FP: Mortgage debt putting our national economy at risk.

Interesting article in the Financial Post yesterday. Titled Stephen Harper told mounting mortgage debt is putting ‘our national economy at risk’, the news article details how the Federation of Canadian Municipalities, made up of member cities representing 90% of the nation’s population, have told the Prime Minister that the high cost of housing was the most “urgent” financial issue facing Canadians today.

We have been warned before, and often. The federal government and the Bank of Canada, in particular, have lectured us about the evils of sky-high consumer debt and still-creeping house prices — and the mounting threat to the economy — as rock-bottom interest rates inevitably begin to rise...

Canada Housing and Mortgage Corp., the Crown agency responsible for insuring mortgages to approved buyers, uses a 30% threshold of total household income going to housing. Anything above that, and consumers could end up over their heads.

Dallas Alderson, director of policy and program at the Canadian Housing and Renewal Association, said one-quarter of Canadian are over that limit.

What do they want the Prime Minister to do?

“We believe that as the government sets its priorities for the next two years, it should address the high-cost of housing in Canada, the most urgent bread-and-butter issue facing Canadians today."

Of course when these groups ask the Federal Government to intervene, it usually means more subsidies, which is the type of meddling in the past which has created the mess in the first place.  Remember, greatly increasing CMHC's balance sheet was all about making housing 'affordable'. Notes the FP article...

Finn Poschmann, vice-president of research at the think-tank C.D. Howe Institute, said Ottawa has “little jurisdiction and almost no practical capacity to deliver housing.”

“Past attempts to do so, through CMHC for example, have produced financial disasters for the people who participated and put CMHC in grave financial situation.” he said.

“We wouldn’t want to see that again, nor the federal mortgage agency deeply underwater and as similar U.S. agencies have been, through the course of much more recent financial disasters.”

Curiously no one suggests removing the punch bowl which created the sky-high housing values to begin with.

Yanking that punch bowl away will trigger a very painful process.  But it's the long term solution that is required.

Speaking about the punch bowl of ultra low interest rates, the Globe and Mail notes that GM Canada chief frets over credit-driven car sales.

The president of General Motors of Canada Ltd. is worried that ultra-cheap auto loans could be causing Canadian vehicle sales to spike just as home sales did during the U.S. housing bubble.

Canadians are on pace to drive more than 1.73 million new vehicles off dealers’ lots this year, breaking the record of 1.703 million, but that’s a higher level than economic indicators suggest sales should be, Kevin Williams told The Globe and Mail’s editorial board Monday.

Part of the reason, he noted, includes eight-year, interest-free loans being offered by some auto companies. His comments highlight again the hot-button issue of consumer debt, singled out by Finance Minister Jim Flaherty and the Bank of Canada as a critical concern before the inevitable rise in interest rates.

Mr. Flaherty has focused on mortgage debt, but auto loan debt has been rising in the fierce fight among auto makers for market share and their battles with each other and Canada’s Big Six banks in the auto lending market.

Auto loan debt rose 8.6 per cent in the second quarter from year-earlier levels, outpacing the increase of 6.1 per cent in total debt, according to numbers compiled by Equifax Canada.

Consulting firm J.D. Power and Associates said last month that 64 per cent of Canadians who finance vehicle purchases are taking on terms of six years or longer.

The longer terms are designed to make monthly payments as low as possible, Mr. Williams said, but they mean in some cases buyers will return to dealers for a new vehicle still owing money on the vehicle they’re trading in.

The unwinding of all of this is going to be very, very painful.

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Ottawa Citizen Newspaper chastises Federal Government on debt message

Yesterday the Ottawa Citizen newspaper chastised the Federal Government on it's mixed message about Canadian debt.

Here is the content of their editorial:

OTTAWA CITIZEN MARCH 10, 2012 

Why is the federal government warning Canadians about debt while it is encouraging aggressive mortgage lending?

When it comes to interest rates and housing prices, it's difficult to see the thread of consistency in federal government policy. Bank of Canada governor Mark Carney and Finance Minister Jim Flaherty frequently warn Canadians that levels of household debt are too high. At the same time, the Bank of Canada's low interest rates make possible the low mortgage rates that are fuelling the housing market.

The government encourages risky mortgage lending even more by facilitating it through the Canada Mortgage and Housing Corporation. The government-owned mortgage insurer charges a substantial premium to home buyers with less than 20 per cent to put down, a federally mandated practice that effectively takes the risk out of mortgage lending for Canada's banks.

As concerns about a contraction in Canadian housing prices increase, the CMHC is finally getting some long overdue scrutiny. This week, the Ottawa-based Macdonald-Laurier Institute recommended a thorough review of how Canada finances mortgages. The institute questioned whether home buyers are paying too much for CMHC mortgage insurance, a fee which can be up to 2.9 per cent of your loan, higher if you are self-employed.

This mortgage insurance fee costs home buyers thousands of dollars, and the institute asks whether the fees are unduly high. The fact that the CM-HC has returned profits to the federal government of $14 billion over a decade suggests that this is a cash cow.

Other organizations, including the International Monetary Fund and the C.D. Howe Institute, are worried that the publicly owned CMHC has taken on too much mortgage liability, exposing Canadian taxpayers to undue risk. While there is a debate about whether Canada has a housing bubble, housing prices have increased 44 per cent since 2006. The CMHC's total loan insurance portfolio is now $541 billion, up from $350 billion in 2007. The Howe institute has suggested encouraging private mortgage insurers to play a larger role.

The main question, generally unasked, is why a federal agency has to take the risk out of mortgage lending for Canada's big banks. It's particularly pertinent with banks lowering rates again this week as they fight for more lending businesses. Normal businesses take risks. Why not our banks?

Our financial leaders say they are against debt, but their policies encourage it, and the government makes a tidy profit off insuring it. As long as those policies persist, they should spare us the lectures.

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Trumpeting the obvious

Our friends over at VREAA picked up on an article which is simply too good not to share with those faithful readers of this blog who may not visit that site.

For years I have ruminated with a couple of colleagues how, years from now, we will look back in amazement at how Canadians could watch the housing bubble implode in America, repeat the exact same mistakes as Americans, and then watch our country experience a similar collapse (albeit with a distinct Canadian bend to the story).

And while the collapse has not happened here yet, Americans are watching dumbfounded that we could so wilfully move forward into the same trap they fell into.

One of the best articles capturing this sentiment has been published in a magazine put out by - of all places - the Philadelphia Church of God.

In the latest issue of "The Trumpet", a magazine the religious group publishes 10 times a year, an article headlines 'Canada's Housing Bubble is Stretched to the Limit'. And it's a great synopsis of the Canadian situation.

The magazine starts off by zeroing on the key metric that demonstrates our real estate market is way, way out of balance.  Noting that Canadian incomes have not been growing during the inflating of our housing bubble they say:

(Canadian) house prices have inflated virtually non-stop for more than a decade (but there has been no) income growth. Consequently, it is virtually impossible for the typical person to purchase a home without bankrupting himself in the process. For many families, even with two incomes, buying a house is stretching beyond the breaking point...

Before the massive run-up in house prices in 1999, the price of a home was 3.2 times the average person’s salary. It averaged that for decades. By 2010, the average house in Canada cost 5.9 times the average yearly salary, according to the Globe and Mail.

The article then outlines the average Canadian worker's income and costs out how much is being eaten up trying to service a mortgage and observes:

Talk about being a slave to your house. The average Canadian is forced to spend almost 100 percent of their income just on “ownership” costs! How do people feed themselves?Of course that is why single-income families rarely buy houses in Canada anymore. To buy a house, both spouses need to work. One full salary goes toward paying for the house. The other salary goes toward feeding the family, paying for vehicles, paying other debt, and life.

The next comment struck a chord with me and is bang on in it's assessment. It is what this, and virtually every single bear blog, has been saying:

Canadians rarely seem to consider the fact that their biggest investment might (read: will probably) go down in value. Falling house prices is an idea that many Canadians laugh at. Americans laughed too before America’s bubble burst. Now, many Americans are locked into paying mortgages on houses that are becoming worth less and less each year.

Does this sound like the basis for a healthy economy? Indentured servitude for three decades just to see every dollar, dime and penny earned go toward paying for a depreciating asset! If you buy a house today, or if you bought a house over the past five to ten years, that is what you are risking.

If Canadians do default on their mortgages, banks can not only take the house, but have full recourse to go after all their other assets and income.

Yet Canadians seem more than willing to take the risk. Why? The same reason Americans did. When house prices are going up, it makes everyone rich! A 5 percent yearly gain on $300,000 is a cool $15,000—money that can be tapped through equity lines of credit.

Next they zero in on the cause - low interest rates:

Offering interest rates yielding only fractions of a percent, the Bank of Canada is practically driving people into real estate.

And how effective has this been to drive people into real estate?

In Vancouver, so many people are buying houses, second houses and investment houses, that the ratio of home prices to incomes is the highest in the English-speaking world, according to consultancy firm Demographia. The survey labeled it the second-least affordable city in the world! An average house there costs over 10.6 times the average pre-tax income.

In Toronto, the real-estate bubble is so out of hand that the city has 173 skyscrapers under construction. New York, which boasts a population almost four times larger, is only building 96.

Since America’s housing bubble popped in 2007, Canada’s house prices have risen an astounding 22 percent. That has to be the definition of insanity—piling into the very investment that made your neighbor and most important economic partner virtually collapse.

But perhaps the biggest sign of a Canadian housing bubble is debt! Rising debt is the gas that fuels all bubbles. The average debt burden of Canadian families stands at a remarkable 153 percent of disposable income—and growing. It was only 150 percent three months ago. Canadians are now one of the most indebted people in the developed world, and just about as indebted as Americans before their bubble burst.

Based on this measure, the Economist figures the Canadian market is overvalued by over 70 percent. Even U.S. bubble epicenter Los Vegas has only seen house prices fall by 60 percent.

Last month, Merrill Lynch called Canada’s housing market overvalued, oversupplied and driven by speculation.

And in a report released last week, CIBC argued that the people least likely to be able to afford new mortgages are the ones taking on new debt. One third of debtors hold about 75 percent of all personal debt. And who is this one third? According to cibc, it is boomers nearing retirement and those already burdened by high debt.

The Trumpet, as it is with most Americans who take the time to look northward, shake their heads and conclude what bloggers in Canada have been saying for the last few years:

Canada’s bubble is getting close to bursting, and when it does, expect a massive economic implosion. Unemployment will soar, banks will fail or ask for bailouts, and the dollar will plunge in value. Millions of Canadians will be left paying a fixed mortgage on a rapidly depreciating asset that will destroy their financial lives. Five years following the popping of America’s housing bubble, Canadians may be about to wish they had learned a lesson. Get your ear plugs ready.

It truly is sad the everyone outside of Canada can see all of this so clearly, yet we remain purposely blind to our predicament.

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Thur Post #2: Housing mania leaves Canadians over-indebted, economy vulnerable to pullback

Earlier today we talked about how precarious the debt situation is for a friend's landlord (see Thur Post #1 below).

Now the Vancouver Sun expands on how tedious the debt situation is for Canadians in general.

According to a report released today by the Canadian Mortgage and Housing Corporation, the record level of household debt in this country is a "serious issue."

And what prompted this exclamation?

As of March 2011, Canadians owed more than a trillion dollars on their mortgages.

That's Trillion with a "T".

The CMHC reported that housing-related spending of about $330 billion a year in 2010 has risen by 67% since 2001 and now comprises 20.3% of Canada's gross domestic product in 2010.

These statistics underline the importance of that debt load, and what might happen to the economy if for any reason Canadians crack under its burden.

CMHC figures show that mortgages made up about 68% of total household debt in 2010. Consumer credit, which makes up the other 32%, has been growing faster than mortgage debt over the past two decades.

"Concerns expressed about household indebtedness have been largely driven by the total household debt-to-disposable income ratio," the report says.

"The major risk in the mortgage market is impairment in a household's ability to pay, often due to job loss. Recession or other adverse economic scenarios, such as rising interest rates, could certainly pose a challenge for some Canadian households."

Subprime was the trigger in the United States. Our's may well be debt piggies who can no longer keep their heads above water.

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Thurs Post #2: Concern over Canadian bank exposure to overleveraged consumers

One refrain you have heard constantly during the inflating of our housing bubble in Canada is that 'Canada is different... Canadian banks did not lend money to those who couldn't pay it back.'

That, as this blog as insisted over and over again, is a crock.

Our banks permit liar loans - loans where a self-employed person can 'declare' their annual income to qualify for a mortgage.

Our banks offer cash back for mortgages (as much as 7%) which effectively means we have zero down mortgages. You can take out a mortgage, receive 7% back (which covers the 5% down payment) and this allows you to be PAID to buy a house.

And most significantly, CMHC is absorbing all lender risk.

Take away CMHC and there is no way twenty-something couples would qualify for a 5% down mortgage at the same rate as people with money.  Without access to this easy credit, the housing bubble would collapse.

As these measures have pushed up home values, Canadians have pigged out on an orgy of debt from HELOC's and credit cards fueled by the value of their houses.

Now, according to a report by Moody’s Investors Service, concerns are being raised about Canadian bank exposure to overleveraged consumers.

Observers are asking a question that would have been almost unthinkable a year ago: Would the big banks take a hit if the debt crisis spread here and consumer defaults spiked?

The biggest single asset on Canadian bank balance sheets is residential mortgages, more than 30% of which are insured by the Canada Mortgage and Housing Corp., essentially shifting the risk of default onto the shoulders of the government.

But banks also hold substantial uninsured assets such as credit card debt, and that leaves them vulnerable.

According to David Beattie, Moody’s analyst and author of the report, the Royal Bank of Canada is the most susceptible with 24% of its total managed assets made up of uninsured loans. Next is Bank of Nova Scotia at 21%, CIBC at 20%, Toronto-Dominion Bank and National Bank of Canada both at 18%, with Bank of Montreal the most protected at 14%.

“Canadian household debt as a share of personal disposable income stood at a record 150.8% at the end of June this year.” said Mr. Beattie. “We are concerned that, while taking advantage of low interest rates, consumers are also taking on debt the may not be able to service when rates inevitably go up.”

We haven't begun our downturn yet. And people have no idea how closely tied Canadian mortgage debt and consumer debt is.

As the Financial Post notes, the European debt crisis is already having a negative impact on the global economy.

The fear is that a significant rise in unemployment could leave many households unable to meet their obligations despite the record low interest rates.

Analysts are uncertain how Canadians would react in such a situation, whether they would stop paying their mortgages — as many Americans did when U.S. economy collapsed three years ago — or whether it would be credit card debt or auto loans that would take the hit.

Another area of uncertainty is the makeup of the banks’ consumer loan portfolios. There is limited detailed information on the various categories of loans, making it difficult to guage Canadian banks’ true exposure.

Certainly this blog suspects that if real estate turns in Canada, the resulting fallout will be catastrophic.

Perhaps that's when the ruling federal Conservative government in Canada moved heaven and earth to protect the real estate industry when the US market started going under in 2006.

We've had the zero down, forty year mortgage. The ability to raid the RRSP fund for down payments. The Home Reno Tax Credit. Emergency interest rates. First-time buyer’s closing cost credit. Regulations that permit liar loans. Regulations that permit zero-down payments with cash back from mortgage lenders. And CMHC increasing loan value on their books from just over $100 million to well over $700 million while assuming all lender risk.

Cheap credit, artificially supressed interest rates and government policy have attempted to fuel and protect the real estate boom in the hopes the Great Global Recession would pass before the impacts him home in the Land of the Maple Leaf.

In short our government gambled... much like the Trudeau government gambled on oil in the 1970s.

If it blows up... it is going to be really, really ugly.

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There will be no US-style housing correction in Canada, or so says Royal LePage

Just 'cause we wanna refer to this down the road, we bring to you today the latest from Phil Soper, president and chief executive of the real estate company Royal LePage.

• "Canada is not set for a U.S. housing crash. Canada’s housing market will cool off in coming months, but a U.S.-style housing crash won’t happen."

Gee Phil, how comforting to know the raison d'etre of your business isn't a concern.

This comes, naturally, as many real estate observers have appeared in mainstream media predicting Canada’s housing market is set for a major correction as record low interest rates have spurred buyers to take on more debt than they can afford,

But Soper doesn't want you to be concerned.

He says prices in some markets are over blown, but "the Canadian economy is structured differently from that of the U.S., making a collapse unlikely."

Ahh, yes... Phil tells us it's 'unlikely'.

It brings to mind David Lereah, the man who was the chief economist of the US National Association of Realtors when the US Housing Bubble started to implode.

For those of you who don't know him, Lereah gained eternal notoriety when he brashly told everyone that - despite overwhelming evidence to the contrary - the US housing market was going to keep on chugging forever.

And Lereah did more than issue rosy forecasts.

Not only did he regularly trumpet the infallibility of housing as an investment in interviews and on TV... the brash Lereah even wrote a book in 2005 titled, Are You Missing the Real Estate Boom?.

Lereah says he grew concerned about the direction of the market in 2006, but that didn't stop him from re-issuing the book under the new title, "Why the Real Estate Boom Will Not Bust."

Even in January 2007, when the crash was picking up steam, he boldly stated: "It appears we have established a bottom."

Lereah is infamous for his cheer leading efforts during the height of the bubble and then later when he was denying that the industry was going bust.

Four years after that fiasco, as concerns spread that the Canadian Bubble is unsustainable and on the crest of imploding, the head of one of Canada's largest Real Estate companies tells us a collapse is 'unlikely'. 

Wouldn't care to publish a book telling us that, would you Phil?

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American Home Prices vs Canadian Home Prices

Canada Housing Bubble posted the link to the above chart yesterday over at Daily Markets (click to enlarge).

The chart shows how the Canadian home price index (Teranet–National Bank National Composite House Price Index) compares to the 20-city Case-Shiller Composite Index for the United States.

When both indexes are adjusted to equal 100 in January 2000 you find that from 2000 to 2005, home prices in the U.S. doubled (+100%), while Canadian home prices increased by only 50%.

Since then, U.S. home prices have fallen by 30% and Canadian home prices increased by another 40%.

Compared to January 2000, U.S. home prices have appreciated by 41% and Canadian home prices are up by 112%.

As Daily Markets notes, the main question all real estate observers are asking is: Are Canadian home prices in an unsustainable bubble headed for a future major correction or crash? Or are the home price increases in Canada sustainable?

The rise in U.S. home prices during the early 2000s was dramatic and occurred because of  massive government interventions in the housing and mortgage markets.

In Canada we had a lower but more sustainable rate of home price appreciation. The height of our housing bubble came later than the Americans because the hard core intervention didn't start here until 6 years later. The Conservatives gave us the zero down, forty year mortgage. They allowed Canadians to raid RRSP's for down payments. They created the Home Reno Tax Credit. They gave us the first-time buyer's closing cost gift and they instituted the infamous 'emergency interest rate'.

As we said yesterday, Harper's Conservatives have given us more pro-real estate initiatives in the last five years than Canadians have seen in the last quarter-century.

As a result CMHC has gone from backing $100 Billion in mortgages in 2006 to over $800 Billion in 2011.

And as you can see by the chart, our market has been propelled even higher than that experienced by the Americans.

It really shouldn't come as a surprise then that since our real estate market didn't start receiving it's hard core juicing until 6 years after the Americans started jacking theirs... that our collapse may not start until 6 years after the Americans imploded (2006 vs 2012).

Our home price increases are not sustainable. And we will not escape the same experience as the Americans, the Irish, the British and now... as we have started to see this year... the Australians. 

The cycle merely needs time to play itself out.

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Wed Post #2: Another R/E Bubble Warning

We last heard from Capital Economics (CE) back in June 2011.

 They are an economic think tank founded in 1999 to provide "independent macro economic research in the US, Canada, Europe, Asia, Latin America, the Middle East and the UK, on the property sector", had concluded that Canada's housing market was in a bubble that's set to burst.

They say housing prices could plunge by as much as 25%.

• “Housing valuations have lost all touch with fundamentals and household debt is at a record high. Canadian house prices are overvalued at close to the excessive levels seen in the frothy U.S. market at its 2006 peak.”

Two months later the group continues to pump the same message.  The Globe and Mail put out an interesting chart on Monday by the group which shows 'house price to income per capita'. As you can see we are nearing the same levels the Americans had just before their crash took hold (click to enlarge):

CE notes that our current boom has produced the largest increase ever seen in Canadian housing prices and has wrenched real estate out of its usual alignment to people’s income and concludes that all signs increasingly point to a housing bubble.

“The stories we hear about people buying homes to rent out as investment properties, and others buying homes fearing that if they wait they will be priced out of the market, only convince us even more,” CE's David Madani (pictured above) writes in a research note.

Madani restates the same concerns as those articulated in June.  Mass psychology – “animal spirits” – have driven housing prices to unsustainable levels and that it can only lead to a collapse of at least 25% over the next few years.

In the short term, Mr. Madani sees any further gains as modest. “Housing affordability is already stretched, with costs accounting for a very large share of household income, over 40 per cent according to some estimates.”

Olympic Village - Millennium Water

Speaking of bubbles and a declining market, have you seen the latest bit of promotional desperation over at the former Olympic Village (now Millennium Water)?

Our friends over at Vancouver Condo Info are reporting today on the latest from the sales team team at Rennie Marketing,

The website hails: "We’re kicking off a brand new promotion tomorrow—an amazing move-in package of essentials for every buyer—it’s everything you’ll need for life at The Village!"

And almost as if you are watching a Ron Popeil commerical, the list of goodies carries on missing only Popeil's trademark "but that's not all... you will also receive..."

The package includes:

• A hybrid bicycle – for your 5KM ride along the seawall to Stanley Park
• A portable BBQ – for Saturday’s BBQ with the in-law’s, on your balcony or at Hinge Park
• A one-year Aquabus ferry pass – for a last minute trip to Granville Island or Yaletown
• A single person kayak – get to know the neighbourhood sea life
• A year’s worth of one-zone Translink FareCards – the skytrain is only 5 minutes away
• A coffee per day for a year at Terra Breads Café – just downstairs
• A pair of running shoes – run the seawall in style
• A year’s worth of groceries from Urban Fare – an elevator ride away
• A year’s membership to Modo Car Co-op – for your day trip to Seattle
• A set of All-Clad cookware – for your Miele kitchen

I wonder if Rennie could get Weird Al to redo his Popeil song for him?  "Now how much would you pay?"

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Is a much worse Financial Crisis looming on the horizon?

Everywhere there are signs the economy is headed for a double-dip recession and Macleans has a great article on the looming worldwide economic condition.

And it's ramifications could be horrific for Canada.

People finally seem to have woken up to the fact that the breadth and depth of the 2008 Financial Crisis is much deeper than was first understood and that the crisis hasn't been resolved.

In short, the world has too much debt. And you can't solve a debt problem by adding more debt, which is all we have done.

It seems that the goal of central banks and Government over the past 2½ years has been a return to economic growth driven by ever-increasing home-ownership rates, a booming finance and investment sector and everyone using their home like an ATM machine.

Now that the bills are now coming due, the world finds itself mired in a long and painful process to unwind all that debt.

Gary Shilling, author of The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation, observes that, “with the rally in stocks and commodities, most people thought we were going back to the good old days we knew and loved, and that 2008 was just a bad dream. But that was just a bear market rally, and now we’re going back to reality. There is just no such thing as an easy fix in an age of deleveraging.”

The U.S. economy is in a far more precarious position than it was before the credit crunch of 2008. Unemployment remains alarmingly high, at 9.1 per cent. The average time it takes for Americans to find new jobs has spiked to 40.4 weeks, the longest duration since records were first kept in the 1940s. It turns out the recession was also deeper than first thought. At the end of July, the U.S. Commerce Department revised down growth data, showing the U.S. not only shrank more than earlier believed, but economic output has yet to reach pre-recession levels.

All eyes are on Europe right now. 

London is burning. Greece is in receivership, nobody wants Italian bonds and France’s AAA rating is at risk, before long the spotlight will swing back to America’s failed states, beginning, as always, with California.

All signs are pointing to California facing a new budget gap.  Many other state and local governments in America are also showing serious signs of stress. Just days before S&P downgraded Uncle Sam’s debt in Washington, the Rhode Island city of Central Falls defaulted on its debt after municipal budget-cutting negotiations failed. Last Wednesday, Jefferson County in Alabama was expected to file for bankruptcy, which would make it the largest municipal bankruptcy in U.S. history.

Suddenly Meredith Whitney’s prediction of “hundreds of billions of dollars of muni defaults” for the upcoming year seems all the more plausible, with California leading the way. 

And China, the booming economy that is supposed to be everyone's economic saviour, is a source of concern, too.

When the 2008 crisis hit and American consumers stopped buying Chinese exports, Beijing instituted a huge US$620-billion spending program. The measures unleashed an orgy of construction projects across the country, but also sparked what has been described as history’s largest housing bubble, while driving up prices for consumers.

“They’ve already had to introduce a big stimulus package a couple of years ago, so it’s going to make it harder to go back to the same playbook again,” Brian Jackson, economist at Royal Bank of Canada in Hong Kong, told the Wall Street Journal.

Shilling believes China’s economy could be headed for a hard landing. It that happens he believes the bubble in commodity prices will burst. Already such signs are showing. Over the past three months, prices for oil, copper and cotton have slumped, and while commodity bulls insist the drop is temporary, Shilling believes it signals something worse. “It’s like those old cartoons where Wile E. Coyote runs off the cliff and for a moment he’s standing on air,” he says. “Then he realizes there’s no ground beneath him and - wham.”

If that happens, some fear Canada’s resource-dependent economy and stock market will get hit hard.

“The recovery thus far in Canada was, to a large extent, relatively better than other countries, and that’s because of commodity prices and a hot housing market,” says David Madani, an economist with Capital Economics. This time around, though, there are concerns that China’s cooling economy and a drop in raw material prices would have a big impact on Canada. Already there is talk in Alberta about the possibility of big oil sands investments being shelved if oil prices stay below US$85 a barrel.

Our unstoppable housing market almost single-handedly pulled Canada through the 2009 recession.

But Madani fears a commodities pull-back combined with a European/American/Chinese double-dip recession could set the state for a catastrophic Canadian situation.

During a June speech in Vancouver, Bank of Canada governor Mark Carney suggested the rush among Canadians to take advantage of rock-bottom interest rates to buy homes has not only ruined the balance sheets of many households, but has actually impeded growth by diverting resources from other parts of the economy.

Our soaring debt-to-income ratios have left the number of Canadian households vulnerable to an economic shock at a nine-year high.

“If we see housing go into a slump, an external shock like falling commodity prices could be what ultimately tips things over the edge,” says Madani.

And if that happens, Canada will not weather the next stage of the downturn the way we did in 2008.

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"They wouldn't dare"

After the financial crisis of 2008, as the greatest recession since the Great Depression of the 1930s set in, Canada's economy fared remarkably well.

So well, in fact, that many Canadians are oblivious to all this talk of a 'Great Recession' around the world.

Everyone is aware of the 2008 Financial Crisis... but few appreciate how severe the underlying credit crunch was.

And that's because Canadians never really felt that crunch.  The banking sector in Canada insulated our citizens from the worst of that crunch.  Because of the emergency level interest rates brought in by the Federal Government... because the Canadian Mortgage and Housing Corporation (CMHC) dramatically lowered the requirements to qualify for a fully backstopped mortgage... and because CMHC insurance fully guaranteed mortgages given out by Canadian banks, those Canadian banks  kept on lending money to Canadians.

As a result Canadians kept on buying. 

But the availability of cheap credit has driven Canadian household debt levels to record highs. Household debt as measured against disposable income currently sits at a record high of 147%.

As Canadians have piled into massive consumer spending, and buying as much house as they could afford under emergency level historic low interest rates, there is this perception that the Bank of Canada will never raise interest rates because they wouldn't dare upset the economy.

This, of course, if pure nonsense.

Echoing this sentiment is the chief economist for  RBC Global Asset Management, Eric Lascelles.

• “There is a popular misconception that the Bank of Canada cannot afford to raise interest rates because this would prove too damaging for mortgage holders. The opposite is in fact true. The reality is that the Bank of Canada cannot afford to delay raising interest rates, for precisely the same reason. The longer the bank delays, the more marginal borrowers will enter the market and be walloped when rates rise, and the further home prices will go above their equilibrium levels, only to tumble later.”

You can clearly see how the domino's will inevitably fall here.

Once the Bank of Canada raises its key lending rate from the current “astonishingly cheap” one per cent, costs of servicing mortgage and other debts will rise. 

These increased costs will sap consumer spending, housing prices will fall as lower-tier buyers are forced out of the market by diminished affordability, and the endless annual increases in real estate values will cease.

Just as so many Australian's (as we saw in yesterday's Aussie TV clip) were dependant on rising real estate, so are many Canadians. And as lower-tier buyers are forced out of the market by diminished affordability, the vicious catch-22 cycle will begin.  The lack of buyers will increase inventory.  Increased inventory will create competition for what buyers remain.  And a 'high supply, limited buyers' condition will start collapsing the market.

The Reserve Bank of Australia first started raising their interest rates back in October 2009.

By January 2010 it was evident the Australian collapse has started.  As Mish Shedlock observed:

• "The day of reckoning has finally arrived for Australia. A day of reckoning awaits Canada, China, and the UK as well. It's too late now to do much of anything except: exit the Australian stock market, get out of the Australian dollar, pick up some popcorn and stay on the sidelines and watch the collapse unfold."

Since January 2010 the Australian collapse has picked up speed. Yesterday's Australian TV clip quoted a stunned Aussie who said "I don't think anyone saw it coming."

That will be our future.  So many do not see what is coming. And right now we're still telling ourselves, "they wouldn't dare raise interest rates."

But as the chief economist for RBC Global Asset Management noted... they most certainly will.

The risk is clearly greatest of all for those who have just purchased a home since the 2008 financial crisis.

All the people who were lured by emergency level interest rates over the last 3 years are, on average, earlier in their career, and their income has not yet fully blossomed. They often begin with little equity in their dwelling, having neither contributed much equity up front, nor made many mortgage payments, nor have they enjoyed the fruit of rising home prices.

Their debt load is likely at its lifetime peak.

As Lascelles’ notes, the outcome of rising rates will be quite painful these buyers.

The only remaining question is... do these buyers represent a systemic risk similar to the devastation on the U.S. economy of its housing collapse?

Interestingly Lascelles discounts this outcome.  Despite that fact that many will face higher rates when they renew, Lascelles argues that by the time many do renew the impact will be mitigated by three years of rising household incomes.

A downturn saved by a rebounding economy? Didn't American economists predict that same outcome in the United States?

In 2007 many well known economists in America (like the infamous Ben Stein in the clip below) were adamant that the few who would be affected by resetting mortgages at higher interest rates would not adversely affect the overall real estate market. 

And in the summer of 2011, a similar sentiment seems to exist in Canada.

Not only will interest rates will rise, but the mantra of "they wouldn't dare" will give way to "I don't think anyone saw it coming"... just like it now has in Australia.

And just like we see in Australia today, the impact here will be more severe than expected.

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The looming Canadian Debt Crisis?

I was going to post my thoughts on the new R/E theme that 'HAM is not prevalent in Vancouver' yesterday but didn't get a chance.  Look for it later this week.

Other themes from the past couple of weeks have been the European/Greek debt crisis, the US debt situation and Carney/Flaherty's comments on the Canadian debt situation.

Ultimately all these topics are inter-connected, which is why we focus on them.

And the Canadian debt situation will hinge on how all these external factors play out.

Our blogging colleague Ben Rabidoux, who now blogs on his great new site The Economic Analyst, has come out with some great graphs that reflect the status of Canadians. 

The first clearly show how debt is exploding in Canada as the growth in lines of credit is compared to the growth of disposable income, GDP and inflation (click on images to enlarge):

Next the growth in Mortgage debt is similarly compared:

Mortgage debt as a percentage of GDP:

And finally how mortgage rates have fallen over the past 30 years:

For the past 2 years there has been a steady stream of warnings from analysts that the artificial accomodative money policies of the past 30 years will be coming to an end.

Our own central banker and federal finance minister have spent the past year issuing warnings that Canadians should get ready for interest rates that will return to the historic norm.

These charts clearly show why they are concerned.

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What's wrong here...

Above is a Global TV story which argues that Vancouver home prices are the most expensive in the English speaking world when compared to the income we make. 

And the underlying reason offered is that the infamous HAM (Hot Asian Money) is the cause of the explosion in housing prices.  Wealthy foreigners, with ample cash, are driving up local real estate prices with their Tsunami of purchases in the Village on the Edge of the Rainforest.

The argument offered is that comparing the insane local real estate prices to local incomes in not an accurate measurement of the market.  Vancouver's growing reputation of a 'world class city' is altering the dynamic and that prices are an accurate reflection of the moneyed demand for real estate from Asian buyers.

But, at the same time, local realtor Larry Yatkowsky releases a Greater Vancouver Real Estate Board monthly survey of Realtors which tells us something entirely different is going on.

The survey provided by Yatkowsky covers 1246 sales over Jan-May 2011 and concludes that more than 80% of buyers are locals.  Of those buyers who did come from outside of the Greater Vancouver area, about 15% come from outside of the Lower Mainland. And a little more than half of those from outside the Lower Mainland came from outside the country.

So... only 7.5% of buyers of Vancouver real estate are wealthy foreigners from outside of Canada.

That means 92.5% of the buyers are Canadians. And it means the concerns about the gigantic level of debt being assumed by Canadians combined with the concerns from Carney and Flaherty about the impact of a bursting bubble on our citizens are more than justified.

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Flaherty joins Carney with more interest rate/debt warnings

Yesterday we posted yet another warning from Bank of Canada Governor Mark Carney about debt and interest rates.

Well it wasn't only Carney issuing warnings in the Land of the Maple Leaf. Finance Minister Jim Flaherty also chimed in his concerns.

• "We have very low interest rates in Canada. We need to remind Canadians that historically low interest rates will not be there forever, that interest rates really only have one way to go and that’s up. So Canadians in terms of their most important – their largest debts, residential mortgages, need to be aware that their monthly payments are going to go up when interest rates go up."

These guys are starting to sound like regular bloggers with all their doom and gloom, aren't they?

What is most interesting is that a survey by the Certified General Accountants Association suggests 58% of indebted respondents are taking on more debt just to pay for daily living expenses like food, housing and transportation.

And if consumers are taking on more debt just to pay for daily living expenses, it deprives them of resources for other purchases, like cars, TVs, appliances, clothes slowing economic activity.

Which means the economy doesn't grow.  Which means income doesn't grow. Throw in rising interest rates and the problems compound.

Can you see it? There is a growing perfect storm here.  And when it breaks, the fallout is going to be wicked.

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Yet another warning from Carney

Ahhh.... our own central banker is issuing warnings again. 

Dropping by the Village on the Edge of the Rainforest on Wednesday, Mark Carney chose Vancouver for a speech on housing.

How appropriate.

And what did he have to say?

The latest blatherings were a sharp warning that the housing market may be overheating. Seems his ultra-low interest rates, combined with too much optimism on the part of buyers, has been jacking up prices in places like Vancouver. 

With investment in residential properties nationwide now near peak levels, Carney left little doubt that he is concerned.

• “The risk is that expectations become extrapolative, prompting the classic market emotions of fear and greed – greed among speculators and investors, and fear among households that getting a foot on the property ladder is a now-or-never proposition.”

Carney even singled out Vancouver saying that Asian wealth is fuelling valuations that in some cases are “extreme.”

Carney’s speech comes a day after a report from the Certified General Accountants Association of Canada showed household debt has hit $1.5-trillion.

If household debt were distributed evenly across all Canadians, the report said, a two-child household would owe an estimated $176,461, including mortgage costs.

Topping it all off was a report, that also came out on Wednesday, from Statistics Canada that showed Canadian families’ income from earnings, investments and private pensions fell 3.2% in 2009 to $63,000 – the first “significant” drop in market income since the early 1990s.

In the end it came down to Carney repeating the warnings he has been uttering for more than 18 months now as Canadian borrowers continue to binge on cheap credit,

Carney said the share of households “highly vulnerable to an adverse economic shock” has risen to its highest level in nine years.

He says borrowers and banks should "be careful."

Carney knows what the blogosphere has been saying for almost two years now: we are sitting on a powderkeg ready to implode.

In his speech Carney noted that real estate loans now make up more than 40% of Canadian banks’ assets, compared with 30%.

Our Nero-ish central banker called this “unprecedented exposure.”

• “The central position of housing assets and liabilities on the balance sheets of both households and financial institutions means that any housing excesses could generate important vulnerabilities in the financial system. Historically low policy rates, even if appropriate to achieve the inflation target, create their own risks.”

Vancouver, of course,  is Ground Zero for this looming disaster with prices up an astounding 25.7% to $831,555 – more than 11 times the city’s average family income – from $661,745.

But there is no economic recovery and Carney can't raise interest rates yet.

He knows what's coming.  But after so many warnings, all the children in the Land of the Maple Leaf hear is the muffled "whaa, whaa, whaa" sound of the adults talking on the Peanuts cartoons and it becomes background noise to the oblivious.

The Financial Post had an interesting take on it, though.

• "With the Bank of Canada’s hands tied in so many ways when it comes to cooling off a housing bubble, the message for Canadians is simple: Homeowners you’re on your own on this one. Get sucked into the housing hype if you must, but be prepared for interest rates to rise — and with all that mortgage debt you’re carrying on your fancy new houses, be prepared for those rates hikes to bite."

Indeed. The Post even had this little tidbit:

• "Cut through the bankspeak and Mr. Carney also said some parts of the housing market may be acting like a classic financial bubble, with expectations of rising prices and ever higher returns driving dynamics rather than supply and demand."

No one knows when our bubble will burst, but Robert Kavcic, an economist at BMO Capital Markets, came out with an apt comparison given the events of this week in the NHL.

• “By pure coincidence of course, the last time the Canucks suffered a heartbreak game 7 of the Stanley Cup final (1994) was just before red-hot Vancouver house prices tumbled more than 26%.”

And just as the heartbreak of a Canucks loss this time around was more intense than in 1994 because the expectations were higher (we were the league's best team)... so the bursting of this bubble will be more intense than it was in 1994 because that bubble is so much bigger.

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