A Second Look at the CMHC

The CMHC guarantee is a direct and unconditional obligation of CMHC as an agent of Canada. It carries the full faith and credit of Canada, and constitutes a direct and unconditional obligation of and by the Government of Canada.[ref]http://www.cmhc.ca/en/corp/about/anrecopl/upload/2010AR_EN.pdf[/ref]

If the above quote doesn’t bother you, it should, because it represents a potentially massive amount of debt that will be shoveled on to to backs of every man, woman and child in Canada. A government bureaucracy, staffed by unelected functionaries, has pledged over a trillion of your tax dollars as payments to investors should their decisions turn sour.

In The Canadian Moral Hazard Corporation I highlighted the issues faced by the Canadian mortgage and housing market. As a country we’re faced with record high levels of debt in both absolute and relative terms, record high housing prices and record low levels of savings. Based on overly-rosy future outlooks, Canadians have by and large become extremely leveraged and could soon have little to show for it.

In order to really understand just what we’re facing as a nation and how it will unfold, a closer inspection of the CMHC is needed. It’s also instructive to compare the CMHC to other similar organizations. For this comparison, it will be appropriate to use Fannie Mae (FM) in its 2007 incarnation. The CMHC is essentially the Canadian-based clone of FM with only one major exception; the US-government had a choice whether or not to bail them out. FM was 50% owned by the US government and 50% publicly traded. The CMHC is, by contrast, a 100% government-owned crown corporation.

Raw numbers on their own aren’t always useful, it’s better to look at ratios and leverage ratios give us a good look as to how far down the debt-hole a company has ventured. So without further ado:

CMHC 2010 Fannie Mae 2007
Assets to Equity 25.64 20.05
Guarantees to Equity 73.46 65.63
Debt to Income 18.89 18.73

From the vital statistics above, it’s obvious that the CMHC is in an even more precarious position than FM. It is more leveraged in every respect and so the conditions are ripe for a collapse in this company. Its exposures to credit, interest and market risk are extremely high and it appears that little is being done to correct this situation. Little can be done though since the contracts have been signed and promises already made to investors.

Further compounding the situation is the short-term nature of CMHC’s debt. Much of which matures over the next few years.

Canada Mortgage Bonds

(in millions of dollars) Amount Maturing Yield
2011 36,152 4.07%
2012 38,956 4.30%
2013 36,128 3.40%
2014 36,025 2.53%
2015 31,008 2.52%
2016-2020 19,219 3.40%
Total 197,488 3.40%

Borrowings from the Government of Canada

(in millions of dollars) Amount Maturing Yield
2011 1,661 2.71%
2012 1,406 3.59%
2013 26,137 3.58%
2014 29,133 2.52%
2015 2,275 3.68%
2016-2020 1,442 7.18%
Thereafter 2,215 8.41%
Total 64,269 3.40%

Interest expenses are the largest line item on the income statement, making up 68% of all expenses. Rising interest rates will quickly wipe out what little net income the CMHC is still making, further endangering the company. If they start realizing losses, the company will either have to start selling off its assets or borrow even more at higher rates, further compounding the problem. Over half the CMHC’s assets are made up of mortgage-backed securities that they themselves guarantee. Turning from a net buyer to a net seller of MBS will have a profound impact on the mortgage market.

In fact, it appears that the CMHC doesn’t even consider credit risk an issue since they make absolutely no allowances for it. Instead we’re faced repeatedly with the statement that “CMHC’s liabilities are backed by the full faith and credit of the Government of Canada and there is no significant change in value that can be attributed to changes in credit risk.” When an organization knows that it can get in to debt and guarantee anything it wants in the pursuit of profit, and be able to put the taxpayer on the hook for it all if it goes bad, is it any wonder that this is what happens?

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5 Responses to “A Second Look at the CMHC”

  1. Raja K says:

    BOC has been indicating the coming rise in rates. We are at such low rates and high leverage that a small rise in rates is enough to derail the train. Low rates have artificially allowed so many extra houses and commercial properties to be built and sold. Net present values with such low rates projected into the future with only moderate increases cause unsustainable projects to appear sustainable.

    As the reality of rising rates sets in these projects will start to look unsustainable, hence, leading to a loss cutting. Now the average person doesn't like to take a loss and is probably going to hang in there tough allowing the savvy to dump their properties until the time that the holder of properties can't take it any longer and dumps at the bottom . Some with enough financial resources will hold it all the way down and back up leading to years of lost gains until they break even.

    I would even suspect commodity prices and food prices to continue to rise. These rises may reverse for some quarters because of simple profit taking or short term market conditions but the longer term seems primed to support the price rise. This also means gold might continue to go beyond the 2000 mark in a few years as well with most currencies depreciating due to rapid printing.

    New opportunities will be aplenty once the bubble bursts and in a few years the housing market ripe for buying. For lets hope our freedom and liberties are not compromised when all's looking temporarily bleak.

    The US credit problems were resolved by the concerted effort of the developed countries and they central banks. I suspect the Canadian housing market was a bit stronger and before it could bust the coordinated effort to drastically lower rates reflated the market and it's been going up since then. This situation is untenable and eventually the piper will have to be paid for such excesses.

    It doesn't seem easy to predict for how much longer the party shall last. I just hope when it comes to an end my children don't end up in state marred by ultra-socialist tendencies and rules.

  2. I shared this article on my Facebook wall and one of my friends made the following comment:

    "A pretty primitive look at CMHC and its dealings if you ask me. The Canadian housing market is nowhere near what the US market was in 2007; Canada's loan-to-value standards along should prevent the massive defaults on housing loans which would actually force CMHC to ask the Canadian tax payer to cover CMHC's obligations."

    Your thoughts?

  3. Redmond says:

    Unfortunately Steven, the people who put us on this path are long dead. We are entering the fiat money endgame.

    We should just call it even, lose the BoC and reestablish free banking!

  4. Steven says:

    There is a simple solution to this. Once CMHC gets bankrupt and once the government of Canada gets bankrupt, for the new people that will replace the current oligarchy to arrest Stephen Harper, James Flaherty & Mark Carney, and all their wives, children and grand-children, confiscate all their goods and force them to daily work until they repay the gov debt. This will send a strong message to any looter that might want to consider taking over the country and sending it in huge debts for their own political benefit.

    Also, the power to be can give the finger to the banks and pay them nothing for not taking any risk and for approving mortgages without a serious credit check.

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