Yesterday, I promised to write a letter to Jim Flaherty. In this letter, I’ve detailed my strategy to reduce the negative impact of the impending Canadian housing recession. I’m posting it here before emailing it to Mr. Flaherty so that, if any of you would be so generous, you can provide feedback. Without further ado:
Dear Honourable Minister Flaherty,
I believe in free markets. If my proposal in this letter is partisan, I assure you it’s not leftist. I firmly oppose socialism.
I am greatly concerned about the Canada Mortgage and Housing Corporation (CMHC).
This Crown corporation guarantees over half a trillion dollars in mortgages by way of its insurance products. Their mortgage insurance assures its holders that, in the event of default, loans will remain profitable regardless of market conditions. The CMHC will step in to help collect owed debts and pay out any loss of interest or principal. The holders of this insurance are the mortgage lenders and investors – mainly banks and institutional investors.
The CMHC was established over half a century ago with good intentions. The CMHC has allowed people who would not otherwise receive an affordable mortgage to do just that. These folks are known as “sub-prime” borrowers. As a result, CMHC insurance has distorted lenders’ evaluations of risk. It has rendered moot the profit-maximizing risk management afforded by a real free market.
This CMHC-caused distortion might seem innocuous at first glance. But it has infected much more than the market for mortgages.
CMHC insurance has pushed demand for housing to the extreme. Prices have predictably followed suit. Artificially low interest rates and larger hypothetical “home equity” have been used by borrowers to obtain Home Equity Lines of Credit (HELOCs). The HELOC has become a tool critical to the conspicuous consumption of the middle class for, without cheap credit, they’d need to live within their means. Consumer spending is now three quarters of our GDP whereas, just a decade ago, it was only two thirds. The housing ‘wealth effect’ has depressed savings rates. Investors now flip units for seemingly guaranteed profits, crowding out equity investments in productive ventures. Home-related employment has been a shining star in an otherwise bleak jobs picture.
The CMHC’s balance sheet is dismal. Some analysts claim that it’s worse than the balance sheets of Fannie Mae/Freddie Mac before they went bankrupt. The CMHC has an insufficient amount of equity – only about 1.5%. Keep in mind that this 1.5% equity backstops over half a trillion worth of subprime mortgages. Even the Office of the Superintendent of Financial Institutions has now expressed public concern about banks’ lending habits and, by consequence, the CMHC’s liabilities.
It all seems very reminiscent of a time not so long ago, in a powerful nation not so far away.
Nostalgia aside, the CMHC’s extraordinary distortion of Canada’s economy is damage done. There will be deleveraging and home price deflation. The CMHC’s good intentions have paved a well-known road, down which it now travels.
My big problem, however, is that taxpayers will be along for the ride.
If the CMHC can’t meet its obligations after the housing bubble bursts, then the federal government will be obliged to bail it out. This bailout could be to the tune of billions and billions of dollars, all of which will come from Canadian taxpayers. Let’s not mince words. Taxpayers like you and I would pay billions of dollars to the banks, to compensate them for their own foolish lending practices. This bailout would occur after the banks enjoyed the recent run-up in prices. The run-up in prices has surely been due, in part, to CMHC insurance. Higher prices created ever-larger mortgages and tons of imaginary ‘home equity’. Banks could lend more money against this “equity” by way of HELOCs. The CMHC insures a lot of HELOCs, too.
This bailout for the banks would be a massive wealth transfer. The transfer of money would be from middle class taxpayers to the banks. This would constitute a perverse travesty. If I can borrow a phrase from hippies, it would be “socialism for the rich.”
It’s evident from recent comments, like those of TD Canada Trust, that the banks are setting up the Canadian federal government as a scapegoat when the housing bubble comes crashing down. The banks will wring their hands and point to their half-hearted cautionary statements (despite years of pumping up the markets with Realtors and their ilk). They’ll cry crocodile tears and moan “We were prudent. The feds did this to you, Canada,” as they take billions of our tax dollars from the CMHC trough.
“I find it a bit odd that some of the bank executives are taking the position that the minister of finance or the government somehow should tell them how to run their business… We have bank executives in Canada going and saying ‘really, the rules on insured mortgages should be tightened up.’ They must forget that they are actually the ones that issue the mortgages. It’s their market. It’s not my market.”
You’re right. It is the banks’ market insofar as they profit from it. But you’re also wrong – the banks face none of the market’s risk. It is not truly their market. It is merely their cash cow.
I’m not sure who will get blamed in the aftermath of the CMHC’s spectacular end. Regardless, the real scapegoat will be taxpayers. Like I mentioned before, as soon as the CMHC’s 1.5% equity has sublimated into the banks’ bottom lines, ‘We the People’ are on the hook. I have a strong suspicion that the next election will be a lot tougher for incumbents who failed to protect taxpayers.
But the worst of the disaster is still avoidable, Mr. Flaherty, if you decide to protect the Canadian people.
I have an idea. I’d sincerely appreciate if you gave it more than token consideration.
I’m not going to tell you to throw money at the problem. Please don’t try to solve the supply side of the bubble by bailing out homeowners. It won’t work any better than cash-for-clunkers. I think we’ve got enough watchdogs in Canada. We certainly don’t need a new Crown corporation or a Housing Czar.
My idea is simple:
Remove the taxpayer’s guarantee for the CMHC.
This could get a little messy in execution, but Canada elected a majority government to do what needs doing. The fancy “mortgage-backed securities”, constructed by the CMHC and the banks, might take a valuation hit (their prices are surely artificially buoyed by the taxpayer guarantee). At least one bank, if not all of them, will want to sue the feds. Tough for them. My heart doesn’t bleed at the idea of taking subsidies away from Canadian banks. Pass a law that protects the government. Invoke the “Notwithstanding” clause if you need to. You can make it work.
If I’m wrong about the CMHC, good. Maybe the CMHC has only been prudent and risk-averse in its lending operations. Maybe 1.5% equity is plenty. Maybe the Realtors and Big Banks have been telling us the truth all of these years. Maybe a personal home truly is an investment, even though it doesn’t produce rent or dividends or interest. Maybe Canadian home prices only go up. I didn’t buy a condo in Toronto yet, so maybe I’m priced-out forever. Maybe it really is different this time. Maybe the CMHC can stand on its own two feet without its hand in the taxpayer’s pocket. This would prove that there’s no price bubble. We’d chalk it up to a little irrational exuberance that got out-of-whack with fundamentals. Equilibrium would be restored and the market would reign. I’d be proven wrong. I promise I’ll shut up about it and Canada will be better off.
On the other hand: if I’m right about the CMHC, then removing the guarantee is the only responsible choice to protect taxpayers.
Banks want us to protect their profits. I have zero problem with banks making money. As I said, I’m not a socialist. What I dislike is that Canada is subsidizing bank profits. It’s extremely perverse. If the government represents the interests of the taxpayers then this practice must end. Right now the banks get all of the rewards and taxpayers get all of the risks. Let investors take on the risks and the rewards. That’s how a free market works effectively and efficiently.
The CMHC is a market-distorting institution. Its role in creating the Canadian housing bubble is a mistake that cannot be undone. The blame game is irrelevant. The CMHC is not ‘too big to fail’. It is too big to save. Let’s look forward because it is not too late.
There’s a clear choice to be made. The government can risk taking billions from hard-working Canadians to give it all to the banks, or you can protect taxpayers like me.
Mr. Flaherty, I started this letter by saying that I believe in free markets. Now, I ask:
I’m going to send this to the Minister of Finance after it’s finalized. I’ll copy the Leader of the Opposition (Thomas Mulcair), and The Right Honourable Prime Minister Stephen Harper. I’m also going to copy Bob Rae (Leader of the Liberals); I know he’s read my favourite book on economics, “The Efficient Society” by Joseph Heath.
Here’s a list of those email addresses, in case you want to share your CMHC concerns with the same Parliamentary officials:
email@example.com, firstname.lastname@example.org, email@example.com, firstname.lastname@example.org
I’d encourage you to copy your local MP (click here to find yours by typing in your postal code). I’m copying Dean Del Mastro who is the MP I know the best as I lived in his riding for years (and I hope to again, sometime soon).
Here’s a possible idea for an email to get the attention of elected officials. If you just want to copy and paste it, feel free:
Dear Mr. Flaherty,
I want you to protect taxpayers. The ability and willingness of a candidate to protect my interests will weigh heavily upon my mind in the next election.
The CMHC is a taxpayer-backed Crown corporation that ensures over half a trillion dollars in subprime loans. I am unhappy that I may have to reward banks for poor behaviour with a multi-billion dollar bailout.
Please take the time to consider the information presented at http://www.timelessfinance.com/2012/03/28/the-cmhc-and-me/
Protect taxpayers by ending the CMHC guarantee that rests on our backs.
A Concerned Citizen