Coming Into Focus

In the last post I wrote, "As I have repeated ad nausem, the interest in precious metals is simply an extension of the interest in the housing bubble in Real Estate that has been our primary focus these past two years."

And, as if on cue, weekend reading reinforces the theme.

Following news that Chinese inflation in March hit 5.4%, the PBoC has once again decided to intervene, enacting its fourth Reserve Requirement Ratio hike of 2011. The move, taking the requirement to 20.5% for the nation’s biggest lenders, came less than two weeks after the central bank boosted benchmark interest rates.

“Tightening will continue until there are signs that inflation has been effectively brought under control,” Shen Jianguang, a Hong Kong-based economist at Mizuho Securities Asia Ltd.

The increase in reserve requirements was the fourth this year and has been triggering  a  plunge in Chinese real estate, as noted by a number of blogs earlier last week including our friends over at VREAA and at Zero Hedge.

“Prices of new homes in China’s capital plunged 26.7% month-on-month in March, the Beijing News reported Tuesday, citing data from the city’s Housing and Urban-Rural Development Commission... Home purchases fell 50.9% year over year and  41.5% month over month the newspaper said…  For all intents and purposes a drop of this magnitude levered even 2 times (assuming 50% or so equity down) means that China is on the verge of a complete bubble implosion.”

And as China's capital suffers it's biggest drop in real estate prices in 5 years and the nation suffers a 7% countrywide plunge, JP Morgan's Jing Ulrich has come out and said what we all know is already happening. 

Ulrich says it all means that real estate is no longer an attractive asset bubble and that the "mass affluent" Chinese will be forced to invest in gold and alternative property investments.

From Dow Jones: This group "has seen its investment options sharply affected by restrictive housing measures" such as property taxes, increases in down-payment requirements, and raised interest rates, "since these households possess sufficient capital to purchase investment property, but do not have the same degree of access to investment vehicles such as private equity funds and retail property as the super-rich,  equities, gold and alternative property investments become the key beneficiaries."

It is important you appreciate what is going on. 

The worldwide rush into Gold and Silver is only just starting. Back on  April 7th I posted this chart from Sprott Asset Management which shows how small the current investment in gold and gold mining shares is compared to large the investment has been during the previous bull market era's in Gold. 

As a % of global assets, investment in Gold in 2009 was less than 1%.

What you are going to witness over the next few years is a massive rush into precious metals.

And concrete evidence of this trend surfaced this weekend as it was revealed that the University of Texas has taken delivery of  $1 Billion in physical Gold.

With an entity as large as the University of Texas moving so solidly into Gold what have concrete proof that what you are seeing is the start of hedge funds making the move - just like they did in the years leading up to 1981, 1948, 1932 and 1921.

As this moves intensifies, the supply/demand equation for Gold/Silver will be squeezed hard... and the price will soar.

Meanwhile as the China real estate bubble collapses, the prognosis for the Vancouver market is that we will not escape the same destiny of the United States, England, Ireland, Iceland, Spain, Portugal, Greece, Italy, etc.

Foreign investors are always the last to pile into a bubble.  As the Chinese super-rich rush to join the precious metals stampede, they will dump their Vancouver real estate holdings to avoid loosing capital on real estate in the same fashion that is now playing out in China.

The writing has been on the wall for several years and it's clearly visible now to anyone who wants to see it.

If you have real estate in Vancouver, sell it and cash in on the equity at the height of the bubble while you can.  If you are in debt, get out of it ASAP. And if you have money to invest, take advantage of what are now extremely low prices for precious metals... especially silver.

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Against the grain: $18 million Condo sells for 60% off

Back in 2007, The Tyee profiled this condo for sale at #2601-1000 Beach Avenue which was listed and offered for sale that year with an insane asking price of $18.2 million.

But the loft condo on Beach Avenue wasn't alone in the offerings at that price tag.

Justifying that insane $18 million price tag was the fact that a 48th-floor unit at the Hotel Georgia's "Private Residences" pre-sold (also in 2007) for $18-million, even though it wouldn't be finished until this year.

The Tyee article had a great passage at the end of the article:

• "You're constructing fantasy," says Arbel of 1000 Beach (which on his own website is dryly called Project 15.2). And there's no denying that the city's recent architecture is, by comparison, overwhelmingly banal. "It's time that Vancouver wakes up from the sleep we've been in," says Arbel. For all the men worrying about their place on the scrotum pole, 1000 Beach Avenue is just the right kind of wake-up call.

Well it seems that the lofty $18 mil asking price was 'constructing fantasy' alright. I guess we can truly say that it appears Vancouver may be experiencing the start of that wake up call.

After four long years the condo has reportedly sold. On last night's CTV local newscast, it was announced the condo sold for $7 million... a 60% drop off the original asking price.

I wonder how the buyer of that $18 million condo on Georgia Street feels right now?

60% off and the collapse hasn't even started here.

I'd suggest that in a few years you will see it sell for another 60% off this current $7 million purchase price.

Oh my!

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Shanghai Daily: It's only a matter of time before China's housing bubble bursts

Excellent post today regarding China on the Australian blog, The Unconventional Economist. It articulates the issue succinctly.

China has, on a per captia basis, pumped more money into their economy than the Americans.

While most are viewing the results as the growth of an emerging economic superpower, the reality is that China's economy has become over-dependent on fixed asset investment - i.e. the building of infrastructure, real estate and manufacturing plants.

This over-investment in fixed assets, which now comprises a whopping 60% of China's annual GDP, has caused China to build far too many things (apartments, factories, etc) that are not needed, resulting in significant over-capacity.

We have seen this time and time again in bubbles everywhere.

One only has to view footage of China's empty cities on youtube to understand the extent of this malinvestment.

Jim Chanos, founder and president of New York investment company Kynikos Associates, famously described China's fixed asset malinvestment and manufactured growth earlier this year as "a treadmill to hell".

China has a massive over dependence on real estate construction. They have built entire cities that are now sitting empty. Yet, despite this over building, construction is continuing, with 12 million to 15 million residential units this year.

These units, which are priced similar to those for US residents, are intended for Chinese workers who earn about $3,500 annually and are in the bottom 20% of wage earners. To make matters worse, many of the Chinese who have moved to cities from the country are construction workers. So when the construction slows, many will likely move back to the country-side, leaving a construction ghost town and one massive financial black hole.

• “Construction is 60-plus percent of GDP, compared to exports of 5 percent... The problem is that consumption as a percentage of Chinese economy has declined in the last 10 years, from 40 to 35 percent. It’s all real estate...When construction is 60 percent of your economy, and you are building lots of things that people don’t need, the state may let this get out of control... It’s hard to manage this type of bubble".

Now Business Insider has provided proof of China's over-building and malinvestment with alarming satellite photos of entire cities laying vacant. From their article:

• "The hottest market in the hottest economy in the world is Chinese real estate. The big question is how vulnerable is this market to a crash.
  
  One red flag is the vast number of vacant homes spread through China, by some estimates up to 64 million vacant homes.
  
  We've tracked down satellite photos of these unnerving places, based on a report from Forensic Asia Limited. They call it a clear sign of a bubble: 'There’s city after city full of empty streets and vast government buildings, some in the most inhospitable locations. It is the modern equivalent of building pyramids. With 20 new cities being built every year, we hope to be able to expand our list going forward.'"

Last week Yu Yongding - a prominent economist from within the Chinese establishment - published a scathing attack on China's economic model in the state-run China Daily. This article supported the concerns voiced by external commentators over the Chinese economy.

Now the Shanghai Daily has published an explosive article entitled: It's only a matter of time before China's housing bubble bursts.

The Unconventional Economist notes that China's housing bubble is approaching Japanese proportions. Back in the 1980s, Japan's residential housing values reached a stratospheric 3.8 times GDP at the peak of its bubble. As of February 2010, China's housing values were 3.5 times GDP.

In the heyday of Japanese prosperity, the land value of Tokyo alone exceeded that of the entire United State. This 'wealth effect' had Japanese tycoons considering buying up America.

What happened to Japan is well known history.

Will China follow a similar pattern?

The Unconventional Economist speculates on how a collapse in China could devastate Australia.

The ramifications are no different for the Village on the Edge of the Rainforest.

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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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No laws are more basic than the laws of arithmetic

So what is quickly developing as the central story in world finances right now?

Sovereign debt.

And yesterday there was a dramatic worsening of the eurozone sovereign debt crisis as Standard and Poor's downgraded Greece's credit rating by three notches to junk status, citing concerns about the country's ability to implement the reforms needed to slash its budget deficit.

The agency also cut Portugal's rating by two notches to A minus.

This, of course, led to heavy falls for European and US equities as investors sought sanctuary in German and US government debt, gold and the dollar.

The moves came towards the end of a European session that saw mounting uncertainty over whether Greece would secure financial aid in time to meet a refinancing deadline on May 19.

In view of the popular opposition in Germany to helping Greece, markets have grown increasingly concerned about just how Angela Merkel, Germany's chancellor, can push the country towards participating in a bail-out.

Jane Foley at Forex.com said: "If Germany doesn't come through with a loan for Greece, it would seem unreasonable to expect cash-strapped economies such as Spain, Ireland and Portugal to help make good the shortfall - meaning that an EU loan could yet fail. Even if Germany does present a loan to Greece, there would be no guarantee that there would be an end to Greece's problems. Until Greece can prove it can live within its means its bond yields will carry an inflated risk premium on the open market reflective of higher default risk."

Five-year credit default swaps on Greek government debt, a measure of insuring against debt default, hit a record yesterday of 800 basis points, up from 710bp on Monday. The spread of Greek 10-year government bond yields over Bunds - the premium demanded by investors to hold Greek rather than German debt - hit a record wide of 718bp.

"Risks are mounting and governments should move swiftly to take additional corrective measures to improve their outlook and bolster market confidence."

What is most interesting is the way investors are seeking sanctuary in the the US dollar and US Treasuries.

Mark my words... it will be a shortlived strategy.

As has been stated on this blog earlier this year, the UK and the US are not that far removed from Greece and Portugal.

In fact on the very day all this transpires, US Federal Reserve Chairman Ben Bernanke is warning the United States that America's debt is unsustainable.

And perhaps the most significant quote was this little gem: "Failure to cut the deficits would push interest rates higher - not only for Americans buying cars, homes and other things - but also for the government to service its debt payments," Bernanke said.

Which brings us to our insular little world in the Village on the Edge of the Rainforest.

So many of the R/E cheerleaders living in denial and delusion have clung to Bernanke's comments about keeping the Federal funds rate low for an extended period of time, even as the economy appears to be recovering.

But as I have cautioned time and time again, that does not mean interest rates for the common mortgage holder won't rise.

Today Bernanke came out and said so.

What is happening in Greece and Portugal today will - soon enough - play out in the UK and the United States.

Many of the individual States in America are in dire financial straights. And the federal balance sheet, as Bernanke notes, is unsustainable.

"No laws are more basic than the laws of arithmetic: For fiscal sustainability, whatever level of spending is chosen, revenues must be sufficient to sustain that spending in the long run," Bernanke told President Barack Obama’s commission to tackle the soaring deficit yesterday.

The bond market is going to drive interest rates up.

And I don't think it's a stretch to imagine that if the Bank of Canada raises the BoC rate by 3% over the next six months that the bond market also won't drive up rates an additional 3% as well (we've already seen them boost rates 1% with no raises from the BoC).

That would be a rate increase of 6% added to the current five year rate of 6.25%; for a mortgage rate of 12.5%.

Perhaps that's why BoC Governor Mark Carney was telling a Parliamentary committee that Canadians should get ready for more expensive money and less expensive houses. “We see a marked weakening in housing over the course of our projection (into 2012), starting from the second quarter of this year and over the balance,” he said.

Central Bankers choose their words with extraordinary care.

And when Carney says he sees a "marked weakening in housing" between now and 2012, you should pay particular attention.

Perhaps he sees what a 12.5% mortgage rate will do to it.

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The Elusive Canadian Housing Bubble

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The machinations of the daily grind have left me a few days behind in getting the next posts in our series out to you.

Since you have dropped by, I offer a paper by Alexandre Pestov titled, "The Elusive Canadian Housing Bubble"... if you haven't already seen it elsewhere.

Canadian Housing Bubble ==================

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New Mortgage Rules

As I mentioned last week, the start of the Olympic Games would make it difficult for me to post on a daily basis and that's exactly what has happened. I have lots more Olympic pics for you, but I may stick them on a subsite and reference the link here.

The main news today is the new mortgage rules that the Canadian Finance Minister came out with.

In a nutshell (1) all borrowers must meet 5 year fixed rate standards instead of the previous standard of 3 years, (2) limit refinancing to 90% vs 95% of a home's value, and (3) require 20% down for speculative/investment mortgages that require CMHC insurance.

Comically Finance Minister Jim Flaherty said he is responding to growing concerns that Canada's housing market is overheating, but stresses there is no bubble in Canada's real-estate market.

"There's no compelling evidence of a housing bubble, but we're taking proactive, prudent, measured and cautious steps today to help prevent a housing bubble."

Riiighhttt!

We have a housing bubble and the government is scrambling to find ways to tamper the fire without putting it out.

As for discouraging speculation by demanding that prospective homebuyers who want to purchase a property for rental purposes will have to come up with a 20% downpayment, instead of the current 5%, Economists are already noting that it will be difficult for lenders to determine on which side of the line buyers fall.

And the creation of a test threshould of meeting a 5 year fixed mortgage rate? All this change does is limit the size of the mortgage you are going to be able to get; it doesn't prevent people from buying homes, it doesn't drive a lot of new homebuyers out of the market and it doesn't lead to higher payments.

Currently you can get a 5 year fixed mortgage for 3.75%. What kind of test threshold is that?

The infamous stress tests conducted by the Bank of Canada released at the end of the year tested current Canadian mortgages at a 4.5% rate threshold and found that 10% of all Canadians would be severely stressed at this level.

It all comes down to interest rates.

And on that front events are moving very quickly with the PIIGS, Dubai and the global demand for money. More on that tomorrow.

I steadfastly maintain that events will push intrerest rates levels to the historic norm of 8.25% AT THE VERY LEAST!.

That rate is almost double the BOC stress test rate that places 10% of Canadians in 'severe distress'. Recall that one morgage broker considers 8% to be a 'doomsday scenario'.

These are the same brokers, btw, who rationalized that anyone who receives a 5% down/35 year amortization mortgage "are getting them because they’re well qualified. It’s that simple."

Well... no it's not. And the fact that the Finance Minister's hand was forced into taking some sort of action proves that they are not well qualified.

But let's not kid ourselves. The new mortgage rules do nothing to address the dangerous and precarious position that a vast majority of current Canadian mortgage holders are already in.

When the global demand for capital pushes yields ever higher, the 'Canadian-housing-bubble-that-isn't' will trap all these Canadians and implode in spectacular fashion.

It's all about interest rates, and not the 5 year rates at a piddling 3.75% or 4.5%.

Interestingly, Minister Flaherty took a small jab at lenders in his release today, saying these rule changes are designed to “help prevent some lenders” from “facilitating” irresponsible lending.

Nice of you to finally admit that this exact problem already exits, Jimbo. The problem is... irresponsible lending has already created a collossal mess. And there is only one way that mess will be unwound.

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Apparently it's only a bubble... if the bubble bursts (note: G&M link repaired)

Okay... let me get this straight.

A senior bank executive, who spoke to the Globe and Mail on condition of anonymity, said, "we're not in a bubble yet, or a credit crisis."

But he then goes on to explain that the heads of the country's six largest banks have privately told federal government policy makers that they fear the wide-ranging economic fallout of a U.S. style binge-and-collapse in housing hitting Canada.

Say wha???

Now don't get me wrong. That's exactly what this blog has been saying for the past 14 months. But why, if the bankers don't believe we are in a bubble or face a looming credit crisis, are they worried?

The answer is simple - we are in one. That's exactly why they're worried.

It makes me wonder how all those perma-bulls, who have been deriding the likes of us contrarians, feel about the fact that our nation's banking elite is now sounding alarm bells?

Even the freakin' Wall Street Journal has come out and pinpointed the danger Canada is facing, a danger we all can see as plainly as the noses on our faces.

To wit: that household debt in Canada — largely mortgages — was 1.42 times disposable income during the second quarter of 2009, a record high. And because Canadian banks typically reset adjustable-rate mortgages every few years, those who are buying now at low rates will likely see major increases soon.

“This is exactly what happened in the U.S., when affordability had moved way out of whack with prices,” quotes the WSJ.

So what's wrong with this picture? I mean, why are the Canadian banks concerned?

You and I both know they aren't threatened by any collapse in home mortgages when these significant rate hikes kick in.

The vast majority of their housing mortgages are CMHC insured. So even though Canadian mortgages account for 40% of the loans of the six largest banks, and comprise the biggest chunk of their portfolios, Canadian banks face little risk of direct loss because of federal government mortgage insurance.

So again... what gives?

"It's not the potential of big losses on mortgages that scares banks," says Peter Routledge, an analyst at Moody's Investors Service. "But if there were a spike in foreclosures in Canada, as has happened in the United States, consumers would likely struggle to make payments on other loans that aren't insured, such as credit card debt."

"Imagine instead of a few hundred people in Toronto in any particular month being foreclosed upon, it's a few thousand. The impact on the broader economy would be significant," said Mr. Routledge.

Ahhh... the truth is revealed.

Our omnipresent (that's omnipresent, a latin term for 'weasel') Canadian banks know damn well that the future holds a dramatic upswing in interest rates, a development that will have crushing impacts on real estate.

But that's not what bothers them. Somehow these brain surgeons have only now realized that they have screwed themselves along with the rest of us - despite CMHC carrying the can on all this mortgage debt.

And now they desperately want to try and put the brakes on things before real estate spirals hopelessly out of control and comes crashing down.

Not because a collapsing real estate market will hurt the Canadian public, but because a hurt Canadian public will default on credit card and other uninsured debt.

Marvelous.

But I've got news for them... it's already too late. There are already so many Canadians who have jumped on the low-rate money gravy train (either by max'ing out on their purchases or by extracting from the home ATM) that the looming significant interest rate hikes will begin the domino process that dooms our bloated real estate bubble.

But it's nice to finally see these weasels recognize and acknowledge what they have done, even though the only reason they are speaking up is because it dawned on them they aren't as protected with CMHC insurance as they originally thought.

Interest Rates

So once again the story is all about interest rates.

Adding to the chorus of warnings is this one from Tim Bond of Barclay's.

Bond has been remarkably accurate in predicting the strength and length of the current global equity rally. He claimed that analyst estimates and high levels of bearishness would lay the foundation for a continuing equity rally - and he was right.

But yesterday he did an abrupt about-face.

“Fiscal dynamics point towards higher government bond yields in many economies, including the UK and US. History is unequivocal in linking fiscal deterioration to higher yields. This point is clearly becoming recognized by investors. As a result, a contagious process has started, during which risk premia in bonds, equities and currencies adjust higher to reflect the fiscal situation. This process is unlikely to remain confined to southern Europe, but will eventually embrace all those economies with sizeable budget deficits.”

That means Canada and, especially, the United States.

And what does Bond see on the horizon?

1)The majority of the G20 is a fiscal mess. 2)Demographic trends of the G20 are highly negative, and 3) Containing the long-term government debt problem will be painful.

Most alarming to Bond, however, is the close relationship between high debt levels and rising rates. In studying 6 developed nations over the last 20-30 years, Bond found that a 1% change in deficit/GDP caused a 32 bps increase in 10 year rates. Based on this, Bond says we are due for a substantial rise in global interest rates.

Not just an uptick, but a 'substantial' rise. Don't be surprised to see a return to late 1970s style rates.

It's coming.

And no five year fixed rate renewal is gonna save any Canadian family with a large mortgage - the time span of those high rates will easily surpass that period.

Bond sees it coming.

And the heads of the six major Canadian Banks see it too.

And if you read this blog all last year; you saw it coming as well.

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On another note... only two days to go.

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Another example of our irrational real estate market (UPDATE: see end of post for more Oly photos)

The irrational march upward carries on and not just in Vancouver proper.

Today's treatsie is this 5 bedroom, 3 bathroom 3,000 sq. ft. home sitting on a 12,160 sq. ft. lot is the suburb of Coquitlam.

You can see the realtor's listing here (with many more photos).

According to listing agent Josh Bath, this home hit the market last Friday. On the weekend 120 potential buyers came through and the house received 15 offers.

The house was last sold in 1990 for $200,000.

On Friday it was listed for sale at $639,900.

So what did the feeding frenzy produce? A final sale of $688,500... $48,600 over asking price.

Said the agent, “The previous owners of this home owned it for 19 years and after raising their family and renovating, decided to downsize to a town home. The features that really sold this home were definitely the neighbourhood and the yard."

No Josh, the features that really sold this home were ultra low interest rates and a 'buy now or be priced out forever' mindset.

Olympic Pics (click on images to enlarge)

It was a picture postcard sunny day in Vancouver today and the views were stunning. We do this to tease the media. Fear not, tho... it will piss rain for the Opening Ceremonies and Day 1 on Friday.

Below is a picture of the newly set up German House right next to the Seabus.

Next is a shot from near the Cambie Bridge. This is the east end of False Creek. Science World (the big dome) is transformed into Russia House (and is promoting the Sochi 2014 Winter Olympics). The big Q is where Quebec House is. On the left is GM Place, renamed Canada Hockey Place for the Olympics.

The big draw hockey games are at Canada Hockey Place. Other games are also at the new UBC Thunderbird Arena. Below is a picture taken today of the transformed Arena, ready for the Games.

Even the police are out enjoying the Sun at Thunderbird Arena.

Speaking of Russia House, here is the countdown clock to the 2014 Winter Games.

I notice that the Russian athletes have now staked out their turf at the Village.

More photos to come...
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Vancouver is Number 1!

So the big news yesterday was the release of the latest Demogaphia survey which compares house prices in Canada, the US, the UK, Australia and elsewhere in the world.

The result? Vancouver is declared the most unaffordable housing market in the world.

Now faithful readers know that our little Village on the Edge of the Rainforest is North America's most bubbly city and Demogaphia now portrays us as the most bubbly in the world. But don't expect that to change local perceptions.

The Bull vs Bear debate on the wet coast will remain unchanged.

Bears will hail the news as further proof that fundamentals are out of whack. And Bulls will counter that the Bears don't understand Vancouver fundamentals (nor does Demogaphia) and that Vancouver's prices rebounded faster than anywhere else in the world precisely because of those strong 'fundamentals'.

In other words... nothing new.

And it's intriguing to watch how it is starting to make some of the Bears question themselves.

On another blog I like to check out from time to time, the longtime Bear author is having doubts.

Convinced that the 2008 correction was the start of the long anticipated bursting of the bubble (and fulfillment of the boom-bust model); convinction has now given way to self-doubt.

The problem, of course, is that people assumed we were at the peak of the bubble. The 2008 dip in prices was, in reality, just part of the jagged climb to the true peak. The boom-bust model will play out... just not necessarily on the timeline many want it to.

The Vancouver (and Canadian) market was starting to correct in 2008. But that correction was hijacked by the actions of the Bank of Canada and the federal government.

• For the first time in history the central bank rate was cut to just 0.25%.
• Through policy and stimulus programs, the Federal Government engineered mortgages rates in the 2-3% range.
• This was supported with CMHC insurance for anyone leveraging 95% of a house purchase.

What other possible result could come from those actions? It triggered an explosion in demand and the average house price in Canada rose last year by 19%, or twenty times the rate of inflation and average wage gains.

Households in Canada are more in debt than ever before, the economy is stalling, government deficits are giving way to massive looming tax hikes and the pressures are building up.

The end result is not all that hard to predict.

Just the timing of it.

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The pressure ploy

Pressure Ploy or 'marketing'?

I started off the year telling you about James Schouw, Chairman of James Schouw and Associates. Schouw specializes in ultra high-end custom developments.

Schouw is keen to promote the old supply and demand argument about Vancouver. To wit: people are constantly moving here, no one is leaving, scare land results in a property shortage... ergo buy now or be priced out forever.

Central to the argument is the wealthy Asian component. They have money, it's nice here and they can afford it even if we can't... end result: real estate is going up, up, up.

Lest you think that last dynamic is self developing, you might find this of interest.

XinhuaNews is a Chinese news organization.

Recently, infamous local realtor Bob Rennie hooked up with XinhuaNews to do a little local promoting. The result was this little gem in it's english online site.

Rennie is keen to leverage the wealthy Asian angle and work the exposure of the Olympics to ensure the Asian influx to Vancouver intensifies.

As part of his campaign, Rennie seeks to separate Vancouver from other Olympic cities and tells XinhuaNews in an exclusive interview that:

• "When people watch the Winter Olympics, I don't think they say 'I want to buy a house in Turin' or 'I want to work from Lillehammer'." (referring to the Italy and Norway cities, respectively, that hosted the Games in 2006 and 1994). "But they do for Vancouver. This is one of the most amazing cities on the planet to work from."

Rennie strives to assure Asians that now is the time to buy. He discounts an Olympic hangover and moves to a full court press to convince them that there is a shortage of rental housing in the City.

• "Vancouver is going to face a shortfall of apartment units following its hosting of next month's Winter Olympics Games... If there was ever going to be an Olympic overhang we took care of it in 2008-2009 by canceling buildings. We are now coming into a shortfall where banks are very conservative, Canadian banking practices are always very conservative, and developers are just coming off the sidelines."

Rennie hastens to predict that by the first quarter of 2011 the shortfall in apartment units will be noticeable in downtown Vancouver as there were very few major sites left to develop. Also, with a lot of "money on the sidelines" earning low interest, coupled with a low supply of available properties, extreme pressure will be put on the real estate market.

Vancouver is then portrayed as a virtual licence to print money.

• "The unique thing about Vancouver is nobody builds rental towers (anymore). For the offshore investor properties are easy to rent out as there is no rental stock."

So there you have it. If Vancouver is being too unaffordable for it's current residents to afford, what does the ambitious realtor do?

He finds customers in other parts of the world who will keep these values rising.

As Rennie says,

• "With the amount of money being made in China, and with the acceptance of China to Vancouver, we have to be in the top two places on the planet for China to look at, to move money to. We see it happening right now, it's happening a lot. It used to just happen in the luxury market, now it's happening in all the market."

Rennie even plays the 'buy now' card with the Asians as he tells them:

• "That's the danger of the Olympics. As the world sees [the Games on TV], they go from 'I want to spend two weeks in Vancouver', to ' spending two to five months in Vancouver', to 'I want to send my children to school here'."

So there you go, China.

Buy real estate in Vancouver now... or be priced out forever (what the hell, it worked on most of us who actually lived here, why not the Asians).

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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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Et tu, Mark?

Pontius Pilate was the Roman governor of Judaea from 26 CE to 36 CE; in this capacity, he was responsible for the execution of Jesus of Nazareth.

According to the gospels, Pilate refused to condemn Jesus of Nazareth but was forced to execute him by a hysterical Jewish crowd. In Matthew, Pilate acquiesces to the crowd's demands and washes his hands of the entire affair, reluctantly sending him to his death.

After re-reading last Monday's Bank of Canada speech, I can't help but wonder... is Mark Carney pulling a Pontius Pilate and washing his hands of the Canadian housing bubble?

As mentioned earlier this week, a significant portion of Monday's speech was dedicated to the housing market. Canadians are reminded several times that rate policy is to be used to control inflation, and that housing is only one factor of many that affects inflation.

• “As Canada’s economic growth moves towards its potential, it is expected that a robust housing market, supported by exceptionally low interest rates, will continue to work as an important engine pulling the Canadian economy out of recession. This has implications for monetary policy, which, as I’ve said, aims to achieve the Bank’s inflation target of 2 per cent over the medium term. It’s important to remember that this target is symmetrical; that is, we are equally concerned about whether inflation is above target or below target – as we expect it to be until 2011. The revival of the housing market is one factor that is helping us to achieve our inflation target, and it is a powerful means through which monetary stimulus affects the economy. Of course, we need to keep a close eye on the housing market, along with all other sectors of the Canadian economy, to ensure that we are providing the right amount of monetary stimulus. In setting monetary policy, we view housing – or the exchange rate, the energy sector, the auto industry, or any other factor – through the prism of our inflation target.”

As mentioned in Tuesday's post, after refusing to raise the bank rate to deal with the housing bubble, the Bank of Canada then very deftly laid responsibility for the developing mess in housing directly at the feet of Finance Minister Jim Flaherty.

It came at this point in the speech:

• “An array of supervisory and regulatory instruments can be used by the government to restrain a buildup of systemic risks. These include capital requirements for institutions, leverage ratios, loan-to-value ratios, terms and conditions for mortgage insurance, and a variety of other measures. These instruments can be targeted to risks to the entire financial system that stem from particular markets or institutions.
  
  Using these instruments to safeguard the whole financial system – not just individual institutions – is the essence of the macroprudential approach. Macroprudential supervision is one of several concepts in a current global initiative to strengthen supervision and regulation in the wake of the global financial crisis. In Canada, a system-wide, or macroprudential, approach is the shared responsibility of the Department of Finance and all of the federal financial regulatory authorities, including of course the Bank of Canada, the Office of the Superintendent of Financial Institutions, and the Canada Deposit Insurance Corporation. Ultimately, it is the Minister of Finance who is responsible for the sound stewardship of the financial system.”

That last line is the killer and it begs the question... what gives?

Carney has, for the past two months, been just like a little blogosphere perma-bear with the alarms he's been sounding on the damage that will be caused by the inevitable rise in interest rates.

He's warned Canadians that they need to be 'prudent' and urged them to remember that "households need to assess their ability to service these debt obligations over their entire maturity, taking into account likely changes in both income and interest rates."

Now, in one swift move, he's dropped all of it at the feet of the Minister of Finance.

Why?

I wonder if it has anything to do with this little gem from Monday's speech?

• “Using the current path of household indebtedness, and alternative assumptions about how quickly interest rates may increase, the simulation generates a scenario indicating that, by the middle of 2012, almost one in ten Canadian households would have a debt-service ratio that makes them vulnerable to economic shocks.”
  

The day of reckoning is coming fast and Carney can see it.

In just over 2 years, the Bank of Canada forecasts that 1 in 10 of us will be in serious debt trouble.

And when the interest rate tide changes, the Canadian financial system is going to drown all of them and pull down many others as real estate values crash.

Seeing what's coming and sensing the inevitable fallout, 'Pontius' Carney has effectively said "pass the soap."

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Bubble? What bubble?

Every once in a while it's fun to compare real estate here on the wet coast with other areas.

One of the things you hear right now is that international demand is going to keep pushing Vancouver values up, up, up.

And who can disagree. Eight months of dreary, endless rain make Vancouver a destination paradise.

And if you had the cash... would you want to live here? Or some crappy local like Hawaii?

Let's compare the two, shall we.

Hat tip to Vancouver_Bear who points out that you can currently procure this little 3 bedroom, 2.0 bathroom, 1,568 sq ft single family rancher home in Kailua. It sits on over 9,000 sq. ft. of land and comes with swimming pool, updated kitchen, indoor laundry, and mountain views.

Asking price $725,000 USD. Here are some photos...

Beauty, eh?

Or you can plunk down an extra $625,000 over and above the 'asking' price of that Hawaiian home and get this four bedroom, 1 bathroom, 1300 square foot dump which could easily pass as the local crack shack. It sits on a 1/2 acre property adjacent to the 401 freeway and just north of Canada Way (another freeway) & Sperling.

Available now for only $1,350,000.

I wonder if the ladders are included?

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Succinct

Yesterday's Vancouver Sun had an article that succinctly summarizes the current state of Vancouver's Real Estate bubble.

The article insightfully notes that the main trouble with real estate is that while prices are rising, incomes are not.

And the main culprit for this imbalance is that rock-bottom borrowing costs continue to lure buyers, and investors are rushing in — despite a shortage of listings — for fear that if they don't get into the market now, they'll miss their chance.

And what are the dire concerns/consequences?

From the article:

• "It's absolutely not debatable that housing prices cannot rise faster than incomes over the long term," said Will Strange, professor of real estate and urban economics at the Rotman School of Management. "Sooner or later, incomes have to rise, or home prices fall, for balance to be attained."
• "If I didn't personally have most of my wealth tied up in housing, this would not be the time that I would choose to jump in," Strange cautioned.
• "At the same time, interest rates have nowhere to go but up, which could leave some buyers in a position similar to U.S. homeowners, who had houses worth less than their mortgages after the subprime bubble burst and prices crashed."
• "We're certainly urging people to error on the side of caution," said Bruce Cran, president of the Consumers' Association of Canada. "If you're paying an amount of money, whatever that might be, that you couldn't sustain if interest rates rose by say 25 or 30 per cent — I can see that being a problem for a lot of people."
• "Don't buy [a house] because you think the price is going to go up."

Couldn't have said it better myself.

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

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

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

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

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

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

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

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

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

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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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Get Ready for Real Estate to Really Catch Fire

Sound incredible?

Consider....

November/December, normally a down time for the industry, have been red hot. Word has it that concerns about possibly missing out on low interest rates, combined with the looming introduction of the HST tax, are pushing many new buyers into bidding wars to get into the market.

Regardless of the shortsightedness of this, I am told it is a definite factor in the current market frenzy.

And if that is indeed the case, then prepare for the market to explode.

In an exclusive interview with Canwest News Service and Global National, Finance Minister Jim Flaherty said the government is closely monitoring the red-hot housing market for signs that it is reaching "irrational" levels.

Now... we already know that the market is irrational and, as we have discussed, this is largely by design.

The government, seeing what happened to real estate based assets in the United States, slashed interest rates to dirt in a desperate attempt to re-inflate the collapsing economy and housing market.

And their actions have been wildly successful.

We've also talked about how they don't want to destroy this momentum... just slow it down a bit.

To this end Bank of Canada Governor Mark Carney has taken to the talk circuit issuing 'warnings' to individual Canadians and financial institutions to be 'prudent'.

Now Flaherty has come out and said that the Federal Government will, if necessary, further tighten the conditions under which the Canada Mortgage Housing Corporation insures mortgages,

The Conservatives have done this once already.

In July 2008 the Finance Department announced that CMHC would shorten the maximum amortization period that it would accept to 35 years from 40, as well as require a down payment of at least 5% of the value of the home. The new rules came into effect in October 2008.

"If we have to, we'll do what we did last year and limit the rate of amortization further than we already did, and require higher down payments,"said Mr. Flaherty.

If Flaherty takes action, it will likely come when the next budget is brought down in March, 2010.

But watch... the mere suggestion will inflame the market and sent another crush of people dashing after cheap rates in a desperate attempt to avoid both the increased costs of the HST and the looming spectre of 10% down and 30 or even 25 year amortizations. Potential new buyers will panic as they try to get the property that they want - regardless of how much they overpay.

Far from helping to moderate the overheated market, the fear is that Flaherty's simply pour gasoline over it.

(Note: Two posts for Saturday. See below for 'Financial Heroin')

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