The C.D. Howe Institute has published a report suggesting that, given steadily rising housing prices, Canada's mortgage insurance system may be inadequate.

The report, Mortgage Insurance as a Macroprudential Tool: Dealing with the Risk of a Housing Market Crash in Canada, was written by economics professors Thorsten V. Koeppl and James MacGee. It warns that while Canada has avoided a severe housing crash up until now, 30% to 50% real estate market declines have indeed taken place in other OECD countries over the last fifty years.

"Our analysis indicates that a low-probability, but severe, housing crash could result in roughly $17 billion of losses for mortgage insurers, which is about 1 percent of GDP," says Koeppl.

Although mortgage insurers' reserves currently exceed the minimum required, the authors note that heavy losses could still leave the federal government with a bill of up to $9 billion should they need to be recapitalized. The paper also suggests that a housing crash could activate the 10% deductible on policies issued by potentially insolvent private mortgage insurers. "Anticipation of deductible losses could also trigger a 'run,' where lenders avoid dealing with private insurers, which could result in restricted access to finance for homebuyers, further destabilizing the housing market," they write.

Koeppl and MacGee have three specific recommendations. First of all, they believe government's backstop should be redesigned to anticipate both a severe housing crash and rising unemployment. "The backstop should be organized as a standalone fund that accumulates reserves in advance of a housing crisis, up to a target level, and has the capacity to borrow against future revenue if needed," reads the report. They also think that the Financial Institutions Supervisory Committee (FISC) should oversee this backstop fund, and that it should only be available for the residential ownership market.