The Canada Mortgage and Housing Corporation complex in Ottawa.The Globe and Mail
Ian Russell is a partner of Russell Deacon & Company and past president of the Investment Industry Association of Canada.
In several somewhat innocuous sentences in the budget papers in March, the federal government put forward a sweeping proposal to overhaul the financing mechanisms and related infrastructure of Canada’s successful mortgage-backed bond market.
While those unacquainted with the arcane world of securitized finance have overlooked the budget proposal, it has provoked surprise and concern in the financial sector, even with a familiarity of the interventionist tactics favoured by government.
At issue is the Canada Mortgage Bonds, or CMB, operated by Canada Mortgage and Housing Corp. These bonds are a key source of mortgage credit – the money that investors pour into these bonds is ultimately what is loaned out to borrowers. It’s a system that has worked well. Ottawa’s proposal to overhaul that system comes with more risk than advantages and is the wrong decision.
The federal government says it has identified significant cost savings and potential revenue by displacing CMB with regular Government of Canada bonds. The reason stated is that investors in regular government bonds get lower yields than CMBs – the former is therefore cheaper for the issuer to finance. The resulting savings, the government says, will go toward affordable housing programs.
The precise details for this overhaul are left to coming consultations. But according to the government, the estimated savings total a probable $1-billion.
A preliminary assessment of the budget proposal, however, makes it clear the cost savings and potential revenue from the proposed consolidation of the CMB and Canada bond markets are overestimated, much less than the estimated $1-billion. This applies even if we take at face value the government’s rationale for the move, which many in the finance sector have disputed.
First, the substantial amounts of additional Government of Canada borrowing to replace the $260-billion in currently outstanding CMB, and additional funding of continuing new mortgage originations will push up average Canada bond yields, estimated roughly five basis points, making it more expensive for the government to issue. (A basis point is one-hundredth of a per cent.)
Further, an upward move in bond yields would need to be even higher to encourage the large contingent of foreign investors in CMB to reinvest in Canada bonds. These investors are now invested $100-billion in CMB, just under half of CMB outstanding, and these bonds carry a yield of 30 basis points above that of regular government bonds. With CMB gone, it will be hard to attract these investors to Canada bonds and keep them in Canadian assets.
Moreover, as Government of Canada bonds are the benchmark for pricing the domestic bond market, the higher yields needed to replace the outstanding CMB will result in higher yields right across the market, including provincial, municipal and corporate bonds.
Finally, the liquid CMB bond markets have become over time a natural hedging instrument for regular government bonds with similar maturity and are integrated into the Canada markets. The steady withdrawal of this hedging instrument from the markets would make regular bonds less attractive, weakening liquidity of it and correspondingly push up yields even more, making them even more expensive for the government.
It is clear the proposed restructuring of the securitized mortgage market, with consolidation of the CMB market as its centrepiece, will not generate anticipated cost savings needed for affordable housing.
Meanwhile, the risks to potential damage and loss of the successful existing mortgage-backed market are understated, high and consequential.
The success of the proposal depends on instilling confidence on a consistent government commitment to the matter. Any ripple will result in dislocations in the mortgage market and higher mortgage rates. And much effort will need to be taken to rebuild the market if the proposal fails to meet its objectives.
The overhaul of Canada Mortgage Bonds could result in large negative unintended consequences in financial markets and risk damaging a highly successful and well-functioning mortgage finance program.
The focus and priority of the planned consultations on the matter by the federal government should be to determine the merits of the budget proposal before proceeding, not to determine how to implement the proposal.