Purchase of Mortgages from Canadian Banks Winding Down

It has been become increasingly clear that the uptake by banks of Ottawa's $125 billion Insured Mortgage Purchase Program (IMPP), the primary component of the $200 billion Extraordinary Financing Framework (EFF), is winding down. To date, the banks have only accessed about $58 billion -- less than half of what was available and the rate of purchase has slowed to a trickle.

While most Canadians are completely unaware of this initiative, it has borne a striking resemblance to the original TARP program in the U.S., designed to remove troubled assets from bank balance sheets. This is despite the fact that we have been repeatedly told that our banks did not have this exposure. Thus the reasons for a program like IMPP might not seem obvious.

We too, however, had our fling with dicey mortgages. In his first budget as Finance Minister in 2006, Jim Flaherty announced measures to open up the mortgage insurance market to providers other than CMHC and GE subsidiary Genworth, which together controlled the market in Canada. The Globe and Mail provided this history in a March special feature:

For nearly 40 years after CMHC was founded in 1954, the business of mortgage insurance was about as exciting as an actuarial table. The agency was set up by the federal government as a kind of financial cushion to encourage the country's conservative financial institutions to open their vaults and lend more money to homeowners.

If a home buyer couldn't pony up a 25-per-cent down payment on a house purchase, CMHC shouldered the risk of default by insuring the mortgage and charging the buyer an insurance premium. Backing CMHC's insurance policies was a 100-per-cent federal guarantee. In bad years, Ottawa piped money into CMHC; in good years, the agency added to the federal treasury by paying taxes.

The smooth working system hit a pothole in late 1988 when Canada's only other mortgage insurer at the time, Toronto-based MICC, was nearly wiped out by new international bank capital rules. The rules threatened to shutter MICC because they effectively made it cheaper for banks to use CMHC's government-guaranteed mortgage insurance.

Faced with the imminent collapse of Canada's only private-sector mortgage insurer, the then Conservative government went to a place that few other industrialized countries have gone by agreeing to guarantee the policies of a non-government mortgage insurer. According to people involved in the crisis, Ottawa “hesitantly” agreed to “taking on an enormous liability” of guaranteeing 90 per cent of MICC's insurance policies.

The government's worst fears about a massive liability materialized in 1995, when MICC's risky insurance bets in the construction sector threatened to torpedo the company. As Ottawa wrestled with the grim prospect of losing the insurer for millions of dollars in mortgages, the world's largest non-bank financial company came knocking with a rescue proposal.

The company was General Electric. The U.S. conglomerate was offering to take over MICC's mortgage insurance portfolio provided Ottawa met one condition: It would bless GE's planned new Canadian mortgage insurance subsidiary with a federal guarantee.

“It was a bit of a slam dunk,” recalls one former Ottawa official. “GE was one of the strongest companies in the world.”

Ottawa agreed to GE's offer, thereby shifting the federal government's 90-per- cent guarantee from a small Canadian mortgage insurer to a unit of a global giant with aggressive Canadian ambitions. GE's mortgage subsidiary, later spun off and renamed Genworth Mortgage Insurance Co., rapidly carved out a major presence in Canada, capturing about 30 per cent of the market and reporting $205-million of profits in 2005.

Other U.S. insurers took notice. . . .

The days of a CMHC-Genworth duopoly were numbered. In the fall of 2005, a tiny paragraph buried in a 280-page federal government estimate of expenditures signalled a new era of competition in the industry.

The Finance Department's provision was considered so insignificant at the time that many staffers of the minister, Liberal MP Ralph Goodale, didn't recall it when contacted by The Globe. A current spokesman for the Saskatchewan MP insisted that the provision was not designed to open the market to riskier products.

Another federal official who declined to be identified said the wording of the provision was eased because Genworth's name had changed and the government wanted to leave room for additional switches.

Despite these explanations, executives and advisers to a number of U.S. insurers and Canadian players said the paragraph was widely interpreted as a signal that Ottawa was opening the country's mortgage insurance sector to outside competitors.

Intended or not, the shift followed years of mobilizing by U.S. insurance companies, all hungry for a piece of what is regarded as one of the most lucrative and the second-largest mortgage insurance market in the world. At the forefront of this movement was mammoth AIG, now in near ruins as a result of its role in the U.S. subprime crisis.

U.S. competitors had envied premium rates on Canadian mortgage insurance policies for years. With only two players competing in the space, Triad's Mr. Tonnesen said CMHC and Genworth were so profitable that they were “basically printing money.”

Eyeing the rich northern market, representatives from at least three U.S. insurers made regular trips to Ottawa for meetings with the Finance Department and Office of the Superintendent of Financial Institutions, the insurance regulator. But AIG created a strategic advantage by hiring Bill Mulvihill, a Canadian mortgage expert who had spent years as the chief financial officer at CMHC. Mr. Mulvihill, who is still a director of AIG's Canadian operation, declined to comment.

“The difference that Bill Mulvihill made was that he was able to connect into the policy folks with OSFI and at Finance and convince them that we were for real,” said a former AIG executive who asked not to be identified. Following in AIG's footsteps were such U.S. insurers as PMI Group Inc., Triad and the Milwaukee-based Mortgage Guaranty Insurance Company.

Ultimately, Parliament did not vote on the Finance Department's proposal, thanks to the 2006 federal election and the Conservatives' rise to office. But the U.S. insurers' efforts weren't for naught; the new Harper government quickly embraced the idea of them coming north.

On May 2, 2006, in his first budget, Mr. Flaherty announced that not only would Ottawa guarantee the business of U.S. insurers, it was doubling the guarantee to $200-billion.

In a scenario that has now become depressingly common, we had large financial institutions prepared to take excessive risks knowing that losses could be passed along to government. The results were of course predictable.

New mortgage borrowers signed up for an estimated $56-billion of risky 40-year mortgages, more than half of the total new mortgages approved by banks, trust companies and other lenders during that time, according to banking and insurance sources. Those sources estimated that 10 per cent of the mortgages, worth about $10-billion, were taken out with no money down.

The mushrooming of a Canadian version of subprime mortgages has gone largely unnoticed. The Conservative government finally banned the practice last summer, after repeated warnings from frustrated senior officials and bankers that the country's financial system was being exposed to far too much risk as the housing market weakened.

Just yesterday, Finance Minister Jim Flaherty repeated the mantra that the government acted early to get rid of risky mortgages. What he and Prime Minister Stephen Harper do not explain, however, is that the expansion of zero-down, 40-year mortgages began with measures contained in the first Conservative budget in May of 2006.

At the time, Mr. Flaherty announced that the government was opening up the market to more private insurers.

“These changes will result in greater choice and innovation in the market for mortgage insurance, benefiting consumers and promoting home ownership,” Mr. Flaherty said.

The result, by the time regulatory changes closed off these mortgages, was about $60 billion in high risk mortgages for which the Government of Canada was on the hook. So when Minister Flaherty announced a $25 billion IMPP program last fall, and when the program was eventually expanded to $125 billion in the January budget, its aim was clearly to provide banks with increased liquidity by taking these obviously risky assets off of their books.

What wasn't said at the time, either by the government (hardly surprising) but by the opposition parties as well, was that this was a problem of the Tories' own design. By encouraging new entrants and providing guarantees, they had assured tha all providers would have to insure risky mortgages if they were to remain competitive. It is not surprising then that the uptake on CMHC purchases roughly equals the total of high-risk mortgages that were made.

And the Harper government has been appallingly dishonest about this. Because it purchased these assets through a reverse auction process, it can claim that these discounted instruments will provide an excellent rate of return to the federal coffers. But this is only if the assets continue to perform, and presumably the banks sold them at a discount because of concerns that they would not do so. Moreover, the claim that this initiative was "revenue neutral" was used by the Conservatives to keep the program off the books and the government unaccountable to Parliament for this money.

What is even more disturbing is that none of the opposition parties have called the Harper government to task for this. Though it is a reasonably complex issue, it is nonetheless something Canadians need to understand and to hold their government to account for, both in Parliament, and soon, it can be hoped, at the ballot box.