Canada’s Subprime Mortgage Headache Is Part of the Harper Legacy
There was no particular reason for Canada getting involved in the subprime mortgage racket. The Globe and Mail (12/13, "How high-risk mortgages crept north" by Jacquie McNish and Greg McArthur) tells the tale: "Essentially the appearance of the subprime mortgage phenomenon was part of the Stephen Harper legacy. Canada since the founding of the government’s own Central Mortgage and Housing Corporation agency in 1954 has not privatized it as the US government had done its mortgage agencies – Fanny Mae and Freddy Mac.
"If a home buyer couldn’t pony up a 25% down payment on a house purchase, CMHC shouldered the risk of default by insuring the mortgage and charging the buyer an insurance premium. Backing CMHC’s insurance policies was a 100% federal guarantee. In bad years. Ottawa piped money into CMHC. During good years CMHC added to the federal treasury by paying taxes.
"The smooth working system hit a pothole in late 1988 when Canada’s only other mortgage insurer at the time, Toronto-based MICC was nearly wiped out by new international bank capital rules. The rules threatened to shutter MICC because they made it cheaper for banks to use CMHC’s government-guaranteed mortgage insurance.
"Faced with the imminent collapse of Canada’s only private-sector mortgage insurer, the then Conservative government went to a place that few other industrialized countries have gone by guaranteeing the policies of a non-government mortgage insurance’s enormous liability, guaranteeing 90% of MICC’s insurance policies.
"The government’s worst fears about a massive liability materialized in 1995, when MICC’s risky insurance bets in the construction sector threatened to torpedo the company.
"In the first half of this year, as the subprime mortgage crisis was exploding in the US, a contagion of US-style lending practices quietly crossed the border and infected Canada’s previously prudent mortgage regime. The mushrooming of a Canadian version of subprime mortgages has gone largely unnoticed. Just yesterday, Finance Minister Jim Flaherty repeated the mantra that the government acted early to get rid of risky mortgages. What he and Prime Minister Stephen Harper do not explain, however, is that the expansion of zero-down, 40-year mortgages began with measures contained in the first Conservative budget in May, 2006.
"The new rules encouraged the entry of US players such as American International Group – the world’s largest insurance company – and Triad Guarantee Inc. of Winston-Salem, NC. Former Triad chief executive officer Mark Tonnesen, who spearheaded his company’s aborted push into Canada, said the proliferation of high-risk mortgages could have been mitigated if Ottawa had been more watchful.
"Virtually unavailable in Canada two years ago, high-risk mortgages proliferated in 2007 and early 2008 and must now be shouldered by thousands of consumers at a time when the economy is sinking quickly and real estate prices are swooning. Long-term mortgages – designed to help new-comers get into the housing market sooner – are the most expensive in terms of interest costs, and least flexible when mortgage-holders cannot meet their payments and need extensions."
Bank of Canada Warns About Doubling of "Vulnerable Households"
"The Bank of Canada warned this week that the perilous economy could lead to a doubling of so-called ‘vulnerable households’ – those unable to meet their debts – and perhaps cost thousands of Canadians their homes.
"The federal government waited until June of this year to slam the regulatory door on 40-year mortgages. In October, as the global financial crisis erupted, Mr. Harper lauded his ‘early’ response to the mortgage dangers.
"He didn’t say that, not only did his own government open the sheltered Canadian mortgage market to US insurers, but it also doubled to $200 billion the pool of federal money it would commit to guarantee their business. The foreigners unleashed what one US insurance executive described as a fierce ‘dogfight’ for ‘market share’ that prompted rivals, including the giant federal agency Canada Mortgage and Housing Corporation, to aggressively push such risky American-style lending.
"An investigation by The Globe and Mail found AIG’s Greensboro, NC, mortgage subsidiary launched a quiet lobbying campaign in 2004 with senior US executives and a former CMHC official to push open the doors of Canada’s mortgage insurance markets, where some of the world’s highest insurance rates are charged. Two years later, on May 1, 2006, AIG’s mortgage insurance division registered with the lobbying commissioner’s office. It was the day before the federal budget revealed new players would be allowed into Canada.
"Banking and insurance officials were so concerned about the alarming rush to 40-year mortgages at the beginning of 2008 that one bank executive warned the Bank of Canada’s chief financial stability officer, Mark Zelmer, in a meeting that ‘the government has got to put an end to this.’
"The story of how the US housing crisis spread to Canada is a tale of carefully orchestrated US corporate lobbying, failed public-policy promises and government inaction to numerous private and public warnings about reckless mortgage practices.
"Few of these consequences appear to have been anticipated by either the government or the financial institutions pushing high-risk mortgages on the public."
"How did the staid world of mortgage insurance become the cradle of so much financial risk in the Canadian housing sector? It started almost by accident.
"For nearly 40 years after CMHC was founded in 1954, the business of mortgage insurance was about as exciting as an actuarial table. The agency was set up by the federal government as a kind of financial cushion to encourage the country’s conservative financial institutions to open their vaults and lend more money to homeowners.
"The [government] rules threatened to shutter MICC because they effectively made it cheaper for banks to use CMHC’s government-guaranteed mortgage insurance.
"Faced with the imminent collapse of Canada’s only private-sector mortgage insurer, the then Conservative government [of Brian Mulroney] went to a place that few other industrialized countries have gone by agreeing to guarantee the policies of a non-government mortgage insurer. According to people involved in the crisis, Ottawa ‘hesitantly’ agreed to ‘taking on an enormous liability’ of guaranteeing 90 per cent of MICC’s insurance policies.
"The government’s worst fears about a massive liability in 1995, when MICC’s risky insurance bets in the construction sector threatened to torpedo the company. As Ottawa wrestled with the grim prospect of losing the insurer for millions of dollars in mortgages, the world’s largest non-bank financial company came knocking with a rescue proposal.
"The company was General Electric. The US conglomerate was offering to take over MICC’s mortgage portfolio provided Ottawa met one condition: it would bless GE’s planned new Canadian mortgage insurance subsidiary with a federal guarantee.
"‘It was a bit of a slam dunk,’ recalls one former Ottawa official. ‘GE was one of the strongest companies in the world.’
"GE’s mortgage subsidiary, later spun off and renamed Genworth Mortgage Insurance Company rapidly carved out a major presence in Canada, capturing about 30% of the market and reporting $205 million of profits in 2005.
"Executives and advisers to a number of US insurers and Canadian players said this was widely interpreted that Ottawa was opening the country’s mortgage insurance sector to outside competitors.
"Intended or not, the shift followed years of mobilizing by US insurance companies, all hungry for a piece of what was regarded as one of the most lucrative and the second-largest mortgage insurance market in the world."
Insurers Basically "Printing Money"
"At the forefront of this movement was mammoth AIG, now in near ruins as a result of its role in the US subprime crisis. US competitors had envied premium rates on Canadian mortgage insurance policies for years. With only two players competing in the space, Triad’s Mr. Tonnesen said CMHC and Genworth were so profitable that they ‘were basically printing money.’
"The days of a CMHC-Genworth duo-poly were numbered. In the fall of 2005, a tiny paragraph buried in a 280-page federal government estimate of expenditures signalled a new era of competition in the industry.
"Eying the rich, northern market, representatives of at least three US insurers made regular trips to Ottawa for meetings with the Finance Department and the Office of the Superintendent of Financial Institutions, the insurance regulator. But AIG created a strategic advantage by hiring Bill Mulvihill, a Canadian mortgage expert who had spent years as chief financial officer at CMHC.
"Following in AIG’s footsteps, were US insurers such as PMI Group Inc., Triad and the Milwaukee-based Mortgage Guarantee Insurance Company.
"Ultimately, Parliament did not vote on the Finance Department’s proposal, thanks to the 2006 federal election and the Conservatives rise to office. But the US insurers’ efforts weren’t for naught; the new Harper government quickly embraced the idea of them coming north."
"On May 2, 2006, in his first budget, Mr. Flaherty announced that not only would Ottawa guarantee the business of US insurers, it was doubling the guarantee to $200 billion.
"Twenty-four hours before Mr. Flaherty’s announcement [to the latter effect], AIG’s mortgage subsidiary first registered with Canada’s lobbyist commissioner, according to a federal registry. At the time, companies that spent more than 20% of their time lobbying the government for changes in policy, were required, by law, to register. It is not known how much time AIG spent promoting its cause to the government.
"In a statement, AIG’s mortgage subsidiary first registered chief executive officer, Andy Charles, said the company began a ‘preliminary investigation’ of Canadian opportunities years ago. He said the company ‘did not engage in discussions with elected officials until we became aware that our market entry was being debated.’ Until that point, he said, the company’s interactions were with the Department of Finance and Office of the Superintendent of Financial Institutions.
"The lobbyist AIG hired was John Capobianco, a former aide to various MPPs in the Ontario government of Mike Harris. Mr. Capobianco said in an interview he wasn’t familiar with any of AIG’s negotiations with the federal government before he was retained in May. He was brought aboard to promote AIG’s argument that more competition was good for consumers and massage the proposed policy through the finance committee of the House of Commons and Senate. By the time he was hired, Mr. Capobianco said, ‘the rubber was on the road.’
"In February, 2006, as AIG was still trying to establish itself in Canada, CMHC moved to protect its coveted spot and announced a pilot project to insure 30-year mortgages.
"For the industry it was a declaration of war. Two weeks later, Genworth announced it would do the Crown Corporation one better, saying it would insure 35-year mortgages. CMHC matched that with its own 35-year product and raised the stakes by announcing it would insure interest-only loans that effectively required no down payment.
"The aggressive new mortgage products alarmed Mr. Dodge, the Bank of Canada governor, who scolded the president of CMHC, Karen Kinsley, in as letter for ‘very unhelpful’ mortgages that he said would inflate prices and ultimately make homes less affordable.
"Two and a half years after Ottawa launched its mortgage insurance initiative, the promise of increased competition has all but died. Three of the entrants, PMI, Triad and Mortgage Guaranty Insurance Co. have retreated. Genworth and AIG are still operating, but, as financial woes mount for their parents, their future in Canada remains uncertain. Industry sources said that most banks have become so cautious in the wake of global financial crisis that they have sharply reduced their use of private insurance in Canada.
"The retreat by international insurers means that CMHC’s dominant grip on the mortgage insurance market is expanding again, possibly beyond the 70% share it enjoyed prior to the arrival of the bigger US competitors."
And in this swirling mess our Prime Minister claims the kudos for having steered our way out of the subprime mortgage storm blowing in from the US!
– from Economic Reform, January 2009