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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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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Mon Post #2: This crisis is a long way from over

Faithful readers know that I am fond of saying that the 2008 Great Financial Crisis is not over.

We suffered a financial earthquake in September 2008, the depth and breadth of which many of us still do not understand nor appreciate.

The western world has been on a credit binge for the last 40+ years and we have put off dealing with the effects of this binge over and over again the past four decades. Rather than deal with difficult recessions, Government has constantly intervened with 'stimulus' to avoid the pain of dealing with inherent problems.

The result?

As noted by the Boston Consulting Group in a recent report, the developed world currently has $20 trillion in debt over and above the 'sustainable threshold'.

The definition of "stable threshold" is a debt to GDP of 180%.

This $20 trillion in debt encompasses household, corporate and government debt and you read that correctly... that's $20 trillion over and above a debt to GDP ratio of 180%! 

Since 2008 all attempts to eliminate the excess debt have failed. 

This includes that US Federal Reserve's relentless pursuit of inflating our way out this insurmountable debt load... which after adding $3 trillion to the US National Debt have been for nothing.  Inflation has not worked so far because of the pressure to deleverage and because of the low demand for new credit.

And looming on the horizon is the elephant in the room that no one wants to acknowledge.

While everyone today is focused on the European sovereign debt problem right now, the debt problems of the PIIGS (Portugal, Italy, Ireland, Greece, Spain) et al are nothing compared to what looms in America.

US states have spent nearly half a trillion dollars more than they have collected in taxes, and face a $1 tillion hole in their pension funds. California alone is a bigger problem than the 'PIIGS' (less Spain) combined. Then throw in Illinois which has spent twice as much money as it has collected and is about six months behind on creditor payments.

From 2002 to 2008, the individual states had piled up debts right alongside their citizens’: their level of indebtedness, as a group, had almost doubled, and state spending had grown by two-thirds. In that time they had also systematically underfunded their pension plans and other future liabilities by a total of nearly $1.5 trillion. In response, perhaps, the pension money that they had set aside was invested in ever riskier assets. In 1980 only 23% of state pension money had been invested in the stock market; by 2008 the number had risen to 60%. To top it off, these pension funds were pretty much all assuming they could earn 8% on the money they had to invest, at a time when the Federal Reserve was promising to keep interest rates at zero. Toss in underfunded health-care plans, a reduction in federal dollars available to the states, and the depression in tax revenues caused by a soft economy, and you are looking at multi-trillion-dollar holes that can be dealt with in only one of two ways: massive cutbacks in public services or a default—or both.

At the municipal level, the financial health of American cities is in even greater deplorable shape.

Meanwhile there is consumer debt.

American Households are still more indebted than their counterparts in Austria, Germany, Spain, France and even Greece. Tens of millions of citizens remain burdened with mortgages they can no longer afford, in addition to soaring credit card bills and sky high student loans.

Trillions of dollars in outstanding consumer debt is stifling demand for goods and services and that's why the demand for new credit is so low. And without the consumer demand, cash-rich U.S. companies are reluctant to hire and unemployment remains stubbornly high.

As of June 30, roughly 1.6 million homeowners in the U.S. were either delinquent on mortgages or in some stage of the foreclosure process, according to CoreLogic. And the real estate data and analytics company reports that 10.9 million, or 22.5%, of homeowners are underwater on their mortgage — meaning the value of their homes has fallen so much it is now below the value of their original loan. CoreLogic said the figure, which peaked at 11.3 million in the fourth quarter of 2009, has declined slightly not because home prices are appreciating but because a growing number of mortgages are entering foreclosure.

America's banks, meanwhile, still have more than US$700-billion in home equity loans and other so-called second lien debt outstanding on those U.S. homes, according to SNL Financial.

Debts owed by American consumers account for almost half of the nearly US$9-trillion in worldwide bonds backed by pools of mortgages, car loans, credit card debt and student loans, which were sold to hedge funds, insurers and pension funds and endowments.

And that doesn’t include the US$4.1-trillion in mortgage debt sold by government-sponsored finance firms Fannie Mae and Freddie Mac.

Kenneth Rogoff, professor of economics and public policy at Harvard University and former chief economist at the International Monetary Fund, has said the ongoing crisis should be called the “Second Great Contraction” because households remain highly leveraged. He says the high level of consumer debt is what distinguishes this from other recessionary periods.

Meanwhile American banks also have their own big debt burdens to deal with. Next year alone, banks and financial institutions must find a way to either pay off or refinance US$307.8-billion in maturing debt, compared to the US$182-billion that is coming due this year, according to Standard & Poor’s.

This maturing debt for banks comes at a time when they must start raising capital to deal with new international banking standards.

Beyond bank debt, hundreds of billions of dollars in junk bonds sold to finance leveraged buyouts also are maturing soon. S&P says “the biggest risk” comes in 2013 and 2014, when US$502-billion in speculative-grade debt comes due.

The problems you see in the news today about Bank of America and Morgan Stanley are only the tip of the iceberg.

The issue of this decade is Debt.

And the issue hasn't even begun to be dealt with yet.

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Casting Shadows

In case you haven't seen it, the Globe and Mail has started a series on the Canadian Real Estate market called 'the long shadow over Canada's Housing Market'.

I encourage you to read the full story.

I disagree with parts. The writer states, "The trouble is not that Canada is on the brink of a gruesome real estate bust like the U.S. – because it isn’t. It has been shielded by more cautious lending practices, and avoided such bad practices as zero-down-payment or no-documentation mortgages. With few exceptions, Canadians have equity in their homes."

As faithful readers know, this blog has contantly talked about how Canada has done exactly all of those things. We aren't 'shielded' at all. When our market starts collapsing in earnest, those practices will be clearly exposed.

The Globe article, however, does focus on the emerging trend that is raising alarm bells in the real estate industry.

We are nearing the completion of the 5th consecutive month of year over year sales declines of 40% or more. More significantly, each of those 5 months will have registered sales totals that are the lowest in the last 10 - 15 years... meaning that the sales drop is not simply the year over year fallout of a blistering hot sales year in 2009.

The fear identified in the Globe article is that we have entered a period of stagnation or slowly falling prices. And weak home sales coupled with waning construction activity will cut off one of the engines that drove impressive economic growth and job creation in the years before the 2008 financial crisis.

Housing has played a stunning role in keeping Canada's economy rolling. And a significant correction in housing will hit our nation hard.

As the Globe notes the primary reason for that, of course, is the mountain of debt carried by many Canadian households. Canadians will soon owe more than $1.50 for every dollar of disposable income, an unprecedented level.

It all adds up to a simple, unpleasant equation: High debts, plus high home prices, plus high unemployment, plus slow growth in incomes will all have dramatic implications for employment and consumer spending levels – and for an economy that has grown accustomed to relying on housing-related spending for about 20%t of its gross domestic product.

Adding to this precarious situation is the fact that growth in consumer credit has collapsed by over 50%. As Jonathan Tonge notes on his blog, after an unprecedented rebound in borrowing and spending in 2009, growth in consumer credit has collapsed over the summer.

Consumer credit accounts for practically all household borrowing outside of residential mortgage debt. Personal debt such as credit lines, credit cards and loans make up the majority of outstanding consumer credit.

After last year’s record borrowing binge, if the trend holds, we could see retail purchases drop by as much as $6 billion YOY in just the final quarter of 2010.

The fear is that the economy begin to sputter, weighted down under record debt, falling home prices and a sudden collapse in spending as exhausted consumers refuse to borrow.

The Globe and Mail article notes that market forecasters are near-unanimous in the belief that prices will fall in the coming years, though few foresee the sort of rapid declines that savaged the American market.

I would suggest to you that analysis is wrong.

We arrogantly proclaim the American disaster was largely fuelled by loans made to people who weren't creditworthy and that Canada's problem is different.

We insist that easy credit is luring people into buying houses they may not be able to afford when rates rise to more historically normal levels.

But when those rates do rise to more historically normal levels, then it will be Canadians who are now no longer creditworthy. Almost all Canadian home mortgages are structured like the infamous American subprime loans. Who do you know who has a 25 or 30 year mortgage here?

Those 'deadbeat Americans' were able to afford the mortgage payments when they were are the subprime teaser interest rate levels. They only became a problem when the interest rates reset higher and they couldn't secure another loan at the low teaser rate level.

Our situation is as different from the American situation as we want to believe.

The vast majority of Canadians have 5 year mortgages. And they all have emergency level low interest rates attached to them... teaser rates, if you will.

And all are going to reset... at higher rates.

I personally know an astonishing number of people in Vancouver who have bought in the last 3 years. And almost all have bought the maximum amount of house they could afford under these ultra low interest rates.

None can handle a return to the average interest rate of the last 20 years: 8.25%.

At 8.25% they are most certainly uncreditworthy.

The Globe and Mail outlines the short term looming crisis of the slow melt and I agree with them.

It's what could will get the 'fire' burning.

Toss in higher interest rates and the conditions for implosion are complete.

Remember... calculate inflation as it was calculated prior to 2000 and inflation in September was 8.5%. Add to that the fact the US Federal Reserve wants a significantly higher level of inflation than the one we are currently experiencing.

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Sign, sign, everywhere a sign.

So the big item on a lot of Canadian blogs today is a report from TD Bank titled Canadian Household Debt a Cause for Concern.

No kidding.

A couple of salient points:

• At 146% of average after-tax personal income, Canadian household debt has become excessive.

• Nowhere was the impact of lower borrowing costs and greater household confidence more clearly observed than in the housing market, where ownership rates increased steadily over the past two decades. A self-perpetuating cycle occurred. Strong increases in demand bid up housing prices, which together with equity market gains prior to the 2008/2009 recession, raised net wealth. This positive wealth effect encouraged households to increase their rate of investment and consumption, further driving up borrowing and debt levels.

• Based on the new figures, a slightly higher 6.5% of households are currently financially vulnerable (or have a debt-service ratio of 40% or above).

• More striking, the share of those on the verge of becoming vulnerable (those with a debt-service ratio of 30-40%) had risen from 7.2% in 2009 to 9.3% – up almost two percentage points.

• Given the change in the distribution of debt, we have estimated that as much as 10-11% of households may become financially vulnerable if the overnight rate rose to 3.5%.

Thus we have a situation whereby if the Bank of Canada rate rises to 3.5% from the current 1%, over 10% of all households will be diverting over 40% of their pay to debt servicing.

And I can guarantee you that in the Village on the Edge of the Rainforest this will apply to more than 10% of all households.

As I have said over and over, it is going to be rising interest rates that will trigger an implosion of our housing market, with Vancouver as ground zero of a massive correction.

Those who wring their hands in frustration at the stubborn persistance of the housing bubble here only have to look at interest rates to find the reason why.

The Bank of Canada has issued endless warnings about the levels of our debt and the threat of rising interest rates. Bank after bank has come out with similar warnings.

Interest rates are at emergency levels. They will not stay there.

If you own, now is the time to cash in on your equity. Well invested it will multiply exponentially in the coming years as we are hit with the ravages of currency induced cost push inflation.

If you're afflicted with housing lust, DON'T BUY! Rent and force yourself to invest the difference between what you pay in rent and what you would be paying on a mortgage. When inflation and cost push inflation strikes, and the housing market collapses under rising interest rates, you will be in a position to buy a house outright - double digit interest rates be damned.

The warning signs are everywhere. I do not yearn for the carnage they portent, but neither do I deny the ominous calamity they give warning to.

Recognize those warning signs... and position yourself to take advantage of what's coming.

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And the band played on...

Some may be blissfully blind, but others appear to be gleefully blind.

And throughout it all, our American cousins shake their heads in disbelief.

Over at seekingalpha.com Rolfe Winkler looks at the Canadian housing bubble and declares, "so much for Canadian sobriety."

Winkler notes that the average price for a single detached home in the Village on the Edge of the Rainforest now exceeds $1 million, that prices have climbed 23.3% in just 12 months, and that prices are now nearly 3% higher than they were before the housing market crashed.

The Americans know where we are headed.

Of course the gleefully blind proudly proclaim that "because of the economic rebound. And the Olympics. And the warm winter [here]. Vancouver is different."

The rational is always, "it's different here".

Meanwhile Winkler makes the point that all R/E contrarians make:

"Household debt to income in Canada is now more than in the US. All the usual metrics to gauge whether housing is overvalued, eg House Price/Income or House Price/Rent are at levels up to over 30% from their long-run average. These are normally consistent with an overpriced market that is due for a correction; the question is when, as often these things persist for much longer than most people dare to guess. If Canada’s banks are behaving so responsibly, where are households getting so much leverage?"

Cause for concern?

Not according to the Bank of Canada who, according to Reuters, says "Canada's housing market is not in a price bubble but seems firmly valued."

That will be a quote for the ages.

This all comes just days after a CIBC study found that household debt - mostly mortgage debt - is growing three times faster than income.

And all of this comes at a time when many analyst share the sentiment that "the current rebound in the economy is a statistical mirage orchestrated by record amounts of monetary and fiscal stimulus that are simply unsustainable and actually risk precipitating a very unstable financial and economic backdrop in coming years."

One blogger I follow compares the current economic conditions to the Titanic disaster and suggests that we are at about same point in time as that famous ship was after it struck the iceberg.

Instead of a band playing on deck as the vessel took on water, we have the equivalent of an IMAX theater, complete with surround sound, to keep us occupied as we meet our fate.

Regretfully, I couldn't agree more.

May I have the next dance?

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Bank Failure Friday

As faithful readers know, bank failures in the US escalated dramatically in 2009. In 2008 there were 25.

In 2009... 140.

The 2009 total was an average of almost three per week and the most failures the United States has experienced in one year since 1992.

Because the announcement of these failures (and the actual take-over by the FDIC) are always delayed until late on Friday afternoons, Friday has come to be known as 'Bank Failure Friday' on many economic blogs.

But 2009 was just a prelude to 2010.

How do we know?

Because the FDIC has already publicly announced that they are preparing for a greater number of bank failures than in 2008 & 2009 combined.

The FDIC has set aside $2.5 billion for the handling of receiverships, almost double that allowed in 2009's budget of $1.3 billion.

The overall operation budget for 2010 has been set at $4 billion, significantly higher than that for 2009, a revised $2.6 billion.

And why is the FDIC preparing for such a huge wave of bank failures?

It's all in the chart at the top of this post (click on the image to enlarge it).

In 2006, 2007 & 2008, the defaults on a large number of resetting subprime mortgages took place (they are shown in mid green).

As the short term teaser interest rate on these mortgages can due for reset to a higher rate, homeowners couldn't negotiate a new mortgage with a new, ultra-low teaser interest rate (as they had done in years past).

That's how subprime mortgages caused the real estate collapse in the United States. Housing values fell in a few cities and when the first mortgages that came due with their ultra low interest rates (set at a two year duration before a higher rate would kick in), homeowners couldn't secure a new mortgage. In the past, because the value of the property had grown, they had always been able to negotiate a new mortgage (with a new two year, ultra low teaser interest rate).

Forced to assume the mortgage at a substantially higher interest rate - they defaulted.

As the market was swamped with a bunch of foreclosures, it drove housing values down across the USA. That triggered the same scenario with other cities subprime mortgages.

As the foreclosures picked up steam, those households with more normal mortgages were trapped because declining real estate values (from all the subprime foreclosures) meant that when it came time to renew their mortgages... they couldn't because the value of the mortgage was substantially higher than the value of the property (called being 'underwater').

No bank is going to give you a $500,000 loan on a property worth $300,000.

Now, looming on the horizon, are Prime, Alt-A, Agency and Option Adjustable Rate mortgages.

These 'normal' mortgages dramatically outnumber subprime mortgages.

Many of them are like sub-prime in that they reset at a higher interest rate, the only difference being they reset after 5-7 years instead of two.

Thus they are just coming due now.

And those who didn't have teaser interest rates that reset are facing the brutal proposition of being 'underwater'.

The end result will be the same as subprime.

The mortgages will reset to dramatically higher interest rates and/or the value of the property has dramatically fallen so renewing cannot be done without the mortgage holders bringing down the principle to the value of the property (which means paying off about $200,000 plus on renewal).

End result: another wave of defaults and foreclosures... which is what is putting all these American banks at risk.

They key element for Canadians here is that subprime was a minor player in all of this. Subprime mortgages were simply the first type of mortgage caught in the interest rate squeeze.

Look at the graph. Subprime mortgages are almost non existent in 2009 and beyond. While about 21% of all mortgage originations from 2004 through 2006 were subprime, when you add up all the mortgages due to reset from 2007 to 2015, the subprime portion of total mortgages is miniscule.

In fact, in June 2008, the total number of subprime mortgages in foreclosure or REO represent (as a percent of total housing units) less than 1/2 of 1 percent of all housing units in the United States (0.44%).

Yesterday we noted how the Bank of Canada has come out and stated that within 2 years 10% of Canadian households will be in danger of collapsing from rapidly rising interest rates.

That represents a higher percentage of all total Canadian mortgages than subprime did vs. the rest of the American mortgage family.

They are the first domino that will be affected by a dramatic change in interest rates.

And just like in the United States, when that first domino falls it can bring down the entire pack.

In Canada we don't have 'subprime' mortgages. But we do have scores of people who have taken on massive debt with ultra low interest rates that will reset. All those five year mortgages will come due for renewal. And if 10% can't handle the shock of a return of interest rates to their historic norm (over the last 20 years, that's a five year rate of 8.25%), then it means we are in a far more precarious position than the United States.

The collapse of that 10% will dramatically lower real estate values when those properties are eventually foreclosed upon and resold. When that happens, a great many of other Canadians will be in a sever 'underwater' position and will not be able to renew... further collapsing the real estate market.

In 2005 and 2006 the majority of the American financial sector ignored the looming threat these numbers represented. The only ones sounding the alarm for what was coming (and the threat it represented to the greater economy) were the likes of Peter Schiff.

In 2010, in Canada, we are just as ignorant.

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Finally... an admission.

It's been interesting watching the reaction to Finance Minister Jim Flaherty's comments that that the Federal Government will, if necessary, further tighten the conditions under which the Canada Mortgage Housing Corporation insures mortgages.

But Flaherty made a significant comment today and it seems to have escaped notice in all the hand-wringing over what changes the Finance Minister could possibly introduce. Flaherty said,

• “The Governor (of the Bank of Canada) and I have both encouraged the banks to maintain their lending standards, that’s important. We don’t ever want to end up in a situation like the Americans ended up with — people getting into a lot of trouble with the interest rates on their mortgages.”

Did you catch the significance of the comment?

We'll come back to it in a second.

Flaherty's nascent attitude on dealing with the housing issue (increasing minimum downpayments, reducing amortization periods) is clearly at odds with what he really wants to do... which is nothing.

Everyone knows there are mortgage brokers out there, like this one, who are getting Canadians into the market with nothing down and spreading the loans over 35 years.

That's how payments have been made affordable.

Scotiabank estimates 18% of Canadian mortgages are for terms longer than 25 years, and 10% are amortized over 35 or 40 years.

Broker acquaintances suggest the 35 ams are even higher.

Flaherty and Carney are clearly trying to strike fear into the industry in hopes that the industry will clean up it's act when it comes to manipulating the 'lending standards'.

Personally I don't think it's going to work.

And as 2009 comes to a close, its interesting Flaherty and Carney feel they can no longer publicly ignore what is going on.

Perhaps more startling, however, was Flaherty's startling admission.

Did anyone notice that he finally acknowledged that the conditions surrounding the American housing collapse are not all that different from the conditions looming in Canada?

Flaherty did not dismiss the American housing collapse by blaming it on 'subprime mortgages' and an 'irresponsible banking system' like so many times before.

Isn't that the snake oil government and the real estate industry has been selling us all year long?

No... for the first time we have seen a Canadian official publicly admit what really caused the American collapse:

"People getting into a lot of trouble with the interest rates on their mortgages.”

In America it was teaser rates that reset, first with subprime mortgages and then with regular mortgages.

In Canada it is ultra-low emergency rates that will reset.

Bloggers like this page have been saying all year that Canada is really no different than the United States.

We have thousands of Canadian homeowners who have been using their homes as ATM's, just like the Americans. They have renewed their mortgages, maxed out their equity, and are clinging to low variable rates.

In addition, we have thousands of Canadian homeowners who have jumped into the market with little or nothing down and cannot deal with interest rates returning to their historic norms.

The American condition was rotten with these factors and what set the collapse in motion was a resetting of interest rates. First it took down the subprimers, then the regular mortgage holders.

Now that very condition threatens not only the Canadian housing market, but the Canadian economy as well.

Today's news is not that Flaherty may change the rules for mortgages. Today's news is that Flaherty finally admitted that the Canadian situation is no different from that in America.

But we already knew that, didn't we?

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O tidings of comfort and joy...

You may have seen them if you occasionally read the comments section of this blog.

Some like to chide me for being so negative and repeating, ad nausem, my warnings about debt and rising interest rates. The number of comments pale in comparison to the dozens of the emails I get on that theme, but I love to read them.

So it makes me wonder if similar letters and emails are now being sent to Bank of Canada Governor Mark Carney.

'Cause let's face it... his public statements lately are inter-changeable with the posts of those in the blogosphere.

And yesterday the Governor had more tidings.

Speaking to a business audience in Toronto, Carney delivered this clear and unequivocal warning to Canadians:

• "Responsibility starts with the individual. Our advice to Canadians has been consistent: We have weathered a severe crisis—one that required extraordinary fiscal and monetary measures. Extraordinary measures are the means to an end: the return to the ordinary. Although we expect the recovery to be gradual and protracted, these measures are working. Ordinary times will eventually return and, with them, more normal interest rates and costs of borrowing. It is the responsibility of households now to ensure that in the future, when the recovery takes hold and extraordinary measures are unwound, they can still service their debts."

As we are found of reminding faithful readers, 'normal' interest rates over the last 20 years mean a rate of 8.25%.

Yikes.

The implications for many recent homebuyers in the Village on the Edge of the Rainforest who have taken out variable mortgages at rock-bottom rates and maximized the amount they could borrow are clear: any rise in interest rates risks putting a financial squeeze on a large number of debt-laden Vancouverites.

Even the Mortgage Brokers Association of B.C. is starting to take notice as they said yesterday that, "Canadians are potentially leaving themselves wide open for significant financial obligations once interest rates begin to rise."

Really, who could have known?

But it didn't end there. Carney once again focused on a fact we quoted yesterday from The Globe and Mail:

• "The ratio of mortgage debt to household incomes in Canada recently hit a record 70%, up from 65% a year ago. And 40% of home buyers are opting for short-term, variable-rate mortgages, which will eventually ratchet up, leaving some owners in deep financial trouble."

To this Carney told Canadians that the nation “must be vigilant” in containing the threat rising rates would have on increasing the debt-servicing costs for Canadians who have taken on increasing levels of debt.

Sorta rings hollow because what is coming is serious business and I think it's too late to be 'contained'.

Consider the bold prediction earlier this week from economist and author Jeff Rubin. He predicted the jump in interest rates could be as steep as 3% to 4% over the next two years as the Bank of Canada struggles to contain inflation caused by increasing energy costs.

3% - 4%! Yikes again.

That type of increase could add up to $1,000 to the monthly payment on a $400,000 Vancouver mortgage.

And everyone I know that has bought a house in the last three years is carrying much more than a $400,000 mortgage.

None of them can afford even a $500 increase in their monthly payments, let alone $1,000 or more.

While the Globe and Mail can publish joyous, helpful little articles like this one that urges Canadians to "Wrestle Down That Debt While You Can", the reality is that its too late, the damage has been done.

Maybe that's why Carney had this Christmas message for banks:

• "Similarly, lenders have responsibilities. Financial institutions should actively monitor risk stemming from households and not take false comfort derived from mortgage insurance and past performance of household credit. As our simulations suggest, the overall credit profile of Canadian households could well shift if debt continues to grow at current rates."

Oh... it will shift alright. And it's going to create a dire situation for banks. Under one of Carney's 'stress test profiles', the BOC hypothesises that:

• "the consequences for financial stability from the potential impact of a more severe economic downturn on households could result in a hypothetical increase in unemployment that could produce loan losses for financial institutions representing about 10% of their Tier 1 capital."

And as faithful readers will recall, Sprott Asset Management predicted that if the Canadian banks’ tangible assets were to drop by 3%, their tangible common equity would effectively be wiped out.

Double Yikes!

But bloggers have seen this scenario coming all year. And did anyone catch American Karl Denninger on BNN yesterday?

He was asked to be on the Canada's Business News Network to talk about housing. After his appearance he wrote about it on his blog:

• "[I did] a bit of research after the show [and] I came up with the following....
  
  Canadian family income as a whole ("families of 2 persons or more") is allegedly $70,000 (approximately.) The average house price? $325,000.
  
  That's a multiple of 4.64, or dramatically into bubble territory (the maximum for affordable housing is roughly 3x, so this is 154% of the maximum!)
  
  It's worse in places like Vancouver - there the ratio is over 10 (!) for single-family homes and about 8x for all residences.
  
  Let me be clear, strictly on the numbers: Canada is in for a housing bust WORSE THAN OURS.
  
  Beware Canadians..... you can argue over the timing of the outcome here, but if you think the 'bad event' won't happen and act on that belief, don't cry when a year or three down the road I start piping up with 'I told you so!'

And some think I'm too negative when I call for a collapse of over 40% in the value of Vancouver houses and over 50% in the value of Vancouver condos.

God rest ye merry gentlemen... Let nothing you dismay.

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Email: village_whisperer@live.ca
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Please read disclaimer at bottom of blog.

The Greatest Threat to the Canadian Economy? The BOC says Household Debt.

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The Bank of Canada released its bi-annual Financial System Review yesterday.

On the whole, the BOC says Canada's banks and credit markets are as strong as could be expected amid the deepest global recession since the Second World War.

The BOC has come to the conclusion that overall risks to the financial system are unchanged from its last report in December.

“Despite the severe impact of the global crisis, the Canadian financial system has continued to perform well compared with those of other countries.”

Hmm... somehow being front of the pack in a herd of turtles isn't all the comforting. And I wonder, how much of that performance is attributable to the hundreds of billions of dollars of liquidity that the Bank of Canada and other major central banks have injected into the global financial system?

Rock-bottom interest rates have lowered the cost of borrowing and slowed the the crashing housing market from it's perilous decline... at least for now.

But the Bank of Canada warns that a potentially catastrophic threat looms on the horizon: household debt. The risk posed by household balance sheets is significant. And it has grown.

The Bank of Canada reports that the level of debt to income reached a record in the fourth quarter as real net worth dropped 6.7% from the same period a year ago. While stressing that the possibility of a mass bankruptcy is remote, the ability of Canadians to repay their bank loans has replaced frozen credit markets as the main fear factor among policy makers, the report said.

“There has been a further deterioration in the financial position of the Canadian household sector as a result of the continued turmoil in financial markets, the deepening global recession, and worsening labour market conditions,” the report said.

Canadians' household debt is about 140% of disposable income, compared with about 150% in Britain and almost 190% in the United States.

The fact of the matter is that Canadians have been no different than Americans in using their homes as ATM machines and withdrawing equity to spend. That's why the Bank of Canada has been so desperate to halt the slide in real estate values. Should the economy worsen, global financial conditions could trigger a surge in interest rates. If that happens Canadian real estate values will come crashing down.

The end result? Negative equity and household debt combining to drown many Canadian families.

In the face of these conditions, Canadians are frantically trying to save more and spend less. Which is, of course, what politicians fear will devestate the economic recovery.

Unfortunately the only solution our government is working towards is trying to provide more credit for everyone.

Can you say Catch 22?

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Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

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