Government fixes mortgage market, but will it work?

Once again Ottawa has stepped in to slow what it believes is an overheated housing market, this time by putting the Canada Mortgage and Housing Corp. under tighter oversight and banning the use of CMHC insurance on covered bonds.

But what are the odds the measures will succeed? Certainly the last few efforts haven’t had much impact.

Since the financial crisis Finance Minister Jim Flaherty has tightened the rules around CMHC insurance three times, shortening the maximum amortization, raising the minimum down payment and various other tweaks.

Last month the federal banking regulator announced proposed new guidelines requiring banks to take a lot more care around real estate lending, especially home equity lines of credit (HELOCs), one of the most successful products in the history of the industry.

Yet home prices continue to rise, grinding steadily higher in most major markets and prompting  commentators such as Bank of Canada Governor Mark Carney to warn of a possible bubble.

For their part, proponents of Ottawa’s strategy claim it’s not surprising that the mortgage market hasn’t leveled off given that the government’s moves are aimed at achieving a gentle landing as opposed to slamming on the brakes, potentially leading to dire economic consequences.

The idea is that by gradually tightening up lending standards around CMHC insured mortgages, the “froth” will be removed from the market and equilibrium will return.

Problem is, Canadian real estate is anything but a normal market.

A crown corporation, the CMHC has already provided insurance on roughly $600-billion of the roughly $1.1-trillion of mortgages outstanding in this country. The purpose of that insurance is to allow wider access to the housing market.

Since the borrower pays for the insurance, the banks are able to lend the money at no additional cost compared to conventional uninsured mortgages. Indeed, because they’re ultimately backed by the taxpayer, CMHC insured mortgages are actually safer for lenders than conventional uninsured home loans, requiring less capital. They’re also much more easily packaged up into mortgage backed securities.

Despite all the moves it’s taking to limit the issuance of CMHC insurance, the government has so far done nothing to dampen the fundamental appeal of taxpayer guaranteed home loans for banks, who are one of the most important players in all this.

Just how significant the mortgage business is for the banks was made apparent in the near record earnings the big banks reported last year, as outsize revenue from consumer lending at their domestic operations offset declines in other businesses.

Once all the recent changes have come into effect banks will still be inclined to favour customers with insured mortgages — those folks who in a normally functioning market should have the toughest time getting financing.

Peter Routledge, an analyst at National Bank Financial, puts it this way. Imagine two customers trying to borrow the same amount to buy a house, except one customer wants to make a 40% downpayment while the other can afford only 15% which means he has to take out insurance.

All else being equal, the less credit-worthy borrower will be the more likely to get the loan, according to Mr. Routledge, because it’s more profitable to the lender.