CMHC’s office in Ottawa.Sean Kilpatrick/The Globe and Mail
A wave of anti-globalization that leads to widespread protectionism and increased tariffs could cause Canadian house prices to fall by more than 31 per cent in the next five years, according to the results of scenario tests by Canada's national housing agency.
Canada Mortgage and Housing Corp., which insures mortgages against defaults, released the results Wednesday of internal modelling that tests severe economic scenarios. The scenarios – which include a wave of anti-globalization, a severe earthquake, steep oil price declines and a massive housing correction – are all chosen as worst-case events and are not forecast to actually occur, CMHC said.
"We seek out extreme, almost unimaginable situations, and ask ourselves, 'what if,'" said CMHC chief risk officer Romy Bowers. "That is the goal of our stress testing, to measure how we would stand up to these unlikely shocks."
Ms. Bowers said CMHC added the anti-globalization scenario to its testing this year because there has been a wave of protectionist sentiment across the world.
"The scenario we actually modelled is pretty extreme, but that theme was of interest to our board and management as well," she said.
The agency forecast Canadian house prices would fall by 31.5 per cent over the next five years under its anti-globalization scenario as unemployment levels in Canada spiked to 15.3 per cent in five years.
The dramatic scenario assumes a rapid increase in U.S. interest rates and unsustainable debt levels in China would cause large demand shocks globally, spurring greater protectionism, widespread use of tariffs and a euro-zone breakup.
CMHC predicts its core insurance operations could see cumulative claims losses climb to $12.5-billion in total over the next five years under the protectionist scenario, compared with an anticipated base-case scenario of claims losses at $1.7-billion under current conditions.
The scenario would cause CMHC's total profits in its insurance operations to fall to just $118-million over a five-year period from a currently predicted base case of $7.3-billion in profits over five years.
The agency predicted its parallel securitization business – which offers securitized mortgage products to investors – would actually see a small improvement in profits under the anti-globalization scenario, however, because CMHC anticipates the program would be used as a policy tool to provide liquidity to stressed lenders.
However, the agency noted that under all scenarios it studied, it would still remain solvent, and its key capital ratios would remain well above required target levels, indicating it is able to withstand even extreme scenarios.
CMHC's insurance protects lenders in the event of loan defaults by borrowers who have insured mortgages. The stress-testing project helps to reassure banks, investors, home owners and regulators that there will be strong protection for financial institutions even in severe downturns.
The agency's stress tests assume that should any of the studied shocks actually occur, CMHC would halt paying dividends to the federal government to conserve capital.
The most severe impact for CMHC would come if Canada were to suffer a severe housing correction, similar to the correction the U.S. faced in 2008 and 2009, which included a 30-per-cent national decline in house prices and a sharp drop in employment levels.
Under the scenario, CMHC forecasts house prices would fall 30 per cent, unemployment levels would peak at 12 per cent and it would lose $217-million over five years as claims losses hit $11.8-billion. But mandatory capital ratios would still remain strongly positive, the agency concluded.
In 2016, CMHC studied the impact of a sudden spike in interest rates as one of its stress-testing scenarios, assuming a 2.4-percentage-point increase in rates over two quarters would lead to a severe drop in house prices and ultimately the failure of a Canadian financial institution.
The agency did not include the risk in its stress testing this year, however, even though interest rates have recently started climbing and alternative lender Home Capital Group Inc. faced a major crisis in the spring that threatened its viability.
Ms. Bowers said CMHC concluded it did not need to redo the interest rate scenario this year because it had fairly complete information on hand already. CMHC deputy chief risk officer Nadine Leblanc said the anti-globalization scenario also assumed a large increase in mortgage interest rates would occur, so the impact was included in that test.
Janet McFarland