Blessed by the Potato

Hello faithful readers! I’m going to be doing some work on the back end of the site over the next week whenever I find the time to. It is very possible that I will temporarily break the site as I fiddle. Have patience, and remember to come back to holypotato.com if you have bookmarked the IP address directly (or if you’ve subscribed to the RSS feed and you don’t get any new posts next week). Also, I have a number of drafts here with further rants about the housing market. I’m not 100% pleased with these, but since Wayfare and I have found a place to move to, real estate is moving out of the forefront of my mind (or the secondfront of my mind, as the forefront is probably still that grad school thing I work on every day and dream about every night), so if I don’t push them out now, they’ll die a cold, lonely death in the drafts folder. I’m also posting them to give you something to keep yourselves busy with while I work on the server.

“…Through the mechanism of CMHC, Canada’s banks HAVE ALWAYS had pre-arranged taxpayer bailouts” — Future Expat, comment at greaterfool.ca.

The CMHC was created to help make housing affordable in Canada. Affordable housing. It sounds like such a noble goal.

Unfortunately it’s one of those things where what’s good for one person is bad when it happens to everyone in society at once. Maybe it’s related to Jevon’s paradox, though the closest I can come to finding a term for this phenomenon is “congestion” (opposite of the network effect).

It may be a noble pursuit to give low-cost government insurance to cover a mortgage for a young person to buy a house in a rural area, as they may not have any rental options in a small town, and with no appreciable down payment, a bank might not give them a loan otherwise. Government intervention in these small, inefficient markets probably does bring some benefit to people, at very low cost and risk to the taxpayer. However, CMHC insurance is not limited to those looking to buy in areas where rentals are not available, but country-wide. Even in the cities where a large rental market means it’s not needed. Even to speculators who have no intention of living in their investments.

Even if a rental is an option, give a girl some low-cost government insurance to step up to owning her own condo, and she’ll take it.

As the housing bubble has inflated here, everyone started needing CMHC insurance. Houses went up faster than people could save for the downpayment, so more and more people got past the stigma of having to pay for the insurance, and took the CMHC option to “get into the game” earlier and earlier. This started a positive feedback loop, made all the worse by the government lowering the minimum CMHC downpayment to 0% (since raised to 5% — still not much!).

At the same time, amortizations increased to 40 years (since reduced to 35 years). Again, something introduced with the intention of giving home buyers a safety net and to make housing more affordable — if you could afford a 25-year amortization, you could opt to take a 35-year one and just top up your payments as long as things were good, but have a lower minimum payment if things went poorly (e.g.: if you got hit with a big repair bill, or lost some hours at work). Instead, people just bid houses up to the point where most people needed a 35-year amortization just to afford things. Houses, paradoxically, became less affordable.

CMHC insurance is also perverse because the insurance isn’t just on the part of the downpayment missing, that is, it doesn’t insure the 15% difference between the 5% downpayment made and the ideal 20% down. The government is on the hook for the whole mortgage, leaving the bank with essentially no risk for writing a CMHC-insured mortgage. For this reason, people with no downpayment, who have shown no history of financial discipline (as long as they meet some minimum credit score), can get just as good of a mortgage rate as someone with skin in the game, all because the risk is offloaded to the government. This leads the banks to be less stringent in the loans they make — the same sort of incentives towards risky behaviour that securitization of subprimes in the states had. Not quite the exact same since CMHC does have some standards, and will occasionally check up on a borrower and/or appraise the house — but saying “we’re not quite as bad as the Americans” does not bring me any joy. It’s a difference of degree but not of kind. The banks have a split interest in housing bubbles: they want to drive bubbles (at least on the way up) because it leads to larger mortgages, which means more interest income for them. Simultaneously, they want to limit losses, so they don’t want to stoke a bubble too much. But with the CMHC the risk side of the balance is blown away completely, as from the bank’s point of view a first-time buyer with 5% down, a 35-year am, buying the absolute most house they can afford and with no credit history is less risky than a millionaire putting 50% down with the intention of paying the rest back in 15 years.

Canadian Capitalist recently had a post about the bubble, shaking his head at Canadians who are driving housing prices to the moon with (currently) cheap mortgages, even after seeing the disaster that caused in the US (and many other nations), saying: “Those who fail to study history are condemned to repeat it. Those who ignore very recent experience are just being stupid.”

Over at the Canadian Money Forum, I saw something that made my jaw drop. The CMHC charges insurance fees, and if we assume that ~6% of mortgages written today will default when the bubble collapses, which a severity of ~40% each (i.e. in the same ballpark as the US experience), then the fee of 2.75% is probably not too far off. However, one poster said that:

“…CMHC mortgage insurance operation is a great expensive rip-off of Canadian homeowners. […] last year cost Canadians $1.2-billion in premiums paid to CMHC. The net claims against CMHC for mortgage default totaled $117-million, for a premium-claim ratio of 10 to 1.”

…which made me wonder what was going through his head. On the surface, it does sound like the CMHC is a cash cow for the government, netting over a billion dollars — indeed, put like that, you could see a motive for a government facing record budgetary short falls to perhaps play with fire and stoke the bubble a bit. However, the housing market has been on steroids for the last few years, and interest rates were on the way down to the ground floor. The fact that there were any payouts made me wonder what the hell was going on. Anyone who bought more than a year ago should have been able to easily sell (or in the parlance of the times, “flip”) their place if they ran into trouble for whatever reason, and break-even at the very least. Yet somehow the CMHC had to pay out hundreds of millions to the banks on defaulted mortgages. What’s going to happen when we actually have a housing correction? Is CMHC insurance too cheap for the risks being assumed?

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