“CMHC practices have been supporting high debt and risky borrowing by homeowners. The size of the drop in refinancing is surprising to the point of shocking.”

Refinancing activity [at CMHC] tumbled nearly 40% following a move by Finance Minister Jim Flaherty to tighten mortgage rules this spring. Sales of the CMHC’s mortgage insurance fell by 10% immediately after the changes were introduced, though they have regained some ground since then. … Changes to mortgage rules, [included] reducing the maximum amortization period for loans qualifying for CMHC insurance to 30 years from 35 years; lowering the maximum amount that Canadians can borrow to refinance their mortgages to 85% from 90% of the value of their homes; and withdrawing CMHC insurance from non-amortizing home equity lines of credit.

“The size of the drop in refinancing is surprising to the point of shocking. You could hardly have better evidence of the extent to which CMHC practices have been supporting high debt and risky borrowing by homeowners.” – Finn Poschmann, vice president of research at the C.D. Howe Institute

– from ‘Did CMHC support risky borrowing?’, John Greenwood, Financial Post, 29 Aug 2011

Answer: Yes, it clearly did.
The risk remains present in the form of overextended ‘owners’.
– vreaa

32 responses to ““CMHC practices have been supporting high debt and risky borrowing by homeowners. The size of the drop in refinancing is surprising to the point of shocking.”

  1. Lest we forget CMHC was formed in part because “nobody” thought investing in real estate and housing was a good idea.

    • …and in order to provide affordable housing for Canadians.

      A wonderful example of unintended consequences and the risks involved when committees intervene.

  2. I think history will show that 1) CMHC isn’t really to blame, if you believe we humans living in Canada have free will, and 2) there are significant liabilities not appearing on anyone’s balance sheet — what does one think happens to CMHC’s balance sheet if prices drop 20% and low-ratio loans decide to stop being low-ratio?

    • The lesson from down south is that everyone is to blame, to one degree or another. But that doesn’t keep each player from pointing the finger at everyone else.

      • After I wrote that I had a change of heart. CMHC is to blame as well, though I like to think we’d be in the same pickle regardless.

        On a completely unrelated topic, some guy offered to sell me crack. I said no; I’m bearish on crack.

      • Come on now. Crack is a great investment. Impervious to business cycles.

      • the responsible businessman always keeps his finger firmly on the pulse of dependency

  3. I don’t know why CMHC was ever in the business of allowing cash-out refis, or insuring zero-down purchases, or especially insuring zero-down rentals…

  4. CMHC insured mortgages down 40% this year.
    Yet still the beat goes on in Vancouver.
    Can’t keep a good city down

  5. I’m not convinced this is the primary explanation, but I’m too swamped to do a detailed analysis at the moment.

    Suffice to say, refinancing started in earnest (you can pull it from the CAAMP surveys) 27% of existing mortgage holders had some kind of activity in 2009, 31% in 2010. At the same pace, toss in another 8% before the CMHC changes plus the rush in December as rates fell. Then consider that 27% have a variable rate mortgage already and don’t “need” to refinance…

    I don’t think there is anyone left. I think that’s why it dropped off so quickly.

  6. “The lesson from down south is that everyone is to blame, to one degree or another. But that doesn’t keep each player from pointing the finger at everyone else.”

    I think we can point to particular causes of the problem.

    TX didn’t have nearly as much of a housing bubble/ drop in large part as Texas has surprisingly strict mortgage rules (and lax land restrictions). Texans can not take out HELOCs for more then 80% of their equity. Saved a lot of people.

    This drop of loans in Canada was not suprising to anybody who read (or observed) the US housing bubble.

  7. “what does one think happens to CMHC’s balance sheet if prices drop 20% and low-ratio loans decide to stop being low-ratio?”

    taxpayer bailout? I’m assuming that’s what CMCH does — guarantees an automatic government (taxpayer) bailout to the bank if things go bad in the housing market.

    • “taxpayer bailout?”

      What will shock people is that if housing prices drop say 20%, CMHC’s balance sheet will consume more and more of the outstanding mortgages and will likely be hit with an increasing delinquency rate as well. The more I analyse it the more it’s evident nobody is carrying future liabilities on their books.

      We can trace the accounting of this to see the problem: low-ratio loans are provisioned by banks with a relatively small capital reserve and the assumption that any equity collapse can be recouped after a 5 year duration (i.e. falling prices won’t eat up the DP over the loan duration), at which point the bank gets its money and tells the borrower to f-off, or laterals to CMHC MI. So far, no major risk shows up on the books.

      But now CMHC faces a loan application from a desperate mortgage holder who needs to refi with little to no equity — potentially not even the minimum 5% — and CMHC makes them pony up the MI premium and assumes the liability, now using an insurance accounting model. The problem, of course, is that prices are falling and historically defaults will happen close to a magnitude higher frequency typically with a 15%+ drop in prices. CMHC has provisioned for uncorrelated risk when mortgage defaults are anything but.

      The government can simply bridge CMHC some loans — the “taxpayer bailout” — but it’s a huge political egg on face and there will be pressure to “fix” the system, since the government will eventually face a repayment shortfall of these bridge loans that they’ll likely attempt to hide with hilarious consequences. The notional amount CMHC could be asking for could be significant, in the order of many tens of billions of dollars. That’s not an unreasonable scenario going forward.

      I think taking a step back, no matter the benefits of home ownership, prices are in the long run tied to rents. It is non-intuitive for many but that’s what the data support and what the theory tells us.

  8. Does Vancouver house prices in a bubble also imply gold prices are also in a bubble?

    • oh, my yes. Gold has been bubbling for a while now. Gold is more expensive then platinum right now, which makes no sense.

      (in fact, the gold bubble is helping to inflate the Vancouver housing bubble directly, because of the mining corps in Vancouver.)

  9. What’s interesting is the effect of CMHC rules on borrowing. See banks and other lenders could continue to offer 35 year mortgages, they would just not be insured by CMHC. Same with HELOC’s

    But the facts are that as soon as CMHC changes their requirements these products are no longer offered. None of the lenders want anything to do with 0% down 35 year mortgages unless it’s insured. Why? Because it’s a damn bad idea, that’s why.

    The other day I was on CMF and a poster there who is a mortgage broker had the utter gall to state that he wishes that “The government should stop interfering in the mortgage market” meaning CMHC increasing their requirements. Except of course CMHC is the government interfering. Dollars to doughnuts he didn’t mean CMHC bowing out and going back to the days of 25% down.

    Furthermore there should be a cap on the amount CMHC will insure. They should not be helping people buy large expensive McMansions. If you want a big fancy house save your money and put 25% down. Why the government should insure a mortgage so you can have champagne dreams on a beer budget is beyond me.

    • Rachelle, lenders wouldn’t want high-ratio loans on their books because they have to provision significant capital for them. Someone once told me banks actually prefer loans with MI because under accounting rules they don’t need to provision any capital because it’s perfectly hedged by a government-underwritten body; with non-insured mortgages they are required to have a capital reserve. (On a side note, having fully-insured mortgages makes banks’ leverage ratios look worse if you don’t know how to read the reports properly.)

      I noticed a few odd things when the government reduced the ams from 35 to 30 years earlier this year, namely the banks followed suit, even on low LTV loans, though some still kept 35 years for preferred clients. My guess is the government came down hard on the banks to reduce their ams to match CMHC’s offerings.

      Another troublesome issue is that some lenders have been qualifying low LTV borrowers under shorter duration and discounted rates, and using various favourable add-to-income ratios for secondary rental income, to get their DSRs under the requirement but CMHC loans require approval at the 5 year rate. (Central parts of Vancouver CMA are often 100% add-to-income! Not sure, but some lenders may still be using 80% rental offset when calculating payments :shock:) So if prices do drop there is an immediate disconnect between a borrower who was qualified at, say, the 3-year (or 5 year) discount rate with what CMHC requires — the 5-year posted rate. That’s a big problem only solved by recasting the mortgage in an even higher LTV offering, if possible. Otherwise… This may not apply to a ton of people but it’s enough it would tip that many more people into “needing to sell” territory.

      This is of course in addition to the obvious, that when people have their equity reduced they destroy the move-up market LTVs as well. What’s so interesting about Vancouver is that, even after the CMHC rule changes, sales are not “40% less”, they are about the same as last year with prices ostensibly 7% higher. So much for crimping first-time buyers. The federal government may be awaking to the fact that this market may not be what fire marshals call “self-extinguishing”.

      Man I’m blabbing tonight but this is important stuff to discuss.

    • “Furthermore there should be a cap on the amount CMHC will insure”

      A great suggestion! Even in Vancouver, if you’re hard up to find an abode, you shouldn’t have to spend more than $400K and yes you’ll need a car. T.S.

      Back to my previous comment, I highlighted some interesting insight into CMHC, here: http://housing-analysis.blogspot.com/2011/07/bill-c-3-gets-royal-assent.html

      Regarding the condition of 100% underwriting of CMHC-insured loans, where other private insurers are only 90%, meaning banks don’t require any capital provisions on CMHC loans, a CMHC representative Karen Kinsley stated the following:

      The issue of the differential in our mandate and the cost of that really gets to the nub of the difference in the guarantee between CMHC and the private insurers. We are, by virtue of being a crown corporation, 100% guaranteed by the Government of Canada. Recognizing that private insurers can select the markets they choose to be in, and obviously they will not serve those that are less profitable, the government has set the guarantee for private insurers at 90%. That 10% differential in the guarantee, in order to create a level playing field between us, compensates us for that difference.
      We have been able to operate successfully on that basis, as is evident by our annual returns, and the over $12 billion that we’ve been able to return to the government.

      HOLY F&CKING MORAL HAZARD, BATMAN!

  10. Thanks for the discussion, all.
    It’s very clear that the CMHC has caused the ‘mis-pricing of risk’ in the Canadian markets, making lending effectively even looser than the emergency low rates would suggest.
    The BOC, MinOfFin, CMHC must surely see that this has fueled a speculative mania in RE, especially in markets like Vancouver.

  11. “HOLY F&CKING MORAL HAZARD, BATMAN!”

    🙂 laughed out loud after I read.

  12. I know you’re all a bunch of austrian economics, zerohedge reading shitheads so I’ll assume most of you read this: http://www.theglobeandmail.com/globe-investor/take-bloggers-bank-warning-with-several-grains-of-salt/article2147693/

  13. “Canadian banks aren’t in trouble because there’s an automatic taxpayer bailout in place through CMHC”

    this is a melodramatic representation.
    The reason why banks in this country are in good shape is because of our conservative lending practice.
    And the reason why our housing market is in such good shape is due to the strict rules CMHC has in accepting high ratio mortgages.

    • ok – let’s restate:

      If in the unlikely event that the “conservative” jumbo mortgages made in Vancouver can’t be paid, CMHC acts as an automatic taxpayer bailout.

      • Don’t even bother. Rusty’s that guy on yahoo finance that’s pumping worthless stocks with the hope of making it rich

    • Where the hell have you been for the past 10 years man. I had two variable teaser mortgages and an interest only – all recommended and offered by the major Cdn banks that I deal with. I couldn’t believe how much my payments jumped when rates went up briefly by 200 bps. The same products are still widely popular plus I know many people with these mortgages who also have drawn their prime minus lines of credit to the tune of half a million to help buy / build their dream homes. Debt is everywhere in Canada and the country will not be spared from the global real estate crash.

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