CMHC at fault ?

Warnings about risky mortgages ignored - Federal officials told CMHC it could overburden borrowers

JACQUIE MCNISH AND GREG MCARTHUR
December 18, 2008 at 2:00 AM EST

Canada Mortgage and Housing Corp. officials ignored warnings from senior
Finance Department and Bank of Canada officials during the past two years that its active business in high-risk mortgage insurance could overburden consumers.

According to sources familiar with the discussions, CMHC executives did not heed the warnings and continued to underwrite larger volumes of insurance policies for risky home loans with 40-year amortizations and minimal down payments.

The sources said the federal agency's executives disagreed about the potential risks and defended the creditworthiness of borrowers who were granted insurance for the riskier mortgage products.

One senior Ottawa official said CMHC was such a significant underwriter of 40-year mortgage insurance polices that it currently accounts for two-thirds of the nearly $56-billion of 40-year mortgages that were approved by banks, trust companies, credit unions and other lenders during the first six months of 2008.

Unlike the United States, Canada does not publicly release data about different classes of mortgage debt. CMHC does track mortgage data, but its officials have declined requests by The Globe and Mail for information about the volume of 40-year and low-down-payment mortgages.

In a statement issued last night, CMHC said it discussed mortgage risks with central bank officials in 2006 after former bank governor David Dodge raised concerns about the new breed of long-term home loans.

"CMHC officials took the governor and senior bank officials through the materials and discussed how the product was administered. The Bank of Canada was reassured by the fact that CMHC's product includes no change in mortgage qualification criteria and as such would not be of significant concern to the Bank.

"We know of no other concerns that the Bank of Canada or the Department of Finance had with our activities that in their view would threaten financial stability," the statement said.

The agency said only a "relatively small" proportion of the $334-billion in mortgages it insures are either 40-year or zero-down-payment mortgages. A spokeswoman declined to put a figure to "relatively small."

Finance Minister Jim Flaherty announced in July that the federal government was cancelling its policy of guaranteeing 40-year mortgages as of Oct. 15 in order to shield Canada from the kind of housing crash that has devastated the U.S. economy. However, according to sources, bank executives had been warning Mr. Flaherty and central bank officials since the beginning of 2008 about a dramatic and unexpected increase in demand from consumers for 40-year mortgages with small down payments.

Lenders, insurers and government officials interviewed by The Globe characterized the first half of 2008 as a period of apparent paralysis by federal decision makers. These sources said bank and insurance executives and finance officials disagreed over how to pull the plug on popular and risky mortgage products. One of the few things they did agree about, according to sources, was that there was insufficient
monitoring of CMHC, which accounts for about 70 per cent of the total value of mortgage insurance underwritten in Canada.

"There is an accountability issue at CMHC," said one senior Ottawa official, who declined to be identified.

CMHC is a federal agency that has been supplying mortgage insurance since 1954, and is currently overseen by Human Resources and Social Development Canada.

In response to a question about its accountability, CMHC said in its statement: "The lines of accountability are very clear, like all Crown corporations CMHC is accountable to Parliament through its minister."

When The Globe contacted Human Resources Minister Diane Finley, her spokeswoman replied: "We will have to decline and allow CMHC to respond to the questions applicable."

According to people familiar with CMHC, the agency imported U.S.-style mortgage products to protect its dominant market position from large U.S. insurers who were allowed into the Canadian market in 2006. Canadian laws require borrowers with less than a 20-per-cent down payment to obtain insurance for their mortgages.

"They felt they were pushed into to this because of the new competition," said a person familiar with CMHC.

Underlying these concerns, sources said, was a federal internal study launched by the new Conservative government in 2006 to review the possible privatization of a number of agencies, including CMHC. The prospect of privatization, one source said, fuelled concerns that the agency needed to be seen as an effective competitor.

CMHC said in its statement that its decision to insure longer-term and lower-down-payment loans in 2006 "reflected the market trends for the period." Until 2006, the agency and its only rival, Genworth Financial Inc., did not insure mortgages that were amortized beyond 25 years. In February of 2006, several months before four U.S. insurance giants were allowed into Canada, CMHC introduced the country's first 30-year mortgage insurance product. What followed was a ferocious battle for market share between CMHC, Genworth and American International Group, the first of the new insurance entrants.