The Mortgage Market
Read here for a primer on the internal workings of the mortgage market and how it is or will affect you!
Contrary to popular belief banks don’t like to lend their own money in mortgages. The reason is that once the money is lent out, it is tied up there for the term of the contract with a return of only the nominal rate of that agreement. What has become their chosen strategy in the past 15 to 20 years has been to lend out the mortgages initially then pool all of these mortgages into an investment vehicle which is then sold to institutional investors such as pension funds and insurance companies. These types of organizations have large amounts of money that is on hold for future liabilities but demand a no risk investment in exchange for a low rate of return. In most cases this ”no risk” is achieved by CMHC insurance* (guaranteed by the Government of Canada is about as close as you get). This process of selling pools of mortgages is called securitisation. The bank retains a margin of 1-1.5% on the face value of these investment certificates to provide for the managing of these contracts. What the banks have discovered is that they can lend out their money, securitize the mortgages, there by getting their money back to lend out again and securitize again, over and over. If they can repeat the process 4, 5 or 6 times in the same time frame as the original fixed term mortgage they can earn 1.5+1.5+1.5+1.5 etc equalling 8 to 12 % return as compared to being committed to perhaps 3.5% for a 5 year term in today’s market. The side effect of this strategy was to create unlimited demand for mortgage borrowers by the banks. This was the very same strategy that brought down the American real estate market although having no CMHC to provide the no risk guarantee; their guarantees were given by independent institutions like insurance companies and banks all around the world. However the fact that it was not one single institution overseeing the guarantee process and reviewing the underlying asset quality and combined with the insatiable demand for mortgage borrowers to fill the pipeline it caused the mortgage market to over lend by some 30% of the value of the American real estate market. As is now common knowledge when this all came undone it took the world financial system with it touching off a global recession.
In Canada CMHC does oversee and review the underlying assets however due to the crisis created south of the border the market for securitized packages has dried up. The government also steped in to buy the mortgage pools for awhile during the crisis. Without this government intervention we could have followed the American scenario. The government had little choice as they have been providing the guarantees through CMHC for years and allowing the market to fail like that would have created an unthinkable loss for them. Better to buy the securitized paper and move forward. Currently if you are looking for a mortgage you will find the banks pushing you toward CMHC insured products as it fits better in their securitized packages. The private mortgage market is also showing appetite for mortgages as rates paid by the banks on gic’s are at all time lows so investors are looking else where are for better returns. Although these are uncertain times as long as you are working toward a long term hold strategy you will never go wrong with real estate. As some infamous person once said “When there’s blood on the street buy real estate”