Government intervention in the mortgage insurance market is exposing Canadian taxpayers to enormous potential liabilities if Canada were to be hit with a mortgage default crisis similar to what occurred in the United States, according to a new peer-reviewed study released by The Fraser Institute, a public policy think-tank.
The report, Mortgage Finance Reform: Protecting Taxpayers from Liability, finds that the Canadian government is heavily exposed in the mortgage market because 43 per cent of all residential mortgages (including all loan-to-value mortgages over 80 per cent) are backed by the government through the federally owned Canada Mortgage and Housing Corporation (CMHC). The report recommends that the federal government follow Australia’s example by opening Canada’s mortgage insurance market to full competition including the privatization of the CMHC.
“The CMHC dominates the Canadian mortgage insurance market because it enjoys regulatory advantages not available to private-sector companies. As a result, several private-sector mortgage companies have withdrawn from offering mortgage insurance in Canada,” said Dr. Brett J. Skinner, Fraser Institute director of insurance policy research.
“The Canadian government should reduce taxpayer exposure by allowing the private sector to take responsibility for insuring and securitizing Canadian residential mortgages. This includes the complete privatization of the CMHC’s mortgage insurance business.”
The report points out that the Canadian model has the majority of risk concentrated with the Government of Canada, and therefore the taxpayer liability is much greater in Canada than in Australia. By privatizing the CMHC or removing its unfair regulatory advantages, the market would likely be more pluralistic with multiple mortgage insurance providers serving Canadians. This would be similar to the Australian model of mortgage financing, which has been highly successful in achieving home ownership outcomes and has produced a stable mortgage market, but has minimized taxpayer liabilities during financial crises.
The study also looks at recent events in the United States and that country’s mortgage insurance policies. It points out how the American government interfered in the U.S. mortgage market through legislation that encouraged financial institutions to issue mortgages to high-risk groups for social reasons. It also highlights how the U.S. government signaled an implicit public guarantee against financial failures by directing government sponsored enterprises (GSEs), similar to the CMHC, to buy and securitize mortgages for high-risk borrowers.
“In the wake of the recent financial crisis, American taxpayers are facing an enormous future liability to pay for the government bailout of the financial industry. Canadian taxpayers could face a similar liability because our government is so heavily involved in the mortgage insurance market through the CMHC,” Skinner said.
The report, written by researcher Neil Mohindra, examines the mortgage finance models in use in Australia and Canada, as well as the European covered bond model, focusing on the question of how to minimize risk to taxpayers while still achieving the housing objectives espoused by government policy-makers.
Australia had its own sub-prime debacle in the 1980s when a state government securitization agency created a program to fund mortgages for low-income borrowers. The program was a disaster and resulted in taxpayer losses of close to half a billion Australian dollars. Once the Australian state governments got out of the mortgage securitization market, the private sector became active in securitizing residential mortgages. The Australian federal government also exited mortgage insurance by privatizing its mortgage insurer.
The study finds that home-ownership rates in the period following the privatization showed no adverse effects from the lack of government involvement in mortgage finance. In fact, the proportion of Australian homeowners relying on mortgage finance increased and housing quality improved.
“The Australian experience shows that a market for mortgage insurance can operate effectively without any form of government guarantee,” Skinner said.
“In order to lessen the taxpayer exposure and reduce the likelihood of a Canadian mortgage crisis, the government should emulate Australia and allow the private sector to take total responsibility for insuring and securitizing Canadian residential mortgages.”