Canada’s $30,000,000,000 Purchase is Crazy

Summary

The Canadian government's plan to take a $30 billion loan to invest in a hedge fund-like strategy has raised eyebrows. The initiative involves purchasing mortgage-backed securities (MBS) from Canada's big banks, wrapped into Canadian Mortgage Bonds (CMBs), to profit from the interest paid by homeowners. This move deepens the government's involvement with the real estate market and raises concerns about potential taxpayer liability if mortgages default. Critics argue that while the government plays with financial instruments, everyday citizens face heavy taxation. The strategy's success hinges on interest rate arbitrage, borrowing at a lower rate and earning a higher return on CMBs, but it also risks inflating bond supply and potentially increasing borrowing costs for the government.

Takeaways

• 🏦 The Canadian government is taking on a $30 billion loan to engage in a hedge fund-like strategy, aiming to support new and expensive plans through a special money-making strategy.
• 💼 The plan involves purchasing billions of dollars' worth of mortgages from Canada's big banks, which are then wrapped into mortgage-backed securities (MBS), complicating the relationship between the government and the real estate market.
• 📈 If these mortgages default, the Canadian government would be responsible for bailing them out, essentially facilitating the creation and purchase of new MBS.
• 🏡 Canadians often opt for mortgage loans with smaller down payments, which require them to buy mortgage insurance to protect the banks in case of default, not the homeowners.
• 🔒 The majority of mortgage insurance is purchased from the Canadian Mortgage and Housing Corporation (CMHC), a crown corporation fully owned by the government.
• 📊 Banks bundle insured mortgages into MBS, which are then sold to investors, allowing banks to raise funds quickly and providing a return on investment for the buyers.
• 💼 The CMHC created the Canada Housing Trust to buy MBS from banks and repackage them into Canadian Mortgage Bonds, making them more attractive and accessible to investors.
• 📉 The government of Canada now intends to become the largest investor in Canadian Mortgage Bonds, borrowing money to invest in these bonds, hoping to generate revenue for initiatives like affordable housing.
• 💸 The government's borrowing strategy is likened to a hedge fund operation, where they borrow at a lower interest rate and buy bonds that yield a higher rate, pocketing the difference.
• 🤔 There are concerns about the potential risks and societal impacts of this strategy, including the possibility of increased taxes on citizens while the government engages in financial market speculation.

Q & A

What is the Canadian government's plan involving a $30 billion loan?

The Canadian government plans to borrow $30 billion to invest in a special money-making strategy. This involves buying billions of dollars worth of mortgages from Canada's big banks, which are wrapped into mortgage-backed securities (MBS), allowing the government to receive a portion of the interest paid by Canadians on their mortgages.

How does the Canadian government's involvement in mortgage-backed securities affect the real estate market?

The government's involvement further complicates the relationship between the incentives of the Canadian government and the real estate market. It essentially facilitates the creation of new MBS while also becoming their primary buyer, which could influence housing policies and market dynamics.

What is the role of mortgage loan insurance in Canada?

Mortgage loan insurance in Canada is required for homebuyers who cannot provide a full 20% down payment. It protects the banks from losses if the homeowner defaults on their loan. The insurance, paid upfront by the homeowner, is often purchased from the Canadian Mortgage and Housing Corporation (CMHC).

What is a mortgage-backed security (MBS) and how does it work?

A mortgage-backed security (MBS) is a financial instrument created by bundling numerous insured mortgages together to form a pool. The average interest rate from these mortgages is determined, and then the pool is divided into smaller portions, which are sold to investors. Investors receive a yearly return based on this rate and get their initial investment back at the end of the term.

Why did the CMHC create the Canada Housing Trust?

The CMHC created the Canada Housing Trust to make it easier for banks to sell mortgage-backed securities. The Trust buys these securities from banks and repackages them into Canadian mortgage bonds, which are more attractive and easier for investors to purchase.

What is the purpose of the Canadian government wanting to become the largest investor in Canada mortgage bonds?

The government aims to support stable, cost-effective funding for mortgage lenders and generate revenues for initiatives such as affordable housing. They plan to profit from the interest rate difference between what they borrow at and the higher rate paid by the mortgage bonds.

How does the government of Canada fund its purchase of Canada mortgage bonds?

The government funds the purchase of Canada mortgage bonds by taking on more debt, specifically by issuing more government of Canada bonds to investors, which are then used to buy the mortgage bonds.

What is interest rate arbitrage, and how is it relevant to the Canadian government's strategy?

Interest rate arbitrage is a strategy where money is borrowed at a lower interest rate and then invested to earn a higher interest rate, pocketing the difference. The Canadian government plans to use this strategy by borrowing at a lower rate and buying mortgage bonds that yield a higher rate.

What are the potential risks for the Canadian government with this strategy?

The risks include the possibility of not making a profit if the cost of servicing the debt is higher than the revenue generated from the mortgage bonds. Additionally, there's a risk of moral hazard, as the government is essentially guaranteeing its own debt and could lead to inflated housing prices or other market distortions.

How could the Canadian government's strategy impact taxpayers and the broader economy?

Taxpayers could be indirectly affected if the strategy leads to increased inflation due to money printing by the Bank of Canada, which devalues savings and increases the cost of living. Broader economic impacts could include market distortions, increased debt levels, and potential inflationary pressures.