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Flaherty uses caution on the mortgage front

Federal Finance Minister Jim Flaherty


Ottawa plans to extend the biggest emergency measure it created to help the banks weather the financial crisis, a sign that the government and the banking industry are not yet prepared to call an end to the economic upheaval.

Finance Minister Jim Flaherty has decided to keep in place the government's $125-billion program to buy mortgages from lenders, a program that had been slated to end next week, according to sources familiar with the matter.

The banking industry has been pressing the Finance Minister to extend the length of the program because they continue to benefit from it and because there is still the possibility that liquidity pressures could re-emerge.

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The move comes amid a global debate among political leaders, central bankers and economists about when to scale back various measures that have been put in place to boost the flow of credit and stimulate economies.

The credit crunch has faded, and Canadian banks have been earning higher profits than expected. As a result, banks have scaled back use of the mortgage program. They've only sold $64-billion worth of mortgages into the program to date, about half the $125-billion the government was prepared to buy.

"While circumstances have changed for the better, the program remains valuable," said Toronto-Dominion Bank chief economist Don Drummond.

"It lowers the cost of funds for the banks. Yes, not as much as at one time, given that spreads have come in, but it still helps."

Both bankers and Ottawa are quick to point out that the program is creating a profit for the government, although the returns are diminishing as conditions improve.

"Usage has abated, but it's still a very useful tool in the tool kit for financial institutions who may require assistance on liquidity," said Nancy Hughes Anthony, chief executive officer of the Canadian Bankers Association. "It would be premature to stop this program right now."

Mr. Flaherty first unveiled the program in October, 2008, at a time when it was extremely difficult for banks around the world to fund their lending operations. It was intended as an emergency measure to boost the flow of credit - one that would also decrease the price of mortgages. Ottawa extended it in the 2009 budget, saying it planned to buy mortgages through the first half of this fiscal year (the halfway point is next Wednesday).

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Economists praise the program. "It supported the banks at a critical juncture in the global financial crisis, and played a big role in keeping mortgage rates from flaring higher late last year, when many global borrowing costs were surging," said Douglas Porter, deputy chief economist at Bank of Montreal. That, in turn, was a key factor supporting the quick turnaround in the country's housing market.

However, Mr. Porter also noted that financial markets are now returning to something closer to normal.

Funding costs are not back to where they were prior to the crisis, but they have dramatically improved. As a group, the big banks have seen profit margins from their Canadian lending businesses rise in each of the last two quarters, thanks to lower funding costs as well as their decision to increase prices on many loans.

In the latest quarter, which ended July 31, Royal Bank of Canada - the biggest bank - had record profit of $1.56-billion, while Toronto-Dominion Bank's Canadian lending business took in more money than it ever has before.

Banks stopped making full use of the mortgage purchase program in February, as their ability to fund improved. The government purchases take place in periodic auctions in which Ottawa, through Canada Mortgage and Housing Corp. (CMHC), tells the industry how much it is willing to buy - for example, $5-billion in mortgages - and then the banks each indicate what they would be willing to pay, in the form of interest, to sell mortgages. CMHC takes the most profitable bids. In the latest auction on Monday, Ottawa said it was willing to buy up to $4-billion, but banks only sold it $2-billion.

"Of the various government initiatives under the Extraordinary Financing Framework, the [mortgage program]has had the most significant impact, and at no incremental risk to the taxpayer," said Jack Aubry, a spokesman for the Finance Ministry. It "has been successful in moderating the impact of the global financial turmoil on credit conditions in Canada," he added.

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Residential mortgage lending in May was 7.8 per cent higher than a year earlier, and total consumer credit was up 7.7 per cent, the Finance Ministry said.

Banks in other countries have relied on guarantees from their governments to raise financing, but in Canada, the mortgage program has obviated the need for banks to take Ottawa up on its offer to, in certain circumstances, guarantee their debt, something that would pose more risk for taxpayers, Mr. Aubry said.

The six largest banks now securitize - or essentially sell off their balance sheets - more than 25 per cent of their mortgages, compared with less than 15 per cent four years ago, according to RBC Dominion Securities Inc. analyst André-Philippe Hardy.

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