Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 19 - Evidence - May 31, 2012
OTTAWA, Thursday, May 31, 2012
The Standing Senate Committee on Banking, Trade and Commerce met this day at
10:30 a.m. to examine the subject matter of those elements contained in
Divisions 2, 10, 11, 22, 28 and 36 of Part 4 of Bill C-38, An Act to implement
certain provisions of the budget tabled in the House of Commons on March 29,
2012 and other measures.
Senator Irving Gerstein (Chair) in the chair.
The Chair: Honourable senators, this morning we continue our pre-study
of certain divisions of Part 4 of Bill C-38, the jobs, growth and long-term
prosperity act. We have already heard from the Minister of Finance and from
officials from the departments of Finance, Industry and Human Resources and
Skills Development, as well as CMHC and OSFI.
Yesterday, we began hearing from those outside of government, and we will
continue in that direction this morning.
We are pleased to welcome this morning, Mr. Finn Poschmann, Vice-President of
Research with the C.D. Howe Institute.
Mr. Poschmann, it would appear that you, like your institute's name sake,
C.D. Howe, who was often credited with being minister of everything, are quite
adept on varying files, having appeared before our committee and other
committees on a number of occasions, as well as committees in the other place.
It is a great pleasure to welcome you back today.
Mr. Poschmann is here to discuss Division 11 and the Canada Mortgage and
Housing Corporation in particular. However, we would also be pleased to hear
comments that he may have on any other division that we are studying.
Mr. Poschmann, the floor is yours.
Finn Poschmann, Vice-President, Research, C.D. Howe Institute: Thank
you for your kind words, Mr. Chair. Good morning, senators; it is an absolute
delight to be here. It is a delight for me to comment on Part 4 of Bill C-38,
which is a very expansive bill. More on that later, perhaps.
I would like to discuss Division 11 of Part 4. I would also like to make
brief comments on Divisions 2, 10 and 28.
First, Division 2, which is about life annuity or life annuity-like products,
clarifies and expands the traditional separation within the Canadian financial
system between products and services delivered by life insurance companies and
those delivered by banks. I will say little about that, but I would like to
observe that perhaps six years ago, when we last gave the Bank Act a serious
look, we might have imagined that, owing to convergence and overlap among the
financial services delivered by different institutions, we would have seen
legislation that reflected the evolution of the marketplace. In other words,
there is convergence and overlap of the services and convergence and overlap
amongst the institutions that deliver them. For that reason, we might have
expected legislation that was less restrictive, rather than more restrictive,
with respect to the separation of roles between banking and insurance. That did
not happen then, and it has not happened now.
I am not sure if that is a good or a bad thing, but I will pose the question:
Are Canadian voters well served by sharp limits on the range of institutions
that might deliver the products and services that they need and want? Life
annuities are certainly among those.
From a consumer perspective, this is not a broad and transparent market. I am
referring to life annuities, which Canadians are required, in general, to buy
when they convert out of their RRSPs at age 71. It is not a broad and
transparent market. Pricing does not seem to be as liquid as it might be. Having
asked the question, I will simply assert that the answer is far from clear.
I will move on to Division 10. Division 10 permits certain international
financial bodies — the shorthand everyone uses is ``sovereign wealth funds'' —
to invest in domestic institutions, subject to suitability criteria and a range
of other criteria specified by the minister, including, in particular, a
commercial market goal. I think this is good, mainly because it increases the
breadth and depth of potential investors into Canada, and foreign investment in
Canada is a positive thing for the economy. Hence, I am supportive of these
provisions. It is very good to see them.
Division 11 is very important to the development of the housing finance
framework within Canada. It concerns Canada Mortgage and Housing Corporation,
its intersection with financial markets and its regulation and oversight, as
well as the introduction of a framework for the Canadian cover market. This is a
really fascinating and important piece of legislation. I have focused on this
area for some time, and I would like to take a minute to address it in a little
Going back several years, some of us, and me in particular, became very
concerned about the scope and breadth of CMHC's insurance market operations —
its mortgage insurance operations — which are a significant part of the agency's
field of responsibility. CMHC is a very large financial institution. Its
insurance backs a significant percentage of residential mortgages that are
entered into by Canadian home buyers. It is a big gross exposure. The net
exposure of the agency is much smaller than the gross number that you hear
people talking about, $500 billion to $600 billion. The net exposure of the
agency is less than that because, when mortgages go bad, the insurer can recover
a significant portion of them. Many Canadian mortgages are paid down, in
significant part. As well, the property is security against the mortgage. The
mortgage insurer disposes of the property, typically at less than the face value
of the underlying mortgage, and the residual is the cost to the agency, in this
case to the federal government.
Having been concerned about the scope of CMHC's activities, the question
becomes: What do you do about them? Something that we looked for was to reduce
the growth of the exposure in the first instance to create room for private
insurers to take on a larger role in the marketplace, with more market exposure
of their own. In other words, risks would be taken on by private parties willing
and able to bear them and to understand them as well. Further, one would look to
see an expansion of the range of possible financing sources, low-cost, secure
financing for Canadian mortgages. Hence we focused on the covered bond market.
The covered bond market is a very interesting one. It is a centuries old
European tradition. They have been in the U.S. market, in fits and starts, since
the mid-19th century, but the Canadian market has never developed much. The
covered bond is called covered because the surety that it provides is dual.
The mortgages are pooled and sold off through a simple bond. It is a simple,
one-step securitization process. It is very linear and a very short and simple
mechanism. The mortgages that back the bonds are hypothecated to paying the
interest and principal on those bonds. It can be a very secure investment. It
has dual cover because the full faith and credit of the backing financial
institution is also dedicated to supporting those bonds, which means that if the
mortgages go bad, the investors in the bonds are as sure as they can reasonably
be, within the bounds of human endeavour, to receive their money back. That is
what makes them a very good and potentially secure source of financing.
What happened post-2007 is that a number of Canadian financial institutions
went to market packaging bonds that were insured by CMHC or others, packaging
those bonds within the pools dedicated to the bond covered. This poses a problem
because some of us would have looked to the development of the covered bond
market as an alternative to taxpayer support for the housing financial
framework. If covered bonds going forward were to continue to contain insured
mortgages, some of the goals that we would hope for in developing the financial
marketplace would have remained unattained, hence this bill, and Division 11 in
particular, which prohibits all the financial institutions that might issue
covered bonds from stocking their bond pools with insured mortgages.
I think this is a very good development. I note, with pleasure, that last
week RBC in particular received permission in the U.S. to bring a $12 billion
Canadian covered bond offering to the retail marketplace. This is a development
of the sort that we very much like to see, a broader and deeper investment pool
backing the Canadian housing financial market or financial framework. This is a
good development. There is a lot still to happen as the markets evolve. We are
very supportive of these changes.
I am supportive, too, within the context of Division 11, of regulatory
changes with respect to CMHC, some changes to the configuration of the board of
directors and also in particular the requirement that the Office of the
Superintendent of Financial Institutions prepare, on at least an annual basis, a
report on the status of CMHC. These are very good developments. One of the
things that they do is make this very large financial institution one that is a
little more like the other financial institutions with which it competes in the
marketplace. These are good steps.
I would like to move past Division 11 to the last one I would like to address
in the context of this committee's pre- study, which is Division 28, which
amends the Investment Canada Act to allow the Government of Canada to accept
sureties or securities in respect of commitments made by foreign investors
seeking to consummate domestic acquisitions.
On this, I will cite my colleague, Philippe Bergevin, who points out that to
accept securities against potential fines imposed on foreign investors may
enhance the credibility of the commitments foreign investors make to the federal
government. That is its intent, and it is reasonable to do so. However, the
practice may also have a chilling effect on potential foreign investors if it
were to become common. Accepting securities against the potential fines, which
is their purpose, would raise red flags for some investors. It imposes a cost, a
real cost, which would not be consistent with the government's perfectly
sensible policy goal of ensuring that Canada is perceived as an open and
welcoming place or destination for foreign investment.
Further, and again I cite here Mr. Bergevin, the legislation imposes no
formal requirement for the minister to disclose publicly the reasons for
rejecting an investment proposal, in particular if or when an investor withdraws
a proposal, as we have seen in recent years. It is important for the minister to
articulate publicly his or her reasoning even perhaps when such decisions are
positive, so as to build an inventory of decisions that would help clarify the
legislation and therefore clarify too for potential investors their
understanding of their likelihood of success in putting forward or proposing an
acquisition within Canada.
Neither do the amendments address the so-called net benefit test. This is an
inherently vague and ill-defined concept and one on which valuable investments,
investments which could be on balance, long term, very valuable for the Canadian
economy, may simply not happen because of a rather vague concept that seems to
be applied at times and in ways that are quite unclear to investors and are
certainly unclear to me. Accordingly, I am unconvinced that this set of
amendments is headed in the right direction, and in at least some dimensions it
does not go as far as it should.
Thank you very much for your time, and I hope we have some good discussion on
The Chair: Thank you, Mr. Poschmann, for your opening remarks.
I will refer particularly to Division 11, CMHC. You repeated in your opening
remarks today something that you said in the Financial Post, I believe on
April 26, if I could quote for a moment:
Notwithstanding the bill's 431 pages, what grabbed attention was a few
short sections overhauling Canada Mortgage and Housing Corp. oversight and
dealing a short, sharp shock to an important corner of the bond market.
Obviously you were talking about OSFI and prohibiting the banks' use of
collateral of their insured mortgages in their covered bonds. Could you relate
those two issues to the debacle we saw take place in the United States and the
degree to which you feel this sort of insulates Canada from the sub-prime
mortgage issues that took place south of the border?
Mr. Poschmann: Thank you, Mr. Chair. It is a good question and one
that comes up a lot and for good reasons, because we certainly did see a
disaster in securitization markets in the U.S. in the wake of the housing
meltdown through the federal homeowner corporations, through Fannie Mae and
Freddie Mac, which are now very famous names around the world. Who would have
thought not many years ago that phrases like ``CDO'' and ``CDO squared'' would
become common parlance?
There were multiple failures in the U.S. system. One was, in the first place,
with respect to the regulation of mortgage insurance. Over the years, from the
late 1980s right through to the mid 2000s, congressional representatives on both
sides in the House of Representatives and in the Senate in Washington encouraged
Fannie Mae and Freddie Mac to loosen their mortgage underwriting standards. They
were backed in doing so by, at the very least, the Clinton White House and Bush
II. There was significant relaxation of the insurance standards under both
presidents, with bi- partisan support. This reduced the quality of underwriting
that took place.
Second, the U.S. marketplace with respect to mortgage origination is a little
different from ours. In other words, the originate to distribute model was much
more commonplace, where an underwriter would arrange for a mortgage through a
third party, the third party would sell off the claim on that mortgage to a
fourth, and Fannie and Freddy were at the end of a sometimes long and complex
securitization chain. There is more that went wrong in the U.S. marketplace, but
you have enough right there to set the stage for a lot of trouble.
Let us switch to the Canadian marketplace. With some confidence, we can say
that mortgage underwriting standards and mortgage insurance standards have been
more stable and perhaps at different times more restrictive in Canada, probably
to the good overall. Certainly, though, we have had fairly loose underwriting
standards at times, and we will note that, over the past 18 months, the
government imposed through regulation some tightening of insurance underwriting
Second, it is much more likely in the Canadian marketplace that mortgages
will reside directly on the underwriting bank's books which, for the most part,
means that the Canadian bank is properly exposed to the risks embodied in the
mortgage loan. I point out, however, that that is not entirely the case. As a
matter of fact, it is not the case in the majority of the situations because of
the presence of the government-backed mortgage insurance agency, which at this
point insures 22 per cent of chartered bank assets, which is the composition of
their residential mortgage loans with respect to overall the asset side of their
balance sheet, so it is a remarkable exposure.
What is different about covered bonds, especially when we restrict the
contents of the pools that back them, when we restrict those bonds or those
mortgages to uninsured mortgages, is that by definition the loan-to-value ratio
of the mortgages is under 80 per cent. You know in general that you have a very
secure and fairly reliable asset base or collateral backing a bond.
Second, it is a very simple intermediation mechanism. Many people do not use
the word ``securitization'' to describe a covered bond. I think it is accurate
to use the word and to say the covered bond is a simple and short securitization
chain. It is well understood, so you know pretty well where the risks are within
the bond pool.
I note as well that the legislation requires CMHC to establish a mortgage
registry. For the pools of mortgages that will back the bonds there is an
electronic registry that indicates the characteristics of every mortgage within
it. This exposure lends investors some confidence that they know what they are
getting when they buy the bond.
The proof will be in the pudding over the next couple of years as we see how
this market develops. It cannot displace and is not intended to displace the
mortgage financing market in entirety, or even in large part. Simply, it is
intended to be a significant component of the overall suite of tools available
for financing residential mortgages.
The Chair: May we take from that that it is basically a regulatory
issue that differentiates Canada from the United States, or is it regulations,
oversight and policing of those regulations that come into play?
Mr. Poschmann: I would say regulation in part, oversight in part, and
then institutional structure, the extent to which the assets, meaning loans,
bank assets, are retained on the books within Canada. That is a difference too.
The other one is the incentive mechanism. What I am referring to is the
degree of risk to which investors are exposed, so that the incentives are
appropriately lined up and the investors who are exposed to risks in fact bear
those risks as opposed to third or fourth parties.
The Chair: Thank you, Mr. Poschmann.
Senator Hervieux-Payette: I do not know if I can speak French because
I hear all these terms in English. Most of the time I would like to speak in my
own language. However, I would like you to take us from this recent transaction
that you talked about in relation to RBC bonds and the U.S. and so on. I would
ask that you walk us through the whole process. I gather, from what you said,
they package a number of mortgages. Are they auctioning them? What is the
average size? What is the percentage point between every transaction? I suppose
they go from CMHC to RBC and from RBC to the different entities in the United
States. These mortgages, if I am correct, are a package of several mortgages put
altogether. Are they from different banks? What is the mechanism that makes you
feel this would be to Canada's advantage? Where is the money?
Mr. Poschmann: Let us look at this only and entirely in the context of
the uninsured mortgage pools. That is the environment in which we will be
proceeding in future.
A potential homeowner applies for a mortgage with a loan officer at the local
office of the bank. The home buyer presumably meets the underwriting standards
that the bank seeks to impose, and in this case will be seeking a loan that is
less than 80 per cent of the purchase price of the home.
Banks like to lend money to borrowers. That is how they go about making
money. In turn though, banks, like other financial institutions, are not
directly lending shareholders' money, they are raising funds in the external
marketplace. If you are going to lend money say on a five-year term, in a
prudent financial framework, you would ensure that you had five-year money
available to you on the incoming side. In other words, you would be looking for
either depositors or just plain investors to supply money on similar terms.
Of course, banks, like insurance companies and like most of the rest of us,
like to make money. They would like to borrow money at a lower cost than they
lend it out. You look for low-cost, liquid markets in search of investors.
What happens? The parent bank conveys ownership or conveys the claim on the
mortgage to a third party vehicle, which is structured specifically to do so. It
is a well-capitalized vehicle and it is intended to be bankruptcy remote from
the parent institution. In other words, it has good capitalization relative to
its exposure. It does a few other things to increase the credit quality of its
mortgage pools and therefore to lower the cost at which it can borrow on the
In particular, it will over-collateralize the mortgage pool. In other words,
if you are going to sell a bond worth $100, it would be backed by $103 or $105
or even up to $110 in face value mortgages in Canadian practice and in
regulation going forward. Therefore, you have a slightly over-collateralized
You have a pool of mortgages that are essentially the property of the
sponsoring institution, and the proceeds or the payments of interest and
principal that the home buyer makes flows to that pool. The income is used to
finance interest and principal payments on the bonds sold.
How are the bonds sold? That is the open market. The sponsoring institution
must find a marketplace for them. The reason for having a legislated framework
is that many institutional buyers, particularly in Europe, require a clear
legislative framework with respect to creditor priority in the event of
bankruptcy so they are allowed to invest in this particular class of assets.
That is the primary reason why you look for a legislated framework for the
covered bond market.
This legislation in fact goes a step and prohibits contractual bonds, which
is the form of bonds issued under standard or customized prospectuses, to this
point, by Canadian financial institutions. Going forward, banks will no longer
be able to write contractual covered bonds as they have in the past. They will
only be able to issue them within the framework authorized by this legislation.
Senator Hervieux-Payette: Would you say in this case that this would
remove some of the pressure or at least encourage banks that would make more
money by going elsewhere than the CMHC? Would CMHC continue to build up the
number of mortgages that they have covered without the risk like the American
package that was also put on the market? Some banks were supposed to be
knowledgeable about the risk but, of course, some of them went bankrupt. With
all your knowledge, would you say to the Canadian people this is something that
would not endanger our banks and would not endanger the whole system?
Mr. Poschmann: Thank you for that question, senator. It is an
interesting one. First, the covered bond question and the cap on CMHC insurance
are side by side. They are not interrelated. The cap applies to the level of
insurance exposure that CMHC is able to take on. In the near term lending growth
in Canada is not at such a pace that the $600 billion cap will be under much
pressure, but it will be under some over time on the presumption that it is not
significantly increased. In fact, the government may choose to decrease the
authorized cap on CMHC exposure.
As that happens, presumably the rationing of access to mortgage insurance
coverage from CMHC will drive up the price of that cover, relative to insurance
that might be purchased from private sector competitors. There will be some
encouragement to let the other players in the markets take on a larger share of
the market space.
With respect to covered bonds, if I have the question right, they will all be
uninsured, so there will be no federal taxpayer exposure. The risks to Canadians
are only those to which they are exposed indirectly through their ownership of
Canadian banks and through their expectation that we have a stable financial
system. It is very much the business of the bankers to look after their
operations and their shareholders. They seem to do a very good job of it, and we
can reasonably expect them to continue to do so. It is their job.
Senator Oliver: I have three short questions. When you were giving
your remarks, you were very excited when it came to the scope of CMHC. You said
this is a very large financial institution and you said that you were concerned
about the scope of CMHC. You went on to say that you would like to see this
legislation permit private insurers to take on more of these risks.
My first question is this: If you were in the private insurance business now
and you had a competitive product, you kept your costs down and you had some
innovation in your product, what would prevent you from competing with CMHC
Second, I am interested in corporate governance. The CMHC board will be
expanded, not increased. They are not including independents but they are
including two bureaucrats as ex officios on the board. I would like your comment
as to whether we are going in the right direction. Is this good corporate
governance or should we be looking for someone who is less dependent and less
controlled by the payor?
Third, you made strong comments on Division 28 when you said that it is
really not headed in the right direction. Do you have some suggestions or
proposed amendments, which we could put in our report, on what you would like to
see since we are going in the wrong direction?
Mr. Poschmann: First, on private sector competition with CMHC,
absolutely their private competitors are motivated and have been motivated for
the entire time they have been present in the marketplace to seek market share
at the expense of CMHC.
Senator Oliver: Is that liable to happen?
Mr. Poschmann: They have made headway at different times, in the wake
of the 2007-08 meltdown, when there was a significant retraction in their range
Something that we have to point out, though, is that while the private
insurers are 90 per cent backed with respect to their market exposure by the
Government of Canada, the 90 per cent backing applies only in the case of a
private insurer going bankrupt. CMHC, however, writes bonds that are guaranteed
by the full faith and credit of the Government of Canada, for good or ill.
Certainly, it lowers the cost of raising capital in the marketplace for CMHC
and, therefore, arguably lowers the cost of mortgages, perhaps, for Canadian
However, it means that the cost of capital to which CMHC is exposed is
significantly lower than the cost of capital for the private insurer. The
private insurer is participating in the same market space with similar products
but has a higher cost of capital. That will always be a constraint on their
ability to compete on price. Absolutely, they have an incentive to compete and
win in seeking market share. It is in the interest of all of us to see that
products are competitively supplied.
Board independence is a very good question. I caution assumptions about a
link between board independence, as generally defined in the current corporate
governance literature, and performance of a financial institution. There are
independent directors, and there are independent directors. What matters are the
quality, skills, interest and engagement that they bring to the performance of
the organization for which they are responsible.
It is no secret that in past years the CMHC's board has raised questions
occasionally from outsiders who have wondered about the board's composition and
whether, as a financial institution, it was being adequately overseen. I have no
strong view on that point whatsoever. Clearly, the government of the day has
seen fit to assert quite directly some oversight within the board of CMHC, owing
to the exposure of the Government of Canada and their interest in maintaining
knowledge of and control over the financial market risk exposure of CMHC.
Certainly, it will be a different world if the deputy minister of the
department that oversees CMHC and the deputy minister of finance are on the
board; it is very easy to picture the dynamic within the board changing in that
context. Whether that is to the good or ill, I do not have a strong comment.
On Division 28, my colleagues wrote a paper on the Investment Canada Act
earlier this year or late last year. It contains several useful recommendations,
including the elimination of the net benefit test, that Canada's security
interests be maintained and protected in a clear and simple manner, and that the
minister give reasons within the context of that test for accepting or rejecting
a proposed acquisition.
Further, our authors supported the recommendation of the Wilson committee
going back to mid-2008, which would have seen the onus switch to government to
explain why a proposal should not go forward, as opposed to leaving the onus on
a foreign investor to explain to all Canadians why an economic net benefit would
be manifested if the acquisition were to go forward.
Senator Massicotte: Thank you for helping us to review and understand
the proposed amendments.
Overall, am I correct in saying that you agree with the amendments proposed
except with the approval by the minister of acquisitions?
Mr. Poschmann: Yes, I think that is a fair comment.
Senator Massicotte: I want to be sure that I understand your comments
on covered bonds. In the future with this legislation, the banks will not be
able to securitize mortgages that have been secured by CMHC — or the Canadian
public. However, they can do it with the remains.
Let me ask a question on reserves. I understand the effect on the banks on
that decision. How about the reserves within the bank? Must the reserve
requirements be the same for those insured by CMHC as for those not insured by
Mr. Poschmann: You are right, senator: There is a difference in the
required capital set-asides under OSFI and Basel guidelines with respect to
insured mortgages. I do not recall the specific numbers, with apologies. The
insured mortgages have a low capital set-aside requirement or capital adequacy
requirement. Residential mortgages generally have a good or moderate risk
weighting compared to other terms of disclosure and not a full-risk weighting.
By way of example, under the traditional Basel capital standard, sovereign debt
of some western European nation would have a zero capital requirement. The
implications are, first, that this weighting system is important; and, second,
that we do not always get it right.
Senator Massicotte: As to the systemic risks from this process, is the
bank covenant always maintained in the securitization of mortgages whether it is
CMHC, or is there some non-recourse?
Mr. Poschmann: In general in Canada, mortgages are recourse with
respect to the homeowner.
Senator Massicotte: I am not worried about the homeowner. I am talking
about when the bank securitizes the mortgages. Are they always on the hook for
Mr. Poschmann: They are on the hook within the covered bond framework
and not fully so with respect to the insured bond framework or to insured
mortgages precisely because they are insured. When a mortgage goes bad, the
lending institution will make a claim, against either the private insurer or
CMHC, with respect to the face value of the mortgage. The mortgage insurer is
exposed to the costs of foregone interest and to the further transaction cost on
subsequent disposition of the home. Typically, this will be occurring in a down
market, so the selling price of the home will be less than the face value of the
mortgage. Of course, there are the legal and real estate transaction costs
associated with the overall settlement procedure.
Right now, when a mortgage goes bad, mortgage insurers are recovering roughly
70 per cent of the face value of the mortgage.
Senator Massicotte: As to the 30 per cent, we had an expert witness
yesterday saying that the institution, as well as CMHC, if that is the case,
never sued the home owner for any shortfall. Is that the case?
Mr. Poschmann: You will have occasions where a collection agency will
pursue; in other words, there is recourse in Canada in general, outside of
Alberta. Even in Alberta, mortgage insurers will tend to write contracts that
have recourse in them. Normally, though, there would not be a reason for a bank
to pursue it because you would simply hand over the settlement procedure to the
Senator Massicotte: I appreciate that, but if it is uninsured, the
bank has a right to do so. If it is CMHC, they have a right to do so, and there
Mr. Poschmann: Yes.
Senator Massicotte: Have they never sued the person who defaulted on
the mortgage for the shortfall?
Mr. Poschmann: I could not say never.
Senator Massicotte: Let me talk about Division 10, the revisions to do
with future sovereign funds, basically foreign funds, because Canadian pension
funds have the right to do so today with special exemption. Our Canadian
institutions will now have a right to invest in any form of security — equity or
debt — with the approval of the minister, and there are certain criteria there.
Obviously, the minister will always act, according to his best judgment,
consistent with the interests of our country. However, once that sovereign fund
buys 9.9 per cent of a Canadian institution's shares, they may be there for
decades. Is there a risk to our country? Is that exposure that we should not be
risking? We had this debate a couple of years ago. There are some countries who
say that they have a commercial interest, but their interest is more strategic —
security supply, if you wish, and other political interests. Is there a risk
Mr. Poschmann: Thank you for that question.
I am unclear as to what the risks might be. There may be some unspecific
ones, but on a case-by-case basis, I think it is imperative to explain why a
transaction among willing parties should not go forward. In other words, if we
have shareholders of a Canadian firm who are being offered a good price for
their equity stake, there really ought to be a good reason for a government to
say why that transaction or that sale should be prohibited.
In general, a wealth fund or other institution, such as a pension, is
motivated by commercial interests. A sovereign wealth fund generally likes to
make money as much as anyone else does. The incentives normally will be in the
right place with respect to management and oversight of the future of the asset.
The other thing, too, is that I am not particularly concerned about
relatively large ownership stakes in institutions. We have, for instance, among
Canadian banks, a widely held rule. It is that an individual or a group of
related individuals cannot acquire a control stake in a Canadian bank. One of
the results is that you have completely unclear linkage between the shareholder,
as an interested party, and control and management of the bank. When you have a
significant stake in a financial institution, you are powerfully motivated to
ensure that it delivers the goods.
Senator Massicotte: Let me talk to you about the appointment of the
deputy ministers to the board and see how you respond because there are pros and
cons. In your response, I think you noted the same.
Governments are responsible to the governed, but they also have a political
interest to win power and be re-elected. I generally see it as a negative
tendency to have deputy ministers sitting on the board because the other board
members will be very sensitive to any political signal that they make. At the
same time, as you rightly noted, board members of these Crown corporations and
of many private organizations are usually less engaged than we would like them
to be and, therefore, pass on and allow management too much discretion. I am
betwixt and between. I do not like them sitting there, but they will certainly
be very engaged in results and overseeing management, probably compensating for
the fact that the other board members are maybe not doing their job. How do you
respond to that comment? Is that a good balance of the competing interests?
Mr. Poschmann: Thank you, senator. I do not think I will be addressing
the last part of your comment, but I would point out that it is a very
interesting question. I observe that the changes proposed here will change the
dynamic, for good or for ill; that is an uncertain outcome. It is normal for
deputies to sit ex officio on a number of agencies. It is not so typical
in the case of Crown corporations or Crown financial corporations.
I do not mind telling you, though, that it is a question that we have been
batting around in our office recently. We do not have a clear answer to the
question of who the duty of the director of a Crown corporation or a Crown
financial corporation is owed to. Is it to the corporation? Is it to the
shareholder? Is it to the government? Is it to the taxpayer? There are a number
of different possible answers to that question. Normally, in the private sector,
while the answer might be unclear in change-of-control transactions and in a
number of other circumstances, usually you have a pretty good idea to whom the
duty of the director is owed. In the case of Crown corporations, this is
slightly less clear.
Senator Massicotte: Chair, may I have one last question?
The Chair: Second round, please.
Senator Maltais: At the beginning of your brief you refer to the fact
that Canadians are very worried about their annuities when they must convert
their RRSPs into RRIFs. What would you suggest to them?
Mr. Poschmann: I missed a word there, senator; my apologies.
Senator Maltais: When you turn 71, RRSPs have to be converted into
RRIFs. You said that Canadians were very concerned. Are they right to be
Mr. Poschmann: Are they justified? It is difficult to tell. We have a
set of rules that require that we begin the wind- down process of an RRSP at age
71. In other words, individuals must convert them to a Registered Retirement
Income Fund, which is generally a life annuity. The reasons for this, as a
matter of policy, are not at all clear to me. This is the framework within which
A life annuity can only be offered, in general, in Canada by a life insurer
as opposed to other institutions. I have no view as to whether life insurers are
doing a good or a bad job in providing a range of well-priced offerings. Given
that millions of Canadians will be expected to go through this process over the
course of their lifetimes, I think it is incumbent on government to satisfy
themselves that they have a good and well-priced range of financial instruments,
annuities in particular, available to them.
Senator Maltais: If I follow your reasoning, you are suggesting that
at the age of 71, when you have to convert your RRSPs into RRIFs, it is
preferable to go to an institution that specializes in annuities; that would
means a transfer of funds from a financial institution to an insurance company.
Mr. Poschmann: That is an absolutely reasonable point of view. I share
the view that the institution charged with delivering an annuity ought to be one
that is fully capable of doing so. Canadian life insurers are strong and sound
companies. I have no fears or few fears about their ability to continue to do
so. I simply raise the question of the matching of liabilities over time. It is
something that a lot of financial institutions are capable of doing. Our
separation between insurance and banking within Canada, for example, is not one
shared in many jurisdictions around the world, but it is part of the Canadian
financial framework. I am in no sense proposing or suggesting that it should be
overthrown today, but I do raise the question of whether, over time, we might
wish to see the walls between them perhaps get thinner rather than thicker.
Senator Maltais: The government recently announced that the age of
eligibility for old age security would be pushed back to 67. Would it be a good
idea, a bad idea or an idea that should be examined to also up by two years the
age at which one must transfer our RRSPs into RRIFs? That would mean that you
could contribute until the age of 73, and from that age on, you could convert
your investments into RRIFs. What do you think of that?
Mr. Poschmann: I agree with you on that, Senator.
First, with respect to retirement age, the changes that the government has
proposed with respect to public pension entitlement are aimed at being more
flexible and more accommodating and fairer to people who choose to retire
earlier as opposed to later, as well as to increase the reward available to
retirees should they choose to work longer. That is part of it.
Yes, we are, too, over time, going to see an increase in the age at which the
public benefits will be generally accessible. I think it is fair, and authors,
including Bill Robson of our institute, have written extensively on the fact
that Canadians are living and working longer and will continue to do so. It is
neither necessary nor desirable to force them to work longer, but it does make
sense to have a policy in place that accommodates their individual choices on a
To that end, with respect to the formal age at which the RRSP conversion must
take place and when savers are required to enter the disgorgement or the
wind-down phase, personally, I would prefer to see it eliminated and to see
people free to work and contribute to their tax-recognized savings plan as long
as they choose to do so. As far as I can tell, the only reason we do require
conversion and wind down is so that the government can obtain tax revenues
sooner rather than later. I do not think that is a very distinguished policy
Senator Harb: I am looking at the mandate of CMHC. I will read part of
it, and then I will ask my question about it. It states:
. . . helping low-income families, persons with disabilities, seniors and
Aboriginal Canadians access affordable housing . . .
In order to do that, they provide other services such as sources of housing
information, mortgage loan insurance and so on. It seemed to be over the years
that the mortgage loan insurance and the other types of commercial activities
that CMHC are overtaking the other role, which is the social role of CMHC as we
know it. I would have been interested in hearing you talk a bit about that. As
we approach this agency, we have to look at more than just oversight of the
commercial operation. We really need to examine whether or not CMHC is still, in
its current makeup, able to provide the type of services that it was set up to
provide in the first place.
The second part of my question is, out of all of the financial-like
organizations that are Crown corporations, such as EDC, BDC and CMHC, it seems
that we are discriminating somehow against CMHC and trying to tie them down on
the governance side while the other agencies have a free flight.
Mr. Poschmann: Thank you, Senator Harb, for that question. It is an
early day yet.
CMHC is a large camel with two very distinct humps: One is the financial side
and the other is the social policy side. There are a number of other relatively
minor functions that it undertakes, such as information and research, in part
because their mandate expects it of the agency. However, they are very different
parts. There is no particular governance or operational reason that they should
exist together, side-by-side, within the agency. It is not necessarily bad that
they do, but it is difficult to make a claim that there are significant
synergies or economies of scope between these very different activities.
The mortgage insurance business is generally a profitable one. As long as
housing markets stay reasonably stable, it will remain a profitable line of
business to be in. However, that has little to do with the financing of the
social policy parts of CMHC's mandate. CMHC, after all, does receive a
parliamentary appropriation for conducting those activities. As a policy matter,
successive governments have seen fit to maintain that appropriation for those
purposes. I do not, however, see a logical requirement for the two parts
Senator Harb: There seems to be a bit of non-cohesiveness in the way
it is working. In a corporation, normally you generate revenues and profit. You
support your operation, expansion, et cetera. We have a situation with CMHC here
where, unlike what you will see in the private sector, this organization
provides profit and has been profitable for a number of years, but all of the
revenue goes to the general revenue funds. They cannot use any of that extra
money that they get in order to improve on their operation and provide services
to meet their mandate.
If we were to look at their social mandate, I would submit that there is a
deficiency there. It seems to be that what we are doing is almost a kneejerk
reaction rather than really looking at the whole agency in a holistic type of
Senator Ringuette: Thank you for being here. I notice that you were
also here yesterday waiting to appear before us, or anxious to hear what other
witnesses wanted to tell us.
I am going to Division 10. In your written submission, you say Division 10
permits certain international financial bodies to invest in domestic financial
When the officials from the department were in front of us, I do not recall
that they indicated that it was for international financial bodies. I looked
again at the briefing book I have and I do not see a reference anywhere in the
legislation to international financial body.
Could you explain to us where the international comes in from your
Mr. Poschmann: It is simply my phrasing. It is international with
respect to the fact that these are non-resident investors, in other words,
foreign investors into Canada. The subject of discussion is financial
institutions or financial bodies. One of the terms of art to avoid confusion is
``large pools of capital,'' which I am not sure helps really anyone as a matter
The issue here is one of terminology more than anything else. Some people use
the phrase ``sovereign wealth funds,'' but that is a term that carries a lot of
baggage for some folks. Further, it is not entirely accurate with respect to say
some of the pension arms of private or public or foreign governments.
Senator Ringuette: In the information we have received, or in the
bill, I still do not see the international or outside of Canada financial bodies
in these changes. What I saw was a possibility for the Ontario Teachers Pension
Fund, which is a considerable pool of money. I also saw, for instance, perhaps
the current pool within CPP that could be an investment pool related to this.
My question to all of this would be as follows: If the Canadian banks are now
going to be able to have access to these pools of funds that currently are
strictly in the commercial area, outside of financial institutions, will that
not remove funding from Canadian businesses, large corporations, to the benefit
of our Canadian banks that have ample other tools to acquire liquidity?
Mr. Poschmann: I believe the key issue here is simply to expand the
range of potential investors in Canadian financial institutions. I do not see
that there is a larger implication beyond that. The Bank Act and the Insurance
Companies Act and the Trust and Loan Companies Act have always contained some
constraints, criteria, restrictions, with respect to senior officers and
directors of those institutions and have applied, in some context, a fit and
proper test with respect to the executive officers and directors.
These restrictions are there, presumably and I think arguably correctly so,
to protect the Canadian interest generally. To apply these criteria to investors
in these contexts is I think intended to achieve a decent saw-off, to retain
some sort of control or influence over who it is that has stakes in financial
institutions while permitting or encouraging a broader pool of potential
investors. That would expand the capital available in the domestic marketplace
with no particular implication for the lending behaviour of these financial
With respect to domestic public pension plans, I am not aware of any
particular constraint with respect to their taking ownership stakes, subject to
limits, in Canadian financial institutions. That is very much their decision. I
would be wary of any implication or imprecation from government that they should
do more of it or do it in any way that was other than consistent with their
Senator Ringuette: Thank you for your answer.
I want to move on to Division 11. Rightly, you pointed to the mortgage and
the economy in 2008-09. In Canada we have seen the private sector mortgage
insurance reduce their activity considerably; for instance, AIG. Thank God that
the Canadian housing industry and Canadian homeowners had CMHC to backstop and
prevent what has happened in the U.S. From my perspective, CMHC is certainly
providing a main amount of stability in the housing market in Canada through its
You were talking earlier about the uninsured mortgages that can be pooled
into a covered bond situation. What are the mechanisms? We know that the value
of Canadian houses has maintained and even has had slight growth with regard to
market value. What can the bond market rely on in regard to the real value of
those uninsured, covered bonds?
Mr. Poschmann: These are very interesting questions. I will focus on
the covered bond question and housing market performance. Past performance is no
guarantee of future performance. This is something we should all bear in mind.
With respect to the residential mortgages as collateral, we did observe that
with a relatively low loan to value ratio is inherently more stable and more
recoverable than one with a higher loan to value ratio. There are several
reasons for that. One is the arithmetic with respect to the value of the home
versus the mortgage, and the other is the implication with respect to the
financial stability of the borrower. You have a couple of factors that make
recovery fairly secure with respect to a low loan to value mortgage. That is why
we do not regard them as very risky and that is why investors are ready, willing
and able to finance them in the absence of mortgage insurance coverage. Is there
a guarantee? No, of course not, but that is a very good thing. Part of the point
here is to match lenders and borrowers who are ready and willing to undertake a
financial exchange. That is how the market is intended to work.
The bond buyers are protected by the faith and credit of the financial
institution. They have an additional level of security, which is the point of
the covered bond pool. There have been covered bond market failures around the
world and over time. Some trouble has occurred as recently as this week, with
the threat of a downgrade in the European market space. No bond issue is
perfect, and it is not meant to be. The mortgage registry is one of the things
that help the system to work a little better.
In the 1890s U.S. marketplace, there were rolling waves of farm mortgage
failures. Investors found that the managers of the banks had swapped out good
mortgages for their own books and swapped in bad mortgages to underpin the
cover. From the point of view of an investor, this is a really bad idea; and
from the point of view of future investors, they should be fully capable of
ensuring that Canadian financial institutions will not do that in the future. We
have a much different legal framework now and about some of this stuff we are a
little smarter than we used to be. We also have better systems for controlling
the risks. It does not mean that bad things will not happen again, they always
do, but we just do not know what it is yet.
Senator Moore: Mr. Poschmann, I have your piece that was published in
the Financial Post on January 31, 2011. I want to read a bit from it and
then I will ask you a couple of questions. You were talking about CMHC, and its
exposure. You said:
. . . we don't know exactly how huge, or even why we should necessarily be
exposed to it. CMHC produces clear, audited financial statements, but they
are sparse and it is not possible for outsiders to understand the risks in
the mortgage-lending book. Opaqueness does not breed confidence, and it
The solutions are simple. First, CMHC should slow down and eventually stop
writing new mortgage-insurance policies. It doesn't need to. Financing
low-income housing, encouraging home ownership, encouraging lending in rural
areas, tightening credit or loosening it — all of these things can be done
by federal legislation or regulation. None of them requires Ottawa to be
directly in the business of selling insurance. Nor does pursuing financial
stabilization goals, which are in the purview of the Department of Finance,
the Office of the Superintendent of Financial Institutions (OSFI), and
arguably the Bank of Canada.
What Ottawa could do is focus on a vibrant reinsurance and securitization
market. Private reinsurers, such as operate now in global markets, may wish
to sell financial products based on the insurance policies that private
insurers sell. Ottawa could kick-start that market domestically, and one way
is for CMHC to reconfigure itself as a reinsurer.
I expect that you still hold to those thoughts. I would like you to explain,
for the benefit of us and people who are watching this committee hearing, what
exactly ``reinsurance'' is, what a vibrant reinsurance and securitization market
is, and how CMHC would look.
Mr. Poschmann: Thank you for that question. You refer to the part of
my recommendations that has not been done yet.
Senator Moore: That is why I am here.
Mr. Poschmann: I believe it is an interesting one. CMHC currently has
a securitization program; it absolutely does. There is a sense in which you can
regard that as a reinsurance function. Let us start with the definition. Let us
take the point of view of a property and casualty insurer, who insures you
against fire. You pay premiums; the insurer invests those premiums, earns a
return on them, and that supplies a stream of income presumably with which to
compensate shareholders. Also, the insurer will build up capital stock
sufficient to buffer it against the shocks that come when fire hits your house.
However, when a forest fire hits your neighbourhood and burns down not only
your house but also 100 houses around it, the scope of damage, if the insurer
was dominant in that marketplace, is significant relevant to the capital of the
insurer. In fact, it takes it under; these things do happen. A reinsurer
assesses those risks and insures them. The reinsurer is assessing the likelihood
that a significant incident or shock or fire will take down a given insurer, and
sells a product that covers against that likelihood. This is the reinsurance
Internationally, there is a tertiary insurance market called catastrophic
reinsurance, or ``cat re.'' It is intended to cover insurers and reinsurers
against shocks even bigger than those we just described. When we have incidents
like Fukushima in Japan — such a large shock — it shakes the ``cat re'' market
as well as local insurers. It is something that the marketplace has generally
evolved to be able to deal with. My assertion going back to early 2011 is that
it would be interesting to see this market develop more in the mortgage
insurance space. It is a project for the future.
Senator Moore: Are you suggesting that CMHC would get out of the first
tier — the mortgage insurance business, that that part be privatized, and then
act as a reinsurer of those who issue private insurance policies in the example
Mr. Poschmann: Yes. That is similar in a way to some of those
activities now in the fact that it has 90 per cent backing to the private
mortgage insurers in the event of their bankruptcy, which is a slightly
different thing from the reinsurance marketplace.
Senator Massicotte: I want to clarify reinsurance. You seem to suggest
that reinsurance ensures against the solvency of the insurer, which could be the
case in a major catastrophe but most often it has a particular risk of a certain
type of insurance policy. Am I correct in saying that?
Mr. Poschmann: Yes. That was the distinction I was trying to make with
respect to CMHC's current activities.
The Chair: That concludes our questions for round one. We will now
move to round two and we will start with the deputy chair of the committee,
Senator Hervieux-Payette: You are telling us that the government's
approach to changes to the Foreign Investment Act consists in providing a
warning in case conditions are not respected, and you were talking about foreign
investors, specifically financial institutions.
We don't have all of the acts the amendments concern, as they probably would
have had to give us a case of them. I was under the impression that these
measures concerned all foreign investments, and the conditions negotiated with
the minister to permit foreign investments that involve a takeover. In my
opinion, there have to be regulations governing the takeover of an organization
by a foreign investor. And yet you seem to be saying that this only concerns
potential investors in the financial sector.
As for banks, it is impossible, given the maximum a bank can accept, when we
are talking about large banks. Foreign banks are subject to another system.
Then there are insurance companies, and among them there are a lot of foreign
insurance companies operating in Canada. You seem to be saying that this is not
a good idea, but what would you suggest be done in cases of non- compliance?
In the case of a financial institution, it may not have seizable assets, and
so there have to be penalties that can be paid by means of some security or
other. I would like to hear more about why you think that this will be a
deterrent for foreign investors.
Do you think this will affect the financial sector alone, or also the mining
and energy sectors, and so on?
Mr. Poschmann: We are speaking here about Division 28. This is
relevant in particular for foreign direct investment as opposed to portfolio
investment, therefore, with respect to proposed acquisitions, which is the
general application —
Senator Hervieux-Payette: Would you say the resolution of Alcan would
fall into that?
Mr. Poschmann: That is an example, and there are, of course, others.
We have had a couple of controversial cases recently, including some court tests
where the application of a financial penalty was contested by the foreign
I am expressing one concern with two aspects. One is that the imposition of
conditions necessarily and by definition increases the cost of executing the
transaction through legal, financial or other compliance means or methods.
Definitely the cost of completing a transaction goes up the more conditions and
costs you lay on it. That means they are less likely to be completed and, other
things being equal, less likely to be proposed for that reason.
The general proposition that I am making is that foreign investment is good
for the domestic economy, to be encouraged and welcomed to the extent possible,
but not without limit in all circumstances, and it is fully within the
government's right to impose certain conditions under certain circumstances.
The question here, though, applies to the application of monetary penalties,
and this is an interesting legal area. What happens when a corporation fails to
maintain its undertakings or to comply with the undertakings to which it agreed
at the time the acquisition was approved?
Senator Hervieux-Payette: Right now.
Mr. Poschmann: If it disputes the penalty and wishes not to pay it, it
is subject to pursuit in court. This is a pretty straightforward and common
occurrence. Corporations are legal creatures and, if they expect and wish to
conduct business around the world and within Canada, they will, wherever
possible and to the extent they can, comply with local laws and regulations.
They cannot operate otherwise. If a company disputes a fine or seeks not to pay
one, that does not mean it is acting illegally or outside the law; it means it
disagrees with the application of the law or the regulation in that particular
context. The most obvious example with respect to undertakings would be force
majeure, and force majeure is one of those things that happens in the world, and
then you have a question of whether or not a government should be expected to
collect on a penalty where objectively there has been a driving case for a force
Senator Hervieux-Payette: Are you talking about the Japan case? Would
you call that a force majeure?
Mr. Poschmann: Absolutely, it could be, and so could a major financial
crisis. The question is, what happens next? In the case of the recent incident
in Ontario, which had a significant amount of legal action around it, the
company disputed and won some and lost some in court and then pursued a
settlement with government outside the framework. I find that not a particularly
good outcome. Everybody went away happy perhaps, but negotiating an entrance fee
and a fine outside of a previously agreed framework is not that good an outcome.
It is not that good a message for potential investors.
The reason, of course, for requesting a surety is to preclude from the
potential investor the possibility of disputing the fine. It certainly puts
significant leverage in the hands of government, which some of us might feel is
appropriate and others may not.
Senator Hervieux-Payette: When it comes to mining, energy and anything
related to the resource sector, if people are committed by contract to do some
investment, to create some jobs, to fulfil a lot of conditions that are accepted
and negotiated with the government, I think it would be a lot more than a fine
if they talk about creating 3,000 jobs and they are not created and they do not
do the investment related to that. I have the feeling that this would be
minimal, and you think it is not appropriate because it is too much cost at the
beginning. However, at the end of the day, if I look at some experience with
takeovers, sometimes they shut down the whole facility. There is no more
production because they are producing in other countries of the world.
If this is not the appropriate mechanism, what would you suggest would be a
mechanism? Once we enter into a contractual arrangement with the foreign
investor, how do we ensure they comply with their obligations? If it is
contractual and you cannot exercise the contractual arrangement, you have to sue
them, and then you have to go through all the process and probably 10 years in
front of the court. The region that has been closed down does not get anything
in the meantime. For me, this is small. For, you it seems to be a big, bad
decision. I would like to reconcile my view with yours.
Mr. Poschmann: These are matters of trade-offs and estimates of the
relative importance of different issues. I would not for a moment want to seem
to be suggesting that a contract is not a contract and should not be enforced.
That is what contracts are for, and commitments are intended to be lived up to.
That is why we enter into them.
I do not need to make any judgment about any particular commitment under a
given proposed transaction. I am unsure about their value in general, but that
is really neither here nor there for this discussion. I do think it is perfectly
fair to expect that a commitment will be lived up to within the legal framework
There is, however, a danger to giving too heavy a hand to government, and it
is that it will frighten away investment. Governments occasionally do not live
up to contractual commitments. When they do not, individuals and corporations
have to go through a lot of trouble and expense to seek to hold government to
the contracts and commitments into which they enter. If you have any doubt about
this point, I would refer to the recent transactions involving Repsol and YPF in
Argentina. The Spanish parents made plenty of commitments and reinforced and
extended those commitments, which were not respected by the Argentinean
government. It seems like those commitments were not worth the paper on which
they were printed and the companies will have absolutely no hope of extracting
their due under those contracts from the Government of Argentina. It can happen.
Senator Massicotte: I want to raise a subject to confirm something. I
refer to your comments relative to the CMHC and taking away the social agenda.
If you consider the creation of the institution several decades ago, there was a
community purpose of encouraging home ownership and thinking that is better for
the country. As I understand your comments, today you see no reason for having
the government involved by providing that service to maintain home ownership by
Canadians. Is that a correct interpretation of your comments?
Mr. Poschmann: It is perfectly sensible that governments should have
policies that make it possible for Canadians who wish to own homes and can
afford to own homes to do so. I would pull back, however, from the implication
that it is necessary for a government agency or for government policy
specifically to encourage Canadians to own homes as opposed to owning other
Here is an instance where I point to the U.S. example, where we have
long-standing policies aimed at subsidizing home ownership at extreme social
cost over the decades and, most recently, at catastrophic cost.
The promotion of home ownership, as I recall, is not explicitly within CMHC's
mandate, neither do I think it should be. However, supporting a sound financial
framework is a reasonable government policy objective.
Senator Massicotte: The other thing we can debate is that most
governments, and certainly the United States, did say home ownership is good and
we can encourage it, as you say, by way of laws and influences without actually
doing it ourselves. However, the experience in the United States has shown that
home ownership has been negative in a sense because there are a lot of homes
under water and it diminishes the ability of people go to the state or the area
where there are jobs. When we say home ownership is good, we always presume that
home prices will always go up and, therefore, it will create equity and wealth.
However, we learned big lessons from the world. Canada has been saved somewhat,
but look at Spain and the United States. There are many areas where home prices
have gone down. With the demographics that will be facing the market over the
next 30 or 40 years we cannot presume home ownership will continue going up.
Should we not even debate that aspect before deciding to get involved in this?
Mr. Poschmann: Those are interesting comments and big issues. It is a
long-standing debate. I certainly have written in a number of contexts about the
dubiousness of the case for direct or aggressive promotion of home ownership. It
absolutely is not a net positive.
There are interesting points to be made that for all the subsidies we provide
for home ownership in the U.S. in particular and less so in Canada, the home
ownership rates are really quite similar. They go up and down with the state of
the economy and they go up and down with the age profile of the population. For
instance, the U.S. has mortgage interest deductibility, which is a very bad
policy. You would be hard pressed to point to evidence that it in fact supports
a high ownership rate. What it does support is a significant government cost and
exposure and, as the senator pointed out, home ownership by people who would
have been a lot better off had they never been encouraged to do so.
Senator Ringuette: Going back to the covered bond issue, I will read
the following and get your comments. The first comment is from a gentleman
called Ted Lord, who is the managing director and head of the European covered
bond market at Barclays. He states the following in relation to the proposed
changes we are looking at in regard to the covered bond market for Canadian
The proposed changes should increase housing finance costs and decrease
housing credit availability. The change should increase residential mortgage
funding costs. Canadian banks will likely have to pay more to investors to
accept an uninsured collateral pool, and could have to provide more assets
to the collateral to achieve the desired credit rating.
That is from Barclays.
Another gentleman —
The Chair: Is there a question with that?
Senator Massicotte: It is coming.
Senator Ringuette: I need to give the context.
Another analyst at Fitch says that it could drive the bank costs of funding
by around 10 BP, and he says:
This measure may also cause contraction in credit availability, which has
the potential to negatively affect home prices.
We have two experts around the world who say that the current piece of
legislation before us will most probably increase the price of that liquidity to
our financial institutions. We also know that our financial institutions are not
in the market to provide any gifts to Canadian home owners, so that will
probably increase the mortgage rates at least.
Mr. Poschmann: I am absolutely delighted by the question.
First, with respect to the comment from the gentlemen from Barclays, the
article used the word ``should'' several times. I think what he meant to say was
``I predict that,'' which is subtly different from the word ``should.'' The
impact is somewhat uncertain. However, one of the missions here is to decrease
the home financing system's reliance on taxpayer backing. In other words, the
sovereign credit status that is now available to home lenders certainly does
reduce the cost of capital to those banks that take advantage of it and,
therefore, makes it a little easier for them to raise funds domestically and
internationally in financing their residential mortgage lending. Whether that is
a good thing or a bad thing is something entirely different.
One of the concerns among many housing observers over recent years in Canada
is the pace of credit growth, because it is credit growth rather than low
interest rates that tends to fuel house price inflation. There are regulators
who have drawn attention to the fact, as has the Governor of the Bank of Canada
and the Minister of Finance numerous times, that the pace of credit growth in
Canada over the past decade has been, in a word, unsustainable. It does need to
slow, because if it does not we get very bad outcomes down the road.
Second — and I guess I could phrase it as a prediction — is that banks which
go to raise capital through the new covered bond framework with bond pools
comprising uninsured mortgages probably will find that their cost of borrowing
is on the order of 10 basis points higher than they are presently paying to sell
bonds backed by insured mortgages. I agree entirely with that point. I do not
know that it is a good or a bad thing, but if we can have banks or financial
institutions undertaking a significant part of Canadian housing finance out from
under the shelter of the federal taxpayers' backing at a cost of only 10 basis
points I am pretty happy.
Senator Ringuette: It is already unsecured, so it is not really backed
by the taxpayer.
Mr. Poschmann: Thank you. I am referring to the development of a
marketplace outside of the umbrella; one that allows us to rely less on taxpayer
There is another point, however, and that is the impact on the cost of
mortgages and the impact on the cost of houses in general. One of the things
that federally backed mortgage insurance does is make it possible for borrowers
to bid up the price of housing higher than they would otherwise. This is one of
the outcomes that we observed in the U.S. through the actions of Fannie Mae and
Freddie Mac. They supported mortgage credit growth at a heady pace and it
allowed higher prices for homes. That was fine from the point of view of the
people who owned them already but, as we have seen, produced a very bad outcome.
Next, I refer to the matching of funds available to banks, say on a 10-year
term, in borrowing markets to demand for lending on similar terms. The process
of determining the price at which that transaction is conducted was defined once
and for all by Father Guido Sarducci of Saturday Night Live, when he said
that all you need to know about economics is two words: supply and demand. You
have supply conditions for credit and demand conditions for credit; you have
supply conditions for housing and demand conditions for housing. These will
intersect in the marketplace and will determine the price of the house and will
determine the price of the mortgage, and I cannot tell you what direction they
Senator Ringuette: I appreciate that you confirm the assessment of
these two experts. Thank you.
Senator Tkachuk: He did not really.
The Chair: Mr. Poschmann, it is rare that the Banking Committee has a
single witness for in excess of an hour. I must say that it is extremely rare
that a single witness can hold the rapt attention of this committee as you have
today. We are very grateful for it. I speak on behalf of all committee members
and thank you for being with us today.