Because the government not only owns the Canadian Mortgage and Housing Corporation (CMHC), which accounts for more than two-thirds of the mortgage insurance in force, but also provides a 90 per cent guarantee on private mortgage insurance obligations, policymakers play a major role in the evolution of underwriting standards and can thus contain potential excesses.
The government may well exert a strong influence on underwriting standards on paper but, in reality, the government-backed guarantees have introduced moral hazard through the transfer of default risk from bank shareholders to taxpayers.
Bank managements are incentivised to play hard and fast with the written rules and, should a negative shock arise, the CHMC has little room to absorb the losses. The government-owned company currently insures $536 billion in mortgages and has just $11 billion in equity: just 2 per cent equity against its total exposure. It’s easy to envisage a scenario in which the taxpayer is left holding the bag.