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Clayton Research Submission in Response to Finance Canada's 2006 Review of Financial Sector Legislation:

Economic Analysis of the Statutory Requirement for Insurance on High-Ratio Mortgage Loans

Clayton Research

Prepared for:

Genworth Financial Canada
May 26, 2005

Executive Summary

The recent Federal Budget indicated that the Federal Government is seeking views on the implications of removing the statutory restriction on residential mortgage loans exceeding 75 percent of the value of the property made by federally regulated financial institutions, unless the loans are covered by mortgage insurance. Genworth Financial Mortgage Insurance Company Canada (hereafter referred to as Genworth) retained Clayton Research to undertake an analysis of the economic implications of such a change.

This report addresses the following questions:

What has been the impact of mortgage insurance on the economic well-being of Canadian households?
To what extent has mortgage insurance contributed to the economic efficiency of the mortgage market in Canada?
To what extent could the economic well-being of households and the efficiency of the mortgage market change if mortgage insurance was no longer statutorily required for federally legislated financial institutions? and
Should mortgage insurance remain statutorily required for mortgage loans exceeding 75 percent of the value of the property made by federally legislated financial institutions?

Annex 6 of the 2005 Budget Plan - by focusing primarily on whether lenders still need to be protected from fluctuating property values, and whether some insured borrowers may be paying too high costs - is too limited in its scope. It masks the larger issue of how consumers in general and the efficiency of the mortgage market itself would be impacted by allowing more flexibility with respect to requiring mortgage insurance on high-ratio loans.

The conclusion regarding the continuation of the statutory requirement for mortgage insurance for high-ratio residential mortgages is strong and decisive: compulsory mortgage insurance is a vital component of Canada's highly efficiency mortgage marketplace and contributes in a significant way to the economic well-being of Canadians. It would be inappropriate and not in the public interest to drop compulsory insurance on high-ratio mortgage loans at this time. Without mortgage insurance, higher risk borrowers who now qualify for high-ratio loans would likely pay a higher price for mortgage funding.

This report addresses the following questions:

What has been the impact of mortgage insurance on the economic well-being of Canadian households?
To what extent has mortgage insurance contributed to the economic efficiency of the mortgage market in Canada?
To what extent could the economic well-being of households and the efficiency of the mortgage market change if mortgage insurance was no longer statutorily required for federally legislated financial institutions? and
Should mortgage insurance remain statutorily required for mortgage loans exceeding 75 percent of the value of the property made by federally legislated financial institutions?

This would conflict with federal housing policy that encourages households to become homeowners. Moreover, it is not clear that requiring these households to pay more for housing than under the present system would be in the public interest.

Key findings of the research are outlined below:

The mortgage market and mortgage insurance have been important vehicles for the implementation of Federal housing policies, especially the goal of encouraging homeownership

The housing and mortgage markets are closely intertwined given the dependence of home purchasers on mortgage financing;
Residential construction is an important driver of the economy in terms of direct economic activity, downstream spending by recent purchasers on appliances and furnishings and internal and external renovations, and consumer spending fuelled by rising housing wealth; and
Mortgage insurance has contributed to household well-being by enabling prospective buyers to buy a home sooner.

The mortgage finance system in Canada has shown itself to be innovative and adaptable to changing borrower needs, both in terms of the products offered and the changing role of the participants in response to emerging market opportunities

The residential mortgage market in Canada is highly efficient from a capital market perspective and is given plaudits from independent observers, including the Bank of Canada - mortgage insurance is an important element of the Canadian mortgage market;
The growing importance of mortgage securitization and mortgage brokers in the mortgage market are two illustrations of how the mortgage market has adjusted to changing circumstances in a way that promotes market efficiency,
The panoply of mortgage products now available for borrowers to select is probably the most conspicuous feature of the ability of the mortgage market to adjust to the needs of its borrowers;
Mortgage insurance underpins several significant mortgage market developments including the rise in mortgage securitization, the entry of new lenders into the mortgage market and the growing role of mortgage brokers; and
Mortgage insurance allows big and small lenders alike to compete in the high loan-to-value segment of the mortgage market.

Mandatory mortgage insurance allows big and small lenders alike to compete in the high loan-to-value segment of the mortgage market

Mortgage insurance is issued at origination for the life of the mortgage Mortgage insurance pools risk across lenders, geography and product types through successive origination years. This ensures that mortgage insurance is available at more stable and predictable rates in good times and bad times when other risk mitigation techniques may have fled the market or be priced too high. This supports the continued availability of mortgage financing through all phases of an economic cycle;
Risk-based pricing favours large lenders with sophisticated risk management systems and a geographically different client base. Smaller lenders and regional lenders in the prime market would likely lose market share to the larger national lenders, as their risk would be pooled over a smaller base, and they may have lower economies of scale with respect to the costs of internal risk management systems; and
Dropping mandatory mortgage insurance would reduce the ability of smaller mortgage lenders (both existing and new entries) to compete with the larger chartered banks with their much more sophisticated credit and difficult risk assessment capabilities. This would not be in the public interest.

If the statutory requirement for mortgage insurance on high-ratio mortgage loans is removed, the logical alternative is that prime market lenders would consider risk-based pricing. While risk-based pricing may increase the options available for borrowers, it introduces added complexity and reduced transparency into the borrowing process. Although low risk borrowers may pay less, a large group of higher risk borrowers may pay more and have reduced mortgage financing options.

Should some prime sector lenders decide to adopt risk-based pricing for lower risk customers, this could provide some financial benefits to this lower risk group. However, the gain among this group would be at the expense of the higher risk groups remaining within the mortgage insurance pool, as mortgage insurers may have to increase premium rates to reflect the increased risk of the pool,
There is potential for lenders in the prime market who self-insure to charge fees above those warranted by the inherent risk, as long as the fees were still below what the borrower would pay under a mortgage insurance system. The extent to which lenders could extract such a premium would depend on the degree of competition for this business;
Literature on the U.S. market suggests that while there may in theory be potential market efficiencies in a wider role for risk-based pricing beyond the subprime market, it is far from clear that these market efficiencies would in fact occur. Moreover, because of the potential for market failure associated with an expanded risk-based pricing presence in the mortgage market, there will be increased responsibilities placed on the shoulder of financial institution regulators; and
A shift away from compulsory mortgage insurance would disadvantage borrowers living in rural and northern areas since, once again, the higher risks inherent in these areas are averaged over all borrowers in the insurance pool.

Financial institution regulations should not become complacent about housing price behaviour based on the robust housing market conditions that have prevailed over the past several years following the economic recovery since the mid 1990s. This experience only reflects the "upside" of a rather unique economic cycle.

Property value fluctuations will continue to be part of the future housing market as they have been in the past and that these fluctuations cannot be predicted at the time mortgage loans are being made.
It is well known that households in Canada have been committing to higher and higher debt levels, much of it being mortgage debt. Until now, the burden of repayment has not increased correspondingly since interest rates have been very low. This situation could change rapidly if an external shock to the Canadian economy were to cause sharply higher interest rates or a marked drop in consumer confidence resulted in a reduced interest in homeownership.
There is also beginning to be concern that prices in the housing market are reaching a "bubbly high" and may be poised for a decline.

Executive Summary

1 Introduction

1.1 Scope of This Paper

1.2 Some Background on Mortgage Insurance in Canada

1.3 Structure of Paper

2 Mortgage Insurance and The Economic Well-Being Of Canadians

2.1 Housing and Public Policy

2.2 Housing and the Economy

2.3 Housing and the Economic Well-Being of Households

2.4 Mortgage Insurance and Homeownership

2.5 Chapter Summary

3 Mortgage Market Efficiency Including the Role of Mortgage Insurance

3.1 Defining Mortgage Market Efficiency

3.2 The Evolving Mortgage Marketplace in Canada

3.3 Mortgage Market Efficiency in Canada

3.4 An International Perspective on Canadian Mortgage Market Efficiency

3.5 Chapter Summary

4 Economic Well-Being And Mortgage Market Efficiency In The Absence Of The Statutory Requirement For Mortgage Insurance

4.1 Annex 6 of Budget Plan 2005-Too Limited in its Scope

4.2 Financial Institutions Still Need Protection from Economic Downturns

4.3 Risk-Based Pricing as an Alternative to Statutory Requirement for Insurance on High-Ratio Mortgage Loans

4.4 Assessment of winners and Losers in the Absence of the Statutory Requirement for Mortgage Insurance

4.5 Mortgage Market Efficiency in Canada Without Statutory Requirement for Insured High-Ratio Mortgages

4.6 Chapter Summary

5 Conclusions

1 Introduction

1.1 Scope of This Paper

This paper addresses the following questions:

What has been the impact of mortgage insurance on the economic well-being of Canadian households?
To what extent has mortgage insurance contributed to the economic efficiency of the mortgage market in Canada?
To what extent could the economic well-being of households and the efficiency of the mortgage market change if mortgage insurance was no longer statutorily required for federally legislated financial institutions? and
Should mortgage insurance remain statutorily required for mortgage loans exceeding 75 percent of the value of the property made by federally legislated financial institutions?

1.2 Some Background on Mortgage Insurance in Canada

1.2.1 The Origins of Mortgage Insurance in Canada

Prior to the National Housing Act (NHA) being passed in 1954, it was difficult to buy a home in Canada, as lending practices were very stringent as reflected in:

High downpayment requirements averaging 50 percent of the value of the property; and
No blended payment mortgage - with a fixed repayment of principal amount, monthly payments were very large in the early years of the loan.^[1]

Mortgage insurance in Canada was introduced with the passage of the NHA in 1954. The insurance program compensated lenders for homeowners' default losses. It was modelled on the Federal Housing Administration's insured mortgage program which had existed in the United States since the 1930s.^[2]

One of the goals of mortgage insurance was to bring the chartered banks into residential mortgage lending and to reduce dependence on public funds.^[3] Previously, life insurance companies had been the largest private mortgage lenders with the Federal Government providing funding as part of a joint loan program.^[4] The newly introduced NHA was accompanied by changes in The BankAct, which permitted banks to lend against government-insured residential mortgages.

The original mortgage insurance program was, with hindsight, quite narrowly focused and rigidly defined:^[5]

Only NHA mortgages were eligible for insurance;
Only new homeownership and new rental housing could be insured;
New houses to be insured had to meet NHA construction standards and Canada Mortgage and Housing Corporation (CMHC) - at that time called Central Mortgage and Housing Corporation - construction inspections;
Maximum loan limits helped to target lower middle income households as the beneficiaries of the increased private mortgage credit generated,
A uniform mortgage insurance premium was applied to all high-ratio loans, regardless of loan-to-value ratio (LTV) or location;
Lenders intending to make NHA mortgage loans had to be approved by CMHC; and
CMHC could establish prescribed maximum interest rates on insured loans.

The 1954 NHA also allowed for CMHC to conduct auctions of NHA-insured mortgages, provided the mortgage administration was undertaken by an approved lender, to pension funds, individuals and others. CMHC was given authorization to buy and sell NHA-insured mortgages as well.

1.2.2 The Evolution of Mortgage Insurance

The changes to the mortgage insurance program in Canada since it was first introduced in 1954 have been striking. These changes have had the effect of integrating the residential mortgage market with the larger capital market^[6] generally for the purpose of improving access to homeownership on the part of Canadian households.

Among the more significant events affecting the mortgage insurance market have been the following:

In 1966, existing homes became eligible for insurance under the NHA;^[7]
In 1967, The Bank Act was amended to remove the six percent interest rate ceiling on bank loans, including mortgage loans, to allow banks to make conventional mortgage loans;^[8]
In 1969, the NHA interest rate ceiling was removed and the minimum term for NHA mortgages was reduced from 25 years to five years-then reduced to three years in 1978 and one year in 1980, with variable rate mortgages becoming eligible for NHA mortgage insurance in 1982;^[9]
In 1970, lenders were allowed to make high-ratio conventional loans providing they were insured by a private or public mortgage insurance provider;^[10]
As a result of the 1970 change, the business of the Mortgage Insurance Company of Canada (MICC), a company incorporated in December 1963 and allowed to insure high-ratio loans made by selected lenders, increased considerably;^[11]
Two new private mortgage insurance companies, Sovereign Mortgage Insurance Company and Insmor Mortgage Insurance Company, were incorporated in 1972 and 1973, respectively-these insurers remained small in comparison with MICC;^[12]
In 1978, Sovereign and Insmor merged retaining the name of Insmor Mortgage Insurance Company and in 1981 Insmor and MICC merged retaining the name of MICC;^[13]
In 1979, mortgage insurance extended to include financing of existing rental units;^[14]
In 1982, the NHA was amended to allow for mortgage insurance premiums to vary according to the default risk (differing loan-to value ratios).^[15] Also, the maximum loan-to-value ratio for NHA insured loans was lowered to 90 percent from 95 percent;^[16]
CMHC's mortgage insurance program was subject to a mandate review in 1987 with the Federal Government reaffirming its continuation;^[17]
In 1987, the introduction of Mortgage Backed Securities (MBS), which allowed pools of NHA-insured mortgages to be packaged and interest in these pools resold in varying denominations, made mortgages more attractive to a broader range of investors than previously-the timely payment of principal and interest were fully guaranteed through CMHC as the agent of the Crown; ^[18]
In 1992, CMHC reinstituted 95 percent financing for first-time buyers under the First Home Loan Insurance program and the Federal Government allowed for the use of RRSPs for downpayments; ^[19]
In 1993, MICC had to suspend its mortgage insurance operations,^[20]
In 1995, GE Capital Mortgage Insurance Company (GECMIC) entered the Canadian mortgage insurance market, and "raised the level of competition to new highs"^[21] (in 2004, GECMIC's name was changed to Genworth Financial Mortgage Insurance Company Canada); GECMIC introduced portability for mortgage insurance (transfer from one property to another);
In 1996, the Federal Government directed CMHC to view its "mortgage loan insurance and guarantee operations as commercial tools in a competitive environment to achieve public policy objectives" -these objectives included the promotion of housing affordability and choice for homebuyers in all regions of the country and ensuring competition and efficiency in the housing finance system;^[22]
In 1998, the restriction on the 95 percent loan-to-value mortgages to just first-time homebuyers was removed;^[23]
In 2001, GECMIC insured mortgages qualified for the Mortgage Backed Securitization program and its mortgage insurance was expanded to cover equity take out refinancing. ^[24] CMHC also introduced a new refinance product that was "designed to allow homeowners to optimize the use of home equity";^[25]
In 2002, GECMIC expanded its insurance to cover applicants with good credit ratings, but who cannot provide traditional income verification (i.e. self employed borrowers and commissioned sales employees) by introducing Alt-A BFS (business-for-self) loans;^[26]
In 2003, CMHC and GECMIC reduced mortgage insurance premiums by 15 percent and eliminated the homeowner price ceilings. CMHC also introduced new products including Rental Refinance (permits insured second mortgages on rental properties), Homeownership On-Reserve and Secured Line of Credit.^[27] GECMIC followed by introducing Home Equity Line of Credit Mortgage Insurance. In addition, GECMIC mortgage insurance was expanded to cover cash-back loans;^[28] and
In 2004, both GECMIC and CMHC expanded their insurance coverage to secondary homes and GECMIC expanded its coverage to vacation properties. CMHC also introduced the Mortgage Loan Insurance for Energy-Efficient Homes and for Self-Employed borrowers.^[29] CMHC launched Flex Down, a product that allows the borrower to provide a downpayment from a variety of sources including borrowed funds.^[30]

The scope and frequency of changes to the country's mortgage insurance system, which have accelerated in recent years, illustrate its adaptability to changing circumstances.

1.2.3 Mortgage Insurance in 2005

Mortgage insurance now is vastly different than when public mortgage insurance was introduced into Canada 51 years ago. High-ratio mortgage borrowers have an array of insurance products and terms available. A large share of the mortgage market (approximately 45 percent) is covered by mortgage insurance in urban centres as well as rural areas across Canada. Insurance premiums have been declining and there is vigorous competition between the federal Crown Corporation and the private sector insurer.

The Canadian mortgage insurance industry consists of two insurers: one public, CMHC, and one private, Genworth Financial Mortgage Insurance Company Canada (Genworth), the new name for GE Capital Mortgage Insurance Company Canada. CMHC is a federal Crown Corporation that now has the mandate to operate commercially to achieve public policy objectives, most notably in the housing policy sphere. Genworth is part of a large international insurance company based in the United States (Genworth Financial Inc.) which provides mortgage insurance in a number of countries.

Mortgage insurance is a key feature of the mortgage market in Canada:

Mortgage insurance is a big business. In the year 2003, the volume of insured high-ratio residential mortgage loan approvals (both CMHC and Genworth) totalled about $64 billion, according to the Conference Board of Canada;^[31]
According to Conference Board of Canada estimates, nearly half of all residential mortgages in dollar terms in Canada in 2003 were insured high-ratio loans - market shares were about 70 percent for new housing and about 42 percent for existing home sales;^[32]
The number of homeowners protected by mortgage insurance climbed sharply through the 1990s with the introduction of 95 percent loan-to-value ratios and the entry of Genworth (then GE Capital Mortgage Insurance Company Canada). Data from the Bank of Canada show that for the chartered banks, which by far are the largest single source of mortgage funds, the penetration of mortgage insurance reached nearly 60 percent of total mortgage credit outstanding in the late 1990s before moderating to about 48 percent in 2003 (see Figure 1); and

Figure 1

finance - image

Mortgage securitization has grown substantially since its beginnings in the mid 1980s, especially since the latter 1990s. At the end of 2004, total NHA Mortgage Backed Securities (MBS) outstanding stood at $75 billion. The NHA MBS amounts were equivalent to 12.7 percent of the total residential mortgage credit outstanding in Canada ($589 billion). All these securitized mortgages have mortgage insurance. The remainder of the securitized market is through "special purpose vehicles", and accounted for $13 billion of mortgage credit outstanding at the end of 2004 (this includes non NHA insured mortgages and NHA mortgages that have been securitized outside the NHA MBS program).^[33]

Key features of mortgage insurance in Canada today include:

Insurance coverage is available across the country, in rural as well as larger urban centres;
Mortgage insurance is available for the purchase of new and existing homes as a primary residence, the purchase of second homes and the refinancing of existing mortgages (home equity loans). Mortgage insurance is also available for rental and on-reserve housing;
Loan premiums vary according to the loan-to-value ratio, but are the same for all locations;
Risk assessments are conducted to determine applicants' eligibility for mortgages, but the credit quality of borrowers does not affect the mortgage insurance premium payable for prime mortgages, as contrasted with subprime mortgages which are discussed in Section 4.3 (a more general discussion of the prime vs. subprime markets is provided in Section 3.2,4);
For no additional premium, mortgage insurance is portable from one property to another, and
Both mortgage insurers have loss mitigation programs that help keep borrowers in their homes during temporary financial difficulties.

1.3 Structure of Paper

This paper contains four chapters in addition to this introduction. Chapter 2 examines the relationship between mortgage insurance and the economic well-being of Canadians. Chapter 3 focuses on the efficiency of the Canadian mortgage market and the role of mortgage insurance. Chapter 4 examines how economic well-being and mortgage market efficiency could be altered in the absence of statutorily required mortgage insurance on high-ratio mortgages. The final chapter presents the study conclusions.

2 Mortgage Insurance And The Economic Well-Being Of Canadians

The residential mortgage market exists to service the housing market. This chapter looks at how the mortgage market and mortgage insurance have influenced the economic well-being of Canadians through their impact on housing.

2.1 Housing and Public Policy

2.1.1 Housing is a Unique and Complex Good

In economic terms, housing is considered a stock that provides a flow of housing services over a lengthy period of time. Home purchasers prepay the expected future flow of housing services when they buy a home. Renters, in contrast, pay for housing services as they are consumed. A fixed location is a key attribute of housing. This has consequences for local economies across the country since much of the construction work is done on site.

Housing is very much intertwined with social policy. Providing households with adequate housing at an affordable cost has been a long standing policy of the Federal Government. Adequacy encompasses the physical quality of housing units as well as the number of persons per unit (a measure of overcrowding).

Because of its durability and initial cost, the purchase of housing is heavily dependent on mortgage financing. The availability, price and terms of mortgage financing have immense consequences on the housing market. The Federal Government has often used CMHC's mortgage insurance activities as a vehicle for implementing housing policy.

2.1.2 Encouraging Homeownership is a Goal of the Federal Government

While the provision of adequate and affordable housing for all Canadians has been, and remains, a goal of Federal housing polity, a second theme has been to encourage Canadians to become homeowners.

Figure 2 highlights trends in the homeownership rate in Canada in the period since 1951. The majority of households have always owned their own home but there have been distinctive patterns in the ownership rate.

After remaining constant in the 1950s (at 66 percent), the ownership rate declined sharply in the 1960s as pre and earlier baby boomer children left home to establish rental households. The ownership rate then climbed between 1971 and 1996, generally at a modest pace and has been rising sharply since 1996.

Figure 2

finance - image

Looking only at the trends in the ownership rates, which are heavily influenced by changing demographics and household income growth, masks the tremendous growth that occurred in the number of homeowning households, especially since the early 1970s when the baby boomers began to enter the ownership market (see Figure 3). The growth in owner households has been increasing significantly since the mid 1990s relative to the growth in the 1980s and early 1990s.

Figure 3

Census Period	Owners	Renters	Total

	Households (000s)
1951-1961	75.5	39.8	115.3
1961-1971	62.9	84.7	147.6
1971-1981	150.7	74.3	225.1
1981-1991	113.1	60.6	173.7
1991-1996	120.9	39.4	160.4
1996-2001	146.5	2.1	148.6

Source: Claytom Research based on information from Statistics Canada, Housing Stock in Canada, The Provinces and Territories and Census of Canada.

Albeit Rose, a noted housing policy expert, characterized Federal housing policy in the 1945 to 1964 period as "strongly in favour of the attainment of homeownership by every family''^[34] and described the importance of working through the mortgage market to achieve this objective:

Every effort was made to provide adequate supplies of mortgage money, to manipulate the interest rate, and to set forth appropriate terms to encourage individual homeownership. Not only was mortgage money made available through the National Housing Act at rates lower than those prevailing in the money markets, but downpayments were successively reduced as loan amounts were increased. The period of amortization increased from fifteen years in 1946 to twenty, then twenty-five, and then to its present length of 35 years or more to enable lower-income families to acquire a home of their own.

In the 1970s, the Federal Government, as part of the major reform of the income tax implemented in 1971, exempted capital gains from the sale of a principal residence from taxation. At the same time, the tax provisions on rental housing investment were tightened. This exemption has provided a significant incentive for households to buy a home.

In 1973, CMHC launched the Assisted Home Ownership Program that was directed at making homeownership accessible to lower income families with at least one dependent child.^[35] In 1974, the Federal Government introduced the Registered Home Ownership Savings Plan (RHOSP) which allowed renters to establish a RHOSP account in which a maximum of $1,000 per year could be deposited tax free with interest earned also being tax free. This program continued into the mid 1980s.^[36]

In 1982, during a severe housing downturn, the Federal Government introduced the Canada Homeownership Stimulation Plan (CHOSP) which provided $3,000 cash grants to help with the purchase of a new home.^[37] This grant program continued through 1983.

In the early 1990s, the federal Government introduced the Home Buyers' Plan (HBP) that allowed would-be homeowners to withdraw up to $20,000 from their RRSPs to apply against a downpayment for a home. In 1992, CMHC extended its mortgage loan program (the First Home Loan Insurance) to allow first time buyers to qualify for a 95 percent loan-to-value ratio in their financing, which was later extended to all homebuyers.^[38]

Encouraging homeownership remains a goal of the Federal Government. CMHC in its 2003 Annual Report states:^[39]

Through our mortgage loan insurance and securitization program, CMHC continued to fuel the success of Canada's housing sector by helping countless Canadians to realize their dreams of homeownershp.

Mortgage insurance, both public and private, has played a pivotal role in Federal initiatives to promote homeownership since it was introduced in 1954, as the above quote from CMHC indicates.

2.2 Housing and the Economy

2.2.1 Housing Sector is an Important Contributor to Gross Domestic Product (GDP)

Residential construction, as defined in the National Accounts, accounts for a relatively large component of the country's GDP-about 5.3 percent per year over the past five years on average. This spending encompasses spending on new housing construction excluding land, renovations to the existing housing stock, and ownership transfer costs related to transactions of new and resale homes including realtor sales commissions and mortgage insurance fees.

New construction accounted for about one half of total residential construction spending in 2004 with renovation activity (excluding repairs) amounting to just over a third. Ownership transfer costs contributed to about 15 percent of total spending.

2.2.2 Residential Construction Has Grown Much Faster than the Economy as a Whole in Recent Years

Over the past five years, the value of residential construction has grown by about nine percent per year- three times the rate of the economy as a whole (Figure 4). This strength in the housing sector has provided a big boost to the economy, accounting for about 15 percent of growth in 20002004. In 2004, growth in residential construction contributed an extra half a percentage point to GDP growth.

Figure 4

Real Growth Rates, Total Economy and Residential Construction, Canada 1984-2004

2.2.3 Significant Spinoff Spending Generated by Home Purchases

The purchase of a home, whether new or resale, triggers a series of purchases that are not recorded as part of the National Account's residential construction series - part of the so-called multiplier factor. Two major categories of down stream spending are the purchase of new appliances or furnishings and renovations to the recently purchased home, whether to the structure itself or to the surrounding yard (gardening improvements, fencing, etc,).

A recent study conducted by Clayton Research for The Canadian Real Estate Association estimated that the average housing transaction in Canada in the year 2000 generated spending on furniture and appliances of $3,385 while spending on renovations averaged $3,550, for a total of $6,935.^[40] This translates into total spending of about $3.8 billion based on the combined Multiple Listing Service (MLS) residential sales (about 461,100 units) and new home completions (about 188,300 units) in 2004.^[41]

2.2.4 Housing Wealth-Also an Economic Driver

The home Canadian homeowners occupy is, for most, their single largest asset. Housing wealth (the value of homes less outstanding debt) climbed to over 30 percent of total non-human wealth (real and financial assets net of liabilities) in 2003, according to Lise Pichette of the Bank of Canada.^[42] Moreover, housing wealth in real terms has been on an upward trend since at least the early 1960s.

A spin off benefit from rising real housing wealth, according to Pichette, is its effect on consumption. She estimates that households spend an average of 5.7 cents of each additional dollar of housing wealth.

CIBC economists estimate that the appreciation in home prices added more than $7 billion in extra consumer spending last year and a cumulative $21 billion over the past three years.^[43] This is equivalent to more than 20 percent of the total increase in consumer spending over this period.

2.2.5 Efficient Mortgage Market Aids Monetary Policy Transmission Mechanism

Monetary policy operates through the capital market to influence the level of spending in the real economy and, consequently, prices. With the increasing integration of the housing finance system with the overall capital market, changes in monetary policy are transmitted quickly to the mortgage market with a concomitant influence on the housing market Prior to this, when mortgage interest rates were less responsive, through either government regulation or market stickiness, a misallocation of resources devoted to housing could occur over the housing cycle.

2.3 Housing and the Economic Well-Being of Households

2.3.1 Average Ownership Dwelling Has Increased in Size

The high and growing homeownership rate and the sizeable contribution of housing to total household wealth are measures of the importance of housing to the economic well-being of households in Canada Another indicator is that homeowners on average have been able to buy more housing since the early 1950s. The average size of owned dwellings has increased from 5.8 roams in 1951 to 7.1 rooms by 1996. Over the same period the average size of rental dwellings has remained stagnant at 4.5 rooms (see Figure 5).

Figure 5

Housing Condition Indicators, Canada,
1951-2001

	Average Number of Rooms Per Unit		% of Owners with Mortgages

Census Year	Owner	Renter

	Rooms		Percent
1951	5.8	4.5	Less than 33%
1961	5.8	4,4	45.5
1971	6.1	4.4	52.8
1981	6.6	4.3	n.a.
1991	7.0	4.5	51.5
1996	7.1	4.5	11.a.
2001	na.	n.a.	55.2

Note: Percent of owners with mortgages for 1961 and 1971 based on single-detached owneroccupied dwellings only. Source: Clayton Research based on data from Statistics Canada. Canadian Social Trends, Winter 2000 and the Census of Canada

2.3.2 The Availability of Mortgages Has Contributed to Economic WellBeing

The rise in the ownership rate and the betterment in housing conditions among homeowners could not have happened without the ready availability of mortgages to finance home purchases. As Figure 5 shows, the proportion of homeowners with mortgages jumped from less than one-third in 1951 to 55.2 percent in 2001.

The majority of homeowners take on mortgage financing when they buy a home. Figure 6 shows that 89.8 percent of homeowners in the 25-34 age group, a proxy for first-time buyers, had mortgages in 2001.

Figure 6

Percentof Homeowners with Mortgages by Age of Household Maintainer, Canada 2001

2.3.3 The Affordability of Home Purchase Has Been Positive for Economic Well-Being

Access to mortgages at low rates has been a major factor improving the access to homeownership by Canadian households. Figure 7 illustrates how homeownership affordability has changed over the 1971-2004 period. Affordability is calculated as the mortgage payment required to purchase an average priced home, which is sold under the auspices of the Multiple Listing Service (MLS), expressed as a percentage of the average family income in Canada. This ratio stood at 18.0 percent in 2004 compared to 19.5 percent in 1971, 34.7 percent in 1981 and 29.5 percent in 1990. In general, homeownership has been more affordable in the period since the latter 1990s than in any other period since 1971.

Figure 7

Affordability of Home Purchase, Canada, 1971-2004

2.4 Mortgage Insurance and Homeownership

2.4.1 Lack of a Sufficient Downpayment is a Major Obstacle for Prospective First-Time Homebuyers

As already observed, mortgage insurance was introduced in Canada in the early 1950s to lessen the financial burden on households wanting to buy a home. Mortgage insurance contributed to this by allowing smaller downpayments while, at the same time, protecting lenders against loan default losses.

A CMHC survey conducted in late 2004 of home buying intentions in six metropolitan markets found that over half of prospective home buyers plan on making a downpayment of less than 25 percent, thus requiring highratio mortgage financing. Since 40 percent of prospective buyers already own a home, the proportion of first-time buyers looking for high-ratio financing is even higher.^[44]

A recent nation-wide consumer survey from the RBC Royal Bank found similar intentions.^[45] Of the respondents who said they were very or somewhat likely to buy a home in the next two years, only 47 percent stated they intended to make a downpayment of 25 percent or more. For respondents in the under 35 age groups, the predominant first-time buyer age group, only 30 percent expect to have a 25 percent or more downpayment.

2.4.2 Mortgage Insurance Enhances Homeownership

As discussed in Section 2.1.2, a goal of Federal housing policy has been to encourage homeownership based on the concept that homeownership is a "social good". To this end, lower downpayments made possible by mortgage insurance are an important tool for the social good since they provide prospective first-time buyers (generally renters but also young adults in the labour force still living with their parents) the opportunity to buy a home sooner than they would be able to otherwise.

Figure 15 of Section 4.4.1 demonstrates the importance of mortgage insurance to younger households buying a home. Nearly two-thirds of all homebuyers (new and resale homes) under the age of 35 years purchasing a home in 20D3-2004 (the bulk of first-time buyers are from this age group) obtained insured mortgage financing. This compares to 35 percent of buyers aged 35-49 and just 1 11 percent of buyers aged 50 years or over.

Figure 8 shows that ownership rates in the under 35 age groups increased significantly between 1996 and 2001 (really mid 1996 and mid 2001, since this is the timing of the quinquennial Census of Canada) following stability or decline between 1986 and 1996,

Figure 8

Proportion of Households Owning Their Home, by Age Group, Canada, 1986-2001

	1986	1991	1996	2001
Age
Under 25	16.9	13.9	14.1	15.9
25-34	48.8	47.0	45.8	46.7
35-44	70.0	68.0	66.2	67.1
45-54	75.6	74.8	74.0	74.4
55-64	74.9	75.5	76.2	76.9
65 and over	64.3	66.0	68.7	71.2
Total	62.4	62.6	63.6	65.8

Source: Clayton Research based on data from Census of Canada.

Coinciding with this entry of more young households into the ownership housing market was a rapid growth in the volume of high-ratio mortgage loans. Figure 9 shows that between the calendar years 1995 and 2000, the number of homes obtaining high-ratio mortgage loans jumped 54.5 percent compared to 37.2 percent growth in conventional loans (loans with a loan to-value ratio less than 75 percent). The growth in insured mortgage loans by year is illustrated in Figure 1 (these data cover chartered banks only and relate to the proportion of dollar amount of mortgages from the chartered banks that are insured).

Figure 9

Mortgage Loan Approvals Canada, 1995-2000

Type of Mortgage	1995	2000	1995-2000

	Millions ($)		% Growth

High Ratio -	$ 22,106	$ 34,145	+54.5
Conventional	$ 29,842	$ 40,931	+37.2
Total	$ 51,948	$ 75,076	+44.5

Source: Clayton Research based on Conference Board of Canada estimates

The attributes of mortgage insurance became more attractive to prospective buyers in the early 1990s. In 1992, 95 percent financing for first-time buyers was reinstated after a decade of limiting its high-ratio loans to 90 percent of property value In 1998, 95 percent loan-to-value mortgages became

available to all borrowers. According to the Bank of Canada, the rise in mortgage insurance during the 1990s "shows the increased access to mortgage financing that followed the decrease in the required minimum downpayment from 10 to 5 percent in 1992.^[46]

It is clear that a huge proportion of first-time homebuyers since 1992 have utilized mortgage insurance to obtain high-ratio financing. The rise in homeownership coincided with the reintroduction of 95 percent loan-to value financing. The mortgage insurance changes during the 1990s are one of the factors that CMHC states ". . . brought homeownership within reach of many renters."^[47]

2.4.3 U.S. Literature Supports Beneficial Implications of Mortgage Insurance for Homeownership

The results of U.S. research into the influence of mortgage insurance on homeownership cannot be directly transported to Canada because of differences in mortgage financing, housing policy and tax treatment of housing between the two countries. However, it can provide some useful insights for consideration. The basic conclusion from the U.S. literature is that measures that reduce the downpayment requirement have positive repercussions on the timing of the home purchase decision if not on the overall ownership rate (proportion of all households which are homeowners):

Chambers, Garriga, and Schlagenhauf in a recent article examined and modelled the reasons for the steady rise in homeownership rates in the United States since 1995. They concluded that "the decline in the downpayment seems to be the key to understanding the increase in the homeownership rate"^[48]
Quercia, McCarthy and Wachter found that more flexible underwriting guidelines with respect to downpayment and housing burden requirements for lower income and minority households "are likely to increase homeownership opportunities for underserved populations, but that the impact may not be felt equally by all groups";^[49] and
Nichols in 1997 addressed the question whether public mortgage insurance in the United States (FHA) has increased homeownership or just accelerated it. He concludes that FHA is more likely to have accelerated home purchase than to make homeowners of households that otherwise would never be able to buy.^[50]

The literature in Canada is much sparser. Engelhardt examined the impact of the Federal Registered Home Ownership Savings Plan (RHOSP) in Canada which was in place from 1974 to 1985. RHOSP provided prospective first-time buyers with a means to accumulate a downpayment faster through tax savings. He found that the program was relatively popular among households in the prime home-buying years and grew in popularity over time for young households. He concluded the program had "some effect in increasing homeownership among young households".^[51]

2.4.4 Mortgage Insurance Protects Against Consequences That Are Very Costly on an Individual Basis

Insurance by its nature exists because the consequences of a particular event occurring - in the case of mortgage insurance, defaulting on the loan - are costly at an individual level. While few borrowers will actually default on their mortgage loan, when they do, large amounts are typically involved. Mortgage default insurance allows the costs of the risk of default to be shared, and in the situation where a default does occur, provides the same protection to each lender. Genworth also helps borrowers and lenders avoid the adverse consequences and costs associated with mortgage foreclosure through proactive default programs. Genworth works directly with lenders and borrowers to assist borrowers through temporary financial difficulties to help keep them in their homes.

2.5 Chapter Summary

The housing and mortgage markets are closely intertwined given the dependence of home purchasers on mortgage financing;
The mortgage market and mortgage insurance have been important vehicles for the implementation of Federal housing policies, especially the goal of encouraging homeownership;
Residential construction is an important driver of the economy in terms of direct economic activity, downstream spending by recent purchasers on appliances and furnishings and internal and external renovations, and consumer spending fuelled by rising housing wealth; and
Mortgage insurance has contributed to household well-being by enabling prospective buyers to buy a home sooner.

3 Mortgage Market Efficiency Including The Role Of Mortgage Insurance

This chapter focuses on issues related to the efficient operation of the mortgage market in Canada and the role played by mortgage insurance in contributing to an efficient marketplace.

3.1 Defining Mortgage Market Efficiency

A starting point for addressing the elements of an efficient mortgage market is the recent work by the Bank of Canada on the efficiency of Canadian capital markets. Scott Hendry and Michael King state that the role of a capital market "is to transfer funds between savers and borrowers efficiently."^[52] They state that efficiency has three interdependent parts:

Capital markets exhibit "informational efficiency" when financial market participants have all available information about the opportunities and risks involved with different investments;
A capital market exhibits "transactional efficiency" when the transaction costs of transferring funds are kept at a reasonable level; and
A capital market exhibits "allocational efficiency" when firms with profitable investment opportunities (i.e., projects that have a positive net present value) are able to fund these projects, thereby creating conditions for economic growth.

While the Bank of Canada's work has been directed at the Canadian bond and equity markets, including related foreign exchange and derivative markets, the criteria for efficiency can be applied to the residential mortgage market too:

Informational efficiency-borrowers and providers of mortgage funds have access to all available information on the opportunities and risks associated with different mortgage options;
Transactional efficiency-the costs of transferring mortgage funds between borrowers and lenders are kept at a reasonable level; and
Allocational efficiency- providing all borrowers who want to buy a home (or refinance a mortgage) the opportunity to do so since this is positive for economic growth.

While the mortgage market is part of the overall capital market, it is distinctive as has been noted previously. It is very much interconnected with the housing market and Federal housing policy. The encouragement of an efficient mortgage market is part of the mandate of CMHC as Canada's housing agency. Amendments to the NHA in 1996 expanded the "commercialization" of CMHC's mortgage loan insurance and mortgage guaranty activities in order to "help ensure the continuing availability of low-cost financing to home buyers in all regions of Canada, promote market competitiveness and efficiency and contribute to the well-being of the housing sector".^[53]

Mortgage market efficiency should seek to address Federal housing policies in addition to the dictates of an efficient mortgage marketplace. As noted in Chapter 2, mortgage insurance has played a key role in the Federal Government's effort to increase the supply of mortgage funds in both rural and urban areas, thus putting downward pressures on interest rates and overcoming the downpayment obstacle for prospective first-time buyers. Mortgage insurance is also a key element of the Federal Government's mortgage securitization initiatives, which are targeted at broadening the supply of mortgage funds available and represent another tool for making homeownership more available.

3.2 The Evolving Mortgage Marketplace In Canada

3.2.1 The Response of the Mortgage Industry to the Changing Needs of the Housing Market Has Been Innovative and Timely

Lenders in Canada have provided the funds demanded by the housing market in a timely and flexible way. At no time in the past three decades has a shortage of mortgage funds been an obstacle to home purchase. Residential mortgage debt, which stood at nearly $600 billion at the end of 2004, has increased about five-fold over the past 25 years.^[54] This represents an annual growth of about 7.5 percent per year.

While the interest rate on mortgages has not always been as benign as the levels prevailing in recent years, the actions taken by the Federal Government in past years to integrate the mortgage market more with the overall capital market has paid dividends to the borrowing public.

The combined volume of MILS housing resales and new housing completions has risen rapidly since 1997 (see Figure 10), something that could not have occurred without a responsive mortgage market including mortgage insurance).

Figure 10

New Housing Completions and MLS Resales, Canada, 1997-2004

3.2.2 Fundamental Changes in the Structure of the Residential Mortgage Industry

The structure of the residential mortgage industry has changed significantly over the past two decades with trust companies being acquired by the chartered banks, the growth in recent years in the role of mortgage brokers, and the establishment of new specialty lenders such as lenders targeting the subprime portion of the market (the prime vs. subprime markets are explained in Section 3.2.4).

Chartered banks are now the dominant mortgage credit lenders

Currently, the residential lending market in Canada is dominated by the chartered banks, primarily the six big banks, which account for about 73 percent of mortgage credit in dollar terms.^[55] The Credit Unions and Caisses Populaires follow at a considerable distance with about a 15.5 percent market share. The remainder of the institutional loan market (about 11.5 percent) is made up of life insurance companies, trust companies, pension funds and nondepository credit intermediaries like MCAP. The hegemony of the chartered banks is a reversal of conditions before the advent of the NHA when life insurance companies were the primary private sector mortgage lenders.

The disappearance of the larger trust and mortgage loan companies

The market domination by the banks has grown in a major way since the early 1990s. In 1989, trust and mortgage loan companies were formidable competition for the chartered banks accounting for about 30 percent of all residential mortgage assets, not far behind the chartered banks at 39 percent. The acquisition of the trust and mortgage loan companies by the major banks has reduced the trust and mortgage loan company share of residential mortgage assets to only about 1 percent today.

The acquisition of trust companies by the chartered banks was pronounced during the first half of the 1990s. Figure 11 documents these acquisitions by year over the 1991-2000 period. The chartered banks' acquisitions of various trust companies, as well as life insurance interests and other financial institutions, from mid 7991 to late 1995 raised the chartered banks' residential mortgage assets by about $25 billion. In addition, two other major acquisitions occurred after 1995, National Trust in 1997 and Canada Trust in 2000 were acquired by the Bank of Nova Scotia and Toronto Dominion Bank, respectively.

Figure 11

Chartered Bank Acquisitions of Other Financial Institutions, Canada, 1991-2000

Chartered Bank	Acquired Financial Institution	Year of Acquisition

Laurentian Bank	Standard Trust	June 1991
Laurentian Bank	Financière Coopérants	November 1991
Laurentian Bank	Guardian Trust	March 1992
Canadian Imperial Bank of Commerce	Morgan Trust	July 1992
Laurentian Bank	Trust Générale (some branches)	January 1993
Toronto Dominion Bank	Central Guaranty Trust	January 1993
National Bank	Sherbrooke Trust	July 1993
National Bank	Trust Générale (most branches)	July 1993
Royal Bank	Royal Trust (included International Trust and Banker's Trust)	September 1993
Laurentian Bank	Prenor Trust	January 1994
Bank of Nova Scotia	Montreal Trust	April 1994
Toronto Dominion Bank	Confederation Trust	December 1994
Laurentian Bank	North American Trust	October 1995
Canadian Imperial Bank of Commerce	FirstLine Trust	October 1995
Bank of Montréal	Household Trust	December 1995
Bank of Nova Scotia	National Trust	1997
Toronto Dominion Bank	Canada Trust	2000

Source Clayton Research

The maintenance of market share by Credit Unions and Caisses Populaires

Credit Unions and their Quebec counterparts, the Caisses Populaires, have been able to maintain their market share of a rapidly growing mortgage market. In terms of total mortgage credit, these lenders have accounted for about 13 percent of the total over the past decade. In part, this stable market share has been achieved through the acquisition of branches that chartered banks had closed in some rural areas.

New lenders entering the marketplace

A number of new lenders have entered the mortgage market since the early 1990s. These include traditional lenders and companies specializing in a particular facet of the mortgage market. They include both U.S and European lenders as well as Canadian lenders (see Figure 12).

Figure 12

Entrants to the Canadian Mortgage Market, 1987-2004

Name	Type	Year Entered Market	Residential Mortgage Assets
			$ Millions

FirstLine	Prime/Subprime	1987	More than S12 billion of mortgages under administration (2002)	First Line is a branchless lender financial institution that offers innovative residential mortgage loans to ft the needs of each individual client. FirstLine Mortgages is a division of CIBC Mortgages Inc. Mortgages are originated exclusively through brokers.

First National	Prime	1988	About $9 billion in mortgages under administration (2003)	First National is a Canadian-owned financial services company that specializes on a full range of mortgage products to homeowners, investors and developers. Mortgages are originated through brokers and First National experts.

Gibraltar Mortgage Banking	Subprime	1994	n.a.	Gibraltar is a mortgage banker that offers commercial and residential mortgages serving borrowers that do not meet the requirements of the major financial institutions. Mortgages are originated exclusively through brokers.

Citizens Bank	Prime	1997	1,030 (January 31, 2005)	Citizens Bank was formed by Vancouver City Savings Credit Union (VanCity). It is a branchless chartered bank that offers commercial and residential mortgages. It advertises discounted or effective rates (lower than the posted rates of the big five banks) - no negotiation. Mortgages are originated through different channels including the bank's website, telephone and brokers.

ING Direct	Prime	1997	8,215 (January 31, 2005)	ING (International Nederlanden Group) Direct is a branchless chartered Canadian bank. It advertises discounted or effective mortgage rates (usually at least 1% lower than the posted rates of the big five banks) - no negotiation. ING Direct originates mortgages through a number of channels, including the public Website, a secure site for clients only, telephone and brokers.

Bridgewater Services	Prime	1997	About $1 billion in Financial mortgages under administration (2003)	Bridgewater is a mortgage banking company specializing in high-ratio CMHC insured mortgages with terms of up to 10 years across Canada. Bridgewater is owned by the Alberta MotorAssociation (AMA), which is affiliated with the Canadian Automobile Association (CAA). Bridgewater originates product through a network of mortgage brokers.

MCAP	Prime/ Subprime	1998	295 (January 31, 2005)	MCAP is Canada's largest independent mortgage and equipment financing company that offers NHA/conventional residential mortgages, equity mortgages, and subpdme mortgages. MCAP utilizes a number of channels to generate referrals for mortgages, including a network of independent mortgage brokers as well as life insurance agents, lawyers and financial planners.

Maple Trust	Prime	1999	1,070 (January 31, 2005)	Maple Trust is a growing national trust company focused on residential mortgage lending and deposit products. Deposits are used to fund mortgage loans. Mortgages are originated through mortgage brokers.

Entrants to the Canadian Mortgage Market, 1987-2004, con't

Name	Type	Year Entered Market	Residential Mortgage Assets	Services

			$Millions
DR Residential Mortgage Trust	n.a.	1999	n.a.	n.a.

Coast Capital Savings	Prime/Subprime	2000	$4,047 (October 31, 2003)	Canada's second largest credit union that serves customers across the Fraser Valley, Lower Mainland and Vancouver Island. Coast Capital was the result of a merger between Richmond Savings and Pacific Coast Savings. It offers a wide range of mortgage products at low rates. An account/membership is required to apply for a mortgage with Coast Capital.

Italian Canadian Savings & Credit Union	Prime	2000	n.a.	The Italian Canadian Savings & Credit Union is the first Credit Union of Italian Canadian Heritage created to serve the Italian community in the GTA. It offers financing on various types of properties including single-family dwellings, condominiums, and investment properties.

PC Financial	Prime	2000	n.a.	PC Financial offers a range of mortgage products for firsttime home buyers, transferring or refinancing mortgage. It advertises discounted or effective mortgage rates (lower than the posted rates of the big five banks)-no negotiation.

Xceed	Subprime	2001	$14,615 (October 31, 2004)	Xceed is a specialized, single-family residential mortgage lender that serve borrowers that cannot meet the requirements of major financial institutions. Mortgages are originated through other financial institutions (banks) and brokers. Xceed finances mortgages with its own working capital and a warehouse line of credit provided by a major chartered bank.

ResMor	Prime	2002	81 (January 31, 2005)	ResMor is a federally regulated trust company focused on residential mortgage lending, mortgage servicing and deposit products. ResMor relies on broker networks as a source of mortgages.

GMAC Residential Funding	Prime/Subprime	2002	n.a.	GMAC Residential Funding of Canada is a wholly owned subsidiary of GMAC Residential Funding Corporation of Minneapolis, offers residential mortgage loans across Canada through Mortgage Intelligence, Canada's largest mortgage broker. It offers prime and subprime mortgages.

Wells Fargo Financial	Subprime	2003	Over $1 billion (2005)	Wells Fargo Financial Canada Corporation is an affiliate of Wells Fargo & Company that provides banking, insurance, mortgage and consumer finance to Canadians who have a poor or non-existing credit history. Mortgages are originated through a network of brokers and branches.

AGF Trust	Prime	2004	287 (January 31, 2005)	AGF Trust is a wholly owned subsidiary of AGF Management Limited, one of Canada's largest wealth management companies. It offers mortgages and home equity loans. AGF distributes its products through independent financial advisors and mortgage brokers.

Cervus Financial	Prime	2004	n.a.	Cervus Financial is a Canadian mortgage lender that is focused on funding and servicing conventional and high ratio residentia: mortgages originated through mortgage brokers.

These new entries are linked to the growth in independent mortgage brokers, the appetite of institutional investors for highquality debt instruments to replace the shrinking supply of Government of Canada bonds, and the growth of securitization. They are providing competition to the large chartered banks through already discounted posted rates (e.g. ING Direct) and providing innovative products to clients.

Rise in mortgage securitization

Since the introduction of NHA Mortgage-Backed Securities in 1987, the volume of securitized NHA mortgage loans has increased sharply to an estimated $75 billion at the end of 2004 (see Figure 13).^[56] Securitized NHA mortgages now account for 12.7 percent of all residential mortgage credit outstanding and a third of the growth in outstanding credit between 2002 and 2004. This is in large part due to the launching in 2001 of the Canada Mortgage Bonds Program (CMB) that includes a timely payment guarantee by CMHC.

Private securitized residential mortgages started in 1995 with an estimated $0.1 billion and as of the end of 2004, the volume of private securitized residential mortgages was estimated at $13.3 billion.

Mortgage securitization has a number of advantages which enhance the efficiency of the mortgage market, including:

The diversification of funding sources,
Efficient capital management,
Lower cost of funds, and
Better asset-liability snatching.

Figure 13

Growth of Securitization in Mortgages, Canada, 1990-2004

3.2.3 A Panoply of Mortgage Products

Probably the most conspicuous change in the mortgage landscape over the past decade has been the growing selection of mortgage instruments and terms available to borrowers. It was not many years ago that the mortgage menu for borrowers included only limited terms - from one to five years, no prepayment privileges (conventional mortgages) or prepayment with a three month interest penalty, and generally uniform industry-wide interest rates. A perusal of the web page of TD Canada Trust illustrates the range of mortgage products available through the chartered banks at the present time:

Fixed Rate Mortgage Products include Fixed Rate Mortgage with terms from 1 to 10 years; Six-Month Convertible Mortgage with the option of converting to a closed term at any time during the 6 months; One-Year Open Mortgage with the option to prepay any amount without penalty and flexibility to convert to a longer term; four percent and five percent CashBack Mortgages for five to ten year terms for borrowers paying the "posted" rate (see discussion of quoted and discounted rates below); and No Down Payment Mortgage; and
Variable Interest Rate Products include Closed Variable Interest Rate Mortgage with a mortgage rate less than the TD prime rate; Variable Interest Rate Mortgage (Open) with the option of increasing payments at any time or paying off part of the mortgage without penalty; Home Equity Lines of Credit; and High-Ratio Mortgage:
High-Ratio Mortgage allows purchasing a home with a downpayment as low as zero, diverse payment options (e.g., weekly, monthly), ability to increase payments up to 100 percent, and a prepayment option of up to 15 percent per year.

This array of mortgage products allows borrowers to select the mortgage that best suits their individual circumstances and needs. These products include mortgage insurance for self-employed borrowers or for prospective home buyers who cannot provide traditional income verification, home equity lines of credit and others (see Section 1.2.2).

3.2.4 Mortgage Insurance Has Extended the Prime Mortgage Market

The mortgage market has two main "tiers", which are based in large part on credit scores. Credit scores take into consideration a variety of factors, including payment history, amounts owed, length of credit and types of credit in use. The higher the credit score, the lower the credit risk.

The prime (or "A") segment of the mortgage market has typically served borrowers with credit scores of 660 or above, with the subprime market largely those with credit scores below this level. However, more recently, mortgage insurance has extended the scope of the prime market to borrowers with credit scores of 620 and above, as well as to some with scores below 620 (based on a consideration of other factors).

Currently within the prime market in Canada, credit scores are considered to determine if someone qualifies for an insured mortgage or not, however they are not used in the pricing of the mortgage. Credit scores are often used as a basis for pricing in the subprime market.

3.2.5 Separation of Mortgage Market Activities

One of the major structural changes that has occurred in the mortgage market in recent years is the "unbundling" of various market related activities. Origination, funding and servicing can now be done by a number of different players, rather than simply the lender. A securitization market and a risk transfer market are required for this unbundling to effectively take place. Mandatory mortgage insurance has been an important factor for both of these activities.

3.2.6 Rate Discounting and the Growth in Mortgage Brokers

For most of the period since 1954 the interest rate quoted by mortgage lenders was the rate the borrower paid. Beginning in the early 1990s when mortgage lenders were flush with cash and home sales depressed, the banks began offering mortgage interest rate discounts to their better customers or borrowers who would transfer other business to them (e.g. chequing accounts, RRSPs, investments). Borrowers soon caught on to the discounting game and discounts spread throughout the mortgage business with fewer and fewer purchasers paying posted rates. Overtime the gap between the posted and discounted rates of many lenders increased. However, many borrowers were left wondering if they were getting the bank's "best rate".

Mortgage rate discounting created opportunities for mortgage brokers to shop for the best rates on behalf of borrowers. The brokers had the advantage to advertise the best (discounted) rates while the chartered banks advertised the higher posted rates. The percentage of mortgage loans (new and renewals) involving brokers jumped from an estimated 14 percent in 19^,99 to 26 percent by 2003.^[57]

Brokers provide new distribution opportunities for traditional lenders as well as new entrants. By shopping for the best rates and terms for borrowers, among approximately 40 competing mortgage lenders, mortgage brokers have significantly enhanced competition.

Smaller lenders intent on expanding their mortgage business began advertising the effective interest rates (posted less discount). These lenders include ING and PC Financial.^[58] The banks fought back by offering "best rate mortgages" for selected terms (e.g., five years).

All this competition among lenders has been an important factor in interest rate discounting, thus improving housing affordability.

3.2.7 Mortgage Insurance Provides Mortgage Financing in Smaller Urban Centres and in Rural Canada

CMHC has a mandate to ensure that households in Canada have access to homeownership. It provides mortgage insurance to all parts of the country including rural and northern areas and on-reserve housing. Likewise, Genworth also insures mortgages throughout Canada, with a disproportionate amount of Genworth volumes being done in smaller centres (outside census metropolitan areas, see Figure 14).

Figure 14

Genworth's Insured Business and Housing Market Activity Outside Census Metropolitan Areas by Region, 2004

Even though losses are generally larger in smaller communities and rural areas than in large census metropolitan areas, both CMHC and Genworth charge the same insurance premium in all areas, thereby pooling the risk between smaller and larger centres.

3.3 Mortgage Market Efficiency in Canada

3.3.1 Mortgage Market in Canada: Innovative, Adaptable and Competitive

The review of the current mortgage market in Canada, including both the mortgage lending industry and mortgage insurers, demonstrates mortgage borrowers across Canada are being increasingly well served. They now have a large array of mortgage instruments from which to choose and the product range is continually changing as lenders try to get ahead of their competitors. The two mortgage insurance providers also are very adaptable in their efforts to gain market growth. The entry of Genworth -formerly GE Capital Mortgage Insurance Canada - into the Canadian marketplace created a very competitive environment for mortgage insurance, as commented in a 2001 speech by the then President of CMHC, Jean-Claude Villiard. Mortgage insurance by both providers has aided in the achievement of Federal housing polices by making competitive insurance products available for homeowners in all parts of Canada.

3.3.2 Gap Between Effective Mortgage Rates and Bond Rates Has Narrowed

One significant indicator of mortgage market efficiency is the differential between a relevant benchmark interest rate and the effective mortgage rate. If the mortgage market is becoming more efficient over time - due to lower costs incurred by lenders, the expansion of funds through securitization and/or the reduction of risks-this efficiency would be reflected in the narrowing of the differential between these two rates.

Rate discounting was introduced into the Canadian marketplace in late 1993. Prior to this time, posted rates were essentially the effective rates. During the latter 19806 and early 1990s, the typical gap between the 5 year Government of Canada bond rate and the 5 year conventional mortgage rate was about 200 basis points (see Figure 15)

Today the gap between the bond rate and the effective mortgage rate is much narrower. Measuring the effective mortgage rate in the marketplace is difficult, as most lenders typically publish rates above those that they ultimately provide to borrowers. However, data from ING Direct-which has advertised rates below the typical published rates of the major banks -can be used to approximate the prevailing effective 5 year term mortgage rate.

A comparison of the ING rate to the 5 year Government of Canada bond rate suggests that the gap between the 5 year bond rate and effective rate in recent years has averaged closer to the 120 basis points range, much narrower than the 200 basis point range that existed in the latter 1980s early 1990s.

Figure 15

Comparison of Government of Canada Bond Rate, Published Mortgage Rate and ING Mortgage Rate, Selected Periods

3.3.3 Bank of Canada Analyses Consistent with View that Mortgage Market is Efficient

The Bank of Canada has been conducting research on the efficiency of Canadian capital markets. One recent analysis considers selected features of the residential mortgage market "with a view to drawing inferences about their implications for the efficiency and stability of the Canadian financial system".^[59] Among the features examined are: the dominance of the banks as mortgage lenders and indications they intend to continue to be a significance source of mortgage funds; the introduction of innovative and flexible mortgage products over the last 30 years, particularly variable rate products; and the willingness of borrowers to incur and lenders to finance higher leveraged mortgage loans (mortgage insurance).

The Bank concluded: ^[60]

Overall, the analysis presented below suggests that mortgagelending practices are becoming increasingly flexible. At the current time, these developments are also found to support financial stability.

Hendry and King in a Bank of Canada article dealing with the Bank's capital market research findings states that the development in securitization in Canada suggests "that Canadian capital markets are providing better riskmanagement tools and access to cheaper funding".^[61] NHA MortgageBacked Securities and the related Canada Mortgage Bonds account for 80 percent or more of all residential mortgage securitization. These two programs are based on insured mortgages to counter default risk.

3.3.4 Mortgage Market Meets the Criteria for Capital Market Efficiency

Section 3.1 described three criteria for assessing capital market efficiency. The mortgage market as it has evolved and currently operates in Canada satisfies these criteria as well as being a positive tool for the implementation of Federal housing policies.

Both borrowers and providers of mortgage funds have access to available information on opportunities and risk, aided by the diversity of mortgage products available and the growing importance of mortgage brokers information efficiency.

The intermediation of transferring funds between borrowers and lenders is highly efficient with "back-office" efficiencies and the growth of securitization -transactional efficiency.

Finally, with the widespread availability of mortgage insurance more households have access to homeownership sooner which is positive for the economy-allocation efficiency.

3.4 An International Perspective On Canadian Mortgage Market Efficiency

The measures taken by the Federal Government in the past have placed Canada in the forefront of countries with a mortgage market integrated into the overall capital market. Mark Boleat, former member of the Building Societies Association of the United Kingdom, in a paper commissioned by CMHC for the 1990 Canadian Housing Finance Conference concluded:^[62]

Canada stands out as one of the countries with a relatively efficient and effective housing finance system.

Probably of all industrialised countries, Canada has a housing finance system which is most integrated into the financial system and financial markets generally.

The Bank of Canada observes that "overall, the Bank for International Settlements characterizes Canada as among the group of countries with mortgage-lending practices most conducive to financial stability".^[63]

3.5 Chapter Summary

The residential mortgage market in Canada is highly efficient from a capital market perspective and is given plaudits from independent observers, including the Bank of Canada - mortgage insurance is an important element of the Canadian mortgage market;

The growing importance of mortgage securitization and mortgage brokers in the mortgage market are two illustrations of how the mortgage market has adjusted to changing circumstances in ways that promote market efficiency;

The panoply of mortgage products now available for borrowers to select is probably the most conspicuous feature of the ability of the mortgage market to adjust to the needs of its borrowers;

Mortgage insurance underpins several significant mortgage market developments including the rise in mortgage securitization, the entry of new lenders into the mortgage market and the growing role of mortgage brokers; and

Mortgage insurance allows big and small lenders alike to compete in the high loan-to-value segment of the mortgage market.

4 Economic Well-Being And Mortgage Market Efficiency In The Absence Of The Statutory Requirement For Mortgage Insurance

This chapter discusses potential alternatives to the current system of the statutory requirement for insurance for mortgage loans exceeding 75 percent of the value of the property being mortgaged and what this might mean for the economic well-being of households and mortgage market efficiency.

4.1 Annex 6 Of Budget Plan 2005 -Too Limited In Its Scope

In Annex 6 of the Federal Government's Budget Plan 2005, it states that mortgage insurance was established to "protect financial institutions from the risk of fluctuating property values" and also that "the requirement to have insurance in every case when a mortgage exceeds 75 percent of the value of the property may have increased the cost of homeownership to some Canadians". These statements provide the basis for why the Government is seeking views on providing more flexibility to residential mortgage lenders and homebuyers by removing the statutory restriction on residential mortgages exceeding 75 percent of the value of the property.

The main issues therefore in the Government's view appear to be limited to:

Whether federally regulated financial institutions still need protection from fluctuating property values and, if so, whether there are more appropriate means other than the statutory requirement for mortgage insurance on high-ratio loans to achieve this; and
Whether some homeowners are being treated "unfairly" in terms of higher costs than might otherwise be the case.

Both are certainly important aspects of the issue with respect to high-ratio loans, however they are narrow in their scope. Also critical to any review of the role of mortgage insurance and whether more flexibility should be introduced into the housing finance system relating to high-ratio loans are the following:

As discussed previously, mortgage insurance is an integral part of the current efficiently operating mortgage market. What would happen to the consumer and the industry structure if more flexibility with respect to high-ratio loans were introduced? and
While mortgage insurance may have increased the costs for some homebuyers, it has at the same time lowered the potential costs for other homebuyers, and improved earlier access to homeownership for many homebuyers. As such, any review should incorporate equity considerations as well as consideration of the extent to which mortgage insurance has been an important tool for achieving federal housing goals and policies.

4.2 Financial Institutions Still Need Protection From Economic Downturns

Mortgage defaults generally arise from the borrowers' loss of employment, break up of marriages or overextension of credit. These factors determine the frequency of defaults while property value fluctuations drive the size of the loss should a default occur.

It is expected to be the case that property value fluctuations will continue to be part of the future housing market as they have been in the past and that these fluctuations cannot be predicted at the time mortgage loans are being made.

4.2.1 Future Course of Housing Prices Uncertain

The future course of housing prices will depend on the vagaries of national factors such as underlying economic conditions, unemployment rates, inflation and interest rates and local market factors including demand/supply balance and the state of local economies. The collapse of housing prices in Alberta in the early 1980s, Toronto in the early 1990s, and in various resource-based communities, small towns, and in rural areas through the past two or three decades are not events capable of prediction.

The rising willingness of households to take on larger debt to income ratios combined with growing popularity of variable rate mortgages make mortgage borrowers susceptible to an interest rate shock if this was to occur or to an unemployment shock. Falling property values generally or in particular locales could be a consequence.

Thus, the risks of economic cycles, rising unemployment rates and declining property values remain something that has to be a concern of mortgage lenders, financial institution regulators and to the Government of Canada because of its housing objectives and policies and mandate about the safety and soundness of financial institutions. Some form of protection therefore appears still to be in order.

Mortgage insurance currently offers this safety net against economic cycles, rising interest rates and falling house values. Mortgage insurance is issued at origination for the life of the mortgage. Mortgage insurers pool risk across lenders, geography and product types through successive origination years. This ensures that mortgage insurance is available at more stable and predictable rates in good times and in bad times when other risk mitigation techniques may have fled the market or be priced too high. This supports the continued availability of mortgage financing through all phases of an economic cycle.

4.2.2 Price Trends Since Mid 1990s Should Not be Extrapolated into Future

It could be easy to become complacent about housing price behaviour based on the robust housing market conditions that have prevailed over the past several years following the economic recovery since the mid 1990s. But this experience only reflects the "upside" of a rather unique economic cycle. Prudent financial regulatory policy should be based on consideration of the entire economic cycle-and in the 1990s, the cycle included the marked downturn in the first half of the 1990s and falling house values in many parts of the country.

It is well known that households in Canada have been committing to higher and higher debt loads, much of it being mortgage debt. Until now, the burden of repayment has not increased correspondingly since interest rates have been very low. This situation could change rapidly if an external shock to the Canadian economy were to cause sharply higher interest rates or a marked drop in consumer confidence resulted in a reduced interest in homeownership. There is also beginning to be concerns that prices in the housing market are reaching a bubbly high and may poised for a decline. Professor Robert Shiller of Harvard University, who garnered fame with his predictions of the stock market bubble before the April 2000 plunge, has suggested that real estate bubbles are building in "glamour" areas in the U.S. and Canada, and has referred to Vancouver as the most "bubbly city in the world".^[64]

4.3 Risk-Based Pricing As An Alternative To Statutory Requirement For Insurance On High-Ratio Mortgage Loans

One possible alternative to the statutory requirement for mortgage insurance on high-ratio mortgage loans is risk-based pricing. This alternative is examined below.

4.3.1 Risk-Based Pricing is Already in Canada

Risk-based pricing has been in Canada in a limited scope for many years in the subprime market. Subprime lenders serve borrowers whose credit profile does not qualify them for a prime mortgage.

Lenders like GMAC, Home Trust, XCEED, Wells Fargo and Equitable Trust are generally referred to as subprime lenders. They will arrange for a high-ratio loan, either a first mortgage or a combination of first and second mortgages, with the interest rate charged reflecting both the credit rating (score) of the borrowing and the size of loan in relation to the value of the property to be purchased. The lesser the credit score and the higher the loan-to-value ratio, the larger the interest rate charged. This is referred to as risk-based pricing of mortgage loans. Subprime lenders typically charge borrowers upfront administrative fees, as well as a higher interest rate.

The subprime market at present is estimated to be only about 5 percent of the mortgage origination market, based on a consideration of the volumes reported by these lenders.

4.3.2 Theoretical Advantages vs. Practical Considerations for Risk-Based Pricing

It has been advocated by some that risk-based mortgage loan pricing should be broadened to all high-ratio mortgage financing, not just loans to borrowers with lower credit scores. Under this scenario, "prime market" lenders like chartered banks could set interest rates on high-ratio mortgage loans at a level that reflects the assessment of credit risk of the borrower as well as the amount of the loan relative to the value of the property being purchased. If this were to occur, the line between prime and subprime lending would become increasingly blurred.

What are advantages put forth in favour of moving to a broader adoption of risk-based pricing for high-ratio mortgage loans? Below are some theoretical benefits:

Some borrowers in the subprime market today may be charged a combination of interest rates and fees in excess of the risk-related costs. If financing from primary mortgage lenders was available to these high-risk borrowers, they could experience reduced pricing for their loans;^[65]
Borrowers of insured high-ratio loans with high credit scores may benefit if primary mortgage lenders have the option of providing high-ratio loans based on risk-based pricing by paying an interest rate (and possibly fees) lower than under the present arrangement dependent upon the interest charged on a non-insured high-ratio loan; and
Risk-based pricing could, under the right circumstances, produce a more efficient allocation of resources ^[66]-these "right circumstances" include:
The mortgage industry being able to measure, predict and price for systematic credit risks on a loan by loan basis or at least with more categories than the present insurance system; and
Both borrowers and lenders having complete information on product quality and available pricing.

While in theory these arguments may appear attractive, in practical terms there are also reasons for not moving to a broader risk-based pricing for mortgage loans:

A sizeable part of the risk with residential mortgage lending is related to risks of loss associated with the value of the property being mortgaged, not just the risk of loan default (called the collateral asset in the U.S. literature)^[67]
The existing mortgage supply system has shown itself to be innovative, adaptable and highly efficient -the establishment of subprime lenders in Canada and the growth in the involvement of mortgage brokers are illustrations of a system that adjusts to the needs of mortgage borrowers-so why make a fundamental change to a housing finance system that is functioning well?
Mortgage insurance itself already incorporates an element of risk based pricing - not in terms of interest rates, but in terms of variation in premiums paid based on loan-to-value ratios. Currently mortgage insurance premiums balance consideration of "what is fair" in terms of higher-risk prime market customers paying a higher price, with practical consideration of the need for risk-pooling to provide coverage at a reasonable cost for a broader base of homebuyers;
Mortgage insurance has been expanding to cover sectors previously left to the subprime market (e.g. 95 percent loan-to-value ratios, self-employed or the so-called Alt A borrower group, vacation properties, refinancings). The pooling of risk has allowed mortgage insurers to expand the prime market. This has reduced the cost to some borrowers that were previously served by the subprime market (the next section provides an example); and
It is possible that the higher credit risk borrowers who now qualify for insured prime mortgage loans would face higher borrowing costs under a risk-based system since they currently benefit from cross subsidization in the mortgage insurance pooling.

4.3.3 Comparison of Costs Under Risk-Based Pricing and Mortgage Insurance: An Example

This section provides an example of where mortgage insurance has shown itself to be a lower-cost option for a particular group of homebuyers.

Self-employed homebuyers with limited documentation previously had little option other than the subprime market, as they had difficulty qualifying for a prime market loan due to requirements for documenting income and assets.

Today, with mortgage insurance available through Genworth, these self-employed borrowers now have a choice between the prime and subprime markets - but at different costs.

Figure 16 illustrates the situation for a self-employed buyer using Genworth's mortgage insurance versus one arranging a loan through one of the subprime lenders.

Figure 16

Risk-Based Pricing Compared to Mortgage Insurance: Self-employed Borrower

	Mortgage Insurance (Genworth)	Subprime Loan

House value	$200,000	$200,000
Loan-to-value ratio	0.65	0.85
Mortgage amount	$170,000	$170,000
Mortgage insurance premium/administrative fee	3.55%	2.50%
Loan amount	$176,205	$174,250
Mortgage tern (years)	5	5
Amortization period (years)	25	25
Initial mortgage rate	5.00%	5.65%
Monthly payment (principal & interest)	$1,024.82	$1,078.87
Cumulative total payments over initial 5 yr. term	$61,489	$64,732
Difference	-$3,243
Cumulative total payments over 25 yrs (assuming initial mortgage rate applies at renewals)	$307,445	$323,661
Difference	-$16,216

Source: Clayton Research based on information from Genworth Financial Canada

Both scenarios assume a $200,000 house price and 85 percent loan-to-value ratio- The mortgage insurance premium for this buyer would be 3.65 percent - above the initial administrative fee of 2.5 percent that the subprime option would charge, which results in a higher initial loan amount under the mortgage insurance option (assuming the premium/fee is added to the mortgage amount).

However, the mortgage rate under the subprime option would incorporate an additional risk premium, which in late April 2005 was approximately 6575 basis points for a qualified self-employed borrower (the lower end is used in the example).

The mortgage insurance option is overall more favourable for the borrower under the scenario here as:

It reduces the regular mortgage payments, leaving the buyer with more discretionary income; and
It reduces the total costs to the borrower over the initial 5 year term of the mortgage by over $3,000; assuming the same mortgage rates over the term of the mortgage, the savings over the life of the mortgage would be more than $16,000.

It should be noted that in the subprime option, the lender could also require another administrative fee upon renewal at the end of the 5 year term; this has not been factored into this example, but it would further increase the costs to the borrower after the initial 5 year term.

4.4 Assessment Of Winners And Losers In The Absence Of The Statutory Requirement For Mortgage Insurance

Any change typically results in benefits for some, losses for others. Should mortgage insurance for high-ratio mortgages no longer be a statutory requirement for federally regulated financial institutions, there will be some parties who win, and some who lose - both among borrowers and among the mortgage industry.

Before discussing winners and losers among borrowers, it is helpful to provide background on mortgage customers, in terms of the relative role that mortgage insurance is now playing, the characteristics of those homebuyers being served by mortgage insurance, and relative risk (in terms of relative default rates) among different categories of mortgage insurance customers.

4.4.1 Homebuyers Protected by Mortgage Insurance

Data from the FIRM Residential Mortgage Survey^[68] conducted by Clayton Research and Ipsos-Reid indicates that among homebuyers in Canada in 2003 and 2004 (Figure 17):

About three-quarters required a mortgage to finance their home;
Of these, about 60 percent had high-ratio mortgages (i.e. downpayments of less than 25 percent); and
The vast majority of those with high-ratio mortgages took out mortgage loan insurance (over 80 percent).

The FIRM data suggest that of those homebuyers in 2003 and 2004 who required a mortgage, about half took out mortgage loan insurance, which is broadly similar to the estimates by the Conference Board for mortgage loan approvals.

The proportion of mortgage borrowers taking out mortgage insurance however varies dramatically by age group, ranging from two-thirds of homebuyers in the under 35 age groups to about one-quarter in the 50 and older age groups. This mainly reflects the housing lifecycle situations of these age groups - with the under 35 age group mostly comprised of first time buyers with no established home equity and the 50 and older age group dominated by repeat buyers who have equity from the sale of their previous home.

Figure 17

Mortgage Insurance Among Homebuyers in Canada in 2003-2004

	Under 35 Years	35-49 Years	50+ Years	All Ages

% of Homebuyers Taking Out a Mortgage	95	84	44	75
Downpayments of <25%
as % of those taking out a mortgage	73	52	39	59
as % of all homebuyers	69	44	17	44
Took Out Mortgage Loan Insurance
as % of homebuyers with
downpayments <25%	91	81	62	84
as % of those taking out a mortgage	66	42	24	50
as % of all homebuyers	63	35	11	37

Source: Clayton Research and Ipsos-Reid, The FIRM Residential Mortgage Survey

4.4.2 Selected Characteristics of Mortgage Insurance Customers

This section looks at characteristics of mortgage insurance customers in relation to homebuyers in general, based on FIRM data for homebuyers in 2003 and 2004.

Homebuyers in general in 2003 and 2004 were split roughly equally between the under 35, 35-49 and 50+ age groups (Figure 18). However, mortgage insurance is skewed much more to the younger age groups (under 35 years), a testament to its ability to help first-time buyers enter the market with limited equity

Figure 18

Distrubution of All Homebuyers and Mortgage Insurance Customers by Age Group, Buyers in 2003-2004, Canada

Mortgage insurance also appears to be helping some lower income older households purchase a home - as evidenced by the fact that average incomes and house values among homebuyers aged 35 and older who took out mortgage insurance are much lower than among all homebuyers in these age groups (Figure 19 and Figure 20).

Note that because most homebuyers aged under 35 years do take out mortgage loan insurance, the average house values and incomes for those with mortgage insurance are similar to all homebuyers in that age group.

Figure 19

Agerage Household Incomes, All Homebuyers and Mortgage Insurance Customers by Age Group, Buyers in 2003-2004, Canada

Figure 20

Average House Values, All Homebuyers and Mortgage Insurance Customers by Age Group, Buyers in 2003-2004, Canada

4.4.3 Relative Default Rates on Insured Loans Vary by Credit Score, Loan-toValue Ratios and Rural/Non-Rural

Any analysis of winners and losers among mortgage customers needs to take into consideration how mortgage default rates vary among different groups of customers.

Information provided by Genworth for its insurance customers provides some insight into relative default ratios across different groups, based on a combination of customer credit scores and their loan-to-value ratio (Figure 21). The data are based on defaults to date among homebuyers in 2000-2002 who took out mortgage insurance with Genworth. Note that the numbers below are not the actual default rates, rather each multiplier is a ratio of the default rate for that group to the overall default rate.

Figure 21

Relative Default Ratios by Credit Score, LTV Ratio and Rural/Urban, Genworth New Insurance Customers in 2000-2002

The relative default ratios are much higher among those with very high loan to-value ratios (>90 percent) and in particular among those in this group with lower credit scores (<660).

Borrowers in rural areas also have higher relative default ratios than those in non-rural areas-this holds across the credit score spectrum.

Few mortgage insurance customers have initial loan-to-value ratios of 80 percent or less (Figure 22). Customers with LTVs of more than 90 percent account for about half of insurance customers (based on Genworth information), but a much higher proportion of defaults (almost 80 percent).

Figure 22

Distribution of Mortgage Insurance Customers and Defaults by LTV Ratio, Genworth New Insurance Customers in 2000-2002

The higher default risk associated with those with higher LTV ratios is reflected in differentials in insurance premiums, as per the schedule below (as of April 2005).

Loan-to-value Ratio	Fixed Rate and_. Capped Variable Rate	Non-capped Variable Rate

up to 65.00%	0.50%	0.75%
65.01 -75.00%	0.65%	0.90%
75.01 80.00%	1.00%	1-25%
80.01-85.00%	1.75%	2.00%
85.01-90.00%	2.00%	2.25%
90.01-95.00%	2.75%	n .a.

These variations in premiums by LTV ratio confirm that there is already risk based pricing incorporated in the mortgage insurance pricing system, although some cross-subsidization (i.e. lower risk borrowers subsidizing higher-risk borrowers) does still occur. As discussed in Section 4.1, this partial risk-based system balances consideration of "what is fair" in terms of higher-risk customers paying a higher price, with practical consideration of the need for risk-pooling to provide coverage at a reasonable cost for a broader base of homebuyers.

The relative distribution of insured customers can also be looked at in terms of their credit scores (Figure 23).

Figure 23

Distribution of Mortgage Insurance Customers and Defaults by Credit Scores, Genworth New Insurance Customers in 2000-2002

The Genworth information above illustrates that mortgage insurance is servicing homebuyers across the prime market credit spectrum and has expanded the prime market to include borrowers with lower credit scores than would typically be served in the prime market (as was discussed in Section 3.2.4).

While the distribution of defaults is more skewed to the lower credit score groups, there is still a substantial proportion of defaults accounted for by the higher credit score groups- reinforcing that loans to even more creditworthy borrowers also benefit from the protection provided by mortgage insurance.

Based on the combination of LTV ratio and credit score, Genworth has defined three distinctive risk groups as follows:

Risk Groups

The high risk segment accounts for only about one-third of mortgage insurance customers, but the majority of defaults, at about three-quarters (Figure 24). Low risk customers also account for about one-third of customers - but less than 10 percent of defaults.

Figure 24

Distribution of Mortgage Insurance Customers and Defaults by Risk Level, Genworth New Insurance Customers in 2000-2002

4.4.4 Profile of Mortgage Insurance Customers by Credit Score

Information compiled by Genworth provides insight into the characteristics of mortgage insurance customers based on credit scores (Figure 25).

The data reinforce that mortgage insurance is servicing a broad cross-section of buyers and provide support for the findings of the literature reviewed for this study that mortgage insurance allows many homebuyers to get into the market sooner than would otherwise be the case.

It also shows that, in general, the profile of insured borrowers does not vary dramatically by their credit scores - or specifically, that higher risk (lower credit score) borrowers are not pronouncedly different from lower risk borrowers. There are some differences however. Borrowers with higher credit scores do tend more often to be comprised of single-income households, with somewhat lower incomes on average. They correspondingly also are more likely to be purchasing a condominium unit.

Figure 25

Selected Borrower Characteristics by Credit Score, Genworth New Business, 2004

4.4.5 Winners and Losers Among Homebuyers

This section looks at who among homebuyers would benefit, or be hurt, if mortgage insurance were no longer a statutory requirement for high-ratio mortgages.

It is difficult to say with certainty what the outcome would be. However, it is plausible that some prime market lenders may decide in some cases to self-insure on a risk-based pricing basis. The borrowing group that would be most attractive to them is the lower risk customers. The extent to which prime market lenders would go after this portion of the business is unknown, but by removing some or all of this business from the mortgage insurance pool would by default leave the insurance pool with higher risk customers on average (referred to as "adverse selection") - with consequences for premiums.

Under this scenario, the potential winner among homebuyers is the lower risk mortgage insurance customers with high credit scores. While there is variation in insurance premiums based on loan-to-value ratios, mortgage insurance pools risk across the credit spectrum, geographic areas, lenders and economic cycles.

As such, the group of low risk borrowers has the potential to gain if there were more flexibility for lenders with respect to mortgage insurance:

It could provide low risk borrowers with more choice in options and control of their situation;
They might pay a lower premium than they would under the current mortgage insurance system, leaving them with more disposable income for other spending - or allowing them to purchase "more house", and
They would potentially be able to enter the market sooner.

This group, however, is unlikely to be able to fully recoup the current "premium" they are paying relative to their risk. This is because:

Lenders in the prime market would have costs associated with administering a system of self-insuring, which they would attempt to recoup from the borrower; and
More importantly, lenders may be able to operate the system at a financial gain - by trying to recapture from the borrower some of the gap between how low premiums could be under risk-based pricing and what such borrowers would pay if protected by mortgage insurance. Competition among lenders would likely mean this full gap could not be extracted, however there is potential for some "excess premium" over the inherent risk to be paid by lower risk borrowers.

Both of the possibilities outlined above could introduce inefficiencies to the mortgage market.

While the option of mortgage insurance or not would increase the choice for homebuyers, it also complicates the borrowing process in terms of the need to investigate lenders now not only for variation in rates, but also for variation in administrative costs/premiums, etc. The current degree of transparency in the market would likely suffer as a result.

The potential losers would be higher risk borrowers in the prime market whose risk is currently pooled with that of lower risk borrowers:

They could lose out by having to pay higher premiums than under the current mortgage insurance system (since their risk would no longer be pooled with lower risk borrowers), resulting in less discretionary income and/or potentially "less house"; and
For some, there would be delays in when they might be able to enter the homeownership market.

Those borrowers on the margin would be the most vulnerable to the possible effects outlined above. The adverse impact on them would be inconsistent with housing policies which encourage extension of homeownership to as many as possible.

Average risk borrowers might also be worse off under this scenario, depending on whether or not prime market lenders decided to pursue this business on a risk-based pricing basis or not. If not, then this group would only be left with the option of mortgage insurance. Pooled with the higher risk borrowers, they would likely end up paying higher premiums than under the current system, as they now would be cross-subsidizing higher risk groups to a larger extent with the absence of the lower risk borrowers.

As shown on Figure 24, there are as many high risk borrowers who would lose out, as there are low risk borrowers who would gain. If the average risk borrowers are also negatively impacted, a higher proportion of borrowers would be worse off than better off. Assuming that all the low risk borrowers shown by Figure 24 were taken out of the mortgage insurance pool, estimates by Clayton Research suggest that the risk level of the residual pool would increase by about 50 percent - which would require increases in mortgage insurance premiums.

4.4.6 Winners and Losers in the Mortgage Industry

This section examines to what extent there would be winners and losers among mortgage industry participants.

There would be potential advantages particularly for large lenders in the prime market if more flexibility in terms of requiring mortgage customers to take out mortgage insurance were introduced:

For larger lenders with sophisticated risk management systems and geographically different client bases, it could enhance the ability to compete with other lenders if they can differentiate themselves in the marketplace, and
There is the potential for financial gain to the extent that lenders may be able to extract an "economic rent" from the lower risk market segment in terms of setting fees below those that would be incurred under mortgage insurance, but higher than necessary to cover the inherent risk (as discussed in Section 4.4.5).

The disadvantages to this group include the following:

Lenders in the prime market would need to assume more control of their risk and develop more sophisticated risk management systems. Even with low risk borrowers, there still is an inherent risk of default. This increased risk for lenders will have to be addressed for high LTV loans compared to conventional loans (i.e. those with LTVs below 75 percent) either through a mortgage rate increase, or an "administrative" fee, and
Smaller and/or regional lenders in particular may be hurt by the need to compete with the major banks in terms of servicing the low risk market, as their risk would be pooled over a much smaller base and they also may be less able to absorb costs associated with having internal risk management policies.

Increased regulatory supervision may be necessary to protect deposit holders from increased risk.

Increased complexity of mortgage product pricing will complicate the selling process and reduce transparency to borrowers.

There would be consequences for mortgage insurers as well if more flexibility were introduced with respect to high-ratio mortgages. Should prime market lenders decide to self-insure for the low risk component of the market, this will residually leave relatively more high risk customers in the insurance pool. Premiums would need to be reassessed and likely lead to higher premium rates for higher risk borrowers.

4.5 Mortgage Market Efficiency In Canada Without Statutory Requirement For Insured High-Ratio Mortgages

The analysis in Chapter 3 concluded that the residential mortgage market in Canada is highly efficient from a capital market perspective and that mortgage insurance is an important element of this mortgage market. This section examines the implications for mortgage market efficiency of revamping the mortgage system to eliminate the statutory requirement for insurance on high-ratio mortgage loans. The question addressed is whether a change from compulsory to non-compulsory mortgage insurance is likely to enhance the efficient operation of the mortgage market in Canada beyond its current performance.

4.5.1 The Collins, Balky and Case Framework and Findings

A useful starting point for the analysis is a recent article authored by Michael Collins, Eric Balky and Karl E. Case (Collins et al.) prepared for a conference at Harvard University. This paper, entitled "Exploring the Welfare Effects of Risk-Based Pricing in the Subprime Mortgage Market", concludes that:

Risk-based pricing could, under the right circumstances, produce a more efficient allocation of resources. But whether risk-based pricing achieves greater efficiency is an empirical question and is conditional on business practices, consumer behaviour, and if the structure and analysis of information accurately captures underlying risk. Efficiency gains are only realized if the industry is able to measure, predict and price for systematic credit risks.

Collins et al. identify three primary economic benefits that could result from the emergence of risk-based pricing as it is evolving in the subprime lending markets in the United States:

Completion of a truncated market-the extension of the primary mortgage market to serve borrowers with blemished credit or no credit history;
Increased allocation efficiency - before the advent of risk-based pricing in the subprime market, mortgage credit was rationed based on imperfect information; and
Increased positive externalities-more households may become homeowners sooner due to the existence of subprime loans and there may be significant private benefits to homeownership including asset accumulation and better educational outcomes for children.

According to Collins et al, market completion causes the risk of four market failures:

Underestimating risk - miswriting and misallocation of risk due to incorrect measurement of systematic risk;
Principal agent problems-misalignment of incentives and asymmetric information between principals in a transaction and the agents acting on their behalf (mortgage brokers);
Asymmetric information - unequal bargaining power due to information advantage of one party over another; and
Negative externalities - costs not internalized by the entities that create them.

Regarding the underestimating of risk, Collins et al. caution that the risk predictions in recent credit and default markets are estimated with data for a period including an incredibly robust housing market and the longest and strongest economic expansion in U.S. history. Thus, the models may reflect the strong housing market and not a better ability to fragment risk. They state: "subprime lending has never been tested by a severe downturn in house prices and the economic cycle".^[69]

Finally, Collins et al. assert that even though a movement from the current primary mortgage finance system (labelled "rationed credit") to subprime pricing (risk adjusted pricing) may result in efficiency in the mortgage marketplace, "thorny" economic equity issues exist regardless of the quality of risk modelling and pricing. These include:

Economic equity issues due to the elimination of cross subsidies already discussed in Section 4.4.5 of this paper;
Economic equity issues due to increased defaults; and
Economic equity issues due to exacerbated inequality of wealth.

Because of the potential market failures associated with an expanded risk based pricing presence in the mortgage market, Collins et al, suggest an expanded role for financial institution regulators as a response for dealing with these potential failures.

4.5.2 Applicability of the Collins et al. Analysis to the Canadian Mortgage Market

There is no question that financial institutions need protection from fluctuating property values and these values cannot be predicated at the time mortgage loans are being made. There is no more appropriate means other than mortgage insurance on high-ratio loans to provide this protection.

Risk-based pricing is already a part of the Canadian mortgage scene where it is most appropriate -for high credit risk borrowers. The mortgage insurance industry has shown itself to be adept at bringing higher risk borrower groups under its wings-such as the self-employed -when there is a business case to be made. There is no evidence that a broader risk-based pricing system in Canada would enhance what is already a highly efficient housing finance system.

Low risk borrowers would be the most likely beneficiaries if mortgage insurance were to be non-compulsory. This is the product of the pooled risk inherent in insured high-ratio loans. Collins et al. concluded that the only benefit that has been clearly realized is the completion of a truncated market: "Simply put, a market for loans to credit impaired borrowers has been established where one did not exist in any meaningful way before the 1990's".^[70] They also caution, however, that this new market is itself subject to failures that can cause locative inefficiencies and negative externalities.

The essential messages of the analyses of risk-based pricing in the housing finance system in the U.S. are threefold:

While there are potential market efficiencies in a wider role for risk based pricing, it is far from being clear that these market efficiencies will in fact occur,
The estimates of default risk contained in credit risk models favouring risk-based pricing have never been tested in a completed housing cycle; and
There will be increased responsibilities placed on the shoulder of financial institution regulators if risk-based pricing becomes more prevalent in the mortgage marketplace.

These messages are equally applicable to the Canadian mortgage market where the subprime market segment has also been growing though is still less developed than in the U.S.

4.6 Chapter Summary

Annex 6 of the 2005 Budget Plan - by focusing primarily on whether lenders still need to be protected from fluctuating property values, and whether some borrowers may be paying too high costs - is too limited in its scope and masks the larger issue of how consumers in general and the efficiency of the mortgage market itself would be impacted by allowing more flexibility with respect to requiring mortgage insurance on high-ratio loans.
It is not certain how the marketplace would respond to more flexibility with respect to the statutory requirement for mortgage insurance on high-ratio mortgage loans but the logical alternative is that prime market lenders would consider risk-based pricing. Should some prime sector lenders decide to adopt risk-based pricing for lower risk customers, this could provide some financial benefits to this lower risk group. However, the gain among this group would be at the expense of the higher risk groups remaining within the mortgage insurance pool, as their mortgage insurance premiums would no longer be subsidized by the lower risk borrowers.
There is potential for lenders in the prime market who self-insure to charge fees above those warranted by the inherent risk, as long as the fees were still below what the borrower would pay under a mortgage insurance system. The extent to which lenders could extract such a premium would depend on the degree of competition for this business.
Smaller lenders and regional lenders in the prime market would likely lose market share to the larger national lenders, as their risk would be pooled over a smaller base, and they may have lower economies of scale with respect to the costs of internal risk management systems.
Literature on the U.S. market suggests that while there may in theory be potential market efficiencies in a wider role for risk-based pricing beyond the subprime market, it is far from clear that these market efficiencies would in fact occur. Moreover, because of the potential for market failure associated with an expanded risk-based pricing presence in the mortgage market, this will require increased financial institution regulations and supervision.

5 Conclusions

It is legitimate to review the merits of continuing with the current mortgage insurance regime, which requires all high-ratio residential mortgage loans made by federally regulated financial institutions to be insured. Compulsory mortgage insurance has been in place for 51 years. Over such a long period of time, circumstances and needs have changed and new ways of dealing with property value risk may have emerged.

This report provided a comprehensive analysis of mortgage insurance in Canada and the pivotal role it has and continues to play in enhancing the economic well-being of Canadians and its contribution to the efficient operation of the mortgage market. It also assesses the implications of removing the statutory requirement for mortgage insurance on high-ratio loans and, instead, providing lenders with the option of either requiring borrowers to take out mortgage insurance or using a risk-based pricing structure to determine the price (interest rate or combination of interest rate, fees and terms) for high-ratio mortgage loans. Risk-based pricing is the only potential realistic option to mortgage insurance.

The report's conclusion regarding the continuation of the statutory requirement for mortgage insurance for high-ratio residential mortgages is strong and decisive: compulsory mortgage insurance is a vital component of Canada's highly efficient mortgage marketplace and contributes in a significant way to the economic well-being of Canadians.

It would be inappropriate and not in the public interest to drop compulsory insurance on high-ratio mortgage loans at this time. Without mortgage insurance, higher risk borrowers who now qualify for high-ratio loans would likely pay a higher price for mortgage funding. This would conflict with federal housing policy that encourages households to become homeowners. Moreover, it is not clear that requiring these households to pay more for housing than under the present system would be in the public interest.

Property value fluctuations will continue to be a part of the future housing market and these fluctuations cannot be predicted at the time mortgage loans are being made. Mortgage insurance offers a safety net against economic cycles, rising interest rates and falling house values.

A shift away from compulsory mortgage insurance would disadvantage borrowers living in rural and northern areas since, once again, the higher risks inherent in these areas is averaged over all borrowers in the insurance pool.

Lastly, dropping compulsory mortgage insurance would reduce the ability of smaller mortgage lenders (both existing and new entries) to compete with the larger chartered banks with their much more sophisticated credit and default risk assessment capabilities. This would not be in the public interest

1. Canada Mortgage and Housing Corporation (CMHC), Program Evaluation Division, Evaluation of NHA Mortgage Loan Insurance (Draft), May 1986, p. 37. [Return]

2. Canada Mortgage and Housing Corporation, Program Evaluation Division, Mortgage Loan Insurance Assessment Report, July 1984, p. 13. [Return]

3. Ibid, p.16. [Return]

4. Villiard, Jean-Claude, President of the Canada Mortgage and Housing Corporation, Speech/Presentation: Canada's Housing Finance System: Past, Present and Future, 2001, p.4. [Return]

5. CMHC, op. cit., Evaluation of NHA Mortgage Loan insurance and Villiard, op. cit. [Return]

6. Villiard, op, cit., pp. 5-6. [Return]

7. CMHC, op. cit., Mortgage Loan Insurance, Appendix 4. [Return]

8. CMHC, op. cit., Evaluation of NHA Mortgage Loan Insurance, p. 44. [Return]

9 CMHC, op. cit., Mortgage Loan Insurance, Appendix 4. [Return]

10. Ibid. [Return]

11. Hatch, James E, The Canadian Mortgage Market, Queen's Printer for Ontario, Toronto, 1975, p. 68. [Return]

12. Ibid., pp. 68-69. [Return]

13. Canada Mortgage Corporation, Government Housing and Mortgages in Canada, http://www.canadamortgage.com/learn/govt.shtml, (Retrieved April 15, 2005), p. 9. [Return]

14 .CMHC, op. cit., Mortgage Loan Insurance, Appendix 4. [Return]

15. Woodworth, Douglas W., What Is Happening to the Mortgage insurance Sales of the Canada Mortgage and Housing Corporation? ARIMA Models and Ex post Forecasts. A Report Submitted in Partial Fulfilment of the Requirements for the Degree of Masters of Arts in the Department of Economics of the University of New Brunswick, April 1997, pp. 8-9. [Return]

16. CMHC, op. cit., Evaluation of NHA Mortgage Loan Insurance, p. 22. [Return]

17. Villiard, op. cit., p. 6. [Return]

18. Ibid. [Return]

19. Woodworth, op. cit., p. 9. [Return]

20. Ibid. [Return]

21. Villiard, op. cit., p. 7. [Return]

22. Ibid, p. 8. [Return]

23. Based on information from Genworth. [Return]

24. Ibid. [Return]

25. Canada Mortgage and Housing Corporation, 2001 Annual Report, 2001, p. 26. [Return]

26. Based on information from Genworth. [Return]

27. Canadian Mortgage and Housing Corporation, 2003 Summary of Key Achievements, Insurance and Securitization,
http://www.cmhc-schl.gc.ca/en/About/anre/anre_ 001.cfm, (Retrieved April 15, 2005). [Return]

28. Based on information from Genworth. [Return]

29. Canada Mortgage and Housing Corporation, Mortgage Insurance Innovations,
http://www.cmhc-schl.gc.ca/en/moinin/moinle/moinle_012.cfm,
(Retrieved April 15, 2005). [Return]

30. Canada Mortgage and Housing Corporation, Summary of the Corporate Plan: 2005-2009, p. 7. [Return]

31. Conference Board of Canada, January 10, 2005 Outlook, prepared for Genworth. [Return]

32. Ibid. [Return]

33. Canadian Mortgage and Housing Corporation, Housing Now: Canada, March 2005, p. 7. [Return]

34. Rose, Albert, Canadian Housing Policies, 1935-1980, Butterworths, Scarborough, 1980, p. 35. [Return]

35. Ibid, p. 55. [Return]

36. Courchane, Marsha J., and Giles, Judith A., A Comparison of U.S. and Canadian Residential Mortgage Markets, Department of Economics, University of Victoria, March 2002, p. 10. [Return]

37. Ibid., p. 11. [Return]

38. Ibid. [Return]

39. Canada Mortgage and Housing Corporation, 2003 Annual Report, p. 9. [Return]

40. Clayton Research, Economic Impacts of MLS Home Sales and Purchases, January 28, 2003, p. 2. [Return]

41. This is an approximation. Not all existing homes sales take place through the auspices of the MLS and not all new housing completions are destined for the ownership market. MLS is a registered certification mark owned by The Canadian Real Estate Association. [Return]

42. Pichette, Lise, "Are Wealth Effects Important for Canada?" Bank of Canada Review, Spring 2004, p. 32. [Return]

43. Tat, Benjamin," Loonie Boom: How the Dollar is Sustaining the Canadian Housing Market' CIBCWorld Markers, Consumer Watch Canada, March 15, 2005, pp. 3-4. [Return]

44. Canada Mortgage and Housing Corporation, Consumer Intentions to Buy or Renovate a Home, Major Market Highlights, February 2005, pp. 4, 6. [Return]

45. Ipsos Reid, R8C Housing Study Part ll, The Investment Value of The Buy Increases Steadily... Especially In Intensity, prepared for the Royal Bank of Canada, RBC 12^th Annual Housing Survey detailed table, Buying Intentions Section, March 29, 2005, p. 2. [Return]

46. Bank of Canada, Financial System Review, June 2004, p 11. [Return]

47. Canada Mortgage and Housing Corporation, Canadian Housing Observer, 2004, p. 22, [Return]

48. Chambers, Mathew, Garriga Carlos and Schlagenhauf, Don E., Accounting for Changes in the Homeownership Rate, CIRJE, Faculty of Economics, University of Tokyo, January 2005,p.33. [Return]

49. Quercia, Roberto G., McCarthy, George, W., and Wachter, Susan M., "The Impacts of Affordable Lending Efforts on Homeownership Rates", Journal of Housing Economics, V (12) (2003), p. 29. [Return]

50. Goodman, John L, and Nichols, Joseph B., "Does FHA Increase Home Ownership or Just Accelerate it?" Journal of Housing Economics V (6) (1997), p. 184. [Return]

51. Engelhardt, Gary V, "Tax Subsidies to Saving for Home Purchase: Evidence from Canadian RHOSPs", National Tax Journal V (47) (June 1994), p. 363. [Return]

52. Hendry, Scott and King, Michael R., "The Efficiency of Canadian Capital Markets: Some Bank of Canada Research", Bank of Canada Review, summer 2004, pp. 6-7. [Return]

53. Dupuis, Jean, Bill C-66: An Act to Amend the National Housing Act and the Canada Mortgage and Housing Corporation Act, www.parl.gc.ca/36/1/parlbus/chambus/house/bills/summaries/c66-e.htm February 16, 1999, p. 3. [Return]

54. CMHC, op. cit., Housing Now, p. 4. [Return]

55. Ibid., pp. 6-7. [Return]

56. Ibid. [Return]

57. McElgunn, Jim, "The Middlemen, Mortgage Brokers Give Banks a Run for Their Money", Canadian Business, June 7, 2004. [Return]

58. PC Financial is owned by Loblaws Inc. and managed by CIBC. [Return]

59. Bank of Canada, "Developments and Trends" Financial System Review, June 2004 p. 9. [Return]

60. Ibid [Return]

61. Hendry & King, op. cit., p. 7. [Return]

62. Boleat, Mark, The Applicability Potential of Foreign Housing Finance Mechanisms in Canada, prepared for the CMHC for the 1990 Canadian Housing Finance Conference, 1990, p. 13. [Return]

63. Bank of Canada, op. cit., pp. 11-12. [Return]

64. The Globe and Mail, "Housing Market Not in Bubble, TD Says", April 28, 2005. Robert 1. Shiller discusses housing market bubbles in his book, Irrational Exuberance, 2nd Edition, Princeton University Press, 2005. [Return]

65. White, Alan M., "Risk-Based Mortgage Pricing: Present and Future Research", Housing Policy Debate V (15), (Issue 3), 2004, p. 526. [Return]

66. Collins, Michael, Belsky, Eric, and Case, Karl E., "Exploring the Welfare Effects of Risk-based Pricing in the Subprime Mortgage Market", Joint Centre for Housing Studies, April 2004, p. 4. [Return]

67. White, op. cit., p. 506. [Return]

68. The FIRM Residential Mortgage Survey is conducted by Clayton Research and Ipsos-Reid each quarter. About 3,000 Canadian households respond to each survey on their homebuying and mortgage patterns. The sample of homebuyers for 2003 and 2004 used in the analysis in this section is based on combined results from the four surveys conducted during 2004, the total sample of homebuyers in 2003 and 2004 from these combined surveys was about 600. [Return]

69. Ibid, p. 8. [Return]

70. Collins et al. op. cit., p. 5. [Return]