Mini or maxi mortgage reforms in store for Canada?
By Finn Poschmann, Special to Financial Post
Minor reforms from the Office of the Superintendent of Financial Institutions don’t eliminate the need for major changes
The Office of the Superintendent of Financial Institutions last week released its long awaited draft guidelines, known as B-21, on prudent behaviour for federally regulated mortgage insurers. Think of it as the know-your-mortgage-originator rules. Good steps to take amid a seeming calm in housing markets – and where they will lead is up to the new finance minister, Joe Oliver.
Canada has three mortgage insurers. The largest, Canada Mortgage and Housing Corporation, dominates the market, typically providing insurance cover for about two-thirds of insured mortgages, and federal taxpayers comprise the sole shareholder, by way of Ottawa. CMHC’s two private competitors are Genworth Canada and Canada Guaranty.
It is a strange market. When a CMHC-insured mortgage goes bad, the agency more or less makes whole the approved lender that extended the mortgage loan. Any losses, missed interest payments or principal, or settlement costs, ultimately flow through to the Government of Canada’s bottom line. Not so for the private competitors – they are on the hook for losses, and the impact flows through to private shareholders.
However, if the market went really bad, and the private insurers themselves were bust, 90% of their liabilities would be covered by federal taxpayers. The explicit guarantee makes it possible for lenders to raise capital or to borrow almost, but not quite, as cheaply as CMHC, whose capital costs are nearer to the Canadian government’s.
What the three insurers have in common is that they lift risk from financial institutions that extend mortgage loans, and such insurance is required when homebuyers have less than a 20% downpayment. CMHC goes further, and will insure, for a low, low price, bundles of mortgages extended to borrowers who have more than a 20% downpayment, meaning the relatively low-risk crowd.
Lost on no-one is the fact that this federally backstopped mortgage insurance lightens the financial risk associated with mortgage lending; the idea is that this makes it easier for some buyers to find houses, and many believe that it helps on the financial stability front. However, the federal backstop, and the existence of CMHC, also lightens the prudential load that otherwise would bear on mortgage lenders. Prudential failures in the U.S. triggered a widespread financial crisis in 2008, and dealing with them has been part of the international financial regulatory agenda ever since.
Hence OSFI’s other recent guideline, B-20, aimed at ensuring that federally regulated financial institution boards understood and oversaw their institutions’ mortgage lending processes, and could explain them – or, know your borrower. B-21 extends the same concepts to the insurers who lift the risk from others – they are expected to know the risks that their lending clientele are selling on to them.
One might think that financial institutions would manage risk as a matter of course, and they do. Nonetheless, the scale of the exposure, and the fact that taxpayers are exposed to it, warrants the regulatory oversight, so long as the market is structured the way it is.
This makes the odd business of telling financial institutions to pursue the basics of risk management seem a normal thing for a regulator to do. Key goals or principles include assessing the mortgage insurer’s internal underwriting systems, models, and processes, and ensuring the “use of effective portfolio risk management.”
What such guidelines cannot do, however, is address the problems associated with the fundamental market structure, meaning that taxpayers directly or indirectly insure mortgage lending. The stability the mechanism might bring is a thing of value, and one that comes with risks and costs. Addressing these will require a long, hard look at market structure, and the role of CMHC. The previous Finance Minister, Jim Flaherty, clearly had expressed his doubts about the current structure; whether Joe Oliver will push on toward market reform, including a smaller or privatized CMHC, is unknown.
Along the way, Minister Oliver will have to address a rather large gap in housing finance risk and its management. That is because federal regulations are federal – meaning that B-20, for instance, does not really cover provincially regulated home lenders, who also sell mortgage risk to insurers.
This matters. Federally regulated chartered banks have perhaps $900-billion in residential mortgage loans outstanding. Next to them, the provincial institutions are small, but the credit unions and caisses populaires still account for about $155-billion in mortgage lending; collectively, that is not small potatoes.
While the lenders are small, their numbers are big, and this is the no-money-down, cash-back mortgage world. And the provincial regulatory system is fragmented, like the market it oversees. For both the regulators and the regulated, risk management and oversight tend to be overtasked and understaffed.
To provide an exit path from this balkanized system, Ottawa has for years offered supportive federal legislation and regulation, a move that would strengthen the system and bring better armed competition to the large banks.
The 2014 federal budget went a step further, ending joint OSFI oversight of provincial credit union centrals. This is intended to light a fire under provincial regulators, or to encourage trustcos to move to federal jurisdiction.
The new OSFI guidelines can be seen as harmless steps, yet there is much left to do. Without the right incentives and oversight in place, taxpayer-backed housing finance will remain an accident waiting to happen.