Will that be cash or chargex?

Remember those old commercials?

Seems to me it has become ingrained in Canadians to choose the latter.

Maybe that explains why, throughout 2009, we witnessed our housing market rebounding while America's foundered.

Unemployment in Canada has been consistent with that of the United States, but the Canadian economy has seemingly fared better. Perhaps it has something to do with the profound credit numbers Jonathan Tonge posted on his blog this week.

It seems that while Canadian incomes are falling, credit is skyrocketing

According to the Conference Board of Canada, Canada’s income per capita fell in 2008—the first time this has happened since the 1990–91 recession.

The income gap between Canada and the U.S., as of 2008, now stands at $6,400 per person; double what it was in 1984. At $6,400 per person, Americans earn more than 20.2% per person than Canadians.

Yet our economy is doing better than America's... why?

I wonder if it has to do with the fact Canadians are hell bent on spending money they don't have?

Average home prices in Canada are up 20% in 2009.

During the period of April 2008-October 2009, government insured and securitized mortgages (NHA securtized loans)increased by a whopping 67%. Total household credit (consumer credit and residential mortgages) grew 14% or by $165 billion.

Then there is this data. According to the latest release by the Bank of Canada, during the period of February 2008 - November 2009:

• personal loans have increased 19%
• balances on credit cards have increased 14%
• 'other' types of loans have expanded by 14%
• and personal lines of credit have grown 39%

All of this borrowed money has been a massive stimulus on the domestic Canadian economy, but spending on credit like that can't continue forever.

These numbers start to show clearly why the Bank of Canada has forecast that by the middle of 2012, 10% of Canadian households would have a debt-service ratio that is at a severe risk to financial shock.

Americans have taken heed of the 2008 financial crisis and over the past year have increased their average savings rate to approximately 5%.

Canadians, however, are still spending like drunken sailors.

With each passing day it is becoming increasingly clear we have not avoided our day of reckoning here in Canada at all... we've only postponed it.

And when things start to tumble... look out. It's not going to be just real estate that crashes hard.

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Email: village_whisperer@live.ca
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A slow, agonizing bear market trap?

Click on the above image to enlarge.

It's another great graph from Doug Short comparing the 1970's bear market with our current market - after adjusting for inflation.

And it's poignant when you consider that economist after economist is expressing concerns that the stock market is not properly reflecting the state of the economy. Most long-time observers are convinced that we will see another market pullback to the March market lows.

A lot of it has to do with the fact that a year after Washington rescued the big names of American finance, it’s still hard to get a loan.

The problem, it seems, isn’t just tight-fisted banks... but paralysis in the debt markets. It's deepening the credit drought.

The debt-securitization markets have been the source of roughly 60% of all credit in the United States in the past. Continued disarray is making loans scarce and threatening to scuttle any economic recovery.

Those debt-securitization markets that are operating, are only functioning because the government is propping them up.

But the Federal Reserve has put these markets on notice that it plans to withdraw its support for them, policy makers hoping private investors will return to fill the void.

And their return is critical.

The debt-securitization markets are crucial to the American economy. They financed corporate loans, home mortgages, student loans and more. In good times, they enabled banks to package their loans into securities and resell them to investors. That process, known as securitization, freed banks to lend even more money.

But many investors have lost trust in securitization after losing huge sums on packages of subprime mortgages that had high default rates.

The government has since spent more than $1 trillion trying to restore the markets, with mixed success. And with Americans moving into the highest personal savings mode in decades, the outlook isn't promising.

Until more of the securitization market revives, or some new form of financing takes its place, a wide range of loans needed to secure a lasting economic recovery will remain elusive, experts say.

"Given the imperative for securitization markets to fuel bank lending, we won’t have meaningful economic growth until securitization markets are re-established," said Joseph R. Mason, a professor of banking at Louisiana State University. Lee Sachs, a counselor to the Treasury secretary, Timothy F. Geithner. agrees. "It’s very important these markets come back to get credit to businesses and families who need it, and also as a sign of confidence."

But enormous swaths of this so-called shadow banking system remain paralyzed.

Depending on the type of loan, certain securitization markets have fallen 40% to 100%.

A once-thriving private market in securities backed by home mortgages has collapsed. It's gone from $744 billion in 2005, at the peak of the housing boom, to $8 billion during the first half of this year.

The market for securities backed by commercial real estate loans is in worse shape. No new securities of this type have been issued in two years.

"The securitization markets are dead," said Robert J. Shiller, the Yale University economist and housing expert who predicted the subprime collapse. The government is supporting them, he said, but it’s unclear what will happen when it extricates itself. "We’re stuck," he said.

Many bearish economists have recognized this and have been calling for the bear market trap to snap shut on investors due to an irrational run up in stock prices from government stimulus.

But as Doug Short's chart above shows, the current market appears that it could be tracking the pattern of the 1970s.

Instead of another sharp drop, we could simply drift lazily back down to the March low over the next four and a half years as the North American economy fails to find the grease to make the machinery of business function.

That, by the way, is the same way things played out in the 1930s.

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Canada's Emerging Credit Quagmire

CMHC was formed as a crown corporation in Canada after World War II to address the shortage in housing. It's mandate was to make home ownership accessible to all Canadians.

CMHC primarily achieves this by delivering mortgage insurance and mortgage backed securities.

CMHC was once an ultra conservative crown corporation.

But starting in the new millennium, pressures started to build on CMHC to change the way it does business. And those changes are creating an alarming set of conditions that should alarm all Canadians.

In 2001 GE Capital was permitted to join CMHC in the Canadian mortgage insurance industry to provide competition in the marketplace.

GE Capital began insuring Canadian mortgages and issuing NHA-MBS (mortgage backed securities insured by the Government of Canada). In response to this competition, CMHC began loosened that conservative approach.

As late as 2002 total outstanding mortgage debt in Canada (approximately $467 billion) was predominantly issued to only good credit candidates and people with proper down payments. More importantly, CMHC only insured a small portion of this debt.

In 2003 CMHC decided to remove price ceiling limitations on the value of the homes that it would insure. It meant that CMHC would not insure any mortgage regardless of the cost of the home.

In 2007, after years of lobbying, the now defunct AIG group successfully lobbied the newly elected Conservative government to allow AIG to insure high risk Canadian mortgages, issue mortgage backed securities on these loans and exchange them on the open market.

At the same time, the Conservative government launched a radical 35 year amortization campaign and 0% down payment policy.

A few months later 40 year amortizations were permitted.

These radical changes supercharged the real estate market.

Buyers, who couldn’t previously get into the market, flooded in. Historically high home prices continued to gain steam. High risk borrowers surged forward and throughout 2007, the average home buyer who took out a mortgage had only 6% equity in their homes.

6% equity! And that’s not just the new buyers, that's the national average down payment for all mortgages including buyers who moved up.

In 2008, as Canadian home prices started to get slammed with the worldwide bursting of the housing bubble, Canadian home prices started to dip.

CMHC admits that it was ordered to approve as many high risk borrowers as possible to prop up the housing market and keep credit flowing.

42% of all high risk applications were approved, a 33% increase over 2007.

And that was before the dramatic lowering of interest rates to their lowest point in history.

A stunning situation is developing that has some analysts suggesting Canada is in a far more precarious position than the United States was in 2006.

Tomorrow we will take a closer look at it.

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