CMHC: Canada's very own ticking economic time bomb!
May 30 2010
The Star
Stanley Taube
For the past few years, Canada has been basking in the glow of international economic praise.
Our banking system is the best in the world. There has been no need for government bailouts. True, we have recently been running large deficits. But they are manageable in terms of the size of our economy. Our dollar is strong. Investors want to invest in Canada. Best of all, our real estate market, with a short hiccup in late 2008 and early 2009, has been moving steadily upward. Historically low mortgage rates have made housing affordable to practically anyone wishing to purchase.
Not for us the housing disasters that have occurred practically everywhere in the world. No toxic investment paper, as was created in the U.S., by bundling mortgages into investment vehicles that had very poor underlying security. Not for us the “ninja” borrowers (no income, no job, no assets).
We look smugly at states like Nevada and Florida, where real estate values have fallen by up to 50 per cent from their highs in 2006 and 2007. And this gloomy scenario has been repeated in Ireland, Spain, France, Italy. You name it, and real estate has dropped dramatically. Even Manhattan in New York and Kensington in London have not escaped.
So is Canada really the nirvana of the world? We are part of the Planet Earth. Our economy is very much interwoven with many other countries. Are we that much smarter then practically everyone else? Maybe luckier?
Or is there a potential financial disaster lurking just over the horizon, waiting to put us into the real world of true financial crisis? I believe there is. And that disaster is the Canada Mortgage and Housing Corporation (CMHC).
CMHC is a federally owned crown corporation that insures mortgage lenders against losses on their mortgage investments. It charges insurance premiums for this service. These premiums are higher for those mortgages where the borrower has little equity in his home. For example, the premium for a mortgage that amounted to 95 per cent of the home's value would be 2.75 per cent. The premium is generally added onto the mortgage balance. Accordingly, a borrower who takes out a 95 per cent mortgage could owe 97.75 per cent of the value of the home. Until recently, mortgages could be insured for 100 per cent of a home's value!
This all works very nicely if real estate values stay steady or keep rising. The CMHC program encourages people to buy homes by making mortgage loans available that private lenders would not give. But here are the problems:
Mortgage lenders invariably shift the riskiest assets into the CMHC program. You have 5 per cent down payment? Off you go to CMHC! You have 25 per cent down payment? You're our kind of client! We will retain your mortgage for our own account.
At the end of 2009, CMHC had $473 billion in outstanding guarantees. This is up from $408 billion at the end of 2008. With the frantic pace of real estate activity in the past few months, that figure is surely over $500 billion today.
And what is backstopping this huge obligation? CMHC had $9.3 billion in equity at the end of 2009. There is also a very paltry $1.3 billion for loan loss reserves. So there is approximately $10.6 billion available before CMHC runs out of money. After that? Well, CHMC obligations are direct obligations of the Government of Canada. We taxpayers are on the hook for the rest.
Let's assume that real estate in Canada falls a very reasonable 20 per cent in value. Given the recent run-up in prices, rising interest rates, ever increasing listings and fewer buyers who qualify for mortgages, a decline in values is virtually inevitable. Tens of thousands of borrowers will be unable, or unwilling, to make their payments.
The 20 per cent hit that CMHC could take would be more like 25 to 30 per cent. There are significant expenses in disposing of repossessed property — taxes, utilities, insurance, real estate commissions, legal fees, and so on. I would estimate that CMHC (which, in effect, is the federal government) could wind up $125 billion in the red.
This would blast an enormous hole in our government's finances. Canada would be put into the same category as the other prolific spenders. Which is where we should be. We are merely postponing the inevitable.
Stanley Taube is a lawyer and author. He has taught political science at the University of Toronto.
The Star
Stanley Taube
For the past few years, Canada has been basking in the glow of international economic praise.
Our banking system is the best in the world. There has been no need for government bailouts. True, we have recently been running large deficits. But they are manageable in terms of the size of our economy. Our dollar is strong. Investors want to invest in Canada. Best of all, our real estate market, with a short hiccup in late 2008 and early 2009, has been moving steadily upward. Historically low mortgage rates have made housing affordable to practically anyone wishing to purchase.
Not for us the housing disasters that have occurred practically everywhere in the world. No toxic investment paper, as was created in the U.S., by bundling mortgages into investment vehicles that had very poor underlying security. Not for us the “ninja” borrowers (no income, no job, no assets).
We look smugly at states like Nevada and Florida, where real estate values have fallen by up to 50 per cent from their highs in 2006 and 2007. And this gloomy scenario has been repeated in Ireland, Spain, France, Italy. You name it, and real estate has dropped dramatically. Even Manhattan in New York and Kensington in London have not escaped.
So is Canada really the nirvana of the world? We are part of the Planet Earth. Our economy is very much interwoven with many other countries. Are we that much smarter then practically everyone else? Maybe luckier?
Or is there a potential financial disaster lurking just over the horizon, waiting to put us into the real world of true financial crisis? I believe there is. And that disaster is the Canada Mortgage and Housing Corporation (CMHC).
CMHC is a federally owned crown corporation that insures mortgage lenders against losses on their mortgage investments. It charges insurance premiums for this service. These premiums are higher for those mortgages where the borrower has little equity in his home. For example, the premium for a mortgage that amounted to 95 per cent of the home's value would be 2.75 per cent. The premium is generally added onto the mortgage balance. Accordingly, a borrower who takes out a 95 per cent mortgage could owe 97.75 per cent of the value of the home. Until recently, mortgages could be insured for 100 per cent of a home's value!
This all works very nicely if real estate values stay steady or keep rising. The CMHC program encourages people to buy homes by making mortgage loans available that private lenders would not give. But here are the problems:
Mortgage lenders invariably shift the riskiest assets into the CMHC program. You have 5 per cent down payment? Off you go to CMHC! You have 25 per cent down payment? You're our kind of client! We will retain your mortgage for our own account.
At the end of 2009, CMHC had $473 billion in outstanding guarantees. This is up from $408 billion at the end of 2008. With the frantic pace of real estate activity in the past few months, that figure is surely over $500 billion today.
And what is backstopping this huge obligation? CMHC had $9.3 billion in equity at the end of 2009. There is also a very paltry $1.3 billion for loan loss reserves. So there is approximately $10.6 billion available before CMHC runs out of money. After that? Well, CHMC obligations are direct obligations of the Government of Canada. We taxpayers are on the hook for the rest.
Let's assume that real estate in Canada falls a very reasonable 20 per cent in value. Given the recent run-up in prices, rising interest rates, ever increasing listings and fewer buyers who qualify for mortgages, a decline in values is virtually inevitable. Tens of thousands of borrowers will be unable, or unwilling, to make their payments.
The 20 per cent hit that CMHC could take would be more like 25 to 30 per cent. There are significant expenses in disposing of repossessed property — taxes, utilities, insurance, real estate commissions, legal fees, and so on. I would estimate that CMHC (which, in effect, is the federal government) could wind up $125 billion in the red.
This would blast an enormous hole in our government's finances. Canada would be put into the same category as the other prolific spenders. Which is where we should be. We are merely postponing the inevitable.
Stanley Taube is a lawyer and author. He has taught political science at the University of Toronto.
My personal take on this, CMHC can convince people to buy, with whatever incentives they can think up, the losers will always be aplenty. Assuming this fairy tale of a strong real estate market continues, then we will be seeing people being priced out. But on the contrary, when the market adjusts as it usually does, each successive buyers will lose money. Speculators, suckers or whoever the niche, everyone eventually loses if they own a home whether or not the mortgage is payed off. Those who bought near the top just lose more.
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