The “securitization” of mortgages that many economists blame for the housing collapse and subsequent financial crisis in the U.S. is now a runaway problem in Canada, says a new study that also casts doubt on whether Canadians can trust the house price information they are seeing.
The study from Canso Investment Counsel, a corporate bond management firm, says mortgage securitization — bundling mortgages together and selling them to investors — has spiralled out of control in Canada in recent years.
Many economists blamed the process for the collapse of the U.S. housing market, because lenders didn’t have to worry about the ability of borrowers to pay in the long term — they would simply unload the risk onto other investors. (A concept known among economists as “moral hazard.”)
In Canada, the securitization of government-backed mortgages (mortgages that have been insured by the CMHC, or other insurers such as Genworth) has exploded since the early 2000s, when the Canadian Mortgage Bond program was created and the CMHC lifted its $250,000 ceiling on insured mortgages, allowing banks to securitize most of their mortgages, the report said.
It boomed again in 2009, when the Insured Mortgage Purchase Program (IMPP) came into effect in the midst of the recession. That program saw the CMHC, the government-run mortgage insurer, start buying securitized mortgages from banks — the same mortgages it insured.
“Why the federal government would assume all the credit risk of a mortgage and then buy it at a healthy premium as a ‘riskless’ asset is an interesting question,” the report states, hinting that the whole process may just be a scam designed to hold up the housing market artificially.
The result, the report said, is that the proportion of government-insured mortgages in Canada went from 30 per cent in 1988 to 75 per cent in 2013. In other words, taxpayers are on the hook for three-quarters of Canadian mortgages, should something go wrong in the market.
“We believe the IMPP will eventually go down into the annals of Canadian history as a ‘stealth rescue’ of the Canadian banking system that morphed the mortgage market into a credit bubble of immense proportions,” the report says.
HOUSE PRICES ‘GAMED’?
The report also suggests Canadian house prices are being artificially inflated by an industry appraisal system that conveniently over-inflates the acceptable price range for a given house.
The automated system is known as EMILI and is operated by the CMHC. It’s a computer algorithm that allows mortgage lenders to check the asking price of a house against a database to see if the price is reasonable for that market. It looks principally at square footage and previous sale prices in the area.
But the Canso report says this valuation system is susceptible to manipulation — and is being manipulated.
“It is our understanding from real estate professionals and bankers that there has been extensive “gaming” of this system and excessive prices generated by this system,” the report says.
“If a higher price is required for CMHC insurance coverage, the square footage, which is input by the lender and supplied by the mortgage broker, can be increased as required.”
All of this has led to what the report calls “the great Canadian debt binge” — unprecedented levels of household debt driven by record-breaking house prices.
“Canadians will suffer from withdrawal symptoms from their insured mortgage credit dependency. The extent of the Canadian government subsidy to both the banking sector and Canadian homeowners through government guaranteed mortgage insurance is huge. This was not always the case,” the report says.
The report’s conclusions are almost certainly going to be challenged by the economists at Canada’s major banks, who have declared a “soft landing” in the housing market, as last year’s slowdown in sales failed to turn into a market rout. But the report suggests the real housing collapse is yet to come.
The latest housing data has been particularly hard to interpret, but it does suggest a market that is out of balance. Data released last week, for example, showed house prices in Toronto jumping an unexpected 8.1 per cent over the past year. But data released a day later showed home sales in the city falling 30 per cent over the past year.
That would suggest a housing market where supply and demand have become fundamentally detached from prices.
For Canso, all evidence points to a serious market correction.
“We hope very much to be proven wrong, but the analysis is clear. Canada borrowed its way out of the 2009 recession by stoking our residential housing market to absurd levels. We cannot afford the houses we are living in.”