The International Monetary Fund says Canada is exposing itself to risk by insuring mortgages through the Canada Mortgage and Housing Corporation and recommends scaling back the federal housing agency.

The advice is contained in the IMF's latest economic report card on Canada, which projects modest economic growth of 2.25 per cent in 2013, but warns of “downside risk” from the unstable U.S. economy.

CMHC 'exposes the fiscal budget to financial system risks and might distort the allocation of resources in favour of mortgages and away from more productive uses of capital' - IMF report

The IMF notes that Canada’s hot residential property market is a risk going forward, because household debt is so high.

Canada’s relatively robust consumer spending has powered the economy while corporate investment and exports slowed in 2013, the IMF said. But if the housing bubble pops, that could weigh on consumer confidence and hurt the economy, it added.

"We haven’t changed our mind since last year. We don’t see the housing sector as a risk per se, more of a potential vulnerability if the economy slows down," said Roberto Cardarelli, IMF mission chief to Canada.

"The structure of the Canadian housing market is not as in the U.S. – the balance is very healthy.   The risk of boom-bust similar to what happened in the U.S. is not very high," he added in an interview with CBC's Lang & O'Leary Exchange. 

At the same time, the IMF noted the moderation in housing sales and new building over the past three months.

In its concern about the housing market, the IMF is echoing federal Finance Minister Jim Flaherty, who has moved several times over the last 18 months to cool house prices by demanding banks tighten mortgage rules.

Risks from CMHC mortgages

In late spring, Flaherty announced CMHC would not insure mortgages of longer than 25 years, down from 30. That helped raise the monthly cost of a mortgage and could discourage some families from buying.

Flaherty has also mused about privatizing the CMHC, but that could remove from government hands the very instrument he used to cool housing sales.

Like Flaherty, the IMF is worried about the risk to taxpayers from the federal agency, which insures second mortgages for people who cannot afford a full downpayment.

In recommending that Ottawa consider winding down CMHC, the IMF said the agency “exposes the fiscal budget to financial system risks and might distort the allocation of resources in favour of mortgages and away from more productive uses of capital.”

The IMF had praise for Flaherty’s policies, which were aimed at stemming off the kind of housing bubble that afflicted the U.S. and brought down U.S. housing agencies Fannie Mae and Freddie Mac.

Recommends private sector take on 2nd mortgages

“Against this background, the government’s recent initiatives to impose limits on government-backed mortgage insurance have been appropriate,” the IMF report said, recommending that Ottawa take measures to encourage the private sector to take on second mortgages.

It recommends a gradual scaling back of CMHC.

"We think it has worked in terms of guaranteeing the stability of the financial system and discouraging bankruptcies and can be used as a policy too. You can use it to boost the market if you need to, you can use it to cool the market," Cardarelli told CBC.

"But over the long term I think there is maybe a need to review the whole structure."

CMHC, established in 1946 to house war veterans and promote home building, evolved into a backer of mortgages in 1954, when the chartered banks first began offering mortgages. It has a mandate to ensure Canadians have affordable housing and has shouldered part of the risk of mortgages for three generations of Canadians.

Likes low-rate policy

The IMF report backed the Bank of Canada’s policy of keeping interest rates low until the economy picks up, probably at the end of 2014 and said it expects Canadian exports will pick up next year as the U.S. economy recovers. But it warned there is downside risk to Canada because there is no guarantee of a U.S. recovery and things are looking doubtful in the rest of the world as well.

"Renewed political standoff [in the United States] over spending appropriations and the debt ceiling and a faster than expected increase in long-term rates in the context of exit from quantitative easing could negatively affect the U.S. recovery and hence demand for Canadian exports," the IMF said.

"Protracted weakness in the euro area economic recovery and lower than anticipated growth in emerging markets would also hurt the prospects for Canada's exports, including through lower commodity prices," it added.