Reaching for the Top - Another sign we are in the mania phase

Meet Larry and Adam Rachlin.

They're mortgage brokers in Ontario, and our newest poster children for the Canadian Housing Bubble.

Larry has Bachelor of Arts degree in Political Science & Speech Communication (honours) and is a 27 year veteran in mortgage financing and brokerage. He has an even longer tenure in the financial services industry including secured and unsecured funding, debt consolidation as well as personal & business tax preparation.

Adam is Seneca College graduate with a Diploma in Financial Services Underwriting. He's been in financial services for over 21 years including mortgage & loan underwriting, personal & business income tax preparation as well as commercial leasing & property management.

Together they run Mortgages Unlimited, a mortgage brokerage whose slogan is "We don't say 'NO', we offer an alternative."

Larry recently posted a youtube video (you can see it here) promoting their services and here is the opening pre-amble:

Every day someone calls and tells me they have an urgent cash crisis. 

They tell me nobody is able to help them, they're ready to give up. 

They say I'm their last hope. And I tell him this: I don't care if you have bad credit. I don't care if you can't prove income. I don't care if you have tax arrears or if you haven't filed an income tax return. Or even have mortgage arrears. I don't even care if you won't be able to make any payments for a while. 

All I require is that you have a good story and own a home that has some reasonable equity. If you have that, I'll get you the money you need. And I'll let you have up to 12 months with no monthly payments. Got a good story if so call me Larry Rachlin.

Your house is an ATM machine and all you need is a "good story".

Speaking of good stories, did you ever hear the one about the US housing crisis of 2008 and HELOC's?

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First Sunday of December...

Real Estate agent Larry Yatkowsky is out with his stats from November and  he notes Vancouver’s detached average home price had dropped to where it is only slightly higher than the low of last July.

The detached average home price now sits at  $1,053,902 which is now down 14% from the February 2012 peak.

Apparently the Vancouver home sale dollar volume fell 33% year over year from last November.

Meanwhile, as if this news wasn't dismal enough for the real estate industry, there is yet another prominent news organization pointing at our housing market and calling it for what it is: a massive bubble.

This time it's Time Magazine with "Oh NO, Canada! Are We Watching Another North American Financial Crisis Unfold!"

Time looks at Canada's skyrocketing household debt and wonders if Canadians are about to face a 2007-style crisis.

“Borrowing to buy property has helped make Canadians some of the most leveraged consumers in the world, at a time when their counterparts in other heavily indebted countries—such as the U.S.—are digging out. Household debt is now 163.4% of disposable income in Canada, close to the U.S. level at the height of the subprime crisis.”

Time notes that few analysts in America in 2007 predicted that the U.S. real estate market would blow up in spectacular fashion and they wonder if analysts here are being just as wilfully blind.

I'm sure the likes of Tsur Somerville, Rennie, et al are not pleased.

It seems the entire world is now aware of the fact we are in a massive bubble, and yet we still deny the reality to ourselves.

Sigh.

Notwithstanding... it's the first sunday of December and it's that time of the year. I'm off to string the outdoor lights.

Two renditions of my favourite carol to launch the holidays festivities for you.  

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Wall Street Journal picks up on Rosenberg's analysis of Canadian Housing Market

The Wall Street Journal is picking up on Gluskin Sheff economist David Rosenberg's recent analysis about the Canadian Housing Market.

In case you missed it, yesterday the Financial Post covered Rosenberg's analysis that Canadian housing prices are not sustainable.

Jumping on the story, the Journal headlines: Bubble vs. Rubble? Rosenberg Weighs in on Canada-U.S. Housing Divide.

Many economists balk at using the “B-word” to describe Canada’s housing market. Gluskin/Sheff’s David Rosenberg doesn’t.

And remember, he was the guy who called the U.S. housing bubble.

In a report out this week, Mr. Rosenberg describes the different real-estate market landscapes on either side of the Canada-U.S. border–”bubble versus the rubble.”

Rosenberg is highly respected in the United States as an economist who pulls no punches and he gained a high profile in financial markets when as the chief economist of Merrill Lynch he rang some early warning bells on the housing market crisis and subsequent recession in the U.S.

Mr. Rosenberg’s message now: Housing prices in Canada and the U.S. have never been this polarized, with Canada’s prices on average twice that south of the border. Historically, they have been close to parity, he says, and they can’t stay this far apart forever.

Toronto and Vancouver are “undeniably desirable places to live,” but that doesn’t mean that prices in Vancouver should be 4.4 times above the U.S. average, and Toronto three times higher.

Activity in the Canadian market should cool off, with condo sales vulnerable to a 20% drop in hot spots like Vancouver and Toronto. And another tightening of Canadian mortgage rules—which went into effect this week–is sure to bite into demand.

Our friends over on VREAA have summarized Rosenberg's report and his comparative graphs.

If there was any doubt before, you can't ignore it now. The word is out across America and the world about our housing bubble and that a crash is not only imminent, but expected.

Rosenberg summarizes the situation succinctly by declaring; “Not sustainable, my friends.”

Wasn't it Tsur Sommerville who insisted that wealth would continue to pour into Vancouver to support our housing prices?

I wonder if the Sauder School of Business will come out with a report analysing how wealth ignores the evidence when making investment decisions.

I mean, don't they already believe fundamentals don't apply?

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Tues Post #1: Another 'peak' at what's happening in Whistler

Time for another trip up the Sea-to-Sky highway to see what's happening in Whistler.

The picture above is of Greyhawk Condominium.

Specifically unit #303-3317 Ptarmigan Place, Whistler BC.

Unit #303 is a 2,200 square foot “penthouse”. Designer furnished and equipped, it was described as an open floor plan, 2 story, with vaulted ceilings, 3 bedroom plus full office property with the best of everything: full house sound system, TV’s in every room, electronic blinds, air conditioning, top of the line appliances, steam shower, jetted 2 person tub, rare and unique wood species, travertine tiles, granite counters, heated floors plus an HVAC system.

Located in prestigious Blueberry Hill steps away from the Valley Trail and the Whistler Golf Course, the property was purchased in 2007 by an Okanagan resident for $1,730,000.

It was listed in early 2009 for $1,995,000.

According to zrh2yvr who posted over on Vancouver Condo Info, the property sold this week for $1,250,000.

That's $745,000 less than the asking price, $510,000 less than what the owner paid for it in 2007.

It's an example of a wise 'investor' cutting his losses before the real crash takes hold in earnest.

Would you have the guts, or the brains, to do this?

Or would you hold out until you got 'what your property is worth'?

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The Trigger?

As followers of this blog know, China has been trying to engineer a 'soft landing' in their real estate bubble for a few months now.

With property values down over 40% in some cities, some wonder if the 'soft' landing is becoming a 'hard' landing.

Nothwithstanding, China appears resolved to maintain the course they have charted.  In fact China's Premier Wen Jiabao has said he believes there would be chaos if the curbs in the Chinese property market were relaxed.

The ripple effect from these property curbs are being felt around the world and especially in the Village on the Edge of the Rainforest. As property values tumble in China, the evaporating equity is turning off the taps for high end real estate sales to HAM in Vancouver.

But while real estate sales are down, the market has not stalled completely. Canadians continue to pig out on mortgage debt and it has finally reached the point the feds believe it may be time to engineer our own 'soft' landing in the real estate market.

If you have been following the news the past week, several banks have publicly come out calling for a tightening of regulations with an increase in minimum downpayment to 7% and reducing amortization periods from 30 years to 25 years.

This public proposals have been followed up by draft set of changes put forth by the Office of the Superintendent of Financial Institutions (OSFI) of Canada - proposals which will likely be implemented.

(It's less of a draft than a preview of what is coming)

Some of those proposals would leave the casual observer scratching their head in wonderment that they are not already in place.

Banks would have to double-check borrowers’ finances before approving loans.

Home values would have to be confirmed.

HELOCs would see tighter regulations with be less available to access, a move that would slow the use of home equity for more real estate speculation.

Considering how we like to puff out our national chest and boast about the 'soundness' of our banking system, you might find yourself scratching your head that these conditions aren't already in place.

Ditto for the suggestion that banks end the practice of giving cash back to applicants to cover their downpayment.

The claim that our country doesn't give out zero down loans is a lie.

Banks will give you as much as 7% of mortgage back to you in cash.  This means you don't need the 5% down and can actually walk away with money in your pocket to buy a house.

Cutting this off is going to have a dramatic effect on the entry level buyers.

Another change with a dramatic effect is a proposal clarifying mortgage renewals.

This is a topic we have discussed numerous times and have never been able to ascertain clear guidelines about.

What would happen if, at mortgage renewal time, you were seriously underwater (25% or greater) on your mortgage?  Would you be able to renew without coming up with a serious amount of cash to correct the underwater status of your loan?

The common belief is that once you score a mortgage, it’s just automatically renewed at the end of each term at the prevailing rate - regardless of whatever your house happens to be worth.

Random queries to low level mortgage 'specialists' often bring quizzical looks and noncommittal answers.

Nobody has ever definitively answered this.

Now the OSFI does.

The OSFI intends to implement a new regulation which will force the banks to re-calculate the loan-to-value (LTV) ratio of a mortgage every time the home loan comes up for renewal.

What does that mean?

If the housing bubble begins to burst and values fall by 20 - 25% or more, vast numbers of Canadians who bought in the last five years with small down payments (or none at all courtesy of the 7% cash-back programs) of could be in a position where they owe more for the mortgage than the property is worth.

In order for the LTV to be restored to the ratio of the original mortgage, Canadians would have to make up the difference.

As Garth Turner noted earlier today:

"A $400,000 condo bought with 5% down would have a 95% LTV. If, upon renewal, three years later the unit was worth $320,000, then the maximum mortgage amount offered would be 95% of the new value, or $304,000, instead of the original $380,000. In order to renew, the owner would have to hand over $76,000, less the small amount of principal paid."

This is a stunning clarification and as the ramifications becomes known in the mainstream, it could have a chilling effect on the speculative fever so rampant in our market.

The feds are determined to engineer a 'soft' landing in the real estate market and the sum total of all these changes are sounding alarm bells.

Watch for a full court press by the real estate industry to try and temper the implementation of these changes.

Canadian Mortgage Trends is first out of the gate in launching an offensive:

“If the government decrees new insured mortgage regulations, and/or rates rise significantly, and/or unemployment unexpectedly spikes, it could form the proverbial perfect storm that blows over housing valuations. It’s one thing to induce a measured housing correction (which is probably needed in some regions), but a policy-initiated free-fall is another matter.”

And that's the fear, that the scope of these changes could initiate a free-fall.

For years bears have speculated that rising interest rates would be the trigger that burst the bubble.

Bulls have revelled in the fact that the weakened economy had handcuffed the Bank of Canada from even attempting to burst the real estate gravy train by raising those rates.

If will be interesting to see what happens next.

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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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Seeking Alpha: Canadian Market Collapse

Seeking Alpha has joined the cavalcade of articles on a pending Canadian Real Estate collapse.  Of all the ones recently I found theirs particularly relevant.

Here is the body of their latest post on the topic...

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Canadians like to think they are 'different' than their southern neighbors. That is certainly true in some respects, but not in the accumulation of debt. Canadian households debt to disposable income versus that in the USA is shown in the above chart, however Canadians went quite a bit further in debt! Well at least that's different, right?

The above chart shows how Canadian households compare to their American counterparts. Canadian households held more debt (to disposable income) than Americans for every single year of data shown. American households started the process of deleveraging in 2007, but Canadians have yet to start.

Mark Carney, the Governor of the Bank of Canada (BoC), made a speech last year at the Vancouver Board of Trade about the Canadian housing market. Some of the highlights included:

• The value of housing-related debt in Canada has nearly tripled over the past decade to $1.3 trillion.
• This debt is also the single largest exposure for Canadian financial institutions, with real estate loans making up more than 40 per cent of the assets of Canadian banks, up from about 30 per cent a decade ago.
• The average level of house prices nationally now stands at nearly four-and-a-half times average household disposable income. This compares with an average ratio of three-and-a-half over the past quarter-century.

Another difference between Canada and the USA is that you can't get a 30 year fixed rate mortgage in Canada, but you can in the USA. Canadians have to use ARMs (adjustable rate mortgages), or a maximum of 10-year fixed rate, but most Canadians use 5-year fixed rate mortgages and hence have to refinance every 5 years.

The day the BoC start raising rates (which they will one day), there will be homeowners in every market that cannot afford to refinance at higher rates and hence the default rate will rise.

Clearly there is a downtrend in the mortgage rates over the last 25 years, and this can't last forever.

The BoC will raise rates eventually and when they do a lot of households are going to have difficulty adjusting to the higher interest payment.

Canadian Banking System

Something should be said about the 'rock solid' Canadian banking system, which is another point of pride for us Canucks! I read a great article on ZeroHedge titled: Is The Next Domino to Fall… Canada? (Aug, 2011), which discusses the (in)solvency of various banks around the world.

The authors compared 30 of the world's large banks and ranked them by their TCE ratio (tangible common equity). One might expect most of these banks to be European, which is true, but 6 of them (or 20%!) come from Canada. Even worse, 30% of the banks that have 4% TCE or less are Canadian.

TCE is used to measure how much leverage a bank has based on its assets, and hence the lower this ratio, the more highly levered the bank is. TCE is a better judge of the financial strength of a bank than the average pundit's preferred measure: Tier-1 capital. This is because Tier-1 capital can be generated with snazzy accounting tricks, whereas TCE is based on actual equity (i.e.: customer deposits).

A McKinsey paper (Capital Ratios and Financial Distress: Lessons from the Crisis, Dec 2009) stated the following about TCE versus Tier-1:

• Specifically, our analysis of bank distress during the credit and liquidity crisis of 2007 to 2009 suggests that the tangible common equity to risk-weighted assets ratio (or TCE to RWA) was the strongest predictor of future bank distress (with a Gini coefficient of 0.42) of the commonly measured capital ratios, and appears to be a significantly better predictor than other traditional risk-based measures of capital, including Tier 1 capital to RWA (Gini coefficient of 0.27) and Tier 1 capital plus Tier 2 capital to RWA (Gini coefficient of 0.26).

When one considers the following points, it's easy to see that Canadian banks are not as 'rock solid' as commonly believed:

• Canadian banks have some of the worse TCE ratios in the world (i.e.: they are extremely over leveraged), even worse than many of Europe's sick banks.
• Governor Carney noted in his speech that more than 40% of bank assets are in mortgages.
• If I'm right, Canadian real estate prices will likely drop around 30% on average across all markets. These losses will show up on the balance sheets of the banks.

It's interesting to see that Canada's banks are already Basel-III compliant and also rated number 1 for soundness (and may need a government bailout) by the World Economic Forum, Global Competitiveness Report 2010-11. Regardless, when mortgage default rates start to increase in Canada, banks with low TCE ratios may quickly see their losses dwarf their assets, and it's possible Canada will have a banking crisis that requires a US-style bailout.

Conclusion

It is clear that the Canadian housing market has undergone a debt-fueled asset price inflation (i.e.: a bubble) that has greatly outpaced inflation. It is equally clear that Canadian home prices have not yet begun their price reversion to the mean.

On average, I suspect that housing prices will correct by about 25-30% across Canada, with some of the extremely overvalued markets (i.e.: Vancouver) declining more like 40% or more.

(Note: I still maintain Vancouver will decline in excess of 70% - Whisperer)

If the Canadian housing market crash behaves like the USA one, expect most of the losses to occur in the first two years, and then slow down after that.

Canadian banks will suffer, and may need a bailout. They are over-leveraged and over-exposed to housing market debt. I will not be surprised to see a Canadian banking crisis emerge in the next few years, and government bailouts to go with them.

Investment Action: shorting Canadian banks such as CM, BNS, RY, and TD. Also, shorting some home construction companies or commodity companies may work.

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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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Unable to see the forest for the trees?

Locally the chatter amongst those who watch real estate revolves around whether or not the bubble has finally crested.

Inventory is up and September's numbers revealled a 5% drop in the average price from last month and a 10% drop in the SFH average from the high-water mark in May of this year.

Local realtor Larry Yatkowsky summarized it by saying:

• "Detached home prices continue a dramatic reversal from the gains made this spring. Vancouver’s average detached price has dropped more pounds for the second month in a row. From May’s scale tipping all time high of $1,223,421 that scale’s dial has inched its way downward beginning in June at $1,215,265 to reach September’s $1,104,896."

Our friends over at VREAA captured an excellent comment posted by realtor Rob Zwick in his ‘Market Update’ for  Oct 2011:

• “I have been eagerly awaiting this month’s statistics to see what sort of bounce back, if any, we would see after the slower Summer season. The answer, somewhat surprisingly, is that the we didn’t seen any bounce back in sales activity at all – in any of the neighbourhoods we look at."

Oh my! So does Zwick see this as the start of the 'Great Unwind' in our housing bubble? Of course not.

• "It is my belief, however, that the commitment to hold interest rates until 2013, in conjunction with positive employment and immigration numbers, should keep prices steady through to next year.”

Zwick's optimism is in line with all of those who can't see the forest for the trees.

“We have not seen clear evidence of a bubble in the housing market in Canada.” – Jim Flaherty, Canadian Finance Minister, news conference, NYC, 5 Oct 2011

“Well I guess the first question is, is there a real estate bubble at all? … We had a financial crisis, the largest we’ve seen since the Great Depression, we had an ensuing global recession, and if that isn’t a trigger or tipping point, for any kind of inflated market to see a major correction, I don’t know what is.”- Cameron Muir, Economist, BC Real Estate Association, CTV 27 Sept 2011

“Vancouver real estate no bubble says economist”, cbc.ca quoting Brian Yu, economist, Central 1 Credit Union, 15 Sep 2011

“Canada’s market is not in the midst of a bubble” – Sal Guatieri, senior economist at BMO Capital Markets, marketwatch.com, 29 Mar 2011

How reassuring are all these assertions there is no bubble to unwind?

It brings to mind this comment from US Republican Presidential candidate Herman Cain on August 17th, 2005.

Feel better?
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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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R/E and QE

It's been a busy week without time to post but a quick few notes on what is a significant week.

I had hoped to follow up with some commentary on yesterday's post on real estate but I will save that for later in the week. 

Numbers are now out for R/E sales in July and it is clear the market is starting to turn. An article in the Globe and Mail highlights how the latest home-sales figures point to a slowdown.

“The resale market has just gotten stupid in a lot of places,” said Ross McCredie, chief executive officer of Sotheby’s International Realty Canada.

“We’re seeing an increased amount of attention to what’s happening in the economy,” said Don Lawby, the Vancouver-based chief executive officer of Century 21. “It’s having an effect – if a house is priced right and the person is confident about their job, you can do a deal. But the price has to be right.”

And by 'priced right' they mean priced 'lower'.

“You’re starting to see more desperation from the sellers because they want to get out at the top,” said Mayur Arora of Oneflatfee.ca in Surrey, B.C. “It’s not all doom and gloom, because some neighbourhoods in Vancouver are still seeing bidding wars. But you are seeing signs that things are definitely changing.”

We will come back to this theme in the weeks ahead.

The big news of the day was the stock market.

The DOW plunged 512 points, the biggest one day drop since the 2008 financial crisis.  This comes after a 200+ point drop the day before.

The market is finally reacting to the government debt woes that have triggered massive financial bailouts of European countries and major spending cuts in the United States.  Meanwhile indicators show the economy has slowed to a crawl as a slew of global companies have announced broad job cuts.

Ignore all that “soft patch” BS that you hear and read about.  The economic numbers that you’ve seen signalling growth since then were all manipulated to ease fear. The reality is that the US continued to bleed jobs and the number of people going underwater on their mortgages increased. Home values showed a small bounce after the big drop but the downtrend quickly resumed and shows no signs of letting up. 

It’s too early to tell whether or not the stock markets will continue to fall as it did in 2008.  But I suspect one thing will become crystal clear – the public has been completely mislead about the true state of the economy.

As this blog has been fond of saying, few understand the full extend and effect of the financial earthquake that struck us in 2008.

We we have been told the economy is recovering, the reality is that we are still in that crisis.

Former comptroller general of the Government Accountability Office (GAO) David Walker warns that this upcoming phase is going to hurt:

• “Here’s the bottom line. If you take the total liabilities of the United States – public debt, unfunded pensions, retiree health care, under funding with regard to social security, with regard to medicare, a range of commitments and contingencies – as of September 30 2010 we would have had to have had $61.6 trillion dollars in the bank in order to be able to defease those obligations.”

Walker correctly notes that the fact of the matter is that the US problem is overwhelmingly a spending problem.

• “Lets understand something very simple. If you have escalating deficits and mounting debt, that means you have to increase the debt ceiling limit at some point and it means absent structural reforms in entitlement programs, defense and other spending, those represent deferred tax increases."

Walker knows the looming problems are unavoidable and a mathematical certainty. And it's the next part which emphasises why this blog believes so strongly that precious metals like Silver and Gold are destined to rise much higher.

• “We are not exempt from a debt crisis. We’re never going to default, because we can print money. At the same point in time, we have serious interest rate risk, we have serious currency risk, we have serious inflation risk over time. If it happens, it will be sudden and it will be very painful”

It’s not a matter of if, but when.

The current course America is on is mathematically unsustainable. A few hundred billion in spending cuts is simply not going to be enough.

Combine this with the weak economic data and it's clear that the devastation in the stock market has only just begun.

The countdown to QE 3 has begun.

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The Global Housing Boom: It came in waves

Our friends over at Vancouver Condo Info have come out with an excellent link worth checking out.

Since 2005, this article at the Economist have been available for subscribers only.  Now it is online for the public.  It is a landmark article about the worldwide housing boom from June 2005 and is a must read!

So many Vancouverites (and Canadians) have viewed our housing bubble as separate and 'different'.

It isn't.

• "NEVER before have real house prices risen so fast, for so long, in so many countries. Property markets have been frothing from America, Britain and Australia to France, Spain and China. Rising property prices helped to prop up the world economy after the stockmarket bubble burst in 2000. What if the housing boom now turns to bust?... The global boom in house prices has been driven by two common factors: historically low interest rates have encouraged home buyers to borrow more money; and households have lost faith in equities after stockmarkets plunged, making property look attractive. Will prices now fall, or simply flatten off? And in either case, what will be the consequences for economies around the globe? The likely answers to all these questions are not comforting."

Remember - this article is written in 2005. The Canadian bubble was blown into even more gigantic proportions by even lower interest rates when the financial crisis hit in 2008.

• "The most compelling evidence that home prices are over-valued in many countries is the diverging relationship between house prices and rents. The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier."

All these other jurisdictions were convinced these fundamentals did not apply to them.

They were wrong.

Reading the article today and substituting 'Canada' for many of the other countries examined in the article can only leave you with a sickening feeling for what lies ahead for our real estate market.

As we have said before, we have not escaped the fate of the housing market around the world.  Our destiny has only been delayed.

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