CMHC and the Canadian House of Debt

I almost won the lottery in 2015.

The number was 1508. The ticket was not a lotto generated at a tumbledown corner store. It was a piece of the sky on King East, soaring above Don Valley Parkway in modular blocks, like stacked containers.

“You need to get in on the real estate market” said my uncle, as he scrolled through his digital rolodex looking for a contact. “Omar,” he bellowed into the phone, “there is someone I want you to meet.” Omar had made his fortune selling luxury Toronto real estate to oil-rich sheikhs, and, I was told, had privileged access to pre-construction condos.

When I met Omar the next day at the Shangri La, he exuded the calculated warmth of a corporate banker. Sitting at the lounge, he walked me through the math. Real estate in Toronto goes up by seven percent every year. With the leverage built into a pre construction payment plan, the ROI will be 25% per annum. I could sell the condo at completion and pocket the capital gains. “But I’m buying a condo to live in and I don’t see myself living there,” I objected.

“These condos are not for you or me to live in,” he retorted. “They are investments, and you need to make an investment that maximizes your return.”

When did our homes become financial instruments, commodities traded by investors, safe haven assets prized by oligarchs, get-rich-quick schemes peddled by speculators?

A group of men are picketing outside Hotel Vancouver on an icy January evening. “End government buck-passing” reads one placard. “Civic disgrace!” says another. The year is 1946 and Vancouver is in the midst of a housing crisis. The grand hotel, where Winston Churchill once stayed, now lies empty, while returning World War Two veterans have nowhere to go.

Sergeant-at-arms Bob McEwen was one of these veterans. His search for a home to settle down with his wife was waylaid by the acute housing shortage. The vacancy rate was under one percent, with suitable housing next to impossible to find, and yet politicians continued to dither. By January 26th, he’d had enough. That afternoon, McEwen led 30 veterans of the Canadian Legion to occupy Hotel Vancouver. The victory banner they put up on Granville and Georgia announced, “Action at Last / Veterans! Rooms for You. Come and Get Them.”

The housing situation in Vancouver was a microcosm of urban Canada.

There were 620,000 Canadian troops in active deployment as the war machine of WW2 was winding down. They were now returning. The veterans needed homes, but the Great Depression and the war had severely constrained housing supply. Bearing an uncanny similarity to the current housing crisis, households in the 1940s were forced to ‘double-up’ and live in congested, over-crowded homes. Finding a place to live is “a nerve-wracking, heart breaking, time and money consuming experience” exclaimed Toronto Star in 1943, capturing the zeitgeist of the era.

That is the problem Canadian Mortgage & Housing Corporation (CMHC) is founded to solve.

In the two decades that follow, CMHC redefines Canadian housing. A new home building industry takes shape, creating construction jobs and economic opportunity. Between 1945 and 1966, Canada’s housing stock doubles. The middle class moves into mass-produced single-family homes dropped adjacent to cities. The suburbs are born.

This is also an era of urban renewal. Slums are cleared, replaced by city halls and public monuments. Ambitious social housing projects rise up, modeled after contemporary ideals of utopian living.

CMHC’s founding mission was to “improve housing and living conditions” and it delivered. CMHC’s vigor for housing development continued into the seventies — but the political climate had started to shift. Neoliberalism was on the rise and large government programs were falling out of favor. CMHC started to withdraw from housing programs, while doubling down on financialization of home ownership through its mortgage insurance business.

The mortgage on your house is like an anthill. All you see is the mound on the surface. Hidden underneath is a vast architecture that props up the economic system. If you’re like most first-time homebuyers, your mortgage is insured by the CMHC. That means the lender, usually a bank, carries virtually no risk. If you default and the house value tanks, CMHC is on the hook to make the bank whole. Why is a Crown Corporation in the business of helping financial institutions make a killing with almost no risk? That’s a good question.

Your bank pools a bunch of insured mortgages into financial instruments called Mortgage Backed Securities (MBS). Since these securities are guaranteed by the government, investors are willing to buy them for very low interest rates. This money percolates back to you, the home buyer.

The purpose of this financial engineering is to keep the mortgage market liquid. That’s banker-speak for ensuring there is always money sloshing along the system, so you can get a loan when you need it — these days with a low interest rate.

Mortgage insurance underwritten by the taxpayer made sense after WW2 when banks were reluctant to lend to returning veterans. The insurance protected banks from downside risk hence they were more willing to lend, unlocking capital for home building and homeownership. But what happens when lenders can take risks without having to endure the consequences?

Research by two respected economists at Princeton and University of Chicago offers a glimpse. Atif Mian and Amir Sufi stitched together data on consumer debt, house prices and mortgage terms at the zip code level, and it provided an unexpected insight. Home prices in certain zip codes were not going up because of income and employment growth, but because of credit supply. And the source of that credit supply? Mortgage originators who transferred the risk by selling pooled mortgages to unsophisticated investors.

In other words, if lenders don’t carry the risk, they will make mortgage credit easily available. If credit is available, people borrow. When people borrow, home prices go up. The cycle repeats until homes become unaffordable, households are weighed down by debt and the economy tips into a severe recession.

The impact of this credit-fueled exuberance is felt most acutely by millennials.

Intergenerational wealth transfer is the source of much excitement and consternation among wealth managers. The term refers to the wealth that boomers are leaving their millennial children as they die. These wealth managers have it backward. If you broaden the aperture, the main transfer of wealth is not from boomers to millennials, it moves in the other direction.

According to Generation Squeeze, a typical young person in the GTA needs to work for 21 years to save for a downpayment. It took their parents only 6 years. The stagnation of real wages coupled with house price inflation impoverishes millennials and enriches those who own property, often the older generation.

Not only is the government policy to encourage homeownership exacerbating housing affordability, it is also at the heart of wealth inequality. Middle and lower income households are held between the jaws of a tightening vise; between escalating rents that eat into their savings and home prices that continue to skyrocket beyond their reach.

What happens when the return to investors is much higher than the economic growth? We get a world in which those who own assets accumulate wealth, while those who provide labour struggle to get by. A world of income stagnation and social immobility. We get the world we live in.

Mark Blyth, a professor of political economy at Brown University, traces the rise of right-wing authoritarianism to 30 years of deregulation culminating in the bank bailouts of the Global Financial Crisis. “The global revolt against elites is not just driven by revulsion and loss and racism,” he wrote in a 2016 article, “It’s also driven by the global economy itself.”

Canadian housing as an asset-class is a card carrying member of the global economy, a destination of choice for hot capital in need for a snow-wash. Unless the government cleans up and invests in livable, affordable housing, there is a risk that those who feel left behind will occupy more than just Hotel Vancouver.

“By 2030, everyone in Canada has a home that they can afford and that meets their needs.”

That is the aspiration of a CMHC that is reinventing itself, from a backstop for banks to the backbone of Canadian housing. This is the right direction, bold and urgent, but it’s also one that requires confronting inertia and entrenched interests. Can the corporation that makes $1.3B from insurance premiums transfer risk to the lenders in order to better protect taxpayers? Can policymakers safeguard public interest against well-funded lobbying by finance, insurance & real estate companies? Can we roll-back the financialization of real estate, so homes are homes first — not assets seeking market returns?

Five years ago, I did not buy that lottery ticket disguised as a pre-construction condo. It seemed overpriced for 600 sq. ft. bathed in the fumes of DVP. By 2019, the price of that unit had gone up by $200,000. That shoebox in the sky made more money after taxes per year than a postdoc working feverishly in a lab to invent the next vaccine.

The postdoc would do much better as a real estate agent. Who needs vaccines anyway?

ACKNOWLEDGEMENTS

Terence & Farid for your encouragement and editing support, Mehryar, Aaron & Nanu for your insightful comments, Maryam for being a willing and attentive reader, and my banker friends (S. & D.) for incisive feedback on mortgage securitization.

NOTES & REFERENCES

Atif Mian & Amir Sufi’s 2008 research paper on the consequences of mortgage credit expansion; and of course, for coining the term House of Debt, which I’ve shamelessly appropriated

Jill Wade, A Palace for the Public, coverage of post-war Vancouver housing

Sean Perdy, ‘It was tough for everybody’; personal stories of post-war housing

Barbara Wake Caroll, Post-war Trends in Canadian Housing

Generation Squeeze, Straddling the Gap

Bank of Canada, Residential mortgage Securitization in Canada: a Review

Òscar Jordà, The Rate of Return on Everything

Image Credit, Unsplash, Ian; Greystorm