Mortgage Insurance as a Macroprudential Tool: Dealing with the Risk of a Housing Market Crash in Canada

In an era of rising house prices and high mortgage debt, heightened concern over the potential exposure of Canada’s mortgage insurance system – and taxpayers – is merited. While Canada has not experienced a US-style housing bust, house-price declines ranging from 30 percent to 50 percent have occurred in many other OECD countries since 1970. When accompanied by rising unemployment or preceded by lax underwriting standards, housing busts have resulted in loan losses that threatened the solvency of the financial system. Since large busts have occurred across countries with different housing-finance structures, it is vital that Canada’s housing-finance system is able to withstand such a crisis. The federal government currently backstops mortgages insured by the Canada Mortgage and Housing Corporation (CMHC) as well by private mortgage insurers, meaning taxpayers are ultimately on the hook for a share of losses. Our analysis indicates that a low-probability severe housing crash could result in roughly $17 billion of losses for mortgage insurers. Although mortgage insurers’ reserves currently exceed the minimum required, these losses would leave the federal government with a bill of up to $9 billion to recapitalize mortgage insurers. Canadian mortgage insurance already partially incorporates key features that are needed for a solid macroprudential mortgage insurance system. Underwriting standards are prudent and well enforced, especially after recent reforms. In addition, the federal government guarantees – for a fee – all mortgage insurers. However, while the architecture is sound, there is still scope for strengthening. Our recommendations focus on better aligning the structure, pricing and oversight of the governmentsupported mortgage insurance backstop with the objective of mitigating the likelihood and damage from housing crises. Our recommendations: • Redesign the government backstop to focus on events that include a severe housing crash along with rising unemployment. The backstop should be organized as a standalone fund that accumulates reserves in advance of a housing crisis up to a target level and has the capacity to borrow against future revenue if needed. • The Financial Institutions Supervisory Committee (FISC) should oversee the backstop fund, particularly its pricing policy, accumulation of reserves and target level for reserves. • Mortgage insurance backstop should be available only for the residential ownership market. These reforms would better position the Canadian mortgage insurance system to address the risk of a severe housing crash.