Risky Business

There are few occasions in history where a government getting involved helped. There are countless examples of times where the government getting involved completely fucked things up. It seems that government of today cannot help themselves.

One of the least covered stories in the mortgage world seems to be the Canadian Housing Trust, and the CMB pools. I would really hope than most of the people in our business know about the CMB, and how mortgages are securitized and sold, but maybe that is a topic for another day. However, as most of us know, mortgages are bundled and sold as bond in the markets. Mortgages are funded with monies raised in the CMB pools.

In last years fall economic update, it was announced that the Canadian Government was going to mess around with a system that has worked well for decades. Of course a government has not heard of the old saying ” If it ain’t broke – don’t fix it”. No, no, they just had to meddle with it. Lets dive in.

Now, before I begin, I am going to give a very BROAD overview of things. I know I have many people that follow me that are experts on the CMB, the housing trust, that trade bonds etc. I am trying to give some broad strokes and a general concept here for people that may be less than aware, so please don’t email me and tell me I was out by 4 bps on my example. Trying to cover off every single detail of how the CMB pool works will take hours.

Mortgages in Canada that are underwritten by CMHC are bundled together into bonds, and sold in the open market. This is done through the Canadian Housing Trust, and the Canadian Mortgage Bond. This is done in collaboration with CMHC, the BOC and the Finance Department. CMHC guarantees the bonds, and it does so by collecting insurance premiums from borrowers and lenders. The bonds are sold in the open market to investors internationally, and investors right at home. Quite often pension funds, hedge funds, etc will purchase these bonds, as CMB bonds pay a higher interest rate than government bonds. The spread is usually around 20 bps. Since CMB bonds are guaranteed by a Crown Corporation in CMHC, there is an implied government guarantee, but not an actual government guarantee. Luckily, in Canada we have never had to test out how implied that guarantee is – at least until now.

You see, the theory always was that CMHC collected enough money in premiums to backstop the guarantee on the CMB bonds. CMHC was a money making machine for decades. In fact, CMHC made sooo much money, that rather than keep the excess profits in CMHC, and save for a rainy day, the Liberal government in 2017 decide to raid the coffers. CMHC has paid almost 17 BILLION dollars to the federal government since the switch. 17 BILLION dollars that has had no line item in the budget, and 17 BILLION dollars that has been able to be spent with no accountability. And people wonder why the government didn’t want to stop the housing bubble?? CMHC will tell you it is healthy, and everything is fine – and I am not doubting that, but they would be even more fine if they had the extra 17 BILLION dollars they donated to Ottawa back in their own hands.

However, CMB bonds are running into some trouble with purchases. Maybe international investors are not buying Canada bonds because we are a clown show? Maybe they don’t like the Fiscal track record of our current government? Maybe international investors started getting spooked when the Federal government seized bank accounts only 24 months ago on a moments notice? Maybe Canada having one of the most overheated housing markets in the world makes it hard to sell bonds backed by Canadian houses?

Rather than addressing the problem of CMB bonds itself, our government decided to come up with another solution: Buy the CMB bonds themselves. So, basically the Canadian government will now purchase 50% of all CMB’s issued in Canada going forward. That amounts to around 30 BILLION dollars in 2024. The Canadian government will sell 30 Billion worth of Government debt, and then use the proceeds to buy CMB’s. The interest payments on the CMB’s that the government collects will be used to pay the interest on the government bonds that were issued. Here’s the rub: The CMB’s pay a slightly higher rate than the government bonds. Since CMB’s were issued by CMHC and never explicitly backed by the government, there was always a slight premium on the CMB’s over the federal government debt. It is usually around 15 to 20 bps. However, when the government collects 15 to 20 bps on 30 BILLION dollars a year, it adds up to a lot of money. So the feds will sell government bonds, use the proceeds to buy CMB’s, and keep the interest rate spread difference for themselves.

Alright, so you may think that it is a free way for the government to make money – which it is, but there is a larger problem hiding beneath the surface. First and foremost, the Canadian tax payer is now guaranteeing mortgages at CMHC. Since the government is buying the CMB’s, they are not about to let housing bonds go down in value, since they hold 50% of the bonds. This is effectively taking CMHC debt and moving it from an implied government guarantee to an explicit government guarantee. Tax payers are now backing the Canadian housing market directly. The second problem we have is duration. CMB bonds are generally 5 year and 10 year ( at least that is what the government is buying ) while the bonds they are issuing to purchase CMB’s are 1, 2, and 3 year government bonds. Effectively the government is trying to be a bank and borrow short and lend long. If rates come down in the bond market the plan works well – however, if rates for some reason rise, the government bonds will have to mature at a potentially higher interest rate than the government is getting on the CMB bonds. This seems like a lot of risk to make a 15 to 20 bp spread on the bonds. The third major problem we have is that the government has now taken the BOC out of play for buying CMB’s and using those bonds to QE and QT the economy ( for the record, the BOC will be the facility that buys the CMB’s for the government, but they will not be held on the BOC balance sheet ). The BOC was able to use its balance sheet, for example in COVID to allow QE to get things going again, and is now using its balance sheet to tighten things back. Taking control from the Central Bank is akin to removing the central banks abilities. So, is the central bank in Canada independent of the politicians now? This stinks like the central bank losing a lot of its independence and the ability to control its mandate. And to add a cherry to the top of this shit show, international investment in CMB’s is likely to drop further going forward. Since CMB prices are now basically set by the government since they are the largest shareholder, investors are unlikely to want to own the other 50% of the CMB notes as they will all be subject to the whim of the current government. The current administration should not be able to touch even a dollar, yet now they will control 50% of all issuance from the CMB pool? Ask yourself a question: would you purchase a product where the government controlled what happen to it? Would you invest your money in a venture whereby the current government gets to decide your fate? I sure as hell wouldn’t!!!

At the end of the day, this program switch is nothing but pure crap. It was labelled as a way for the government to use the CMB to build more affordable housing, but we all know that will never happen. If it was that easy to build housing – it would have already happened. God knows Canada has sent enough money to Ukraine over the last 24 months, we could have build thousands of affordable homes – but we didn’t. Canada could have spent the hundreds of millions that got spent on scandals to build affordable homes – but it didn’t. So, why then, will this money be used to build affordable homes? Simple – it won’t. Plain and simple this is a way for the government to get their grubby hands on more taxpayer money – without having to show it as a line item, and then use the control of the CMB market to make their own political fortunes. With control of the CMB pools, the government can enact QE whenever they want without BOC oversight. The monetary policy of a country should never be placed in the hands of a currently elected government – especially a government who thinks you can tax the society to make the weather better, and a government who thinks that budgets balance themselves. The current administration has now put taxpayers on the hook for the Canadian housing market – whether they want to be or not. This is moral hazard by definition – the people that took out the most debt will be saved, while the people who saved all their money pay for it.

Of course the media will spin this as a way for the government to make a “free” hundred million or so in spread on the bonds, and help build housing – but we all know it is bull shit. The risks far outweigh the potential rewards, and we have now started down a slippery slope of the government taking away independence from the BOC. No other developed nation in the world has ever done this, and so I think we really need to ask ourselves why the hell Canada seems to ” need ” to do this.

To me, it seems like risky business to put every Canadian on the hook to back the most overheated housing market in the world – but hey, what do I know?