CMHC mirrors U.S. cousins in exposure to bad mortgages
The Canadian housing agency’s vulnerability to mortgage defaults has soared ninefold in 20 years, approaching levels reached by Fannie Mae and Freddie Mac in the U.S. at the height of the housing boom. Canada Mortgage & Housing Corp. says its finances are secure unless the country plunges into deep recession for several years.
Government-owned CMHC insured $541 billion in mortgages as of Sept. 30, an amount equal to 31 per cent of Canada’s annual gross domestic output, as home prices climb and construction expands. In 2006, when U.S. home prices peaked, the combined exposure of the government-backed agencies to potential defaults was slightly more than a third the size of the economy, according to Bloomberg calculations based on U.S. Federal Reserve data. Fannie and Freddie were bailed out in 2008.
“If a significant number of homeowners default, CMHC would have a lot of claims they would have to pay out,” said John Andrew, real-estate professor at Queen’s University in Kingston, Ont. Homes would “sell at greatly discounted prices as supply exceeds demand,” he said, adding “the risk of this is significant.”
CMHC has enough capital to remain solvent unless Canada were to see “multi-year recessionary periods” with “persistent high unemployment going above 13 per cent” and house prices falling close to 25 per cent, the agency said in an emailed response to Bloomberg News. Canada hasn’t approached CMHC’S worst-case scenario since 1982, when unemployment peaked at 13.1 per cent in December at the end of a six-quarter recession.
“You can’t rule out the possibility of a significant correction in Canadian real estate because there is overvalution, but I just don’t see the catalyst to cause it to happen in the near term,” said Craig Alexander, chief economist of Toronto-dominion Bank. “I’m not losing any sleep over the taxpayer liability of CMHC insurance.”
CMHC chief risk officer Pierre Serre said it’s “extremely unlikely” economic conditions would push CMHC into insolvency.
CMHC’S estimate of its ability to stay solvent is based on stress tests it conducted last year using 10,000 economic scenarios. The probability of insolvency is less than 0.5 per cent, the agency said.
An increase in unemployment and decrease in housing prices would be the main driver of insurance claims against CMHC, followed “much further down” by an increase in interest rates, Serre said.
Another 1980s-style housing correction can’t be ruled out, said Finn Poschmann, vice-president of research at the Toronto-based C.D. Howe Institute.
“Everything under the sun will happen again. It always does,” Poschmann said, adding CMHC’S stress tests would be more credible if the agency provided enough data for outsiders to validate the results.
There’s a 15 per cent chance housing prices will decline 10 per cent or more over the next year, according to the median of a Bloomberg survey of 13 economists last month. CMHC said in a Feb. 13 report the average price of existing homes will climb 2.7 per cent in 2013.
“Although there were a lot of discussions in the public domain about a house-price bubble, I must say clear evidence is lacking to support those conclusions,” said Mathieu Laberge, CMHC’S deputy chief economist, in a telephone interview.
Unlike the U.S., Canada avoided having to directly inject public money into the country’s financial institutions during the financial crisis. In September 2008, the U.S. took control of Fannie Mae and Freddie Mac, which have since received more than $180 billion in government funds. Freddie Mac said Friday it will ask for $146 million more in aid to cover its deficit at the end of last year.
As Canada’s housing market has boomed, CMHC’S balance sheet has grown to record levels. In 1982, CMHC insured $29.1 billion of mortgages, equal to 7.7 per cent of the country’s output. The agency’s total assets have increased from $8.9 billion in 1991 to $294 billion at the end of September.
This growth has put CMHC under greater scrutiny. In a December report, International Monetary Fund staff called on the federal government to review the agency’s governance and assess whether it needs to do more to protect itself against housing market risks.the agency controls about 70 per cent of Canada’s mortgage-insurance market. The rest is held by private insurers such as Genworth MI Canada Inc. and Canada Guaranty Mortgage Insurance Co.
CMHC points to several differences between the U.S. and Canadian home-finance systems. The “subprime” loan market didn’t take hold in Canada like it did in the U.S., the agency says, and so it isn’t exposed to such risky loans, as Fannie Mae and Freddie Mac were.
Fannie Mae and Freddie Mac are government-controlled companies that buy mortgages and repackage them as bonds. Pressure to enhance short-term returns for shareholders was one of the factors that led Fannie and Freddie to buy risky mortgages, according to a panel set up by Congress to look into the causes of the crisis.
While CMHC also holds mortgage-backed securities, its main business is insuring home loans against the risk of default. CMHC is fully owned by the federal government.