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Finance Minister Jim Flaherty announces new measures to ease pressure on financial institutions on Friday. ((CBC))

The federal government's $25-billion takeover of bank-held mortgages to ease a growing credit crunch faced by the country's financial institutions is not a bailout similar to recent moves made in the United States and other Western countries, Conservative Leader Stephen Harper said Friday.

"This is not a bailout; this is a market transaction that will cost the government nothing," he told reporters at a campaign rally in Brantford, Ont., ahead of Tuesday's federal election.

"We are not going in and buying bad assets. What we're doing is simply exchanging assets that we already hold the insurance on and the reason we're doing this is to get out in front. The issue here is not protecting the banks."

Earlier in the day, Finance Minister Jim Flaherty announced the government's plan to buy the securities through the Canada Housing and Mortgage Corp. and provide much-needed cash to financial institutions that sell the so-called "National Housing Act mortgage-backed securities."

Flaherty announced the new measures in an attempt to assuage concerns over the burgeoning global financial crisis and defuse criticism that the Harper government was ignoring the spreading lending crisis.

Dealing with Armageddon

Governments in many countries have been grappling with how to stop the deterioration in the health of financial institutions as companies are forced to write off billions in losses from holdings of now worthless asset-backed commercial paper.

However, Canada's market for insured mortgage pools still functions.

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In addition, many of the mortgages that are bundled together to make up these securities are not in default, unlike the situation in the United States. For instance, in the second quarter of 2008, the percentage of American mortgages that were more than 90 days in arrears — a measure of the level of home defaults — stood at a gaudy 4.5 per cent.  In Canada, that same figure stood at 0.3 per cent.

The specialized housing securities, both in Canada and the United States, generate cash based upon the stream of payments from the underlying mortgages. High default rates mean these bonds cannot produce a sufficient amount of cash for investors.

That was what caused the asset-backed market in United States to collapse.

Canada does not face the same problem, Flaherty insisted.

Instead, the country's financial companies are having trouble getting money to borrow because banks and other lenders in other countries are not offering up enough money — a classic credit crunch.

After the announcement, Canada's leading banks said they were cutting their prime rates by 15 or 25 basis points — a quarter or fifteen-one-hundredths of a percentage point.

Greasing Canada's financial system

Under the proposal, Ottawa plans to sell a combination of government bonds and other public debt instruments to raise the $25 billion.  Then CMHC will ask the banks and other financial institutions to ascertain how much debt they would like to sell to the agency, using a process known as a reverse auction.

Conceptually speaking, the financial companies will offer CMHC the debt at a discount to its face value. Starting with the bids containing the largest discounts, the housing corporation will buy these instruments from the financial institutions until the agency uses up the $25 billion.

This way, Ottawa injects money into a cash-strapped market. In return, the government gets a series of securities with a rate of return well in excess of the rate Ottawa would pay on the $25 billion it borrows in the first place.  

The federal government anticipates that few of these mortgages will default, and most are guaranteed by the CMHC. Thus, Ottawa actually expects to earn a profit from its holdings of these securities.

"This program is an efficient, cost-effective and safe way to support lending in Canada that comes at no fiscal cost to taxpayers," Flaherty said.

Flaherty said the action would "make loans and mortgages more available and more affordable for ordinary Canadians and businesses."

On Thursday, Flaherty said he had no doubts over the health of Canada's banks, adding the government has no plan to undertake a massive government bailout similar to those mounted by the United States and other Western countries.

He repeated that theme on Friday, saying the problem the country's financial institutions face is not solvency but the availability of credit.

"It is important to underline that Canada’s banks and other financial institutions are sound, well-capitalized and less leveraged than their international peers. Our mortgage system is sound. Canadian households have smaller mortgages relative both to the value of their homes and to their disposable incomes than in the U.S.," Flaherty said.