Finance Committee on March 24th, 2009

[The Chair, Conservative, James Rajotte]

I call the 15th meeting of the Standing Committee on Finance to order. Pursuant to Standing Order 108(2), we are continuing our study on measures to enhance credit availability and the stability of the Canadian financial system.

We are scheduled to have four organizations with us here this morning. We have three here and we're awaiting the fourth.

From the Canada Mortgage and Housing Corporation, we have the vice-president of insurance product and business development, Mr. Pierre Serré, and the treasurer, Mr. Mark Chamie. From the Canadian Foundation for Economic Education, we have Mr. Gary Rabbior, the president. As an individual we have Mr. Ian Lee, MBA program director for the Sprott School of Business from Carleton University.

We are expecting Option consommateurs.

We will begin with CMHC. We'll have a five-minute opening presentation from each organization and then we'll go to questions from members.

Mr. Serré, will you begin?

[Pierre Serré, Vice-President, Insurance Product and Business Development, Canada Mortgage and Housing Corporation]

Thank you.

It's my pleasure to provide the committee with information on the activities of the Canada Mortgage and Housing Corporation this morning.

Most Canadians know us through our mortgage insurance business. Over the years, we've helped millions of people to obtain a mortgage, buy a home and benefit from lower financing costs. As you know, we compete in the marketplace with private insurers, but we do so with a clear public policy mandate.

In 2008, over 40% of our business assisted Canadians who live in areas or in certain types of housing that are less well-served by the private sector or not served at all. This includes homes in rural areas, northern Canada, and single-industry towns. In fact, CMHC is Canada's only provider of mortgage loan insurance for mobile homes and large rental projects, including nursing and retirement homes.

Even though the economic situation is contributing to a slowdown in the housing sector, Canada's system of home financing is continuing to operate. In many countries it has become very difficult for mortgage lenders to raise funds. This hasn't happened in Canada. This is partly because of CMHC's long-standing Canada mortgage bond, the CMB, and the NHA mortgaged-backed securities programs.

The popularity of CMHC's CMB and mortgage-backed securities programs increased as the liquidity crisis deepened. In 2008, $43.5 billion worth of CMBs were issued, in addition to $61 billion worth of NHA mortgage-backed securities.

A 2008 Program Evaluation concluded that CMHC's Canada Mortgage Bond Program played a stabilizing role in Canadian markets by providing a reliable and cost-effective source of funding for mortgages. The program also provided smaller lenders with funding options. This benefits consumers by promoting competition in the mortgage market.

The Government of Canada also took action recently by introducing the insured mortgage purchase program, also managed by CMHC. This program is providing further support to lenders. Under it, CMHC has purchased over $53 billion to date and can purchase up to $125 billion of insured mortgage pools. In fact another auction is being held today. This provides lenders with stable long-term financing and allows them to continue lending to Canadian consumers and businesses.

Another reason for the relative stability in Canada's mortgage system, especially compared to the United States, is that Canada has a history of prudent home financing. At the peak, in 2006, sub-prime lending represented about 40% of mortgage originations in the U.S. In Canada, sub-prime lending made up only 5% of mortgages. And compared to the types of exotic mortgage products offered in the U.S., it would be more accurate to refer to the Canadian sub-prime market as “near-prime”.

In our actions we're committed to sound risk management and prudent financial practices. We do not believe it is to anyone's benefit to put Canadians into homes they cannot afford.

The government, through CMHC, is also strengthening its commitment to assist those in need of affordable housing. In September 2008 the government committed more than $1.9 billion over the next five years for housing and homelessness programs.

Canada's Economic Action Plan builds on this with an additional one-time investment of more than $2 billion, over two years, in new and existing social housing.

The federal government currently spends $1.7 billion annually in support of approximately 630,000 social housing households. However, a considerable portion of this housing is getting older and is in need of major repairs and upgrading. The $2 billion investment in the action plan includes $1 billion for the renovation of this important national asset. It also includes significant funding for housing in first nations and northern communities, for seniors, and for persons with disabilities.

Canada's economic action plan also commits $2 billion for low-cost loans to municipalities to assist them in undertaking housing-related infrastructure. Municipal governments will be able to complete straightforward loan applications on CMHC's website and receive quick responses to their applications.

In closing, I want to assure the committee that in all of our activities, CMHC is committed to fulfilling its policy mandate while exercising prudent financial management and conducting proper due diligence.

I would like to thank the committee, and we would be pleased to answer your questions.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We'll go now to Mr. Rabbior.

[Gary Rabbior, President, Canadian Foundation for Economic Education]

I would like to extend my thanks to the committee for the invitation to appear before you today.

The Canadian Foundation for Economic Education, or CFEE, as we're affectionately known, is a national, charitable, non-partisan organization working to try to improve economic and financial literacy among Canadians. Founded in 1974, the foundation works with schools, ministries, departments of education, community service agencies, immigrant-serving agencies, and many others to try to improve the economic and financial capability of Canadians. Our goal is to help Canadians plan for and build a successful economic future.

We've had some success over the years, but not as much as we'd like, and not as much as what lies as the potential for success today. The current downturn has created an unprecedented interest in the need to improve economic and financial literacy. It is an opportunity that we feel must be exploited.

Today, virtually all Canadians have been affected by the economic downturn. Economic recovery, when it comes, will likely bring with it increased complacency and more acceptance of what has been a less than ideal status quo. When times improve and the impact of hardship is less widespread, concern and interest will likely diminish. The time is right to initiate efforts to improve economic and financial literacy and level the opportunity playing field in Canada.

I know that many eminent representatives have appeared before you, individuals representing financial institutions, government departments and agencies, industry associations and others, but I would like to try to speak as best I can for the many average Canadians who will not have this opportunity. I would like to try to give a voice, if I can, as best I can, to their interests, their concerns, and their hopes for the future.

In that regard, we believe Canadians aim to act rationally. It is not their desire to dig themselves into financial holes, suffer the financial anxieties of over-indebtedness, have relationships that suffer from financial stress, and see their hopes for the future diminished. For the most part, Canadians are simply trying to build a successful future for themselves and for their families. In doing so, their decisions and actions are affected by many things.

Two factors are especially significant: first, the knowledge and skills they possess; and second, the incentives that influence their decisions and actions, by which I mean the prospects of reward or benefit, or the risk of penalty or punishment. If we want behaviour to change in the future, increasing knowledge and skills will not be sufficient. Our incentive structure, which comes from policies, regulations, programs and statutes, will also need to change.

Consider an example. Most agree that the economic crisis started in the United States, triggered by the subprime lending methods that spread like a virus around the world. Part of the blame is often placed on the so-called foolish people who put no money down on a home, borrowed at low but soon to be higher interest rates, and soon found themselves unable to carry the cost of a home that was now worth less than their mortgage.

Were these people really so foolish, or did they act in a rational way? They, like most of us, held out the hope for a home for their family. The system of rules, regulations, and incentives in place basically reinforced the idea that everyone should be able to realize that hope. So many people bought a home with no money down, as 43% of Americans who bought a home in 2005 did. They took out 40-year mortgages that lowered their monthly costs but dramatically increased the total cost of their home. They believed they could afford the start-up teaser payments, which are low in the first few months, and come to fulfill their dream and put their family in a home.

The reality is that many probably could not afford that home, but the regulations, policies, and programs in place led them to believe they could and enabled them to do so. Without adequate economic and financial knowledge and skills, they jumped into the market, a dive into a pool that would come to be plagued with problems.

What factors were at work leading Canadians to make the decisions they did over the last couple of decades? Do we believe that the past decisions and actions of Canadians created conditions of risk and instability in our financial system and in the lives of Canadians? To answer that question, consider some of the statistics that define the path leading up to the realities of today.

Since 1996, Canadians have spent virtually all of their income. By 2005, for each dollar of disposable income that Canadians had, they owed $1.16. The savings rates for Canadians peaked in 1982 at 20.2%; by 1990, the savings rate was 1.9%; at the start of the downturn it was less than zero. The per capita debt of Canadians rose 5.2 times over the last 25 years, from $5,470 in 1980 to $23,390 in 2005. Between 1982 and 2001, the total amount owed by Canadian households rose 152%, while disposable income grew by 42%. Canada's household debt-to-income ratio went from 55% in 1983 to 105% in 2003. Only one in three Canadians expecting to retire in 2030 is saving at levels that will be required to meet basic household expenses. The proportion of Canadians covered by company pensions had fallen to 39% in 2003, a decline from 45% in 1991. And it continues to fall.

The statistics could go on, but I'll share with you the last one I have on my list. The fastest-growing company in Canada, according to the June 2007 issue of Profit magazine, was Rentcash in Edmonton, Alberta, with a growth rate of 33,700%. Revenues for the company grew from $456,000 in 2001 to $154 million in 2006.

I'm going to skip ahead a bit. I'm just letting the translators know that.

Canadians, therefore, need help now. This was made very evident in the first national survey of economic and financial capability that CFEE undertook recently with The Strategic Counsel. The results are posted on CFEE's website. I brought along a copy of the survey results for the committee, if there's interest.

Canadians are looking for help now and they need help now. They are willing to seek it out from sources they can trust, from sources that are able to provide help in ways that people can understand and can relate to their life circumstances and challenges.

I've brought along a couple of resources, which I've shared with you. The Money and Youth publication has over 300,000 copies in circulation. Our Newcomers to Canada DayPlanner, at more than 400,000 copies, is in its ninth printing in just over two and a half years.

Canadians are desperate for resources to help them with their economic and financial understanding, especially if it is in clear, layperson terms, something we have a big problem with on the supply side of the financial marketplace today.

We would also like you to be aware that the foundation and its many partners and supporters and volunteers stand ready to support the work of the government and this committee, if there is any way in which you think we can exist. There is so much being done, and much more that can be done, to try to ensure that Canadians have the best opportunity they can have to build a successful economic future.

One thing we need to do is to somehow develop a consensus guideline for what actually constitutes economic and financial literacy so that we can all begin to work together toward similar goals. There's so much we can do, and so much we should be doing, to build a national strategy. I commend the government for its task force. However, at the same time, I'm not sure we need two years to put an action plan together. I'm not sure we can afford two years to put an action plan together. I think we need to do something now.

Thank you very much.

[The Chair, Conservative, James Rajotte]

Thank you for your presentation.

We'll go now to Mr. Lee, please.

[Professor Ian Lee, MBA Program Director, Sprott School of Business, Carleton University, As an Individual]

I'd like to thank the committee for inviting me. I'd also like to thank Mr. Pagé and his able staff for supporting me at the last minute with translation.

I am the MBA program director at the Sprott School of Business. However, throughout the seventies and early eighties I was the loan manager, mortgage manager, and commercial credit officer directly across the street from the West Block in the Bank of Montreal building. It was the fourth largest branch of the Bank of Montreal. At the time, we had $200 million in mortgages. I lent millions of dollars in conventional and high-ratio mortgages across this city.

The PowerPoint presentation that I'm going to give is based on an article I have almost completed and have partially presented at a couple of academic conferences.

Before I go into the proposals I'm going to recommend today, I really want to give you their context.

I am arguing in this article that the housing bubble, housing collapse, and financial crisis were due to a government and policy failure in the U.S. Congress. The Congress micro-managed the banks, but did not provide oversight and supervision. They refused to regulate the shadow banking system, and as a consequence, I'm arguing—and I don't know anyone else who has made this argument—commercial banks, populated by highly intelligent people, understood they were being forced by Fannie Mae and Freddie Mac to make a lot of bad mortgages. So they used securitization to dump those junk mortgages on other people to get the mortgages off their books. This lead to the housing bubble and collapse and the financial crisis. There is massive empirical documentation for this.

Most of my slides are graphs, so I can go quite quickly.

This slide shows the percentage of low-documentation or no-documentation mortgages. You can see that by 2005, 2006, and 2007, over half of all mortgages in the United States of America were low-doc or no-doc ones, popularly called NINJA mortgages: no income, no job, no assets.

[Some hon. members]

Oh, oh!

[Prof. Ian Lee]

In terms of the dollars, you can see that the subprime and Alt-A mortgages.... For those of you who don't know, Alt-A mortgages are just above subprime mortgages but are below prime ones. So about 55% of all mortgages written in 2004-05 and 2005-06 were junk mortgages or bad mortgages that should never, ever have been written.

[Professor Ian Lee, MBA Program Director, Sprott School of Business, Carleton University, As an Individual]

I draw your attention to the right-hand graph, which shows the securitization. The yellow is for subprime and the green is for non-conforming mortgages, which is another polite word for bad mortgages. You can see they were about one half of the approximately $2 trillion in mortgages written.

What did this do? Well, as anybody who understands economics and banking would know, it drove up the home ownership rate from about 62% to 69%. In other words, millions of new buyers entered the market.

If millions of new buyers enter the market, what is that going to do? It's going to drive up house prices. During this period throughout the nineties, real incomes were flat; they were not going up. Take a look at that red line; that's average house prices. Even though incomes were not going up at all in aggregate, the house prices went almost vertical, because of these policy mistakes. As a consequence, it drove up debt service from the long-term average over a period of some 25 to 30 years of 12% up to almost 14% of income being allocated to service debt, which is unsustainable.

So this was the outcome of the bad laws and bad regulations. It was perfectly predictable. It drove up inflation. The Fed put up interest rates—which were probably too low in the first place. Secondly, it drove up mortgage delinquencies; that's the graph on the bottom right. And thirdly, home prices started to come down.

So what does this mean for Canada? The very good news is that Canada did not melt down. The argument I'm providing in the paper is, number one, that this was due to the very high quality of the human capital in the Canadian chartered banks, the strongest banking system in the world, in my judgment and according to international evaluators. Second, it should be said that Canada has been very fortunate to have had very strong Canadian regulators. I'm referring specifically to Parliament: you did not go over the cliff, as the U.S. Congress did. Also, the Department of Finance has outstanding people, as does the Bank of Canada and OSFI, the Office of the Superintendent of Financial Institutions. Finally, there is a pragmatic, small-c conservative culture amongst Canadians.

I've read the transcripts of the committee hearings and know that the committee is very concerned about bank credit and its availability and the perception that bank credit granting has declined. In fact, empirically, factually or statistically, it has not. Bank credit has gone up in the last year.

However, before I go to the next slide dealing with the pricing of credit, what has happened is that the so-called shadow banking sector has collapsed and is not lending. So there's less credit being granted, although the banks are doing more heavy lifting.

In terms of the pricing—because some of you are very concerned about the widening spread, and David Dodge has spoken about this in his interviews and his two excellent presentations in late November—banks are recapitalizing in anticipation of loan losses, because in every recession loan losses go up, and that's going to drive up the pricing.

So what is not working today in Canada? The shadow or parallel banking system, which are the money funds, the asset-backed securities, the investment banks, the hedge funds, derivatives, exchange-traded or OTCs, which is over the counter, derive from something else. These are not regulated. I don't have a number for Canada, but Secretary of the Treasury Geithner estimates the shadow banking sector in the United States—this is end of 2007 data—is $10 trillion.

The regulated banking sector is $10 trillion. In other words, the shadow banking in the States was about 50% of the total. That figure corresponds to that of Canada. The Bank of Canada estimates that banks make up 55%, so shadow banking is somewhere around 45%. Almost one-half of the financial system in Canada is not regulated. In other words, there is no recourse for assets, there is no transparency, and there are spurious credit ratings.

MPs are worried about the decline in credit. Yet the shadow banking provided about half of all the loans. But the shadow bankers withdrew because of the financial crisis. I argue they withdrew because they were overleveraged. They were overleveraged because they were not regulated. Now is the time to solve the problem by supporting a national securities regulator. How do you deal with the question of solving the declining availability of credit? For 25 to 30 years banks have wanted to lease cars, and this was opposed by the dealers' association. I was in a bank when they were opposing it. Now the chickens are coming home to roost for them because the acceptance companies, such as GMAC and Chrysler Credit, have pulled out. There's insufficient credit.

Parliament has an opportunity to resolve this by authorizing direct bank leasing in the branches.

These are my last two slides. My recommended policies are: one, approve and establish a national securities regulator to include the regulation of the shadow banking system; two, authorize banks to lease through branches; three, modify mark-to-market accounting rules to eliminate pro-cyclicality, which David Dodge has spoken about as well; four, maintain the OSFI raw leverage ratio at 20:1; five--I argue, with all due respect to the people from CMHC, that we have a problem in Canada--CMHC should be more regulated because they have two businesses in one and they're not regulated by OSFI or some similar agency, and David Dodge has also spoken about this; six, you have to create a clearing house for credit swaps; and finally, I support the lending program, the extraordinary financing program announced in the budget, as there are very imaginative, innovative, and prudent ways to partially address this problem.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Lee, for your presentation.

We'll go to our fourth group now, Options consommateurs.

Monsieur Arnold, you will be presenting on their behalf.

[Michel Arnold, Executive Director, Option consommateurs]

Mr. Chairman and members, it is my turn to thank you for inviting us to present our comments and recommendations regarding the government assistance to the Canadian financial sector, particularly with respect to access to credit for individuals, the protection of savings and the stability of the Canadian financial system.

This is not the first time that we have appeared before this committee, and I will bet that this will not be the last time either. For those of you who are not familiar with our group, Option consommateurs is a non-profit organization headquartered in Montreal, but we also have an office in Ottawa, run by Ms. Anu Bose, who is here with me this morning. Our mission is to promote and defend the interests of consumers. Established in 1983, Option consommateurs closely follows issues pertaining to energy, agrifood, financial services and business practices.

The recession has hit the country's job market head on. According to Statistics Canada, some 129,000 people lost their jobs in January, including 30,000 in Quebec. At the same time, we are seeing a sharp increase in the number of insolvencies. No fewer than 90,000 consumers declared bankruptcy in Canada in 2008, compared to nearly 80,000 one year earlier, which represents an increase of 13.5%. These are individuals who in all likelihood will not be able to participate in the economic recovery.

In order to deal with this economic upheaval and the worsening international credit, the Government of Canada implemented the Extraordinary Financing Framework in order to enable Canadian financial institutions to continue providing access to financing to both consumers and businesses. This framework contains numerous support measures for both private and public institutions, and it would appear that Canadians have no say in the way it is being implemented, something that is essential to the democracy of this country and the confidence of consumers.

Moreover, the comments made by various keynote speakers invited to attend an international seminar that we organized on March 12 and 13, which focused on consumer credit and debt, are rather worrisome, if not downright alarming. Perhaps I am not telling you anything new when I say that, over the past 25 years, consumer debt in Canada has more than doubled, going from 15.7% of disposable personal income in 1981 to 36.2% in 2007. Not only has the amount of debt in households risen, but savings fell beneath the zero mark in 2005. According to Statistics Canada, savings were sitting at minus 0.5% in the second quarter of 2005, something not seen since the 1920s.

As far as access to credit for individuals is concerned, we now see that we have two categories of consumers: for one group, access to credit has been too easy and has quickly led to too much debt, and in the other group, access to this credit has systematically been turned down. In both cases, it is very difficult for us to know what criteria have been used by the financial institutions in their decisions to grant credit.

These observations on the government's financial assistance programs for the Canadian financial sector and on the state of finances of individuals enable us to make three recommendations. I will let Ms. Bose present these recommendations to you. We would then be pleased to answer your questions.

[Anu Bose, Head, Ottawa Office, Option consommateurs]

Thank you.

These observations on the government support programs for the Canadian financial sector and on the finances of individual consumers lead us to offer three recommendations.

In order to help build consumer confidence, we recommend that the Government of Canada take care to ensure that the criteria and rules for its aid programs for the Canadian financial sector are clearly understood by all stakeholders within the financial industry, within business, and among consumers. This will allow for a well-informed discussion.

Secondly, we recommend that the Government of Canada ensure that the accountability mechanisms for financial institutions include criteria for lenders' responsibility in judging borrowers' creditworthiness.

Lastly, in light of its enhanced role in maintenance of the financial sector's stability, we recommend that the government undertake an immediate review of the Canada Deposit Insurance Corporation, CDIC, and its ability to fulfill its mandate to protect the savings of Canadians in the event of insolvency of a financial institution and that the government make public the results of its review.

Thank you very much.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We'll go to questions from members. We'll start with Mr. McCallum, please.

[John McCallum, Liberal, Markham—Unionville, ON]

Thank you, Mr. Chair, and thank you to all the witnesses for appearing here.

I'd first like to ask a question about CMHC to Mr. Serré. It's my understanding that until 2006, the maximum length of a mortgage that CMHC would ensure was 25 years, but as of, I believe, the fall of 2006, that changed, so that for the first time CMHC would insure mortgages for up to 40 years with zero down payment. Is that correct?

I'm interested as to why this change was made. Did CMHC request that, or was it imposed on you, or how did this come to pass? It looks suspiciously like a U.S. subprime-type arrangement.

[Pierre Serré]

Thank you.

In terms of the 40-year amortization, that was introduced in the marketplace in October of 2006, as you said quite correctly. We came in with our offering in December, and 2006 was the year that extended amortizations were introduced. CMHC has been in the mortgage insurance business since 1954 and has always worked with its lenders, and also Canadians, to ensure that the products meet the demand.

[John McCallum, Liberal, Markham—Unionville, ON]

No, no, that's not the question. I know you've been working since 1954. I don't have all the time in the world. Why did you go for a 40-year mortgage with no down payment?

[Pierre Serré]

These products, as we introduced them, are not for everyone. When we looked at the marketplace and the demand for such products, we introduced them in a prudent and very conscientious manner--

[John McCallum, Liberal, Markham—Unionville, ON]

Okay.

Professor Lee, I notice you nodding your head. You were talking about the problems with the subprime in the United States, south of the border. You were talking about how things were good here. What's your interpretation as to whether it was a good idea to introduce this, and if you have any knowledge, why do you think they did it?

[Prof. Ian Lee]

I thought it was a terrible idea. I thought it indicated at that point why CMHC needs to be regulated by another authority, perhaps the Superintendent of Financial Institutions. I think any mortgage insurance company that will go to zero down or a 40-year amortization has demonstrated that they do not understand the mortgage market.

Any mortgage manager or person who makes mortgages will tell you that when you get below 10% down, you are getting into very dangerous territory, because, to use the slang, the owner doesn't have any skin in the game. That is to say, when you approach zero, your risk is going up exponentially, and it is very dangerous. They should never ever have done it.

[John McCallum, Liberal, Markham—Unionville, ON]

Thank you. That's my sentiment too.

Mr. Serré, can you tell us the value of mortgages insured at 40 years and zero down payment, and how many there are?

[Pierre Serré]

Yes, I can, but just to make it clear, the 100% mortgages weren't offered to anybody.

[John McCallum, Liberal, Markham—Unionville, ON]

I know, but please, I don't have much time. What is the value of the mortgages issued at 40 years and zero down payment?

[Pierre Serré]

If you take a look at our outstanding insurance in force, all the mortgages that CMHC has insured, the percentage of all of the mortgages we have insured that would be either 40-year amortization or 100%--one or the other--would be about 8%.

[John McCallum, Liberal, Markham—Unionville, ON]

That's 8%. Do you have any idea as to what proportion of those may have gone sour?

[Pierre Serré]

We monitor our arrears rate in the same manner as the CBA reports its arrears rate, and our trend lines are very similar to the Canadian Bankers Association--