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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 more detail.

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 these points.

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 standards.

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 open market.

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 pool.

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 today?

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 of activities.

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 home buyers.

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 CMHC?

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 any default?

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 mortgage insurer.

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 are shortfalls.

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 there?

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. Transferring of?


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 worried?


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 we work.

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 flexible basis.

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 ground.

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 coexisting.

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 approach.

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 institutions.

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 perspective?

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 of communication.

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 institutions.

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 existing mandates.

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 insurance program.

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 should not.

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 marketplace.

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 you gave?

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.


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 acquirer.

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 majeure argument.

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 that exists.

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 things.

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 institutions:

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 financing.

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 will go.

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.

(The committee adjourned.)