true north: the facts about the canadian mortgage banking system

8/9/2019 True North: The Facts about the Canadian Mortgage Banking System

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True NorthThe Facts about the Canadian Mortgage Banking SystemDavid Min August 2010


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True NorthThe Facts about the Canadian Mortgage Banking System

David Min August 2010


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1 Introduction and summary

6 Background on the U.S. mortgage market

9 Background on the Canadian mortgage market

12 Comparing the U.S. and Canadian mortgage systems 13 Similarities between the U.S. and Canadian mortgage systems shows

it was not excessive government intervention that caused the U.S. crisis

17 Differences between Canada and the U.S. that are less important

21 The real difference: Canadas absence of privatesecuritization and unsupervised lending

23 Endnotes

24 About the author

Contents


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3 c r r am r pr gr | tru n r

paymen s less han 20 percen .1 Canadian mor gage insurance is heavily regula ed,and issued by ei her one o wo priva e rms or hrough CMHC. Te Canadiangovernmen explici ly guaran ees 90 percen o he mor gage insurance obliga-

ions o he wo priva e insurers and s ands 100 percen behind he obliga ionso he governmen agency CMHC. Te governmen guaran ee behind mor gage

insurance, like he ederally guaran eed securi iza ion we have in he Uni ed S a es,e ec ively passes credi risk rom he lender o he governmen , an appealingea ure or lending ins i u ions.2

Perhaps as a resul o his rans er o risk, insured mor gages are very popular inCanada, accoun ing or roughly 45 percen o all ou s anding mor gage deb in

he coun ry. Be ween he governmen guaran ee on mor gage insurance and hegovernmen -guaran eed securi iza ion, as much as 70 percen o all Canadianmor gages were guaran eed in one orm or ano her by he Canadian governmena he end o 2008.

Tis is no o say ha all o he shared atribu es ha he Canadian and U.S.mor gage sys em have are laudable. Cer ainly here are legi ima e cri icisms o be made in bo h coun ries abou he lack o skin in he game among mor gagemarke par icipan s and he heavy reliance on governmen guaran ees by hepriva e mor gage indus ry. Bu given he rela ively posi ive experience o Canada

here would seem o be a compelling argumen ha elemen s o he U.S. sys emha also exis ed in Canada were no he driving cause o he U.S. mor gage marke

mel down. Speci cally:

I i were a ordable housing goals o Fannie and Freddie ha caused he mor -gage crisis, as some have claimed, hen why didn Canada, which has similargoals, experience he same problems?

I i were governmen -backed securi iza ion ha caused he mor gage bubble,hen why didn Canada, which experienced remendous grow h in governmen -

backed securi iza ion during he 2000s, have a similar problem?

I i were moral hazard caused by governmen in er erence in he ordinary unc-

ioning o he ree marke s ha was ins rumen al in causing he credi crisis,hen why didn Canada, which had similar governmen al in erven ion hrough

i s guaran ee o mor gage insurance, experience a similar ou come?


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I you believe he cri ics o he U.S. mor gage nance model, hen Canada shouldhave been a pos er child or a mor gage crisis. Canadas mor gage marke is sup-por ed by he governmen o a degree even grea er han ha o he Uni ed S a es(prior o he credi crisis), and is ri e wi h hemarke dis or ionsandmoral haz-ard ha many cri ics o he U.S. sys em blame or he U.S. bubble. Canada relies

heavily on CMHC, a governmen -backed ins i u ion, o provide a signi canpropor ion o i s housing nance needs. Canada ac ively promo es policies meano promo e he availabili y o a ordable housing and a ordable mor gage nance

among low-income and minori y communi ies, bo h among CMHC and priva elenders. And CMHC engaged in signi can levels o governmen -backed securi-

iza ion, he core business o he U.S. governmen -sponsored en erprises FannieMae and Freddie Mac.

Given all o hese ac ors, Canadas mor gage marke s should have experiencedhe same mor gage crisis ha he Uni ed S a es did, according o hese cri ics.

Ins ead, Canada has been rela ively calm hroughou he global credi bubbleand ensuing bus .
http://hensarling.house.gov/list/press/tx05_hensarling/morenews/Hensarling_Fannie_Freddie_Op_Ed.shtmlhttp://www.nysun.com/opinion/moral-hazard-of-fannie-freddie/81851/http://www.nysun.com/opinion/moral-hazard-of-fannie-freddie/81851/http://www.nysun.com/opinion/moral-hazard-of-fannie-freddie/81851/http://www.nysun.com/opinion/moral-hazard-of-fannie-freddie/81851/http://hensarling.house.gov/list/press/tx05_hensarling/morenews/Hensarling_Fannie_Freddie_Op_Ed.shtml


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Background on the U.S.mortgage market

Up un il he implosion o he nonbank nancial sec or in 2008, here were ourmain mor gage lending channels in he Uni ed S a es:

Loans origina ed by deposi ory ins i u ions held o ma uri y, nanced by bank or hri deposi s

Loans origina ed by quali ed lenders, insured by he Federal Housing

Adminis ra ion or he Ve erans Adminis ra ion and packaged in o mor gage- backed securi ies carrying he wrap or guaran ee o he governmen agency Ginnie Mae, which in urn is explici ly backed by he ull ai h and credi o heU.S. reasury

Loans origina ed by quali ed lenders, resold o one o he governmen -spon-sored en i ies Fannie Mae or Freddie Mac, and nanced by he sale o mor gage- backed securi ies guaran eed by Fannie or Freddie, which in urn were hough

o carry he implied backing o he U.S. reasury

Loans origina ed by anyone (including mor gage brokers, nonbank lenders, anddeposi ory ins i u ions), resold o a priva e-securi iza ion condui ( ypically an o -balance shee special purpose vehicle sponsored by a major Wall S ree

nancial ins i u ion), and nanced by he sale o mor gage-backed securi iesha carried credi ra ings issued by he ra ing agencies.

Beginning in he la e 1980s, he U.S. mor gage marke became increasingly domi-na ed by securi iza ion, as Ginnie Mae securi iza ion, GSE securi iza ion, andpriva e-label securi iza ion grew o cap ure a majori y o he U.S. mor gage marke .

Conversely, he share o mor gages nanced by bank deposi s plumme ed, rom75 percen in 1970 o jus under 20 percen a he end o 2008.

One heory as o why securi iza ion grew so much in he Uni ed S a es is haiallows regula ed lenderso reduce heir regula ory capi al requiremen s. Under
http://cscanada.net/index.php/mse/article/view/1063/1124http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1517743http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1517743http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1517743http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1517743http://cscanada.net/index.php/mse/article/view/1063/1124


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he in erna ional bank capi al s andards recommended by he Basel Commitee, banks and o her regula ed lenders mus hold capi al agains he loans hey hold,on a risk-weigh ed basis. While capi al requiremen s increase he sa e y andsoundness o he banking sys em, his capi al is rela ively expensive o raise, andholding more capi al e ec ively reduces he re urn on equi y ha a nancial

ins i u ion can earn.

One al erna ive o raising capi al is o reduce he amoun o loans held on anins i u ions books, and one way o do his is by selling hese loans o hird par-

ies. Securi iza ion, which pools mor gages and o her ypes o loans, and henissues securi ies based on he cash ows (such as mon hly mor gage paymen s)in he pools, provides a ready ou le or lenders seeking o ofoad heir loansand hus reduce heir capi al requiremen s. Selling loans o securi iza ion ou le ssuch as he GSEs or priva e-securi iza ion condui s allows lenders o use he pro-ceeds o hen make ur her loans and earn ees and o her income rom he lucra-

ive origina ion and servicing o mor gages, e ec ively allowing hem o ur herincrease heir leverage while shi ing he credi and prepaymen risks associa ed wi h hese loans elsewhere.

Wi hin he rend owards securi iza ion, i is impor an o unders and he di er-ences be ween he di eren ypes o securi iza ion. As he Congressionally crea edFinancial Crisis Inquiry Commission recen ly no ed , here are impor an dis inc-

ions be ween governmen -backed securi iza ion per ormed by Ginnie Mae or hegovernmen -sponsored en i ies Fannie Mae and Freddie Mac, and priva e-labelsecuri iza ion. Te ormer relies on a governmen guaran ee behind he securi ies being issued o ensure inves or con dence; he later relies on subordina ion anda s ruc ure o ranching (where he higher ranches are shielded rom losses by lower ranched securi ies ha bear rs losses), as well as credi ra ings provided by he credi ra ing agencies, o achieve he same purpose.

Un il he recen Dodd-Frank nancial regula ory re orm legisla ion was passed,priva e securi iza ion was unique among he major U.S. mor gage nancing chan-nels as here was e ec ively no regula ory oversigh on i . Priva e securi iza ion was ypically per ormed by o -balance shee special purpose legal en i ies spon-

sored by (and os ensibly independen o ) nancial ins i u ions such as GoldmanSachs Group Inc. or Merrill Lynch & Co. (now par o Bank o America Corp.). While Fannie Mae, Freddie Mac, and o her regula ed lenders such as banks and

hri s were overseen or sa e y and soundness, wi h regula ory supervision orcapi al adequacy and or he ypes and quali y o he mor gages hey purchased,priva e-securi iza ion condui s had no such regula ory oversigh .

Private

securitization wa

unique amongthe major U.S.

mortgage fnancin

channels as there

was e ectively

no regulatory

oversight on it.
http://www.fcic.gov/reports/pdfs/2010-0407-Preliminary_Staff_Report_-_Securitization_and_the_Mortgage_Crisis.pdfhttp://www.fcic.gov/reports/pdfs/2010-0407-Preliminary_Staff_Report_-_Securitization_and_the_Mortgage_Crisis.pdf


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Te lack o regula ion o priva e securi iza ion was compounded by he acha mos o he mor gages securi ized by priva e-securi iza ion condui s were

origina ed by unregula ed nonbank lenders, such as he subprime lenders New Cen ury Financial Corpora ion or Ameriques Mor gagebo h o which are now ou o business. Regula ed lenders such as banks and hri s had some oversigh o

heir lending prac ices, bu nonbank lenders who did no rely on deposi s o undheir loans e ec ively had no regula ory oversigh o heir prac ices.

Up un il abou 2003, governmen -backed securi iza ion was dominan , accoun -ing or he grea majori y o mor gage lending in he Uni ed S a es. Bu beginningin 2003, priva e-label securi iza ion saw an enormous increase in marke share,growing rom abou 10 percen o nearly 40 percen in 2006. Tis grow h camealmos exclusively a he expense o Fannie Mae and Freddie Mac, which saw anequivalen drop in marke share over he same period.

Much o his drama ic marke share shi occurred because AAA-ra ed priva e-label securi ies appeared o be jus as sa e as equivalen ly ra ed securi ies issued by Fannie or Freddie, while o ering higher re urns o inves ors. In re rospec , given

he sharply higher de aul ra es o he mor gages securi ized by priva e-securi iza-ion condui s, i is clear ha priva e-label securi ies were no as sa e as once hough .

Te rise o unregula ed priva e securi iza ion and all o regula ed governmen -backedsecuri iza ion rom 2003-07roughly corresponds wi h he U.S. housing bubble.
http://www.fcic.gov/reports/pdfs/2010-0407-PSR_-_The_Mortgage_Crisis.pdfhttp://www.fcic.gov/reports/pdfs/2010-0407-PSR_-_The_Mortgage_Crisis.pdf


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Background on the Canadianmortgage market

Te major dis inguishing ea ure o he Canadian mor gage marke is i s uniquesys em o ederally backed mor gage insurance. Canada requires ha all mor -gages wi h a loan- o-value ra io o more han 80 percen (re erred o as high-ra io loans), which are provided by ederally regula ed nancial ins i u ions, beinsured agains he possibili y o de aul . Tis mor gage insurance can only beissued by approved insurers, which are s ric ly regula ed or sa e y and soundness.

Un il recen ly, only wo en i ies were allowed o issue mor gage insurance heCanada Mor gage and Housing Corpora ion, or CMHC, a governmen corpora-

ion wholly owned by he Canadian governmen , and Genwor h Financial Canada,a priva e corpora ion ha en ered he Canadian mor gage insurance marke in1995. In 2006, he Canadian governmen allowed ano her priva e rm, he CanadaGuaran y Mor gage Insurance Company ( ormerly AIG Canada un il he On arioeachers Pension Planpurchased he en i y earlier his year), o en er he marke .

Te requiremen ha high-ra io loans be accompanied by insurance purchasedrom one o several large, s ric ly regula ed mor gage insurers is o se by he

Canadian governmen s explici guaran ee on all mor gage insurance obliga ions, which serves o drive down he cos s o hese ypes o mor gages. Fur hermore,unlike in he Uni ed S a es, where priva e mor gage insurance ypically only covers 20 percen or less o he loan ( he amoun in excess o 80 percen o he value o he proper y), Canadian mor gage insurance covers 100 percen o heloan, wi h essen ially all o his guaran eed by he Canadian ederal governmen .Te guaran ee covers 100 percen o CMHCs obliga ions, and 90 percen o heobliga ions o he wo priva e mor gage insurers.

From he perspec ive o Canadian lenders, hen, he explici Canadian govern-men guaran ee on mor gage insurance essen ially serves a similar unc ion ogovernmen -backed securi iza ion in he Uni ed S a es, rans erring credi risk o

he governmen . Ye in he Uni ed S a es lenders seeking o ofoad he risk associ-a ed wi h a par icular loanand he capi al hey would need o hold agains ha
http://www.financialpost.com/story.html?id=2407616http://www.financialpost.com/story.html?id=2407616


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loanmus ac ually sell ha loan. In Canada, lenders can hold on o governmeninsured loans wi hou raising addi ional capi al agains hose loans. Tis is because,

o he ex en ha insured mor gages in Canada have an explici governmen guar-an ee s anding behind hem, hey are considered as good as Canadian sovereigndeb . As such, banks and o her lenders in Canada who hold insured mor gages do

no have o hold regula ory capi al agains he insured por ion o hose loans.3

Tus, or regula ed Canadian lenders who are par o he mor gage insurance sys-em, securi iza ion o high-ra io loans is ar less atrac ive han i is or U.S. lenders.

As ar as regula ory capi al requiremen s go, securi iza ion is essen ially he sameas holding an insured mor gage backs opped by he Canadian governmen . Inpar because o he regula ory capi al bene s o governmen -backed mor gageinsurance, mor gage insurance (which is predominan ly bu no en irely used orhigh-ra io loans) is prevalen hroughou Canada,represen ing some 45 perceno all ou s anding mor gage deb as o 2009.

On he o her hand, securi iza ionespecially priva e-label securi iza ionplaysa much smaller role in he Canadian mor gage sys em. While he securi iza iono mor gages has grown in impor ance in Canada, par icularly in he las decade,

o al mor gage securi iza ion in Canada is ar less pervasive han in he Uni edS a es. As o year-end 2008, approxima ely $267 billion in mor gages29 perceno o al ou s anding mor gageshad been securi ized, as compared o over60 percen o U.S. mor gages.

No ably, almos all o his securi iza ion is backed by he Canadian ederal gov-ernmen , wi h approxima ely $245 billion securi ized hrough he governmen -owned CMHC. Conversely, priva e-mor gage securi iza ion accoun s or very litle o Canadian lending, accoun ing or less han 3 percen o all mor gages. Inshor , wi h 45 percen o ou s anding home loans covered by mor gage insur-ance and 25 percen o mor gage deb securi ized wi h a backing rom CMHC, asmuch as 70 percen o he mor gage nancing in Canada is ul ima ely guaran eed by he ederal governmen .

Con rary o he Uni ed S a es, where an explosion in unregula ed lending

occurred hrough nonbank lenders, Canada experienced vir ually no unregula edlending over he same period as essen ially all lending was done hrough ins i u-

ions overseen or sa e y and soundness. Tis regula ion was butressed by hepresence o he Financial Consumer Agency o Canada, which is similar o heConsumer Financial Pro ec ion Bureau ha was jus crea ed as par o he Dodd-

Banks and other

lenders in Canada

who hold insured

mortgages do

not have to hold

regulatory capita

against the insure

portion o those
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Frank nancial regula ory re orm bill, and oversees lending prac ices o pro ecconsumers rom decep ive lending prac ices.

Canada has a minimum mor gage down paymen requiremen o 5 percen , buhis need no be cash and can be borrowed, e ec ively allowing or zero down

paymen produc s. Te dominan mor gage produc in Canadaanalogous o he30-year prepayable xed-ra e mor gage here is a ve-year mor gage.4


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Comparing the U.S. and Canadianmortgage systems

In an e or o advance he argumen ha i was excessive governmen in erven-ion, primarily hrough he moral hazard and marke dis or ions crea ed by he

governmen -sponsored en i ies Fannie Mae and Freddie Mac, ha caused hemor gage crisis, a number o observers, includinghe American En erpriseIns i u e ,Te Washington Post ,Te Wall Street Journal ,Marke wa ch,and o hers have relied on incorrec or misleading claims o ry o make he case ha Canadasrela ive s abili y during he global credi bubble was due o he ree marke or

priva e na ure o i s mor gage sys em.

In ac , Canadas mor gage marke experience shows qui e he opposi e. Canadasmor gage marke s con ain essen ially all o he elemen s ha cri ics o he U.S. sys-

em have blamed or i s mor gage crisisincluding, con rary o he claims o many o he above, large levels o governmen backing or he mor gage sys emand yeCanada did no experience he same bubble-bus cycle as i s sou hern neighbor.

Similarities abound, but differences matter

Comparison o the signi icant elements o the U.S. and Canadian mortgage markets

United States Canada

Similarities

High levels o government support or home mortgage markets Yes Yes

Markets dominated by government-backed entities Yes Yes

Substantial levels o government-backed securitization Yes Yes

A ordable housing and air lending policies Yes Yes

Private institutions with government guarantees Yes Yes

Differences

Large market share or frms unregulated or sa ety and soundness Yes No

High number o mortgages originated by unregulated nonbank lenders Yes No

Dominant product is a long-term, fxed-rate, prepayable mortgage 1 Yes No

1 The dominant mortgage product in the United States is the 30 year, fxed-rate mortgage, although notably, this product lost signifcantmarket share in avor o shorter-duration products during the 2000s bubble. The dominant product in Canada is a 5-year mortgage,amortized over a 25 year schedule, that must be refnanced at term.

Source: Center or American Progress. For details on the similarities and di erences, see paper.
http://www.american.com/archive/2010/february/due-north-canadas-marvelous-mortgage-and-banking-system/article_printhttp://www.american.com/archive/2010/february/due-north-canadas-marvelous-mortgage-and-banking-system/article_printhttp://www.washingtonpost.com/wp-dyn/content/article/2010/06/23/AR2010062304024_pf.htmlhttp://blogs.wsj.com/developments/2010/06/10/oh-canada-what-we-could-learn-from-your-mortgage-market/?KEYWORDS=frehttp://www.marketwatch.com/story/wall-streets-smart-bet-against-home-ownership-2010-08-17http://www.businessweek.com/print/investor/content/aug2009/pi20090812_141235.htmhttp://www.businessweek.com/print/investor/content/aug2009/pi20090812_141235.htmhttp://www.marketwatch.com/story/wall-streets-smart-bet-against-home-ownership-2010-08-17http://blogs.wsj.com/developments/2010/06/10/oh-canada-what-we-could-learn-from-your-mortgage-market/?KEYWORDS=frehttp://www.washingtonpost.com/wp-dyn/content/article/2010/06/23/AR2010062304024_pf.htmlhttp://www.american.com/archive/2010/february/due-north-canadas-marvelous-mortgage-and-banking-system/article_printhttp://www.american.com/archive/2010/february/due-north-canadas-marvelous-mortgage-and-banking-system/article_print


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While some cri ics o he American sys em have seized on cer ain, rela ively lesssigni can di erences be ween he U.S. and Canadian mor gage marke s, suchas he ac ha Canada does no have any laws res ric ing he abili y o lenders oseek recourse agains de aul ing borrowers beyond he value o he home, or heCanadian prac ice o having prepaymen penal ies or borrower who seek o re -

nance, hese di erences are grea ly overs a ed. Tey do no explain he enormousdi erences in he experiences o he wo coun ries: he Uni ed S a es su eredi s wors mor gage crisis in nearly a cen ury while Canada remained rela ively unsca hed. Tese various argumen s are addressed below.

Un or una ely, hese same analys s have almos universally ignored he elephan inhe room he absence o unregula ed lending channels in Canada, ei her in he

secondary marke s or a he origina ion level. Simply s a ed, Canada has negligibleexposure o priva e securi iza ion and o unregula ed lending origina ion. Compare

his o he Uni ed S a es, where unregula ed priva e-securi iza ion condui s, acquir-

ing loans purchased mainly rom unregula ed nonbank lenders, accoun ed ornearly 40 percen o he mor gage marke a he heigh o he credi bubble.

I is his di erence ha is he mos obvious explana ion as o why Canadas mor -gage marke escaped he a e ha be ell ours. Why did Canada avoid an in ux o unregula ed nancing and lending? One po en ial answer or his appears o be

ha Canadas governmen -guaran eed mor gage insurance provides subs an ial bene s (in he orm o capi al relie ) or he regula ed nancial ins i u ions

ha have access o i . In o her words, Canada il s he playing eld in avor o regula ed lenders. As a resul , here is ar less incen ive o be unregula ed in hacoun rys mor gage sys em.

Similarities between the U.S. and Canadian mor tgage systemsshows it was not excessive government intervention that causedthe U.S. crisis

In he wake o he U.S mor gage crisis, many commen a ors argued ha i wasexcessive governmen in erven ion in he priva e mor gage marke s ha caused

bo h he mor gage and housing bubbles and heir consequen bus s, claiming hahe governmen guaran ees on liabili ies issued by he governmen -sponsored

en i ies Fannie Mae and Freddie Mac and he governmen agency Ginnie Maecrea ed moral hazard ha dis or ed he mor gage marke . Many o hese same

Canadas

government-

guaranteed mortg

insurance provid

substantial benef

(in the orm o

capital relie ) o

regulated fnancia

institutions that h

access to it.


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cri ics have also argued ha governmen policies, including he a ordable housinggoals o Fannie and Freddie and he Communi y Reinves men Ac s require-men ha regula ed banks and hri s provide nondiscrimina ory access o credi ,caused priva e ins i u ions and he GSEs o ake on bad credi risks, crea ing amor gage bubble in he process.

Tese argumen s are, however, undermined by he experiences o Canada, whichdid no undergo a housing or nancial crisis, main ains similar homeownershipra es as he Uni ed S a es, bu which has policies and ins i u ions similar o heones ha have been so heavily cri icized in he Uni ed S a es. In par icular, many o hese similari ies end o con radic he claims ha i was he governmen -sponsored en i ies Fannie Mae and Freddie Mac, or heir a ordable housing goals,

ha drove he nancial crisis. Canadas mor gage sys em has elemen s ha closely resemble he aspec s o Fannie and Freddie ha cri ics o he U.S. sys em have blamed or causing he American mor gage bubble, and ye Canada has so ar

avoided he bubble-bus cycle ha he U.S. experienced. Among he similari ies:

Government-backed entities with mandates to promote public policy goals

Some observers no eha Canada does no have mor gage-rela ed governmensponsored en i ies such as Fannie Mae and Freddie Mac. While his claim is

echnically rue, i is highly misleading. Te Canada Mor gage and HousingCorpora ion is a governmenowned(no sponsored) corpora ion ha looks muchlike Fannie and Freddie.

Similar o Fannie and Freddie, CMHC hasa legisla ive manda e opromo ehe cons ruc ion o new houses, he repair and moderniza ion o exis ing houses,

and he improvemen o housing and living condi ions, which is rives o mee by improv[ing] access o a ordable, high quali y housing or all Canadians andensuring a s able, low-cos supply o unds or mor gage lending.

CMHC also has numerous manda es o subsidize a ordable housing and ensurehe availabili y o a ordable mor gage nance, par icularly o low-income and

minori y communi ies. In addi ion o i s A ordable Housing Ini ia ive, which ismean o increase he supply o a ordable housing in conjunc ion wi h Canadians a es and provinces, CMHC has anexplici du y o providehousing nance o allgeographic areas and o suppor a ordable ren al housing.
http://online.wsj.com/article/SB10001424052748703999304575398843526638082.html?mod=WSJ_Opinion_LEADTophttp://www.cmhc-schl.gc.ca/en/corp/faq/faq_001.cfmhttp://www.schl.ca/en/corp/about/anrecopl/anrecopl_010.cfmhttp://www.schl.ca/en/corp/about/anrecopl/anrecopl_010.cfmhttp://www.imf.org/external/pubs/ft/wp/2009/wp09130.pdfhttp://www.imf.org/external/pubs/ft/wp/2009/wp09130.pdfhttp://www.schl.ca/en/corp/about/anrecopl/anrecopl_010.cfmhttp://www.schl.ca/en/corp/about/anrecopl/anrecopl_010.cfmhttp://www.cmhc-schl.gc.ca/en/corp/faq/faq_001.cfmhttp://online.wsj.com/article/SB10001424052748703999304575398843526638082.html?mod=WSJ_Opinion_LEADTop


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par icular in eres is he ac ha much o he grow h in his public securi iza-ion, which is ei her issued by CHMC or guaran eed by CMHC, occurred inhe 2000s (even as he Uni ed S a es saw major declines in he marke shares o

Fannie and Freddie securi iza ion). In o her words, during he credi and hous-ing bubble ha hi he Uni ed S a es bu no Canada, U.S. governmen -backed

securi iza ion was declining while Canadian governmen -backed securi iza ion was soaring. I i was he core securi iza ion ac ivi ies o Fannie and Freddie hahad caused he U.S. mor gage crisis, one would have expec ed o see an even worse crisis in Canada.

Public guarantees of credit risk

Te U.S. mor gage sys em isheavily cri icized or crea ing moral hazard because i guaran ees so much o he credi risk in he U.S. mor gage marke s

hrough i s explici guaran ee on he obliga ions o Ginnie Mae and i s impliedguaran ee on deb and securi ies issued by Fannie Mae and Freddie Mac. Bu

he Canadian governmen has similar and even more expansive governmen al backing or i s mor gage marke , bo h in he orm o guaran ees on mor gage- backed securi ies issued or guaran eed by CMHC, which now comprise some25 percen o he o al marke , and he governmen guaran ee on all mor gageinsurance, which accoun s or roughly 45 percen o all Canadian mor gage deb .In o al, he Canadian governmen guaran ees up o 70 percen o all ou s andingmor gage deb in ha coun ry.

High concentration among financial intermediaries

Many observers have cri icized he U.S. banking sys em or being oo concen-ra ed , bo h a he origina ion level, where a hand ul o nancial ins i u ions (andheir subsidiaries) domina e he origina ion and servicing o mor gage loans, and

a he secondary marke s level, where Fannie and Freddie and a ew priva e rmsdomina ed he securi iza ion o lending. Canada has a similar concen ra ion o risk. A he origina ion level, he ve larges na ional char ered banks accoun or

abou 85 percen o all lending in he Canadian banking sys em. Tese lendersare backs opped by a mor gage insurance s ruc ure ha is similarly concen ra ed.Canadian mor gage insurance is en irely provided by CMHCwhich has abou70 percen marke shareand he wo priva e en i ies, Genwor h Financial andCanada Guaran y Mor gage Insurance Company, which bene rom he explicigovernmen guaran ee on heir insurance obliga ions.7
http://network.nationalpost.com/np/blogs/fpcomment/archive/2010/02/11/peter-foster-canada-moral-hazard-corp.aspxhttp://www.bloomberg.com/news/2010-03-21/mit-s-johnson-says-too-big-to-fail-banks-will-spark-new-crisis.htmlhttp://www.bloomberg.com/news/2010-03-21/mit-s-johnson-says-too-big-to-fail-banks-will-spark-new-crisis.htmlhttp://www.bloomberg.com/news/2010-03-21/mit-s-johnson-says-too-big-to-fail-banks-will-spark-new-crisis.htmlhttp://www.bloomberg.com/news/2010-03-21/mit-s-johnson-says-too-big-to-fail-banks-will-spark-new-crisis.htmlhttp://network.nationalpost.com/np/blogs/fpcomment/archive/2010/02/11/peter-foster-canada-moral-hazard-corp.aspx


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Low down payment lending

Many observers argueha he Canadian mor gage sys em is more s able han heUni ed S a es because i has higher down paymen requiremen s han he Uni edS a es. Tis claim is somewha incorrec . Canada echnically has a 5 percen mini-

mum down paymen requiremen , bu his down paymen does no need o becash, and can be borrowed rom o her sources, e ec ively allowing or zero downpaymen mor gage produc s.

Differences between Canada and the U.S. that are less important

Tere are, o course, many di erences be ween he U.S. and Canadian mor gagesys ems, and many leading commen a ors no e a ew o hem as ones ha should be considered in unders anding why he Uni ed S a es experienced a mor gage

crisis while Canada did no . Tese di erences are cer ainly impor an ones, buheir impac s have generally been overs a ed, and i seems implausible ha hese

rela ively minor policy dis inc ions could explain he major di erences be weenhe experiences o he wo coun ries. Among hese di erences:

Canada allows prepayment penalties

Some observers poin ouha Canada allows prepaymen penal ies as one reason why ha mor gage marke is more s able. Bu he consequences o his do noseem par icularly likely o be grea , and a leas one s udy has ound ha hey areessen ially negligible. A 2009 working paper by he In erna ional Mone ary Fund

ound haCanadas prepaymen penal ies are abou he same as he ex ra origina-ion ees paid by U.S. borrowers. When up ron poin s and lock-in ees (which do

no exis in Canada) are ac ored in, U.S. consumers pay similar or even grea eramoun s o re nance heir mor gages han he 3 mon h in eres penal y paid by Canadian borrowers. As a resul , i seems unlikely ha prepaymen penal iesin Canada have had much e ec on homeowner behavior, and cer ainly do noexplain he drama ic di erences in per ormance be ween he wo sys ems.

Canada allows full recourse against borrowers

Ano her aspec o Canadas mor gage sys em ci ed as a reason or heir rela ives abili y is heir legal s ruc ure, which allows ull recourse agains de aul ing
http://www.washingtonpost.com/wp-dyn/content/article/2010/06/23/AR2010062304024.htmlhttp://online.wsj.com/article/SB10001424052748703734504575125682375306488.htmlhttp://www.imf.org/external/pubs/ft/wp/2009/wp09130.pdfhttp://www.imf.org/external/pubs/ft/wp/2009/wp09130.pdfhttp://www.imf.org/external/pubs/ft/wp/2009/wp09130.pdfhttp://www.imf.org/external/pubs/ft/wp/2009/wp09130.pdfhttp://online.wsj.com/article/SB10001424052748703734504575125682375306488.htmlhttp://www.washingtonpost.com/wp-dyn/content/article/2010/06/23/AR2010062304024.html


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mor gage borrowers beyond he value o he home. In conjunc ion wi ha July 2009 s udy rom he Federal Reserve Board o Richmond, which ound a correla-

ion be ween laws limi ing ull recourse and he use o s ra egic oreclosures by borrowers who owed more on heir mor gages han he home was wor h, hisclaim has been used o argue ha limi a ions on ull recourse in he Uni ed S a es

is an impor an ac or in unders anding why he U.S. housing and nance sec orsexperienced a mor gage crisis while Canada did no .

Tere are, however, some serious issues wi h his argumen . Firs , as has beenou -lined in a research no e rom he Federal Reserve Board o A lan a , he RichmondFed research was highly skewed by he ac ha only 11 U.S. s a es have any limi a-

ions on recourse, and Cali ornia and Arizonabo h o which have experiencedex raordinarily high oreclosure ra esare among hese s a es.

Ano her impor an cri icism o his research made in he A lan a Fed no e is ha

limi a ions on recourse are only meaning ul o he ex en ha hey preven recov-ery by lenders. wo o her impor an ac ors may be ar more relevan han recourselaws. Firs , he bankrup cy laws in place in he borrowers jurisdic ion may prevenrecovery ar more han limi a ions on recourse. Second, o he ex en ha borrow-ers have limi ed asse s (and mos borrowers who ace oreclosure would presum-ably all in o his ca egory) here is litle or a lender o recover, wi h or wi houany limi a ions on recourse. Te righ o lenders o seek recourse may be valuablein heory, bu when his righ comes up agains he reali y o generous bankrup cy laws or judgmen -proo borrowers, i may be seen as ar more wor hless.

Canada does not allow mortgage interest to be deducted

Ano her claim is ha Canada did no su er because i does no allow mor gagein eres o be deduc ed , while he Uni ed S a es does or principal residences. While here is cer ainly grea meri o he argumen ha he U.S. mor gage in er-es deduc ion ends o drive resources oward homeownership, in a ing he hous-ing marke and driving specula ion, his claim abou Canada is highly misleading.Canada has a slew o ax and o her policies ha encourage home purchases in

heir own righ , which is one major explana ion o why Canada his orically had asimilar homeownership ra e as he Uni ed S a es.

While Canada does no have a mor gage in eres deduc ion or owner-occupiedhomes, i does have such a deduc ion or ren al homes, which arguably encour-
http://ideas.repec.org/p/fip/fedrwp/09-10.htmlhttp://ideas.repec.org/p/fip/fedrwp/09-10.htmlhttp://realestateresearch.frbatlanta.org/rer/2010/02/index.htmlhttp://realestateresearch.frbatlanta.org/rer/2010/02/index.htmlhttp://www.american.com/archive/2010/february/due-north-canadas-marvelous-mortgage-and-banking-system/article_printhttp://www.american.com/archive/2010/february/due-north-canadas-marvelous-mortgage-and-banking-system/article_printhttp://www.american.com/archive/2010/february/due-north-canadas-marvelous-mortgage-and-banking-system/article_printhttp://www.american.com/archive/2010/february/due-north-canadas-marvelous-mortgage-and-banking-system/article_printhttp://realestateresearch.frbatlanta.org/rer/2010/02/index.htmlhttp://realestateresearch.frbatlanta.org/rer/2010/02/index.htmlhttp://ideas.repec.org/p/fip/fedrwp/09-10.htmlhttp://ideas.repec.org/p/fip/fedrwp/09-10.html


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ages specula ion even more so han a deduc ion or owner-occupied homes.Canada also exemp s he sale o owner-occupied proper y rom any capi al gains

axes (as opposed o in he Uni ed S a es, where capi al gains are exemp romaxes up o $500,000 i he proper y has been he principal residence or 5 years),

and provides a ax reba e on he purchase price o a new or subs an ially reno-

va ed house. Firs - ime home buyers are allowed o use up o $25,000 rom heirax- ree re iremen savings accoun (similar o U.S. 401k de ned con ribu ionpension plan accoun s), wi hou penal y, o purchase a home.

In he aggrega e, hen, Canadian ax policies seem o be comparable o hose inhe Uni ed S a es in encouraging and subsidizing home buying.

Canada has a standard 5-year mortgage, rather than a 30-year,fixed-rate mortgage

Some cri ics o he American sys em poin ouha Canadas s andard mor gage is a5-year mor gage, and sugges ha he 30 year xed-ra e prepayable mor gage ha is

he U.S. s andard ends o des abilize he nancial sys em by leaving excessive in er-es ra e risk wi h nancial in ermediaries (or he governmen ). I is wor h no ing

ha his argumen does no bear on he recen mor gage crisis, in which roublednancial ins i u ions bore losses on heir credi risk, and no on in eres ra e risk.

Moreover, his argumen ignores some impor an bene s o he 30-year xed-ra emor gage as well as some key de ciencies wi h shor er-dura ion mor gages.

Firs , longer dura ion mor gages are more sus ainable. In he Uni ed S a es, since1998 (when s a is ics are readily available), prime adjus able-ra e mor gages (suchas a 5-year or 7-year ARMs, which mos closely resembles he Canadian 5-yearmor gage) have been 2.72 imes more likely o go in o oreclosure han primelong- erm xed ra e mor gages (such as he 30 year mor gage),according o heMor gage Bankers Associa ions Na ional Delinquency Survey .

Second, while i is rue ha he 30-year xed-ra e mor gage (or o her long-dura ion mor gage produc s) pu s in eres ra e risk on o nancial ins i u ions, i is

equally rue ha a 5-year mor gage (or o her shor -dura ion mor gage) moves hisin eres ra e risk on o households. One reason why oreclosure ra es are so muchhigher or shor er-dura ion produc s is he rela ive inabili y o households o deal wi h in eres ra e risk. Unlike nancial ins i u ions, households ypically cannohire exper s o analyze in eres ra e rends, and hey canno purchase complex
http://mjperry.blogspot.com/2010/05/should-we-end-30-year-fixed-rate.htmlhttp://www.mortgagebankers.org/ResearchandForecasts/ProductsandSurveys/NationalDelinquencySurvey.htmhttp://www.mortgagebankers.org/ResearchandForecasts/ProductsandSurveys/NationalDelinquencySurvey.htmhttp://www.mortgagebankers.org/ResearchandForecasts/ProductsandSurveys/NationalDelinquencySurvey.htmhttp://www.mortgagebankers.org/ResearchandForecasts/ProductsandSurveys/NationalDelinquencySurvey.htmhttp://mjperry.blogspot.com/2010/05/should-we-end-30-year-fixed-rate.html


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nancial in eres s o hedge agains in eres ra e risk. ransac ion cos s are alsomuch higher or households because i is rela ively ar more expensive o move oano her home han i is o swi ch inves men por olio alloca ions.

Tird, shor -dura ion mor gages cons rain he abili y o cen ral banks o conduc

mone ary policy,one o he key ndings o he Miles Repor ,he landmark 2004repor on re orming he Bri ish mor gage sys em. Te Miles Repor ound ha incoun ries where shor - erm mor gages (such as he Canadian 5-year mor gage) were predominan , in eres ra e changes had ar grea er impac s on housing prices. As a resul , cen ral banks in hese coun ries mus be much more care ul abouimplemen ing in eres ra e changes because such ac ion can more easily drivehousing bubbles and down urns. Given how much in eres ra e risk is borne by households in hese coun ries, and he heigh ened sensi ivi y o house prices oin eres ra e changes, i is reasonable o assume an implici obliga ion on cen ral banks in hese coun ries o main ain low in eres ra es wi h low vola ili y.
http://news.bbc.co.uk/nol/shared/bsp/hi/pdfs/12_03_04_miles.pdfhttp://news.bbc.co.uk/nol/shared/bsp/hi/pdfs/12_03_04_miles.pdf


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The real difference: Canadasabsence of private securitization

and unsupervised lendingRemarkably, he di erence be ween Canada and he Uni ed S a es ha seemsmos relevan o he ques ion o why Canadas mor gage marke s have been sorela ively s able has gone largely under he radar, o da e. Te unregula ed priva e-label securi iza ion nancing channel ha grew o such grea heigh s in heUni ed S a es nanced very litle Canadian lending, and a he origina ion level,Canada has almos no unregula ed lenders.

While Canada had signi can amoun s o governmen -backed securi iza ion,insured or guaran eed by CMHC, i had very litle priva e securi iza ion undingi s mor gage lending. A he heigh o he U.S. bubble in 2006, priva e securi iza-

ion accoun ed or only $22 billion o Canadian mor gagesless han 3 perceno all Canadian mor gage deb ou s anding. Tis compares o a 38 percen markeshare in he Uni ed S a es.

A he mor gage origina ion level, almos all Canadian mor gage lending was done by en i ies ha were regula ed by he ederal governmen . Canada did no experi-ence much lending rom nonbank mor gage lenders like New Cen ury, Argen ,and Ameriques , which domina ed he U.S. subprime mor gage marke during

he 2000s bubble. Fur hermore, lending s andards were butressed by s rongconsumer pro ec ions, in he orm o he Financial Consumer Agency o Canada, which is analogous o he Consumer Financial Pro ec ion Bureau ha was jussigned in o law as par o he Dodd-Frank nancial regula ory re orm bill.

In shor , Canada appears o have avoided he a e o i s neighbor o he sou h orwo reasons. Firs , Canadas regula ed lenders and nancing channels were super-

vised airly well, and were no allowed o jump in o he exo ic mor gage produc s

ha proved so disas rous in o her coun ries (such as in eres -only mor gages,nega ive-amor iza ion mor gages, or liar loans). Second, Canada did no experi-ence a massive in ux o unregula ed mor gage nancing or lending.

At the mortgage

origination level

almost all Canad

mortgage lendin

was done by enti

that were regulat

by the ederal

government.


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Bu why did Canada no experience an in ux o unregula ed mor gage lenders andnancing vehicles? A leas one impor an reason appears o be he rela ive bene s

provided o regula ed Canadian lenders. Regula ed lenders in he Uni ed S a esseeking o reduce heir capi al levels and raise heir re urn on equi y had s rongincen ives o avoid regula ion and o sell heir loans o securi iza ion condui s.

In con ras , Canadian lenders bene ed rom governmen -backed mor gage insur-ance, which was only available o regula ed en i ies. Because Canadian mor gageinsurance provided capi al relie , here was signi can incen ive or lenders o beregula ed, and among hese regula ed lenders, here was litle atrac ion o ered by priva e-securi iza ion condui s. As a resul , Canadian lending was almos en irely well regula ed, and so did no experience he de eriora ion in underwri ing andrisk analysis ha charac erized U.S. lending over he same period.

In shor , here are many impor an di erences be ween he mor gage sys ems

o he Uni ed S a es and Canada, and given he rela ive s abili y o our nor hernneighbor we would do well o heed he obvious lessons i s experience eaches. Busuch lessons should be based on a rm grasp o he ac s abou Canadian housing

nance, and no upon alse or misleading claims. Te key lesson Canada appearso each us is ha regula ed, governmen -suppor ed mor gage nance leads o

grea er sus ainabili y and s abili y han i s unregula ed, purely priva e coun erpar .


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Endnotes

1 M r g g ur v l bl , bu l r l w d wym 20 r r m r .

2 t g v r m x l ly gu r m r g g ur z - bl g g v r m g y G M , d

w ug r v d m l gu r d b - dur z -r l d bl g g v r m - r d

F M d Fr dd M .

3 L ur d by cMhc j y 100 r g v r m gu r ,w l r v ly ur d l j y 90 r g v r mgu r . U d r B l rd l d rd , l

ur d by cMhc r lly r d l c d v r gd b , d r gul d l d r d v ld y l g

m. W r r v ly ur d l , r gul d l d r d

v ld y l g 90 r r gu r d by c d g v r m ; y mu ld l

g r m g 10 r r rd w B lr -w g g gu d l r ur d r d l m r g g . s ,

.g., R d l M r g g d s ur z c d : ov rv w M r g g M r , DBRs i du ry s udy, . 22, M y 2007,

v l bl ://www.dbr . m/r r /211674 ( t r m ryv r m r g g l d r ur bul ur

b l r l . c l r w g g r u ur d m r g g 50% ( ur r r du d 35% w B l ii b g r gul -

r m l m d) w l ur d m r g g d r yl r qu r m ( m dd d)).

4 t r du y lly m r z d v r 25 y r r d, u b rr w r m ly ym y d w r l d r

m r g g w 25 y r x d-r l . o ur , w 5-y rl m r z d v r 25 y r , b rr w r mu y b l

r l w d r 5-y r l x r , r d w l .

5 t rgum U.s. rd bl u g l r gg r d m r g g r l b l d by umb r y d r d w ll. a Fcic d r l m ry r r , s ur z -

d M r g g cr , m r r r v - ur -z du , w r lly x m r m rd blu g r r l d g r qu r m , r d dur g u g

bubbl , w l m r r d ry u d Gse , w r ubj u r qu r m , dr d rr d-

gly. [See F l cr i qu ry c mm , s ur zd M r g g cr . 10 , v l bl ://www. .g v/

r r / d /2010-0407-pr l m ry_s _R r _-_s ur z -_ d_ _M r g g _cr . d .] Fur rm r , bubbl -bu

y l r r z d m r g g r w l rr d m r , w w r ubj y rd bl u g

l bu w d g x ur g r v d d byu r gul d r v ur z . F r x m l , mm r l r l

x r d m r bl r f dur g r dbubbl d ub qu ly x r d m l r d l qu yr . a l r r l d m r v d dby ad m a r , m w F d r l R rv B rd

n w Y r , w r g r r -b dur z u dur g y r 2003-07, ll w d by r -

u dr . [See ad m a r , D Gl b l B s r d Gl b l

imb l , (i r l M ry Fu d, . 7), v l bl ://m . rg/ x r l/ /r / m r /2009/ r / d / r 1. d .]

i , M k y Gl b l i u r r r m J u ry 2010d, l rg r r d umul urr d m g

u ld 60-90 r l m , y lly rg rd bl u g l . [See D b d d l v r g g:

t gl b l r d bubbl d m qu , M k yGl b l i u , J u ry 2010, v l bl ://www.m y.

m/mg / ubl /d b _ d_d l v r g g/ d x..] i lw r g l r g d u d r rd bl u g l -

v u lly r rm d g ly b r r l ,w m d m b rr w r . [See D v d abr m w z dJ R l , h m w r D R g : W ex r

d R r t U , c r r am r pr gr , a r l 2010,v l bl ://www. m r r gr . rg/ u /2010/04/

m w r _r g . ml.]

6 i w r g gu r j y d by r v c dm r g g ur r x l d rr wly l r d, w r

gu r j y d by F d Fr dd w m l d uru d m r br dly.

7 G v g r d l rg b , u r bl b l v y m y b b g l

d u j y m l d g v r m gu r b d m r bl g , mu l l rg U.s. l u .
http://www.fcic.gov/reports/pdfs/2010-0407-Preliminary_Staff_Report_-_Securitization_and_the_Mortgage_Crisis.pdfhttp://www.fcic.gov/reports/pdfs/2010-0407-Preliminary_Staff_Report_-_Securitization_and_the_Mortgage_Crisis.pdfhttp://www.fcic.gov/reports/pdfs/2010-0407-Preliminary_Staff_Report_-_Securitization_and_the_Mortgage_Crisis.pdfhttp://imf.org/external/np/res/seminars/2009/arc/pdf/ashcraft1.pdfhttp://imf.org/external/np/res/seminars/2009/arc/pdf/ashcraft1.pdfhttp://www.mckinsey.com/mgi/publications/debt_and_deleveraging/index.asphttp://www.mckinsey.com/mgi/publications/debt_and_deleveraging/index.asphttp://www.americanprogress.org/issues/2010/04/homeownership_right.htmlhttp://www.americanprogress.org/issues/2010/04/homeownership_right.htmlhttp://www.americanprogress.org/issues/2010/04/homeownership_right.htmlhttp://www.americanprogress.org/issues/2010/04/homeownership_right.htmlhttp://www.mckinsey.com/mgi/publications/debt_and_deleveraging/index.asphttp://www.mckinsey.com/mgi/publications/debt_and_deleveraging/index.asphttp://imf.org/external/np/res/seminars/2009/arc/pdf/ashcraft1.pdfhttp://imf.org/external/np/res/seminars/2009/arc/pdf/ashcraft1.pdfhttp://www.fcic.gov/reports/pdfs/2010-0407-Preliminary_Staff_Report_-_Securitization_and_the_Mortgage_Crisis.pdfhttp://www.fcic.gov/reports/pdfs/2010-0407-Preliminary_Staff_Report_-_Securitization_and_the_Mortgage_Crisis.pdfhttp://www.fcic.gov/reports/pdfs/2010-0407-Preliminary_Staff_Report_-_Securitization_and_the_Mortgage_Crisis.pdf


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true north: the facts about the canadian mortgage banking system

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