Finance Committee on March 3rd, 2009

[Bob Dechert, Conservative, Mississauga—Erindale, ON]

Thank you very much.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Dechert.

We have Mr. McKay.

[John McKay, Liberal, Scarborough—Guildwood, ON]

My first question is to Mr. Rudin. You put out a $125 billion insurance program for insured mortgages and $51 billion has been picked up. When the banks are assigning you this $51 billion worth of mortgages, how closely do you examine the quality of the paper you're receiving? To put it in a blunt way, how do you know you're not just getting a pile of junk?

[Jeremy Rudin]

We're purchasing mortgage-backed securities guaranteed by the Canada Mortgage and Housing Corporation. These are the same sorts of securities that are purchased on the market. Sometimes they are purchased as NHA mortgage-backed securities, which have mortgage-like flows, and sometimes these are put together into what is called the Canada mortgage bond, a fixed-rate bond, which has payments that are more like a five-year Canada bond than a mortgage-related flow.

So all of the underlying mortgages are insured against default in the first step. They may be insured against default when they are originated, because federally regulated financial institutions are obliged to ensure against default on any mortgage for which the loan-to-value ratio is 80% or above at origination.

We also have lower ratio mortgages in there too. Again, those are all insured against default as a first step. That happens through what's called portfolio insurance, where the lender brings either to CMHC or to one of the private insurers a portfolio of loans, which is examined loan by loan, and then a price is negotiated to insure the portfolio.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Are you getting stuff that's below 75% of appraised value in your bundles?

[Jeremy Rudin]

There are both high-ratio and low-ratio mortgages, but they're all insured against default in the first instance by either CMHC or one of the private insurers.

[John McKay, Liberal, Scarborough—Guildwood, ON]

So even on the low-risk mortgage, you're getting insurance from a private insurance company.

[Jeremy Rudin]

That's right, or it's from CMHC.

[John McKay, Liberal, Scarborough—Guildwood, ON]

The trouble with your high-ratio stuff is it's really government insuring government. The CMHC is government and it's insuring government. In some respects that's just sort of a circular type of insurance, isn't it?

[Jeremy Rudin]

The purpose of the insurance requirement, and CMHC's normal operation in the market, is to provide default insurance for privately originated and privately held mortgages. We are doing something quite exceptional in purchasing those mortgages.

The CMHC insurance program and the private insurance programs are already there. As you said, the government has already taken on all, in the case of CMHC, or most, in the case of the privately insured mortgages, of the default risk of these mortgages in the normal course of the operation of these insurance programs. Therefore there isn't an additional risk taken on by the government in purchasing the mortgages.

[John McKay, Liberal, Scarborough—Guildwood, ON]

The government has the risk in the first place, so it ends up having the risk.

[Jeremy Rudin]

Your question was how do we know we're not getting junk. So through the process of insuring mortgages, all the high-ratio mortgages are examined by the insurer on a loan-by-loan basis, and they have to meet the underwriting criteria of the insurer, whether it be CHMC or the private insurer. Then low-ratio loans are considered as a portfolio, but each individual loan is examined. In some cases, if the insurer is brought 1,000 loans, it will agree to do 950 of them.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Thank you.

The second question has to do with asset-backed commercial paper. I'm not sure if it was the Department of Finance or the Bank of Canada that recently picked up about $3.5 billion worth of.... Well, I'm not quite sure whether they picked up the paper or whatever. It's kind of a curious situation, because most of the loss happened with the Caisse de dépôt et placement du Québec, which prefers to be regulated provincially, and yet the federal government picked up the liability.

So when you book that $3.5 billion, do you do it on the asset side of the equation or on the liability side of the equation for the purposes of government?

[Jeremy Rudin]

You're referring to the non-bank-sponsored asset-backed commercial paper, for which the market froze in August 2007. A restructuring plan was devised for it by the private participants, and the deal finally closed in January of this year. The role of the federal government, in cooperation with the provinces of Quebec, Alberta, and Ontario, was not to purchase any of the restructured notes, but to participate in what's called a margin funding facility.

I don't know how long the committee wants to spend on this.

[John McKay, Liberal, Scarborough—Guildwood, ON]

I'm more curious about whether that ends up being a liability or an asset.

[Jeremy Rudin]

It is a contingent liability of the government, for which the government is being paid a fee.

[The Chair, Conservative, James Rajotte]

Thank you.

Mr. Rudin, if there's anything further you want to provide to the committee as background, please feel free to do so.

Monsieur Laforest.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

Thank you, Mr. Chair.

My next question is for Mr. Rudin. Earlier, Mr. Macklem told us that the global financial problems and the current recession are in large part due to the subprime market loans in the United States. In response to a question asked by my colleague on the government's intention to create a single securities commission, he said that there was no such organization that had an overview of the system in the United States.

Does that mean that this situation has not been rectified in the United States, where the problems began? In the U.S., are there securities commissions that are equivalent to the ones that exist here today?

[Jeremy Rudin]

To my knowledge, there is of course the Securities Exchange Commission in the United States. I believe that a few states hold responsibilities, but there is a single commission. You are right to tell me that despite its existence, the national regulatory securities commission was unable to prevent the problems that occurred in the United States. That does not mean, according to the government, that we cannot improve the Canadian situation by reducing fragmentation within our country's securities regulatory system. Nonetheless, there is no silver bullet to prevent any problem from happening, and the evidence is before us.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

In response to the question asked by my colleague, Mr. Carrier, Mr. Macklem did reply that one of the major causes of these problems was the absence of a central organization in the United States, that enjoyed a broad overview. Yet, you are stating the contrary. There is a single commission, but it was unable to see what was going on and actually have a broad overview. The Securities Exchange Commission in the United States was unable to prevent the initial problem of subprime mortgages from occurring.

The government and the Department of Finance are both claiming that a single securities commission is the answer to the analysis of the problems we are having. You will admit that this is rather strange. In 2006, when there wasn't a recession on the horizon, the government had expressed its intention to create such a commission. It's rather specious to use that reason today.

[Jeremy Rudin]

Firstly, Mr. Macklem was making reference to regulating mortgage markets in the United States, and not securities regulation. He was right in saying that regulation in the mortgage market is highly fragmented in the United States, and that the problems being experienced there are a direct result of this fragmentation.

A lack of coordination and fragmented regulation of the mortgage market in the United States created the problem. That is a lesson we can learn. The American government is now setting up a mechanism to standardize mortgage market regulation.

Secondly, you are right in saying that even before the financial crisis, the federal government supported the creation of a single securities commission. The reasons which have been cited on many occasions, even as recently as in Budget 2007, include increased effectiveness, better protection for investors, and the possibility for Canada to speak with one single voice on the international stage. Based on our experience, the financial crisis would be one additional argument to justify this proposal.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

And yet, the IMF gave the Canadian system a positive assessment, mainly because of the improvements made to our passport system.

[Jeremy Rudin]

The federal government acknowledged that there were recent improvements, but it is now proposing an additional improvement, in the form of the creation of a single commission.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Laforest.

Mr. Bernier.

[Maxime Bernier, Conservative, Beauce, QC]

Thank you, Mr. Chair.

Mr. Rudin, in your presentation, you spoke at length about bank ratios. You stated that capital requirements for financial institutions in Canada is 20 to 1, which is a very good ratio compared to the multiples of the banking institutions in the United States and in Europe, which are in the 30s, 40s and 50s.

Why is the cap on leverage for our Canadian banks so good? Is it due to Canadian regulation, or the Canadian market? How is it that a European bank can have a ratio as high as 50 to 1? How can you explain such large spreads in ratios? I was under the impression that international regulations on capital requirements applied to all financial institutions in the world. Yet, the ratios vary. There has been much talk about the Basel agreement, for banks that regulate the banking system. Should banks not be held to a minimum ratio internationally?

I would like you to provide me with explanations regarding the asset-to-capital multiples.