Canadian Home Builders’ Association — 71^st Annual Conference

Speaking Notes for Evan Siddall, President and Chief Executive Officer, Canada Mortgage and Housing Corporation

Fairmont Chateau Whistler
Whistler, British Columbia

Check against delivery

Thank you Deep [Shergill] and good morning everyone. Thank you for the warm welcome and for the opportunity to say a few words this morning.

I’ve had some great discussions with Deep and Kevin Lee, who have filled me in on the CHBA’s close relationship with CMHC over the years. I’m looking forward to building on that relationship with your new President, Bard Golightly.

I’d like to spend a few minutes this morning talking about Canada’s housing finance system, which is so critical to the health of your industry. In particular I want to address the question: Why CMHC? Does Canada really need a federal Crown corporation to be so intrinsically involved in the housing finance system?

To answer that question let’s go back four or five years, to the time of the global credit crisis and recession that hammered economies around the world. Canada didn’t escape unscathed, but we certainly fared better than most. Canada Mortgage and Housing Corporation was an important part of the reason.

It’s telling that in the U.S., which was particularly hard hit by the recession, housing was part of the problem. In Canada, it was a source of strength. This divergent result, even though our systems share similar outcomes: home ownership in Canada stood at 69 per cent in 2011, versus 66.2 per cent in the U.S.

Similar we may be, but we have very distinct models of how the government supports housing finance.

You’ve all heard of Fannie Mae and Freddie Mac, the two government-supported enterprises whose flawed business models, combined with a deterioration in mortgage underwriting standards and non-recourse mortgage laws, triggered the collapse of housing markets in the U.S. This collapse led directly to a near failure of the global financial system, which we continue to pay for today.

Because of lax underwriting, lenders across the U.S. were routinely approving sub-prime or NINJA loans. NINJA stands for No Income, No Job or Assets. One U.S. commentator said that in the lead-up to the collapse, all an applicant needed to secure a mortgage in the U.S. was the ability to fog a mirror. Many of those risky loans were then securitized — or purchased, if you will — by Fannie and Freddie.  

When the recession hit and homeowners defaulted in large numbers, Fannie and Freddie were left holding the bag. Only the U.S. Government decided they were “too big to fail” and stepped in, eventually investing hundreds of billions of dollars in Fannie and Freddie so they could continue to operate and help stabilize the housing market.

In Canada, rather than being part of the problem, our government-owned agency — CMHC — helped stabilize housing markets and the housing finance system. Our Insured Mortgage Purchase Program helped provide Canadian banks with operating liquidity when banks around the world were engaging in asset “fire sales” to stay solvent.

The financial crisis happened in 2008, and the following year housing starts in Canada bottomed out at 80 per cent of the historical average. In the U.S., by contrast, housing starts — which had already been declining — bottomed out at about 40 per cent of the historical average. The mortgage arrears rate was just over five per cent in the U.S. at the peak of the crisis, compared to less than half of one per cent in Canada.

Housing starts in the U.S. have been increasing since 2010 but last year were still at only 63 per cent of their historical average. In Canada, housing starts in 2013 remained close to the historical average, and the mortgage arrears rate was low and stable at 0.32 per cent, according to the Canadian Bankers Association.

CMHC’s stabilizing presence throughout the crisis was key to the difference in performance of the two housing systems. CMHC did not need to be bailed out, we played a critical role in Canada’s effective and successful response to the liquidity crisis and, importantly, we continued to offer mortgage loan insurance to qualified home buyers as private insurers pulled back from the market.

That’s why I object to the knee-jerk notion that CMHC is Canada’s version of Fannie and Freddie, and that it was luck, more than design, that explains the difference in performance of the two housing systems. Nothing could be further from the truth.

There are fundamental differences between our housing finance practices to be sure, but also in CMHC’s business model compared to Fannie and Freddie. I would like to touch on some of them this morning.

As I noted a moment ago, the Fannie/Freddie business model was fundamentally flawed from the outset. U.S. distrust of public ownership blinded policy makers to the problems inherent in their approach to business.

Fannie and Freddie were privately-owned, profit-driven companies — and certainly there is nothing wrong with that. But they also shared a public policy mandate, which was to increase homeownership, including among low-income borrowers and other potentially high-risk groups. Indeed, starting with the Community Reinvestment Act in 1977, the two agencies pushed this mandate vigorously.

This public mandate created the perception of implicit government backing of Fannie and Freddie. The problem with an implicit guarantee is that it shifts the potential risks to taxpayers without giving the government the ability to monitor and mitigate that risk, or to be compensated for taking it on.

Under our model, the Government of Canada explicitly assumes the risk for insured and securitized mortgages, but also has the ability to set the rules and is appropriately compensated for taking on the risk. 

The implicit government backing of Fannie and Freddie created a moral hazard in the U.S. housing finance system — in other words, it enabled one party to take risks knowing that the potential costs would be borne by others. Worse, gambling with someone else’s money is so tempting, that Fannie and Freddie actually had an economic incentive to misbehave. This is the core perversion known as “moral hazard.”

In this case, Fannie and Freddie were able to use the implicit government guarantee to raise funds at low cost — saving about half of one percentage point on trillions of dollars — resulting in significant financial benefits for the two companies.

Unfortunately, not all of the benefits were used to serve the public mandate by lowering borrowers’ mortgage costs, or to adequately capitalize the businesses against inevitable bumps in the road.

Fannie Mae, for example, kept at least one-third of this saving — billions of dollars per year — and used it to reward shareholders, richly compensate executives and — amazingly — lobby politicians to thwart efforts to strengthen regulatory oversight. This business model rewarded excessive risk-taking and was a proverbial house of cards.

Without clear and effective oversight, Fannie and Freddie were able to continuously expand their scope, creating mammoth financial institutions behind the public purpose of providing affordable housing.

But given the weakness of their foundations, those institutions were ultimately not able to survive on their own. When the good times came to an end in 2008, the walls caved in. Having been bailed out to the tune of almost $200 billion U.S., Fannie and Freddie have only recently returned to profitability. Unfettered free market models proved to be misapplied in the case of these “too big to fail” entities. In fact, even private banks were subject to far more oversight — by the Fed (Federal Reserve System), OCC (Office of the Comptroller of the Currency), FDIC (Federal Deposit Insurance Corporation) and others — than these risk aggregators.

CMHC, on the other hand, does not have such an ambiguous or contradictory mandate. Our public policy objective is to provide mortgage loan insurance to qualified borrowers in all parts of the country, including rural and smaller markets, and for all types of housing, including large rental developments, purpose-built student housing, and nursing and retirement homes.

As for earning a profit, this is not our primary goal but we do operate our housing finance programs on a commercial basis. As a Crown corporation, we aim to earn a reasonable rate of return within our mandate. And in fact over the past 10 years, CMHC has contributed $17 billion towards reducing the Accumulated Deficit of Canada.

All of this brings me to another question — is CMHC, like Fannie and Freddie, “too big to fail?” Well, I would argue that we are certainly too important to Canada’s housing finance system to fail, and we therefore have a sacred responsibility to prevent that from happening. We are subject to active supervision by the Office of the Superintendent of Financial Institutions, or OSFI, as well as oversight by the Ministers of Employment and Social Development and Finance.

That is why we are so careful with our underwriting of mortgage loan insurance. It’s why we do not insure or securitize sub-prime mortgages, or hold them for investment purposes. And it’s why we currently maintain more than two-and-a-half times the minimum capital required by OSFI.

You may have figured out by now that I believe the Canadian model is better than the Fannie/Freddie model. But that doesn’t mean we can’t do better. We need to be prepared for what may be next in terms of economic or other challenges, which is why we are looking closely at our business.

We also need to consider whether consumer debt is growing too quickly and whether residential housing investments are diverting resources from the business sector and slowing productivity growth.

CMHC’s mortgage loan insurance and securitization programs are key elements of Canada’s stable and efficient housing finance system. But they must be provided in ways that limit taxpayers’ exposure, and permit the valuable arbitration provided by appropriate competition.

As you know, we recently announced an increase in both portfolio and homeowner mortgage loan insurance premiums. The higher premiums reflect our increased capital targets, which will further reduce Canadian taxpayers’ exposure to the housing market and contribute to the long-term stability of the financial system. They are not expected to have a material impact on the housing market or builders.

We will be looking at our mortgage loan insurance and securitization programs to see what further improvements can be made to reduce taxpayers’ exposure while promoting the continued efficient functioning and enhanced competitiveness of the housing finance market.

Our business will change in other ways as well. It’s too early to say how, but I can assure you that the changes will be thoughtful, measured and in the best interests of Canadians.

Canadian home builders have placed their trust in CMHC in the past, and I ask that you continue to do so as we look to the future.

Thank you again for your hospitality. I hope you have a great year in 2014.