The federal government and the CMHC enter the fray

From a story in today's Globe and Mail:

The federal government is moving to backstop the Canadian banks' capacity to lend money in an acknowledgment that not even the country's sturdy banking system is immune to the global financial crisis.

A plan originally earmarked for Friday morning would see the government assume some mortgages currently held by the banks by giving them to the Canadian Mortgage and Housing Corp., a Crown corporation. In turn, the banks might receive CMHC paper – possibly bonds – against which they could use as collateral for their own loans from other banks.

In recent weeks, the big banks have faced a sharp rise in the cost of borrowing money in international markets to cover Canadian mortgages – a situation that puts them at risk of losing ever-increasing amounts of money on one of their core businesses.

This doesn't look like a bail-out - in the sense that bail-outs in other countries are trying to deal with banks that are actually insolvent. There doesn't seem to be any suggestion that the mortgages that the banks are holding are 'toxic waste'.

The main issue is one of liquidity: the banks would like to borrow against these assets to finance short-term activities, but since mortgages can't be sold quickly at face value, potential lenders who have liquidity don't want to take the risk of being stuck with assets they can't sell. Trading mortgages to the CMHC for CHMC paper is supposed to provide banks with more liquid collateral. (CHMC paper is backed by the federal government, but its bonds have yields that are about 35 bps higher than T-bills.)

Comments

[Robert McClelland]

This doesn't look like a bail-out

Say what? The government may not be buying up toxic assets but they're still bailing the lenders out of their sticky situation.

[westslope]

Not entirely sure what to make of this. Was this move absolutely necessary at this point? Was it done for electioneering purposes or _despite_ short-term political risks?

On the bright side, the move is cautious and at the same time signals a willingness of the federal government to stand ready to inject more capital into the banking system.

I still have no forgiven Harper for some of the populist economic policy crap that his government has pulled recently and in recent years but so far I like this timid initiative and see it as helpful.

[Andrew]

Why would CMHC paper be at a higher rate than T-bills, if both are backed by the same borrower? Isn't that 35 bps a phenomenal waste of money, spread over many billions?

[NLF]

The Canadian "Toxic" mortgages are already "guaranteed" by the Canadian government via CMHC -- all mortgages with a loan to value of more than 90% must be guaranteed by CMHC. Liquidity is not the same thing as insolvency; Canadian banks are being given "funding" breathing room by the BoC, no one thinks that Canadian banks have been imprudent in providing mortgages to Canadian home buyers (Canadian residential building is growing), these are prime assets. These these days nobody cares about reasonable assets -- Government bonds are considered the only safe haven! Or cold hard cash.

Canadian banks are considered some of the world's safest and most conservative financial institutions.

[Style]

The Backgrounder on the Finance Canada site explains this a bit differently. CMHC will be buying mortgage-backed bonds from banks. "CMHC borrowings from the Government of Canada will increase to fund this operation. The Government of Canada will increase its issuance of treasury bills and bonds to finance these loans." It's a much more direct injection of liquidity - cash for bonds - with the operation funded by issuing new Treasury bills (which people will be eager to buy with current credit market conditions). Overall, the operation reduces the risks on bank balance sheets and increases their liquidity. Not sure if the issuance of new treasuries offsets the cash paid out by CMHC...