday, July 20, 2009

CMHC - Canada's Breaking Point

(ALL GRAPHS EXTRACTED FROM CMHC PUBLICATIONS)

Everyone here is probably very well aware of who CMHC is. For anyinternational visitors, CMHC was formed as a crown corporation inCanada after World War II to address the shortage in housing. It'smandate was to make home ownership accessible to all Canadians. CMHCprimary deliverables is mortgage insurance and mortgage backedsecurities. Think Fannie and Freddie.

In 2001 GE Capital was permitted to join CMHC in the Canadian mortgageinsurance industry to provide competition in the marketplace. GECapital began insuring Canadian mortgages and issuing NHA-MBS (MortgageBacked securities insured by the Government of Canada). In response tocompetition, CMHC began its trip down a new road.


In 2002 total outstanding mortgage debt in Canada was still a cool $467billion. This was predominantly issued to good credit and people withproper downpayments. CMHC insured a small portion of this debt.

In 2003 CMHC decided to remove the price ceilings limitations. That is,it would insure any mortgage regardless of the cost of the home.

In 2007, after years of lobbying, the now defunct AIG found new hopewith the newly elected Conservative government. AIG was now permittedto insure high risk Canadian mortgages. It was also permitted to issuemortgage backed securities and exchange these on the open market. Atthe same time, the Conservative government launched a radical policythat allowed CMHC, AIG & GE to insure 35 year ams and 0% downpayments. A few months later this was expanded to 40 year amortizations.

Thanks to this stimulus in 2007 the market radically changed.Historically high home prices continued to gain steam. High riskborrowers flooded the real estate market. Throughout 2007, the averagehome buyer who took out a mortgage had only 6% equity in their homes.That's the national average downpayment for all mortgages includingbuyers who moved up.
(2006 and prior years reflect acombination of larger downpayments, home price appreciations, paymentson mortgages and shorter amortization terms)

In 2008, Canadian home prices started to dip as affordability becamethe worst on record in many cities. CMHC admits that it was ordered toapprove as many high risk borrowers as possible to prop up the housingmarket and keep credit flowing. 42% of all high risk applications wereapproved, a 33% increase over 2007. (Please see matrix below for moreinformation)



While many banks were flogging that it was a great time to buy a home,not one of them increased their mortgage holdings. Between thebeginning of 2007 and 2009 Canadian Banks increased their totalmortgage credit oustanding listed on their books by only 0.01% (seeCMHC chart below). One has to question if real estate was such a greatinvestment, why didn't they want to touch it?



The only growth has been in the securitization of Canadian mortgages.In Canada this scheme has worked very well despite the credit crisissince the government of Canada insures 100% of any losses (not just the20% downpayment). This means that the securities are as secure asgovernment bonds, yet pay a higher premium (currently 3.1%).

The banks get to keep the difference between the interest rate chargedto consumers and the rate paid to investors. The result of a governmentbacking is cheaper subsidized funds for them to issue mortgages with.It also removes all risk.

Thelargest market for MBS is 5-year fixed single residential homes. Theaverage term has swelled over the past two years and the majority ofissues are for ams over 30 years. Some pools of MBS were issued at 9%but pay investors only 4% - representing how risky and profitable theseloans are. CMHC charges 0.2% for the insurance, leaving up to 4.8%profit for the bank.

Securitization has accounted for 90.5% of all growth in total Canadianmortgage credit outstanding since 2007. Its market has grown from 100billion in 2006, to 130 billion in 2007, to 260 billion by Q1 of 2009 (UPDATE: $295 billion by mid-June 2009). CHMC plans to expand securitization of debt to 370 billion by the end of 2009 as per the conservative government request.

Allof these securties are traded on an open exchange and insured by theGovernment of Canada. Currently TD issued 59 billion in securitiesoutstanding, CIBC 51 billion, BNS 32 billion, RBC 45 billion and BMO 27billion. This explains why, if you are like so many, your eye ballspopped when the bank preapproved your mortgage. Many individuals arebeing granted 500-800K for their first home purchase if their householdincome ranges from 110-170K. The banks don't care. You either qualifyfor securitization or you don't. Their is no emotion or extra thoughtput into the loan by the bank since it bears zero risk. Investors don'tcare who you are since the security is backed by the government. Infact the only person who should care is you, the taxpayer. Butapparently in Canada noone cares about the risk the taxpayer takes on.It's all about having a lavish political career.

As interest rates edged up about a percent in early 2008, Canadian realestate began to nose dive losing 10% of its value by September 2008.10% is a significant confidence level in real estate. Surpassing itmeans that all the buyers in 2007 would move into negative equity.Cranking interest rates down to 0% in October of 2008 along with theexpansion of government backed securities allowed mortgage rates toreach an all time low. The resulted in a house boom in the middle ofthe worst Canadian recession since the Great Depression. Home prices inMay 2009 reached an all time high of $326,613 or over 7x the averageCanadian income.


On Jan 1 2009 CMHC allowed non regulated financial institutions toissue mortgage backed securities. Furthermore on January 26, 2009 CMHCallowed the securitization of line of credits, non amortizing andamortizing loans and readvanceable loans to also be securitized.

CMHCindicates in its plan that it will insure $813 billion via acombination of mortgage insurance and mortgage-backed securities (MBS)by the end of 2009. Looking at 2008 and 2007, one can clearly see thatCMHC has drastically exeeded their planned figures. 812 billion is morethan likely a minimum target. At this rate the Government of Canadawill be insuring well over $500 billion in securitized mortgages andlines of credit by the end of 2010. It will also have issued over $600billion in outstanding mortgage insurance.

Even at the zenith of the US housing bubble, prices peaked around$230,000 US while incomes were around $47,000 US. In Canada, incomesare $44,000 and prices are now at $326,613. If I have evidenced to youat this point how risky our lending has been, how are we so differentthan America? One might even say that we are much worse.

None of this is sustainable. This will all end very badly for our nation and taxpayers in the next couple of years.