The root of the analysts' belief why there won't be a system shock to create a housing collapse here

CIBC joins the list of banks warning Boomers who are counting on funding their retirement by downsizing and selling their bubble inflated house that their plans might be in jeopardy.

In the November 29th, 2012 edition of CIBC's Economic Insights, Avery Shenfeld says:

The evident slowing in Canadian home sales will take a bite out of domestic economic growth... But another dimension of the recent trend, a cooling in house prices, is less of an unambiguous negative as it’s often made out to be.

For one, a retreat today could be the preferred alternative to a harder landing from even higher prices down the road. Less understood is that cheaper home prices could bring winners as well as losers across the economy.

And who might the losers be?

A home owner that counted on downsizing to fund her retirement might have to pare spending plans.

Oh? And why is that?

While a month ago we quoted widely cited estimates of the wealth effect on spending, it’s difficult to disentangle them from the data.

Yes... it's a bitch when reality gets in the way, isn't it?  What is that data?

Most historic wealth declines coincided with other sources of economic weakness, including rising unemployment or high interest rates that depress consumption.

But wait a minute.  Is CIBC suggesting that a bigger storm is brewing beyond a simple 'flatlining' in housing.  Didn't Tsur Somerville just say yesterday that no one can see any economic shock on the horizon?

What about the shock of declining housing prices? CIBC sees a concern:

Didn’t house deflations sink the US and Ireland? Not on their own. It was the accompanying wave of defaults that devastated the financial system in both countries. Canada hasn’t lent as aggressively to its lower-income home buyers, and a correction in house prices caused by a tighter regulatory environment and earlier price overshooting, rather than by defaults, would not on its own generate that same banking system shock.

Hmm... "not on it's own." Does this support Somerville's view?

The central conflict is this belief that "Canada hasn't lent as aggressively to its lower-income home buyers." 

I know I beg to differ.

Zero down mortgages (aided by the banks 7% cash back mortgage plans) which were facilitated by CMHC's excessively easy liquidity boom (which saw the amount CMHC lent out rise from $100 Billion in 2006 to $600 Billion today), and all of this supposedly went to Canadians who weren't "lower-income home buyers?"

Alrighty then.

This belief, that Canada hasn't lent as aggressively to its lower-income home buyers, is the crux of what the analysts like Somerville are counting on.

This is why they say "a correction in house prices caused by a tighter regulatory environment and earlier price overshooting, rather than by defaults, would not on its own generate that same banking system shock."

I suspect the pool of suspect borrowers is far higher than most are counting on. And that they are leveraged in such a way that the 'flatlining' housing market is going to have a much greater impact then ever imagined.

 We shall see in the months ahead.

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The Evolution of Rationalization

We seem to have entered an interesting phase in the media coverage of our housing collapse.

Instead of denying there is even a bubble to burst in the first place, now the media is filled with economists and 'experts' who predict that prices will fall but by a moderate level that does not resemble the U.S. crash.

The latest to join the chorus (after Muir and Somerville yesterday) is CIBC deputy-chief economist Benjamin Tal.

Tal, however, takes it beyond accepting there will be some price declines and minimizing them. For Tal it's about ensuring slipping prices don't trigger a collapse in buyer/seller confidence.

"There is nothing to fear but fear itself... Panic is the worst thing that could happen because when that mentality sets in and people become irrational, it’s hard to forecast how low prices will go."

Tal, Muir and Somerville have one central worry: that Canadians are starting to talk themselves into a housing crash by creating a scenario in which every new statistic is interpreted in the most negative way with an eye on trying to constantly compare the Canadian housing market with what Americans experienced just before their housing prices plummeted by as much as 50% in some markets.

Which is why each and everyone of them keeps insisting/re-assuring that there will be no U.S. style crash in Canada.

Says Tal:

"When you see headlines screaming that Canadian household debt has reached a record level, an eerily similar spot to where Americans were before the market crashed there, it adds to concern. But the similarity ends with the headline-grabbing number. The quality of the debt is much different here."

Err... quality?

Tal maintains the people who have taken on more debt have a much higher credit score than the Americans who did the same prior to their market crash.

Ummm... But if Canadians are such a better risk than what do you make of a Bank of Montreal report that BMO came out with on Monday that noted that almost three-quarters of Canadian homeowners would feel a significant squeeze from even a small rise in interest rates?

The report basically says 73% of the people surveyed can’t afford their own homes. And a lot of them are already feeling the pinch.

A third of these people have already cut back on other spending so they can make the mortgage payment.

One in six has been forced to raid their savings to pay current costs.

This is at a time when interest rates are at historic lows, which means they can only go up. That they will rise, eventually, is inevitable. Yet 16% of the people in the survey said they might not be able to make their payments if rates rose by even a tenth.

So much for Canadian debt being of a higher quality.

Another key factor that Tal insists is ignored in the current housing bubble discussion is how much of our Canadian mortgage debt is locked in for longer terms and not subject to the vagaries of rising rates.

Tal says 70% to 80% of Americans were in variable products at the peak while the Canadian figure is 29% (Tal cites the latest survey from the Canadian Association of Mortgage Professionals for this statistic).

Umm... just a quick question here.  When you say only 29% of Canadians are in variable products... does that mean we don't count a mortgage that resets to a different interest rate after five years?

I mean, aren't ALL Canadians in variable products when you consider this factor?  How many Canadians have 30 year locked in mortgages like in the United States?

Blink... blink.

Sorry Tal... I know I'm afraid.

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Mon Post #3: Newsflash... it's "a stagnating housing market and in Vancouver prices are already falling from sky high levels a year ago"

On Sunday we told you that it's not the news per se that's important... it's how you spin it.

The GVREB had been hard at work MOPE'ing the news (Management of Perspective Economics) and had downplayed the third worst February in real estate sales on record (a decline of -17.8% from February of 2011) into a "pre-spring hike" in sales.

This was achieved when the GVREB compared those very same abysmal February 2012 numbers to that of the absolutely horrendous January 2012 numbers... instead of comparing them to the results of February 2011.

As a result February's abysmal numbers were promoted as being 61.4% higher than the horrid January numbers... thus a "pre-spring hike".

So how embarrassing is it for the GVREB, after heralding an awesome February in real estate sales, to open up today's edition of Canadian Business Magazine?

Generally the article painted a rosy outlook for Canadian Real Estate nationally by the CREA...

"Risks to the Canadian economic outlook remain elevated owing to the European sovereign debt quagmire, but the continuation of low interest rates is the silver lining. So long as the European debt crisis is contained and a global economic recession avoided, low interest rates will support Canadian home sales and prices - CREA chief economist Gregory Klump"

But buried in the article were a couple of real gems.

First off our old friend, CIBC economist Benjamin Tal, tells us the new CREA forecast is "if anything a best case scenario forecast."

Ouch!

Then Tal goes on to say his bias leans more "toward an expectation of more significant price declines."

Oh really?

Tal expects further price declines and that these declines will MORE SIGNIFICANT than what we have already seen?

Pass the popcorn and tell us more!

"This is basically a stagnating housing market," Tal said. "This is not a housing market that is going to be on fire. This is a housing market that you'll see activity moderating and prices actually going down."

Seems Benny is reading from a different script than the GVREB this month. What about Vancouver?

"In Vancouver, prices are already falling from sky high levels a year ago, especially in the once bustling condominium market."

Now I ask you... when you read the GVREB's take on February's numbers, did you come away with the message that Vancouver's prices are already falling from sky high levels a year ago? Or that more, significant price declines are in our future?

Hmmm... didn't think so.

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Are alarm bells sounding in the financial community about CIBC and Royal Bank?

Back in August, the website Zero Hedge sparked a debate about the soundness of Canadian banks.

The issues raised about Tangible Common Equity (TCE) were quickly dismissed by Canadian authorities, but the issue has been raised again with a slight twist.

In a post tonight, Zero Hedge strikes again zeroing in on something called Re-hypothecation which lies at the heart of the whole MF Global scandal.

In investment banking, assets deposited with a broker will be hypothecated such that a broker may sell securities if an investor fails to keep up credit payments or if the securities drop in value and the investor fails to respond to a margin call (a request for more capital).

Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations much to the chagrin of hedge funds.

In the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated.

By 2007, re-hypothecation had grown so large that it accounted for half of the activity of the shadow banking system.

Prior to Lehman Brothers collapse, the International Monetary Fund (IMF) calculated that U.S. banks were receiving $4 trillion worth of funding by re-hypothecation, much of which was sourced from the UK. With assets being re-hypothecated many times over (known as “churn”), the original collateral being used may have been as little as $1 trillion – a quarter of the financial footprint created through re-hypothecation.

In its quarterly report, MF Global disclosed that by June 2011 it had repledged (re-hypothecated) $70 million, including securities received under resale agreements.

The off-balance sheet treatment means that the amount of leverage (gearing) and systemic risk created in the system by re-hypothecation is staggering.

Re-hypothecation transactions are off-balance sheet and are therefore unrestricted by balance sheet controls. Whereas on balance sheet transactions necessitate only appearing as an asset/liability on one bank’s balance sheet and not another, off-balance sheet transactions can, and frequently do, appear on multiple banks’ financial statements.

What this creates is chains of counterparty risk, where multiple re-hypothecation borrowers use the same collateral over and over again.

Essentially, it is a chain of debt obligations that is only as strong as its weakest link.

With collateral being re-hypothecated to a factor of four (according to IMF estimates), the actual capital backing banks re-hypothecation transactions may be as little as 25%. This churning of collateral means that re-hypothecation transactions have been creating enormous amounts of liquidity, much of which has no real asset backing.

So what does all this have to do with CIBC and Royal Bank?

With weak collateral rules and a level of leverage that would make Archimedes tremble, firms have been piling into re-hypothecation activity with startling abandon. A review of filings reveals a staggering level of activity in what may be the world’s largest ever credit bubble.

Engaging in hyper-hypothecation have been

• Goldman Sachs ($28.17 billion re-hypothecated in 2011),
• Canadian Imperial Bank of Commerce (re-pledged $72 billion in client assets),
• Royal Bank of Canada (re-pledged $53.8 billion of $126.7 billion available for re-pledging),
• Oppenheimer Holdings ($15.3 million),
• Credit Suisse (CHF 332 billion),
• Knight Capital Group ($1.17 billion),
• Interactive Brokers ($14.5 billion),
• Wells Fargo ($19.6 billion),
• JP Morgan($546.2 billion),
• and Morgan Stanley ($410 billion).

That's right, CIBC and Royal Bank have over $125 Billion of collateral backing up its derivatives book which is actually client collateral!!!

When the crunch came for MF Global, their clients collateral was seized and is now gone. It is being suggested that MF Global's bankruptcy has already set off a chain of events which not even all the world's central banks can halt.

Back in August, Canadian banks defended themselves against the concerns of TCE. And anyone looking through the balance sheet of Canadian banks could turn up no alert signals.

Was it because hundreds of billions of dollars worth of debt exposure was off the books?

Reuters is reporting on the MF Global Re-hypothecation scan here. It explains the whole issue very well. From the article:

A legal loophole in international brokerage regulations means that few, if any, clients of MF Global are likely to get their money back. Although details of the drama are still unfolding, it appears that MF Global and some of its Wall Street counterparts have been actively and aggressively circumventing U.S. securities rules at the expense (quite literally) of their clients.

After reading all this, do you feel safe with your money at CIBC or Royal Bank?

Look for lots of interest in Canada to be generated by this latest Zero Hedge post.

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The Trigger

Just getting back from my own long weekend and it's gonna be too late for a proper post. Perhaps the most interesting developments on the real estate front this weekend is the release of two seperate reports that conclude that most homes in Canada are overvalued.

Doesn't exactly rate as a 'newsflash' to this blogs faithful readers, but I was drawn to this tidbit from CIBC bank economist Benny Tal:

“The fact that prices are overvalued today does not necessarily mean that they will crash tomorrow. A violent market correction needs a trigger such as the sub-prime crisis which ignited the U.S. real estate meltdown, or abnormally high interest rates as was the case during the 1991 property crash in Canada. Fortunately, that is not on the horizon this time around.”

I'm not sure which is more stunning. Seeing the big banks finally admit that real estate prices are overvalued... or the sheer audacity of denying that there are triggers present that could ignite the real estate powderkeg.

More on this during the week.

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Jeff Rubin: Housing in for shock... prices to drop 25% or more?

Jeff Rubin was the chief economist at CIBC World Markets for 20 years. He was one of the first economists to accurately predict soaring oil prices back in 2000 and is now a popular commentator on oil depletion and its economic repercussions.

He argued that it wasn't sub-prime mortgages, but record oil prices that drove the world economy into its deepest post-war recession.

Speaking of mortgages, he has some advice for Canadians currently holding a mortgage.

Look at your current situation and ask yourself a long, hard question: just how big a mortgage can you carry?

• "When money is free, it’s hard not to borrow it, even if the lender keeps warning you to be vigilant against debt. That’s exactly what Bank of Canada Governor Mark Carney has been telling Canadians while at the same time keeping their cost of borrowing as low as it’s ever been.
  
  Today’s inflation rate is no more sustainable than today’s interest rates... And this time the inflationary fallout won’t just be in the energy component of the Consumer Price Index. The impact will be much broader...
  
  Stress test your floating-rate mortgage three or four percentage points from today’s level and take a good, long look at the resulting increase in your monthly mortgage payment. For some homeowners, that could be as much as another $1000 per month.
  
  Twenty years ago a similar shock to borrowing rates caused Canadian housing prices to fall by an unprecedented 25 per cent. I know because I called it.
  
  That call was as much about where interest rates were going as it was about where housing prices were heading. Based on current borrowing rates, today’s homeowners will be facing almost as large an increase as they did back then.
  
  So heed Governor Carney’s caution when you decide how big a mortgage you can really afford to carry. Because once the Bank of Canada starts raising your mortgage rate, it will be a very long time before they stop."

You all know I completely agree with Rubin on this, it's exactly what I, and the other members of the Rainforest Roundtable, have been saying all year long.

When it comes, however, the drop in real estate prices in Vancouver will be much steeper than it was 20 years ago.

I stand by my prediction of at least a 40% drop in single family home prices and a 50% drop in condo prices.

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