FED'S $1 BILLION PER YEAR SCAM. HOW THE FEDS PROFIT FROM THE RULES THEY CREATE
 by Paul Tuns
Report Magazine
November 2006
CanMedia Inc.
When government entities make billions of dollars, it is not usually thought to be a problem. But the enormous profits of one crown corporation is beginning to get criticism for what amounts to a tidy little racket for Ottawa.
The Canadian Mortgage and Housing Corporation (CMHC) was founded in 1954 by an act of Parliament to run the mortgage insurance business to ensure that potential homeowners with steady incomes but little disposable cash could buy a house. And what a lucrative business it has been.
In its latest annual report, CMHC revealed that profits from its insurance business totalled $950 million in 2005, down from just over $1 billion in 2004.
So what is the problem? What is wrong with crown corporations making money?
According to its critics...plenty. John Williamson, director of the Canadian Taxpayers Federation (CTF), says that when banks or gas companies report huge profits, there are cries of outrage from both the public and politicians about corporate fat-cats, but there is virtual silence about the dough CMHC is rolling in. Terence Corcoran, a columnist with the Financial Post, wrote earlier this year, If CMHC were a private operation, regulators and politicians would be all over the place in search of dubious business practices.
The federal Bank Act requires mortgage insurance for every homebuyer who gets a mortgage from a federally regulated financial institution and pays less than one-quarter of the cost of the house upfront. That a crown corporation reaps the benefits of the government-written rules appears to be a conflict of interest, according to Corcoran who criticized the legislated support structure as the supplier of a government-mandated service.
As a result of this requirement in law, Canadian homebuyers paid more than $1.2 billion in mortgage insurance premiums in 2005, according to its annual report. Yet net claims were only $117 million. That is a reimbursement rate of 9.7 percent. In 2004, it paid out just $51 million in claims, compared to $1.1 billion in premiums. The reimbursement rate in other sectors of the insurance industry such as automobile and home insurance is about 75 percent.
For such a lucrative business, you would think that there would be numerous companies lining up to provide mortgage insurance, but CMHC's only competitor is the General Electric-owned Genworth Financial Canada, which has about 30 percent of the mortgage insurance business.
Genworth is on record supporting the status quo, as it might well be expected. According to government filings, in 2004 homeowners paid $504 million in premiums, while Genworth paid out $26 million in claims the same 5 percent reimbursement rate CMHC paid. Williamson calls this situation a cozy duopoly and notes that it would never be allowed if both players were private companies.
Not that it is always good times for the mortgage insurers. Right now there is a hot housing market, and house prices are increasing at a rate of 7 percent to 8 percent a year and 13 percent in major markets. But if interest rates or unemployment were to rise, the bubble might burst. Over the past decade, the total reimbursement rate has been 40 percent a figure closer to the overall insurance industry norm, although still providing a strong profit margin for CMHC.
Williamson says that the billion-dollar profits suggest that homeowners are paying too much in premiums, and has called upon the government to change the way they do business to make home ownership more affordable, especially for new, mostly younger, buyers.
The CTF is recommending to the finance ministry that CMHC premiums be more flexible. Right now, there are a handful of plans offered, but they are all based on the percentage of the down payment on the house. Most insurance schemes take into account the risk factors of those buying the insurance. But not CMHC. Williamson says that they should examine individuals for credit risk and charge those least likely to meet their obligations more than low-credit-risk homeowners. There must be some allowance for the credit worthiness of mortgage insurance purchasers, and the CMHC should reward those with a better credit rating.
Nor is there any allowance made to people who have paid off previous mortgages and bought new houses; they still have to pay the full fees.
The CTF is also calling for the insurance premiums to be paid monthly rather than upfront, where they are rolled into the mortgage cost and have interest accrued. Williamson said that the typical Canadian with a $250,000 house pays about $2,000 more than an American with the same-value home, because north of the 49th parallel we are required to pay the whole premium upfront.
Canadians also pay premiums for 100 percent of the value of the house, whereas most Americans insure 25 percent of the value of their home. That is because even in the worst housing market, no home will lose 100 percent of its value. Furthermore, federal law in the United States only requires that mortgage insurance be carried until the homeowner's equity reaches 22 percent. Typically, that means premiums are only paid for four to six years.
Williamson said that the burdensome requirements placed on homeowners is needless because it doesn't serve the homeowner to pay for more insurance than he possibly needs.
Finance ministry officials acknowledge that CMHC is being reviewed, but give no indication which direction, if any, changes might take.
Steve Mennill, director of products and strategic direction for mortgage direction at CMHC, is on record saying that American-style flexibility is not applicable to the Canadian market: Our product, for the moment, is appropriate. End of discussion.
CMHC does not respond directly to criticism of their mortgage insurance racket. Rather than address the criticisms levelled at the corporation, its officials point to the good that it does. Karen Kinsley, president of CMHC, points to the fact that one-third of Canadians are aided in the purchase of their home by the corporation through the purchase of mortgage insurance. We were the first to help Canadians who could afford homeownership but hadn't saved a large enough down payment to purchase their first home, Kinsley wrote to the Financial Post this past summer.
That might be true, but buying such insurance could be made less expensive if the burdensome regulations were relaxed and more flexibility offered.
In her letter to the Post, Kinsley also notes the other ways the CMHC contributes to the well being of Canadians, namely through the financing of affordable (subsidized) housing. It also advises the government on housing policy and provides research on the housing sector. Our information products help people make informed purchasing and business decisions, Kinsley brags.
But CMHC's critics wonder if, ideally, it would not be better to separate the responsibilities. In his Financial Post column, Corcoran called for the entire insurance arm of the crown corporation to be hived off and privatized.
Williamson said that the billion-dollar profits of the CMHC will either end up in the federal treasury or be used to cross-subsidize CMHC's housing projects for low-income Canadians, including aboriginals. The CMHC anticipates capital reserves accumulated surpluses of more than $8 billion by 2009. Williamson said that it will be tempting for the government to use that money for program spending or paying down the debt, but that the surplus rightfully should be returned to policyholders in the form of rebates.
The problem with the massive surplus, he explains, is that the crown corporation is doing the government's social policy, and there arises questions about accountability and transparency.
Williamson said there is no reason why the same entity that provides mortgage insurance needs to also build housing for low-income Canadians, but he is not calling upon the government to privatize the insurance arm of the corporation. Rather, he would like to see Ottawa encourage competition in the mortgage insurance sector.
Even though there is one private-sector rival in the mortgage insurance game, Genworth is more of a follower than a competitor. Premiums and programs are set by CMHC, and often the day after changes at the crown corporation are announced, Genworth follows suit. When CMHC announced in June that it would permit interest-only mortgages that is, mortgages in which only the interest is paid for the first few years of the loan before payment begins on the principal Genworth immediately followed suit. At the same time, whereas Genworth's American division provides rebates under certain conditions, the Canadian branch offers none. Might that have something to do with the highly competitive U.S. market, where seven private companies are competing for 70 percent of the market while the government has only 30 percent of the market locked up?
In Canada, the presence of CMHC scares away competitors. When asked why the insurance industry does not provide mortgage insurance, a spokesman with the Insurance Brokers Association of Canada said simply, Our members don't do mortgage insurance. He added that he did not know why, but speculated that it was because it is specialized insurance. Yet an executive at one insurance company who did not want to be identified says that there is little interest in the insurance industry to get into the mortgage insurance market, because no one wants to compete with a government-backed goliath. Williamson understands. No one wants to compete with Ottawa. The CMHC, with the vast resources of the government behind it, discourages others from risking their capital.
Kinsley notes that CMHC is awash in cash right now because of the extraordinarily strong housing market. Even CMHC's critics will admit that when housing prices are increasing by 7 percent to 8 percent, and new housing starts remain strong, there is going to be a lot of home-ownership, and thus more mortgage insurance.
But James Sears, co-owner of Toronto-based Trillium Mortgage, says that CMHC is contributing to the overstimulation of an already hot housing market by making it easier to get a mortgage, with its policy of insuring interest-only loans. Such extra stimulation, Sears explains, is needed when the housing market is cool. Right now, It's simply irresponsible.
That is not the only reason CMHC comes in for criticism from Sears. He explains to all his clients that the mortgage insurance does not insure the borrower, but rather the lender. That is, when someone defaults on mortgage payments, the lender will be guaranteed their money. But the borrower often faces harassment from CMHC. Sears says, It is a misconception that mortgage insurance protects against default. It doesn't. It protects the bank against their default. The CMHC goes after the borrower for the lender.
Yet homeowners who take out mortgages for 75 percent or more of the value of their house are required to purchase insurance. Sears advises clients of an option: get a first mortgage for the first 75 percent of the house and a second mortgage for the remainder. However, because second mortgages are obtained at higher interest rates, this only makes financial sense when the second mortgage can be paid off in three years.
Sears said that few mortgage brokers explain this to clients because it takes time, is complicated and, perhaps, many think it is impossible to get around the government's regulations.
Williamson calls on the government to encourage competition within the mortgage insurance industry. While ideally a company that makes a billion-dollar profit would be privatized its profitability proves that it does not need government support Williamson says the government need not take such a drastic step to reform the mortgage insurance industry. Changing the rules by which it operates so that there are flexible plans offered to consumers is urgently needed to help save homeowners needless expenses. The Canadian premiums hover in the 2 percent to 2.15 percent level, while in the United States they are typically 1 percent of the mortgage cost. The difference for Canadian homeowners is typically more than $2,000. That amount triples when you take into account the interest on the mortgage itself, which the insurance is rolled into.
CMHC should also be made to face competitive pressures so that the free market spurs new innovation within the industry, with consumers benefiting.
Williamson says that now is also the ideal time for change at CMHC. Noting that the Conservative government is in tune with middle-class values and that homeownership is part of those values, he is optimistic that Ottawa will carefully consider reforms that ensure that homebuyers do not pay more for mortgage insurance premiums that they need to.
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