Mortgages: Private profit; Public risk

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Par Michael Vaillancourt le 7 Février 2010 - 4:17pm
Why doesn't the government issue mortgages? Why do we have this system where private banks collect mortgage interest, while the significant risks are shouldered by the government? If we the public are holding the risks, shouldn't we also collect the profits? Excerpt from Globe and Mail article:

The bankers' effort is all the more notable given the unique structure of the Canadian mortgage business. Banks get the profits from mortgages with their decades of interest payments, but have little risk of direct loss because of mortgage insurance.

Consumers cover the premiums and, because most mortgage insurance is underwritten by CMHC, the federal government ultimately takes the risk.
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Mortgages.

Submitted by Bram Kivenko on 8 Février 2010 - 2:15am.

The government should not issue mortgages because it is not something the government can do without political interference and the regular insanity that surrounds government bureaucracy as it relates to monetary transactions.

When I got my first mortgage, one bank required a guarantor.  I shopped around until I found another bank that didn't place that requirement on me.  I also got a better rate.  This is what happens when there is competition.  If the market was dominated by the government, maybe I wouldn't have been able to get a mortgage.  Competition in the market place is good.

Also, banks still shoulder significant risk.  Mortgage defaults are not more likely if they are CMHC insured.  Mortgage defaults are centered around larger economic events.  When a factory closes in a smaller community, many people lose their jobs and they default on their mortgages regardless of how much equity they had built up in their houses.  Concurrently, house prices in the area also drop.  In many cases, by the time a house is foreclosed and resold, a 25% equity cushion is not always sufficient.

Anyway, as far as I know, CMHC has not been losing money.  It is their goal to provide services equivalent to a for-profit insurer -- ie, not to lose money.  And although CMHC insures mortgages, they do not cover legal costs of foreclosure.  Furthermore, the government is responsible for setting federal debt interest rates (assuming it can), which affect mortgage rates, so it should be expected that they facilitate the mortgage market.

You may believe that "we are holding the risk" and "they are making the profit" but the mere existence of the CMHC helps more people get mortgages and it also lowers the overall interest rate they will pay.

It seems to me that the CMHC is a great system.  I bought my first residence insured by the CMHC because it was a high-ratio mortgage.  I have since built up equity so that I no longer need CMHC insurance.  Without CMHC, I would have been renting, and a significant portion of my worth would vanished.

Why can't each bank make its

Submitted by David Barclay on 8 Février 2010 - 8:09am.

Why can't each bank make its own rules?

Reading between the lines in the article; I doubt whether the banks care a hoot about an individual Canadian getting in trouble. In fact they will love to take your home if you miss a few payments, as long as house prices are rising.

They are worried that should there be a rise in interest rates and/or a downturn in employment, they might get stuck with alot of foreclosure properties they won't be able to sell, a devaluation of these assets, as well as personal bankruptcies-credit card defaults, which would stifle their lending business. 

Not sure why they need the government to tell them how to assess a family's ability to carry a mortgage. Bram, you are in the finance area, can you enlighten?

Respectfully, D. Scott Barclay

mortgages

Submitted by Bram Kivenko on 8 Février 2010 - 12:02pm.
Government needs to be involved because a failure of a chartered bank is dangerous. It is also a gross problem for everyone who deals with a bank that ends up failing. I'm on my blackberry so I can't go into much detail, but banks need to participate in CDIC. This makes bank failures everbody's business. As part of being in a highly regulated environment, the government should create facilities to rebalance behaviour toward what should be and what needs to be done. No regulation is what caused the financial meltdown. Specifically, financial institutions will destroy themselves because of agency risk. That is, if it is to someone's benefit to do something, like take risks for bigger bonuses, they will do it based on their personal risk reward profile not the company's risk reward profile -- which in the case of the meltdown was much more favorable to a handful of individuals in charge of making decisions rather than that of all stakeholders and especially that of the shareholders.

mortgages 2

Submitted by Bram Kivenko on 8 Février 2010 - 12:16pm.
Also banks do not and should not care about your situation when dealing with mortgage holders. If you want compassionate mortgages, then the government should create additional regulations. This way all parties know what it is they are contracting. Mortgages involve a lot of money. Banks cannot afford to walk away with losses from very many mortgages. So it is unfair to change the rules in the middle of the game and tell them they have to give defaulters more time to not pay their mortgages. If you want more grace for defaulters, this should be regulated, and banks can adjust mortgage rates accordingly for the additional expense it would necessarily cause. What if a bank dif that to you? You go to withdraw your retirement funds and they tell you to come back in a few months to see if they have anything to give you? You'd be livid. I am certainly all for more compassionate regulation for mortgages, but let's make it law, not just an ethical expectation.

"Reading between the lines in

Submitted by Matthew Day on 8 Février 2010 - 3:56pm.

"Reading between the lines in the article; I doubt whether the banks care a hoot about an individual Canadian getting in trouble. In fact they will love to take your home if you miss a few payments, as long as house prices are rising."

Actually, the last thing in the world a bank wants is to own your' home. They then have to take care of it, and hire all kinds of people to help them get rid of it. Once all this work is done, anything left over after the face value of the Mortgage is retired goes back to the homeowner. So in effect, they have to do a bunch of work that they are not good at, and they don't get paid for it.

I don't think the banks were worried about defaults on their own Mortgage portfolios, they were worried about defaults amongst the Mortgages held by smaller, less risk averse rivals. It is worth adding that they lose a significant amount of business to their smaller rivals, and the main reason that those rivals win the business is that they stretch amortisations, and accept less stringent debt ratios. If mortgages were more stringently regulated, then the competetive advantage enjoyed by the risky lenders would evaportate, and the 6 big chartered banks would see their budding rivals off into oblivion. This is the way oligopolies work. They band together to crush outsiders.

This doesn't mean that it's not a good idea to maintain stability in our mortgage and banking sector. I'm just pointing out that the motives of the big 6 have nothing to do with public welfare, and they are looking for a great business advantage when they float ideas like this.

 

CMHC provides insurance

Submitted by Erich Jacoby-Hawkins on 8 Février 2010 - 2:16pm.

The basic concept of the CMHC is that they provide mortgage insurance. Therefore, although you might say that the public or government is "holding all the risk", we are being paid to hold that risk just like any other insurer. The borrowers (homebuyers) have to pay a premium on top of the insurance they pay the bank; this premium goes to CMHC. The bank profits from the interest, but the insurer (CMHC or other) profits from the risk-based premiums. Under standard economic conditions, this premium is more than enough to make up for any defaults; in fact, under standard conditions, CMHC returns a considerable profit to the government (us).

The only risk is when, as Bram notes, the entire economy goes under. In that case, even borrowers with good credit can default. To prevent this from snowballing, the CMHC can buy extra insurance on their insurance, or the government can just backstop it. In the latter case, it means spreading the risk across the entire nation. It has the implication that the government should be careful to limit the total amount of CMHC liability to whatever level of risk is considered "acceptable". Right now there are many who feel that the CMHC is too large, holding too much risk. They may be right. Canada has used loose CMHC money as a way to provide market liquidity and this can be risky.

As Bram notes, the government sets regulations about who banks can lend to for good reason: to prevent bank failure. Those regs may say the bank can't lend to you (too risky), or they can but only with an insured mortgage (CMHC or other insurance), or that you are not eligible for CMHC. Private (non-bank) mortgage lenders, whether individuals or finance companies, are able to set looser rules. They also charge higher interest rates to reflect higher risk because they are not CMHC-insured.

Historically our system was safer than the US one because the CMHC was more regulated and more (fiscally) conservative than the sub-prime lenders down south. After Harper & Flaherty came in, they began relaxing regs to allow for a much greater sub-prime market. But this was only just getting started when the bubble burst, and they quickly backed out those changes and took credit for being "prudent" when really they had set out on the risky road. But luckily they hadn't been in power long, so their neo-con deregulatory American style wasn't able to send Canada down the tubes with the US. We dodged a bullet - for now, at least.

 

Erich Jacoby-Hawkins, Barrie ON - although I'm on Cabinet (Nat'l Rev. and Ecol. Fiscal Reform), views here are my own and may not reflect official GPC positions. Please visit www.ErichtheGreen.ca

Mortgage Interest

Submitted by Michael Vaillancourt on 8 Février 2010 - 5:22pm.
Great explanation Erich, though perhaps I should have been more specific with my question. I'm more concerned with the mortgage interest. It seems to me it's easy money for the banks, and they have no right to it. I'd be much happier to pay the interest portion of my mortgage to the government. They could use that money for public services, to pay down the debt, and perhaps even lower certain taxes. I'm not as fussed about the interest rate, as it all comes out in the wash. It's where that interest money is going that is the big issue.