Published in the Financial Post on June 21, 2011
By Finn Poschmann
In the wake of a housing-led financial-market meltdown in the United States, our federal government has introduced a legislative framework for oversight and regulation of the mortgage insurance market.
The legislation, which forms part of the budget implementation bill before Parliament today, codifies the contractual arrangements, between the government and individual mortgage insurance companies, that now govern the terms for backstopping private mortgage insurers.
As it stands, private mortgage insurers compete for the edge of the market, against Canada Mortgage and Housing Corp., an agent Crown corporation whose liabilities are backed by the full faith and credit of federal taxpayers.
Because CMHC can borrow on terms similar to the federal government, and private insurers cannot, the private insurers’ cost of capital is higher. They would have difficulty staying in business, were it not for existing contractual agreements, which provide that 90% of the insurers’ liabilities are covered by the federal government. The insurers are required to set aside a fixed portion of their premiums booked, to help manage liabilities in case of meltdown. The existing arrangements enabled a form of managed competition in the mortgage insurance marketplace.
This is, or was, all right, if seen as a stepping stone to a more competitive marketplace. After all, there is no particular reason for the federal government to sell mortgage insurance, and certainly no reason for it to dominate the business, as CMHC’s typical 70% market share indicates it does.
And that’s what makes the current legislative design a deft move, even though it does little more than formalize existing arrangements. The legislation says that the private insurers must set aside adequate capital, and to do so as specified by the Superintendent of Financial Institutions. In other words, sound, prudential oversight remains a requirement, and we will have transparency and risk disclosure that is as good as we can manage.
Better yet, the budget bill provides that the private insurers be charged a fee commensurate with the risks that the government of Canada effectively reinsures. If priced correctly, this arrangement, which amounts to reinsurance, can limit and manage risks well.
So far so good, but what of the elephant in the insurance market?
The budget bill also amends the National Housing Act, which governs CMHC’s activities. On its face, again, the bill would codify existing arrangements governing the agency’s reporting requirements — but it also jumps one stepping stone toward a properly competitive market.
First, the bill is explicit in saying that the Minister of Finance, and through the minister the Superintendent of Financial Institutions, may demand immediate access to any records relevant to CMHC’s activities in this area. Moreover, “the corporation shall make available to the public” such records as are relevant to this part. This is potentially a big step toward transparency and disclosure — and an important one to the Canadian public, given that CMHC insures more than $500-billion in mortgages.
But wait, there’s more. The Minister of Finance may charge CMHC a fee “to compensate Her Majesty for her exposure to the risks covered by her agent the corporation arising” from mortgage insurance. If the Finance Minister regulates fees that are properly risk-based, including the fact that 100% of CMHC’s liabilities are taxpayer backed, we are one step closer to a mortgage insurance market that is both competitive and that prices risks. Because it will be done by regulation, it will be an imperfect market test, but that is better than none, which is what we’ve got now.
Positioning the federal government as a mortgage reinsurer, with adequately priced risks, seems a reasonably stable saw-off, and one with the potential to introduce better risk-management practices and more diversity in approaches to lending and insurance.
What is badly missing, however, is explicit discussion of CMHC’s dominant role in the market and how to wind it back. Canadian taxpayers remain directly exposed to billions of dollars in insurance risks, and this should eventually change.
Finn Poschmann, vice-president, research, testified on these matters Monday before the House of Commons committee on finance. His paper, What Governments Should Do in Mortgage Markets, is available at www.cdhowe.org
