Fri Post #2: Time to rethink government backing of Mortgages in Canada? New guidelines coming?

On November 27th the International Monetary Fund suggested it was time for Canada to rethink its long-time policy of providing blanket backing to insured mortgages.

And today the Wall Street Journal is reporting that federal Finance Minister Jim Flaherty is on board with the International Monetary Fund’s view. Said Flaherty:

"Government-owned Canada Mortgage and Housing Corp. has become “something more grand, I think, than it was intended to be."

The IMF said last week that the system has its advantages, notably in giving the government some ability to guard against market excesses. But it ultimately exposes taxpayers to big risks, should home prices succumb to a sharp correction. The IMF suggested offloading some risk to private-sector lenders.

Flaherty, as we all know, has been tinkering with CMHC for a while.

In his 2012 budget, he gave his finance department authority over CMHC –which for decades had been overseen by the ministry responsible for human resources and social development — and named the top bureaucrat at Finance to the company’s board.

Canada's banking regulator, the Office of Superintendent of Financial Institutions, was also given the authority to regulate CMHC.

Mr. Flaherty said Friday he has sought to limit the risk CMHC poses to the broader government, and to taxpayers, citing government moves to tighten mortgage-insurance regulations four times in the past five years. Those restrictions have put a cap on the amount of liability the CMHC can assume.

OSFI is expected to introduce new guidelines governing mortgage insurers in 2015, CMHC said last week. CMHC also said that, at the behest of Mr. Flaherty, it is now charging a so-called risk fee on mortgages it insures, a move seen as helping compensate the Canadian government for the risk it is exposed to.

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Wed Post #1: Federal Government indicates it plans to stay the course on mortgage changes

Back on October 3rd we told you how the real estate industry was gearing up with it's campaign against the Federal Government to undo it's mortgage changes.

The Globe and Mail reported:

The federal government eliminated the approval of 30-year amortization periods on government-backed mortgages in June – and the decision’s impact can now be seen most vividly in the cooling off of Greater Vancouver’s market, with sales falling for everything from entry-level homes to luxury houses... Real estate sales across Greater Vancouver are sinking. There were 1,516 residential properties that changed hands in September in the region, down nearly 33 per cent from the same month last year. In West Vancouver, where the posh British Properties are located, the number of detached homes sold fell to 43 last month from 71 a year earlier.

The Industry's thrust is that the mortgage changes are hurting everyone, not just the entry level buyer. It's hurting you.  Ergo... you should pressure the government to turn the taps back on.

Eugene Klein, President of the Real Estate Board of Greater Vancouver said:

“There’s been a clear reduction in buyer demand in the three months since the federal government eliminated the availability of a 30-year amortization on government-insured mortgages. This makes homes less affordable for the people of the region.”

It's a theme we have covered numerous times this month as the Industry has kept up the pressure.

Yesterday the Federal Government once again served notice they intend to stay the course.

Canada’s deputy minister of finance says he isn’t convinced tighter mortgage rules his department announced in June are behind the recent cooling in the housing market. 

In a rare public speech, Michael Horgan argued that recent comments linking the two are premature.

“There’s some evidence that the housing market, particularly in some markets, is cooling and slowing at the moment,” he said Monday during a presentation to business students at Carleton University. “We read a lot of press commentary that’s saying it’s because of the government’s changes to mortgage insurance rules. I think it’s actually too early to make the direct link.”

 The Globe makes note of the increasing pressure from the Industry:

In recent weeks, several economists have issued reports or made comments in the media linking the latest housing market data to the policy change. 

Earlier this month, the Canadian Real Estate Association reported that Canadian home sales were down 15.1 per cent in September from a year earlier. More than half of the country’s markets were down by at least 10 per cent. 

The association’s chief economist, Gregory Klump, told The Globe and Mail at the time of the report’s release that the data were linked to Ottawa’s June moves. “The recent mortgage insurance changes are working, it is cooling the market and sales have ratcheted down compared to a year ago,” said Mr. Klump.

But Hogan isn't buying the argument. Hogan says there is likely some cause and effect at this point, but he suspects it is more likely that Canadians are starting to realize their household debt levels need to be addressed and are pulling back on their own:

Mr. Horgan pointed to data released this month that the ratio of market household debt to disposable income hit 163 per cent in the second quarter, which the deputy minister noted is at similar levels as those in the United States before the recession. “We do have a home-grown risk,” he said, as he listed Canada’s housing market among a group of factors that could throw Canada’s projections off track. “This is something we pay a lot of attention to.”

And what does Minister Flaherty think of his underlings comments?

During an appearance on CTV’s Power Play, Mr. Flaherty was asked about his deputy minister’s comments. “I’d certainly agree that the full impact [of the changes to mortgage rules] has not been felt yet,” said the Minister.

The full impact hasn't yet been felt?

Can't make it much clearer than that, can he?

Meanwhile the plunge in home sales has made headlines in the Wall Street Journal. At the end of the article Flaherty is quoted commenting on the impact on house sales:

"We think that's a good thing. I would much rather have a soft landing than a hard landing."

Of course that is what the government is shooting for.  But there has never been a 'soft landing' from an asset bubble born of excess credit.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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The bailouts continue... you're just not hearing about them

A while back, US Republican candidate Ron Paul commented on the ongoing bailouts of Europe by the US Federal Reserve:

The Fed's latest actions in cooperating with foreign central banks to undertake liquidity swaps of dollars for foreign currencies is another reason why Congress needs enhanced power to oversee and audit the Fed.  Under current law Congress cannot examine these types of agreements.  Those who would argue that auditing the Fed or these agreements with central banks harms the Fed's independence should reevaluate the Fed's supposed independence when the Fed bails out Europe so soon after President Obama promised US assistance in resolving the Euro crisis.

And today the Wall Street Journal reported that former Dallas Fed Vice President, Gerald Driscoll has come right out and accused the Fed of bailing out Europe courtesy of "incomprehensible" currency swaps, and implicitly accusing Bernanke of lying that he would not bail out Europe even as he has done precisely that.

The Federal Reserve's Covert Bailout of Europe 

When is a loan between central banks not a loan? When it is a dollars-for-euros currency swap.

America's central bank, the Federal Reserve, is engaged in a bailout of European banks. Surprisingly, its operation is largely unnoticed here.

The Fed is using what is termed a "temporary U.S. dollar liquidity swap arrangement" with the European Central Bank (ECB). There are similar arrangements with the central banks of Canada, England, Switzerland and Japan. Simply put, the Fed trades or "swaps" dollars for euros. The Fed is compensated by payment of an interest rate (currently 50 basis points, or one-half of 1%) above the overnight index swap rate. The ECB, which guarantees to return the dollars at an exchange rate fixed at the time the original swap is made, then lends the dollars to European banks of its choosing.

Why are the Fed and the ECB doing this? The Fed could, after all, lend directly to U.S. branches of foreign banks. It did a great deal of lending to foreign banks under various special credit facilities in the aftermath of Lehman's collapse in the fall of 2008. Or, the ECB could lend euros to banks and they could purchase dollars in foreign-exchange markets. The world is, after all, awash in dollars.

The two central banks are engaging in this roundabout procedure because each needs a fig leaf. The Fed was embarrassed by the revelations of its prior largess with foreign banks. It does not want the debt of foreign banks on its books. A currency swap with the ECB is not technically a loan.

The ECB is entangled in an even bigger legal and political mess. What the heads of many European governments want is for the ECB to bail them out. The central bank and some European governments say that it cannot constitutionally do that. The ECB would also prefer not to create boatloads of new euros, since it wants to keep its reputation as an inflation-fighter intact. To mitigate its euro lending, it borrows dollars to lend them to its banks. That keeps the supply of new euros down. This lending replaces dollar funding from U.S. banks and money-market institutions that are curtailing their lending to European banks—which need the dollars to finance trade, among other activities. Meanwhile, European governments pressure the banks to purchase still more sovereign debt.

This Byzantine financial arrangement could hardly be better designed to confuse observers, and it has largely succeeded on this side of the Atlantic, where press coverage has been light. Reporting in Europe is on the mark. On Dec. 21 the Frankfurter Allgemeine Zeitung noted on its website that European banks took three-month credits worth $33 billion, which was financed by a swap between the ECB and the Fed. When it first came out in 2009 that the Greek government was much more heavily indebted than previously known, currency swaps reportedly arranged by Goldman Sachs were one subterfuge employed to hide its debts.

The Fed had more than $600 billion of currency swaps on its books in the fall of 2008. Those draws were largely paid down by January 2010. As recently as a few weeks ago, the amount under the swap renewal agreement announced last summer was $2.4 billion. For the week ending Dec. 14, however, the amount jumped to $54 billion. For the week ending Dec. 21, the total went up by a little more than $8 billion. The aforementioned $33 billion three-month loan was not picked up because it was only booked by the ECB on Dec. 22, falling outside the Fed's reporting week. Notably, the Bank of Japan drew almost $5 billion in the most recent week. Could a bailout of Japanese banks be afoot? (All data come from the Federal Reserve Board H.4.1. release, the New York Fed's Swap Operations report, and the ECB website.)

More and more balls are being thrown in the air.

The question remains... how long can the ponzi juggling act be maintained?

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US Republican Presidential Candidate says " Blame the Fed"

US Republican Presidential Candidate, Ron Paul, has written an Op Ed piece for the Wall Street Journal reinforcing the theme we have carried for the past week - that the root of our problems lie with Central Banks and the US Federal Reserve.

Here is what he had to say:

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Blame the Fed for the Financial Crisis

The Fed fails to grasp that an interest rate is a price, the price of time. Attempting to manipulate that price is as destructive as any other government price control.

By Ron Paul

To know what is wrong with the Federal Reserve, one must first understand the nature of money. Money is like any other good in our economy that emerges from the market to satisfy the needs and wants of consumers. Its particular usefulness is that it helps facilitate indirect exchange, making it easier for us to buy and sell goods because there is a common way of measuring their value. Money is not a government phenomenon, and it need not and should not be managed by government. When central banks like the Fed manage money they are engaging in price fixing, which leads not to prosperity but to disaster.

The Federal Reserve has caused every single boom and bust that has occurred in this country since the bank's creation in 1913. It pumps new money into the financial system to lower interest rates and spur the economy. Adding new money increases the supply of money, making the price of money over time—the interest rate—lower than the market would make it. These lower interest rates affect the allocation of resources, causing capital to be malinvested throughout the economy. So certain projects and ventures that appear profitable when funded at artificially low interest rates are not in fact the best use of those resources.

Eventually, the economic boom created by the Fed's actions is found to be unsustainable, and the bust ensues as this malinvested capital manifests itself in a surplus of capital goods, inventory overhangs, etc. Until these misdirected resources are put to a more productive use—the uses the free market actually desires—the economy stagnates.

The great contribution of the Austrian school of economics to economic theory was in its description of this business cycle: the process of booms and busts, and their origins in monetary intervention by the government in cooperation with the banking system. Yet policy makers at the Federal Reserve still fail to understand the causes of our most recent financial crisis. So they find themselves unable to come up with an adequate solution.

In many respects the governors of the Federal Reserve System and the members of the Federal Open Market Committee are like all other high-ranking powerful officials. Because they make decisions that profoundly affect the workings of the economy and because they have hundreds of bright economists working for them doing research and collecting data, they buy into the pretense of knowledge—the illusion that because they have all these resources at their fingertips they therefore have the ability to guide the economy as they see fit.

Nothing could be further from the truth. No attitude could be more destructive. What the Austrian economists Ludwig von Mises and Friedrich von Hayek victoriously asserted in the socialist calculation debate of the 1920s and 1930s—the notion that the marketplace, where people freely decide what they need and want to pay for, is the only effective way to allocate resources—may be obvious to many ordinary Americans. But it has not influenced government leaders today, who do not seem to see the importance of prices to the functioning of a market economy.

The manner of thinking of the Federal Reserve now is no different than that of the former Soviet Union, which employed hundreds of thousands of people to perform research and provide calculations in an attempt to mimic the price system of the West's (relatively) free markets. Despite the obvious lesson to be drawn from the Soviet collapse, the U.S. still has not fully absorbed it.

The Fed fails to grasp that an interest rate is a price—the price of time—and that attempting to manipulate that price is as destructive as any other government price control. It fails to see that the price of housing was artificially inflated through the Fed's monetary pumping during the early 2000s, and that the only way to restore soundness to the housing sector is to allow prices to return to sustainable market levels. Instead, the Fed's actions have had one aim—to keep prices elevated at bubble levels—thus ensuring that bad debt remains on the books and failing firms remain in business, albatrosses around the market's neck.

The Fed's quantitative easing programs increased the national debt by trillions of dollars. The debt is now so large that if the central bank begins to move away from its zero interest-rate policy, the rise in interest rates will result in the U.S. government having to pay hundreds of billions of dollars in additional interest on the national debt each year. Thus there is significant political pressure being placed on the Fed to keep interest rates low. The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so. But it will do something, we know, because the pressure to "just do something" often outweighs all other considerations.

What exactly the Fed will do is anyone's guess, and it is no surprise that markets continue to founder as anticipation mounts. If the Fed would stop intervening and distorting the market, and would allow the functioning of a truly free market that deals with profit and loss, our economy could recover. The continued existence of an organization that can create trillions of dollars out of thin air to purchase financial assets and prop up a fundamentally insolvent banking system is a black mark on an economy that professes to be free.

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Will the economy hit a sudden wall? And Flip and Dip, baby! Flip and Dip.

One of the tales of malarky you hear by those rationalizing that the economy is turning around, it that the US consumer is bearing down and paying down debt. This, the argument goes, augers well for the return of balance.

Well, not so fast.

As the Wall Street Journal notes, this isn't what is actually happening at all. The reality is that over the past two years, US consumers have not been deleveraging as a voluntary act of eliminating debt, but have been actually aggressively leveraging more and more until the bank providing them credit puts them into involuntary bankruptcy, cutting off the money flow.

This is a startling realization.

What it means is that the average American is actually hyperleveraging to the point where all available credit is forcefully eliminated by a lender institution in one fell swoop!

The data outlined by the WSJ confirms that of the over $600 billion in deleveraging that has occurred, only $20 billion or so of it was voluntary. Irresponsible borrowing practices, in which US consumers spend, spend, spend themselves into oblivion, accounts for the balance.

Consumers aren't changing their habits at all. They are continuing to binge only to be cut off cold turkey.

Instead of entering a slow deleveraging rehabilitation, something far more insidious is going on.

Consumers are accelerating spending until the charge off threshold at the lender is breached, and all credit is cut off, which results in a collapse of a creditor's FICO score, cutting him or her off completely from future (at least near term) credit access.

What this means for consumption is that we are building to an abrupt collapse of the consumer economy whereby a massive number of consumers will be saying goodbye to credit for a very long time.

With American unemployment still at record highs, and soon to take another leg higher, with paychecks continuing to decline, with excess capacity at record highs, with unemployment claims reaching their ceiling 2 year anniversary from the Lehman collapse, and with the general economy double dipping; the implications of this will be dire, as there will be no gradual decline.

Instead we are staring at a looming abrupt collapse.

The implications here for the economy, and the stock market, are profound.

Meanwhile in local real estate...

On the slow melt front, faithful reader, R.D., has been keeping tabs on 2699 Cambridge Street, MLS V850651 which is located just west of the PNE in Vancouver's eastside neighbourhood of Hastings/Sunrise.

Purchased in early September, 2009 for $838,000 the property was listed just last month (August, 2010) for $926,000. Presumably no additions, alterations nor upgrades were done to the property.

You've got to love optomism, don't you?

But rather than flip for a profit, it appears the buyer is headed to flip for a dip - a dip in equity.

The asking price was first reduced to $859,000 which means the buyer would be only breaking even after realtor fees, transfer fees and any lost/paid out interest - not to mention what could have been gained by investing elsewhere.

But that's not the end of this tale of woe. Now the asking price has been dropped to $826,000.

R.D. tells me he thinks $750,000 is reasonable level for this to drop to.

Seems even some Bears don't fully appreciate what's about to happen.

What about you? Are there any properties you have been watching that have been dropping their asking price? If yes, drop me an email and tell me about it.

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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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