Took the dog for a walk at the beach with a friend yesterday.
He (the friend, not the dog) was keen to take issue with some of my recent blog musings.
"How can you say real estate is not going to do well. People are jumping into the market and the BC economy is getting better, isn't it?"
Uhh... no, it isn't.
Many of British Columbia's lumber mills sit idle. Coal exports are down 40%. The price of natural gas, one of our key commodities, has collapsed and the tourism industy this summer is going to suck wind, big time.
More importantly the industry that had helped fuel the province's economic growth the past 10 years - residential home and condominium construction - is suffering the "nastiest" downturn among the provinces according to a recent report.
Canada Mortgage and Housing Corp. released data this week that showed B.C. has had "arguably the nastiest residential construction recession this cycle" in the country.
But what about the 'Olympic bounce'?
We've already had that, at least in the construction industry. Any added construction oomph from the coming Vancouver 2010 Winter Olympics is gone. Most major projects are nearing completion or have been completed.
So what's the near-term outlook for the construction industry?
Peter Simpson, chief executive officer of the Greater Vancouver Home Builders Association says, "housing starts are abysmal. Builders are hesitant to put shovels in the ground when there's inventory that hasn't sold."
And with interest rates on their way back up, that inventory isn't going to be moved out quickly, creating a further drag on the real estate market.
"We're in a full-scale recession in B.C.," said Jock Finlayson, executive vice-president of the Business Council of British Columbia. "Getting out of it is going to depend on when the global economy, and the U.S. economy, bottom out, and how things look after that."
Hmmm... there's that nasty tie-in to the global economy again. So what's happening out there?
Oil is way up, closing over $71 US a barrel yesterday, the price having shot up over 100% over the last three months. This has sent the Canadian dollar up over 90 cents US and on it's way to par - a development that will kill exports and manufacturing jobs.
Meanwhile, in the US, the economy is about to be broadsided by another huge wave of defaults from Alt-A, Option ARM and commercial real estate mortgage resets (see latest article here). Estimates peg coming residential foreclosures at $1.5 trillion.
As for the global economy, it appears Europe is about to be rocked by banking issues (IMF tells Europe to come clean on bank losses). Seems that, contrary to popular belief, the German banking system was just as irresponsible as the American banking system. Turns out the German state-owned banks, who's boards of directors are filled with the politically well connected, had been a dumping ground for US toxic waste - evidently the 'benefactor' of German trade surpluses.
And Germany wasn't alone in the mad dash to lend to foreigners. Austria is up to its eyeballs in loans made to Eastern Europe. Sweden had done the same in the Baltic States. Spain pumped money in to cajas that were used to finance a property boom fueled by foreign investors. Ireland had engaged in an Florida style construction boom as well. This is only a brief summary.
Now the jig is up. Spain, Ireland and the Baltic states have collapsed into depression. Their debts will never be paid. Eastern European currencies have tumbled, massively increasing their debt burden. They either hyperinflate or default. All of these loans, in addition to the tens of billions of US toxic waste remain on the balance sheets of European banks. And for the most part they are still valued at 100 cents on the dollar.
The message here: Europe's financial crisis is just getting started.
Then there is China, the supposed economic darling who will pull the planet out of recession. Today's China Daily News reports that China's exports and imports shrank for the seventh month in a row in May as the economic downturn continued to dampen global trade (see article here). I have a question for you. Who, exactly, is China going to be selling goods to so that their economy can keep growing?
So much for global recovery.
Far from getting better, we have BC entering a "full-scale recession" with recovery dependent on US and global conditions improving. That will be compounded with rising loan costs, big energy price hikes, reduced consumer spending, more pain for the Canadian manufacturing sector, a US economy that is going to remain stagnant (if not get worse), evidence that Europe is in for some serious pain and no one with money to buy China's goods so that China can, in turn, buy Canada's commodities.
No, my friend... the outlook for BC real estate values remains gloomy. I'd be willing to bet that within a year the prime rate will be double what it is today and Vancouver will have re-taken the lead from Miami in that plunging real estate graph I posted on Monday.
The sun is setting fast on the real estate boom times.
.Click here, listen to Laurel talk about working as an escort while married to Bill Magri.
Today the Wall Street Journal became the latest to warn of rising inflation and higher interest rates. The article, which can be seen here, ominously warns that the unprecedented expansion of the money supply could make the '70s look benign.
As we have already noted on this blog, inflation hit such a pace in the late 1970s that the only way governments could bring it under control was to dramatically spike interest rates to 21.5% in the early 1980s.
Such a move, in today's bubble inflated real estate market, would crush market prices and wipe out many who hold large, variable-rate home mortgages.
The W.S. Journal article touches on many of the issues we have already discussed. The economic crisis has triggered ill-conceived government reactions, which has been followed by an ensuing economic downturn. Throw in the unfunded liabilities of federal United States programs -- such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid -- and the you have liabilities which total a debt of over $100 trillion.
With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.
About eight months ago, starting in early September 2008, the US Federal Reserve (lead by Chairman Ben Bernanke) did an abrupt about-face and radically increased the monetary base -- which is comprised of currency in circulation, member bank reserves held at the Fed, and vault cash -- by a little less than $1 trillion. The Fed controls the monetary base 100% and does so by purchasing and selling assets in the open market. By such a radical move, the Fed signaled a 180-degree shift in its focus from an anti-inflation position to an anti-deflation position.
This 'quantitative easing' initiative was soon repeated by many other Western governments.
The WSJ article does a great job of explaining how quantitative easing affects the money supply and the inflationary pressures it will exert on the system. If you are intestested I encourage you to read the full article.
The most important element from the piece is that, "it's difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed's actions because, frankly, we haven't ever seen anything like this in the U.S. To date what's happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5% and inflation peaked in the low double digits. Gold prices went from $35 per ounce to $850 per ounce, and the dollar collapsed on the foreign exchanges."
Now it must be noted that Ben Bernanke insists he can walk the fine line between deflation and inflation without triggering the consequences we saw in the late 1970s.
And you trust the government not to screw up, right? Unfortunately others, like the Wall Street Journal, have their doubts.
Every year (be they good years or bad) it seems there is a 'spring bounce' in real estate sales. Winter is always a slow time for housing sales and things always pick up in the spring.
The graph above was posted over on Vancouver Condo Info and shows Sacramento over the last three years.
Sacramento has been hit hard in the real estate crash, but as you will notice, Spring has always given the market a boost. The 'spring bounce' has occured each and every year over the last three years despite the fact the market has crashed significantly.
Next we have a graph for San Diego which shows a similar pattern.
As you can see the chart shows the San Diego market starting to drop in September 2005, then it plateau's and bounces in April 2006, drops again, there is a spring bounce in May 2007, the market then drops dramatically, slightly plateaus and rises in spring 2008, and then plummets again with the graph ending in another spring bounce for 2009.
With this pattern in mind, lets look at Vancouver. Vancouver, compared to the US cities, has only just started it's housing collapse.
These two graphs are from Housing Analysis. The first graph charts is a three month moving average which is comparable to the US Case-Shiller data. The graph compares Vancouver to some of the worst-hit cities in the US (San Diego, Miami, Pheonix, and San Franciso. It also compares Seattle and Oregon for reference). Click on the image to enlarge it.
The graph compares the cities side-by-side since the start of their respective collapses. Vancouver is only 11 month into its collapse.
As you can see, Vancouver has fallen faster than all these other cities at their 11 month mark, except Miami. And it is only the spring bounce that has pulled us back from a collapse faster than Miami.
Yes... that's right, the rate of collapse for Vancouver is FASTER than what is being experienced in the worst US cities. If the trend continues the collapse will be just as hard as has been experienced in the United States.
Just for comparison, here is a graph which compares Vancouver to some US cities using the raw benchmark value vs. the Case-Shiller HPI. Again, you can click on the image to enlarge it.
The raw benchmark gives the spring bounce a more pronounced look, but the data still reveals the same thing. Vancouver, at the 11 month mark, has dropped faster than any US city at their 11 month mark except Miami.
Harken back to April 26, 2005. In an interview with Jim O'Connell on Report on Business Television (and reported in the Globe and Mail) Robert Shiller was commenting on the US housing situation just as the problems were starting to loom. Shiller, a Yale Economist, said, "This is the biggest national bubble that the U.S. has seen in over a century. A violent correction is imminent. When people are flocking into the housing market buying more and more houses, it's not a sustainable situation."
Shiller went on to note that the bubble is building in "glamour cities and glamour vacation areas" in the United States and Canada.
Ominously, Prof. Shiller was moved to comment on Vancouver. He said that "Vancouver is the most bubbly city in the world," and that the city has a history of volatile housing prices. He saw no reason Vancouver wouldn't burst exactly like the most bubbly cities in the United States.
The real estate industry wants you to believe the market is turning around and that the recovery has started.
Is it a recovery? Or is it merely a spring respite before the market plunges again?
Saturday night coffee with work colleagues and the conversation turns to Real Estate. Several have recently bought homes and another in our inner circle is about to make a purchase.
And no, they do not read this blog. I shake my head at them.
When asked why they are buying homes at this point in time, the answer is always the same: affordability.
Yet while Real Estate prices have declined by 15% (a decline no where near the bottom of this market, btw), that is not the 'affordability' they are referring to. The deals that have finally begun to materialize, in their minds, come not from plummeting prices, but from record-low interest rates.
Whether consumers are borrowing long-term or short, the historically low interest rates are the key factor in the new real estate affordability. It's all about cheap money.
Cheap money provided by a federal government interested in the economic spin off of a housing industry the Feds so desperately want to rekindle.
I cringe as I watch it happen.
The real estate industry is busy pumping out the statistics to back up the affordability argument. CREA and others in the industry point to three straight months of improving sales activity, adjusted for seasonality. April sales were 32% above the decade's low point reached in January.
But it's highly misleading. While sales are 'up', the numbers still show very slow sales for 2009. April sales were off 9.2% from a year ago while sales for the first four months of 2009 were down 20.7% from a year earlier.
It's an artifical frenzy, hyped by the real estate industry to get people on board.
It has created a classic economic battle. In one corner stands the real estate industry, trying to lure buyers with rates so low it is now cheaper to own than to rent. In the other corner is the skittish consumer who is too focused on what is coming down the road to care how low interest rates go.
Consider a $300,000 mortgage. At the 3.75% rate some mortgage brokers claim they can get for a five-year closed mortgage, the monthly payment is $1,537.67, based on a 25-year amortization.
A couple of years ago, when the rate was closer to 5.75%, the same mortgage would cost 22% more or $1,875.07 a month.
So low intestest rates suddenly make a real estate purchase affordable. But what happens when it's time to renew?
Toronto appraiser Barry Lebow, of Lebow Hicks Ltd., said the Canadian real estate market has nowhere to go but down -- no matter how much cheap money is thrown at consumers. "There are going to be tremendous changes in real estate... There are just not enough first-time buyers. Those people buying today, they are not really first-time buyers. You know what they are? They are renters of cheap money, cheap variable-rate mortgages of 2.99%," says Mr. Lebow.
"If mortgage rates were 8% to 9%, these people wouldn't be buying. It's an artificial market. One hiccup in the rates and it's all gone."
And that's the rub. These are historic low interest rates. Even when I ask my colleagues, "do you expect interest rates to stay this low for 25 years?"
They answer, "no".
Ummmm... So let me get this straight. Two years ago, when interest rates were at 5.75%, that was unaffordable.
To lock into a 10 year mortgage today, the rate today is 6.95%... presumably unaffordable.
If you don't think interest rates will stay this low forever, and it's too expensive to lock into a long term, 10 year mortgage... what are you going to do when rates go up and you have to renew?
On Thursday we posted about the BC Supreme Court decision regarding a UBC condo presale in which the buyer had the contract rescinded because the developer failed to properly inform him of changes to the development. This is a chilling turn of events for condo developers who are trying to hold pre-salers to contracts after the real estate downturn of 2008.
In the next few days there may be another court ruling which could set a major precedent on the future of presales in Vancouver.
A court decision is about to be made on the stalled Jameson House development. The decision will determine if the project will finally be built or if disgruntled buyers can finally exit their contracts and reclaim their presale funds.
The 37-storey Jameson House on West Hastings in downtown Vancouver stalled last November when one of its major lenders pulled out amid the economic downturn. As a result, the Pappajohn family, which is developing the site, was forced to put the $180-million project on hold until they could find a new backer and pay the construction bills. They applied for protection under the Companies' Creditors Arrangement Act (CCAA).
The court will hear details of new financing deals, including the arrangement between the Pappajohns and well-known Vancouver developer Bosa Properties, which is reportedly stepping in to save the day.
The catch? In order for the new financing deals to move forward, Bosa must proceed with the original pre-sale purchasers bound to their original presale contracts.
Naturally those contracts were signed at the height of the housing boom, in 2006. Back then those units sold from $500,000 to $5.3-million. Of the 144 condos to be built, 105 of them pre-sold, generating $150-million of presale contracts.
George Gregory, a lawyer who represents some of those purchasers, is now fighting to withdraw from the deal. Their argument is that the CCAA decision could leave them without the legal right to rescind on a deal they believe has changed from the one they signed up for.
"This is the kind of democracy where the foxes sit around the hen house brewing whether or not to have chicken for dinner," Mr. Gregory says. "And I'm acting for the chickens."
And the chickens are scared. Right now they are suing the developer to rescind their contracts based on default. Should the CCRA case rule the contracts are still valid, it will supercede the rights of the buyers to sue for this reason.
"The plan explicitly says the CCAA proceeding trumps consumer-protection rights and permanently stays the rights of purchasers to sue the developer, or rescind their contracts based on default," says David Polinsky, one of the 22 purchasers that is taking action against the proposed plan.
The developers, naturally, will argue the project has only been delayed, not defaulted, pending some re-organization. No word on if the contracts contained a promised delivery date.
This juicy little story also involves Vancouver Condo King Bob Rennie, the man who originally marketed the project. When reached in Europe for comment, Rennie chose his words carefully: "I am quite confident that when Bosa takes over the management that the building will be built, and that they are very smart developers with a history of treating purchasers fairly."
The final decision will have a profound impact on condo developments currently in limbo in Vancouver.
. As faithful readers know, bank failures in the US always seemed to carried out on Friday afternoons. There have been so many regular failures week after week that Friday has jokingly come to be called 'Bank Failure Friday' in many economic blogs. 2009 is off to a record breaking year with 36 failures so far. Updates in red/blue at the top of this post as they come in from the FDIC (click on blue portion to see press release from FDIC).
Meanwhile I have a great youtube clip for your viewing pleasure created by Chris Martenson (www.chrismartenson.com). It explains Bubbles and focusing on the housing bubble.
A chilling turn of events for condo developers and a ray of hope for pre-sale buyers sewered by the market crash of 2008.
As reported in the Vancouver Sun, the B.C. Supreme Court has ruled that the pre-sale buyer of a UBC condo development is entitled to rescind the contract under the Real Estate Development Marketing Act because the developer failed to properly inform him of changes to the development. The section of law in question is one which requires that purchasers receive all amendments to the disclosure statement.
There are dozens of other cases currently before the courts from people who put deposits on condominium units when the market was red hot, and now, for various reasons, are trying to walk away from them.
I suspect that never in the history of real estate have so many disclosure statements been raked over with such a fine tooth comb nor developments so finitely inspected, as is now being done in British Columbia.
We will watch developments unfold with keen interest.
Meanwhile over on Real Estate Talks, one of the best R/E discussion boards around town, there has been an interesting banter about the spring bounce in the real estate market.
Sales volume is clearly up, driven by the government's desperate attempt to halt falling property values by slashing interest rates to historic lows.
Anecdotal evidence posted on the board suggests that many sellers are tapped out of equity in their properties that they are selling. Once sold, the outstanding mortgages held by the sellers are very close to the selling prices, ie…..no equity left. So, although there are a lot of first time buyers purchasing these properties, the Seller’s don’t have the equity to buy “up” or even buy “down” afterward.
In addition, it is being suggested that some investors who would love to sell, won’t sell because there is no profit on the table. They are underwater on the deals and are left bleeding money every month because they are paying a tenant to live in their investment for rents far below their own mortgage payments. One poster suggested that this negative cash flow each month is like a Chinese water torture for the property owners.
Despite such evidence, one RETalks contibutor (messageboard posting handle 'eyesthebye') is so convinced that the selling frenzy means Vancouver home prices will rise in 2009 that he is betting the naysayers on the board a beverage at Starbucks if he is wrong.
The measurement standard will be the MLS HPI, a concept modeled after the Consumer Price Index. The HPI is touted by MLS as an alternative measure of real estate prices that provides a clearer picture of market trends over traditional tools such as mean or median average prices.
The specific bet will use the January, 2009 HPI numbers for Greater Vancouver Detached Homes (194.8) and for East Vancouver Detached Homes (200.6). 'eyesthebye' states these numbers will be higher at the end of the year.
Clearly 'eyesthebye' is one of those who thinks that the notion that Vancouver is in a housing bubble is pure nonsense. He has even posted that Vancouver 'is different' from other cities and suggests that we are immune here.
I'll keep you posted on the results.
That anyone refutes the fact we are in a bubble that is bursting continues to amaze me. Yet 'eyesthebye' is clearly one who thinks it can go on and on and on.
Reminds me of the lyrics from the song,
Through the door there came familiar laugher, I saw your face and heard you call my name. Oh my friend we're older but no wiser, for in our hearts our dreams are still the same...
Yesterday we talked about the subprime mortgage mess. So much has been made of the subprime mortgage implosion that you would think it was almost totally responsible for the economic collapse, and that once the subprime problem was fixed then the worst would be over.
Well... the subprime implosion is now mostly behind us and the worst is yet to come.
Over the last few years you have heard all about 'subprime mortgages'. Let's now focus on another type of mortgage: Option ARMs.
An adjustable rate mortgage (ARM) is a mortgage loan where the interest rate on the note is periodically adjusted based on a variety of indices. Consequently, payments made by the borrower may change over time with the changing interest rate (alternatively, the term of the loan may change).
ARMs generally permitted borrowers to lower their initial payments if they were willing to assume the risk of interest rate changes. For the borrower, adjustable rate mortgages may be less expensive, but at the price of bearing higher risk. Many ARMs have 'teaser periods' which are relatively short initial fixed-rate periods. The teaser period may induce some borrowers to view an ARM as more of a bargain than it really represents. A low teaser rate predisposes an ARM to sustain above-average payment increases.
The most important basic features of ARMs are that they have an initial interest rate and then they have an adjustment period (this is the length of time that the interest rate or loan period on an ARM is scheduled to remain unchanged. The rate is reset at the end of this period, and the monthly loan payment is recalculated).
An 'option ARM' is typically a 30-year ARM that initially offers the borrower four monthly payment options: a specified minimum payment, an interest-only payment, a 15-year fully amortizing payment, and a 30-year fully amortizing payment
Option ARMs are often offered with a very low teaser rate (often as low as 1%) which translates into very low minimum payments for the first portion of the ARM.
When evaluating an Option ARM, prudent borrowers will not focus on the teaser rate or initial payment level. Specifically, they need to consider the possibilities that (1) long-term interest rates go up; (2) their home may not appreciate or may even lose value or even (3) that both risks may materialize.
When a borrower makes a Pay-Option ARM payment that is less than the accruing interest, there is 'negative amortization', which means that the unpaid portion of the accruing interest is added to the outstanding principal balance. For example, if the borrower makes a minimum payment of $1,000 and the ARM has accrued monthly interest in arrears of $1,500, $500 will be added to the borrower's loan balance. Moreover, the next month's interest-only payment will be calculated using the new, higher principal balance.
The danger of the Option ARM is nasty feature known as 'payment shock'. This is when the negative amortization and other features of this product can trigger substantial payment increases in short periods of time.
Subprime mortgages had resets of 2-3 years and the bulk of those resets has past us now. The domino effect of failing subprime mortgages has collapsed housing values all over the USA. Millions of American homeowners are now in a negative equity position (the value of their home is now less than the amount of their mortgage).
Compounding this condition is the fact that millions of American homeowners began treating their home equity as some sort of housing ATM, meaning they have taken out loans against the inflated values of their houses and used the money to buy things. Some would refinance to pay off credit cards. Others would take out a home equity line of credit to buy a new car or to fund home repairs or both.
The end result is that subprime isn't the mortgage class in the most danger,Option-ARMs are because there are way more Option-ARM mortgages than there were subprime mortgages. Moreover the housing collapse has left far more Option-ARMs in a negative (underwater) equity position than there were underwater subprime mortgages. (click on image to enlarge)
So while the huge wave of subprime mortgages resettings from 'teaser' rates to market rates has virtually ended, we are still dealing with the aftermath of the resettings. Specifically there is a massive spike in subprime mortgages going into default and foreclosure.
And as the housing market struggles to absorb all these foreclosures, along comes the Option-ARM resets. The resetting of these 'teaser' rate mortgages into market rate mortgages has only just begun.
Negative equity is profoundly affecting these mortgage classes even before their teaser rates have expired. While most subprime mortgages had teaser rates lasting 2 or 3 years. Option-ARM mortgages (and a third class of mortgages called Alt-A) usually have teaser rates of 5 to 7 years. All these Option-ARM and Alt-A mortgages are only now just coming due for reset.
Worse, most Option-ARM mortgages have 'triggers' in their contracts that mandates that they automatically amortize once they've reached a certain level of negative equity, usually around 110%.
Alt-A and Option-ARM mortgages are only just now starting to implode with these 'resets' and 'triggers'.
It may be several year before many of these mortgages have to reset, yet we are already seeing defaults skyrocketing because of these 'triggers'.
T2 Partners report titled "An Overview of the Housing/Credit Crisis and Why There is More Pain to Come" outlines all of these coming mortgage problems (see report here).
If this trend continues Alt-A and Option-ARM will easily become the worst mortgage class of them all and they will dwarf the carnage created by the subprime meltdown.
A chilling report was issued yesterday by T2 Partners titled "An Overview of the Housing/Credit Crisis and Why There is More Pain to Come". If you want to see the actual report, click here.
Tomorrow I am going to hilight the key points of the report, but before I do let's cover some background leading up to the current situation. I had several questions about the whole subprime issue and how it came about so let's look at it.
So much has been made of the subprime mortgage implosion that you would think it was almost totally responsible for the economic collapse, and that once the subprime problem was fixed then the worst would be over.
Unfortunately nothing could be further from the truth. But what was 'subprime' all about?
After the dot-com collapse of 2000/2001, a dramatic wave of inducements entered the financial markets to resusitate the economy. Led by the US Federal Reserve under Allan Greenspan, interest rates were dropped making money cheap to borrow at the highest levels of the finance world. Thus began the greatest campaign in American history to get you - the consumer - to borrow money.
When you opened your mailbox in the United States in 2004, 2005, you could barely go a day without all kinds of people pressing on you all matters of schemes in which to expand your personal debt and mortgage debt.
Perhaps the most amazing aspect of this was that you could borrow more than 100% of the price of a house under these schemes with the most fragile of financial bonafides.
One of the mortgage products offered in this atmosphere was something called subprime loans, meaning less than prime quality.
The borrowers that were targeted by these products often had sketchy credit, were financially strapped or lacked sufficient income to qualify for a standard mortgage. The key component of these loans was that after a year of artificially low payments, the interest rates on subprime loans jumped all the way to 10 or 11%.
So why would anyone in the right mind take one of these loans?
Two reasons, primarily. The first (incredibly) was you could actually MAKE money taking out a loan. Yes, you could actually get paid to buy a house!
In many cases people were getting loans in excess of 100% of the value of their property. In this way people were actually putting a little bit of money in their own pocket at close of escrow. You bought the house with nothing down and then were given extra money on top of that for buying the house.
To understand how this was possible, you have to understand what Wall Street was doing with mortgages.
Almost all of the people involved in a mortgage transactions made huge amounts of money arranging the loan, then they passed the risk on to somebody else.
Instead of keeping dicey loans in their own portfolios, the big banks and giant mortgage companies that originally underwrote them resold the mortgages to big New York investment houses.
Firms like Bear Stearns and Merrill Lynch then sliced the loans into little pieces and packaged them up with other investments, then sold them to their best customers around the world as high-yield mortgage-backed securities, turning sows' ears into silk purses, all with the blessing of rating agencies like Standard & Poor’s.
And at every step of the way, somebody has his or her hand out, getting paid.
The broker who arranged the mortgage got paid. He or she was happy. The lending officer, ditto. The rating agencies who assessed home values and the worthiness of the mortgage got paid for passing judgment on these securities. They, too, were pleased, and their stockholders were happy. And on and on.
Because of this 'securitization process', those who instigated the loans were eager to make the loans happen. Therefore whatever a buyer wanted to state for their income, the bank would accepted that at face value and made the loan based on that ficticious income.
You would literaly apply to a bank, or a mortgage broker for a loan. When you filled outthe loan form, you would say, "I have an income of, oh, $150,000 a year." They say, "You do? Fine. Just sign right there." And they would nod, and because they were being paid, not by the veracity of the information, but by the consummation of the deal, not further investigation was necessary.
Next the lending office would say, "Ah. You have verified this?" And the bank would say, "Why, yes, we have." And the lending officer would say, "Great. So do I." Then they would get paid.
Next it was passed on to Wall Street to be bundled up and sold in packages, with Wall Street reaping huge commissions for those sales.
This 'easy money' created a housing frenzy from 2002-2008 unlike anything ever seen.
Easy money started bidding wars for properties and housing values skyrocketed. As the frenzy intensified, Wall Street's hunger for more and more mortgages to securitize grew by leaps and bounds.
Enter the subprime mortgages.
In it's gluttonous lust for more and more mortgages, products were crafted to offer loans to borrowers with sketchy credit (or to offer to those who lacked sufficient income to qualify for a standard mortgage). These subprime mortgages came with artificially low monthly payments in the first year of the mortgage, but then the interest rates jumped after that all the way to 10 or 11%.
People would take these loans because they didn't have to put any downpayment on the house. Then, by getting false assesments about the true value of the house, they would pocket the extra money from the mortgage immediatly (thus getting paid to buy the house).
These false assesments about the true value of the houses were rationalized within the real estate frenzy. Property values were climbing by 10-20% every year. If the house wasn't really worth that now, it would be in a matter of months.
Meanwhile borrowers didn't worry about the interest rate resets after a year because they could afford the initial payments and planned to refinance the mortgage before the interest rate jumped to 11%. Home values would have risen and the mortgage would now represent a smaller percentage of the assessed value of the house. Plus borrowers would have equity in the property (based on the new 'value' after a year of prices booming) and would therefore qualify for a standard mortgage instead of a subprime mortgage.
Real Estate ownership was a licence to print money.
That is... until the bubble began to burst in the most bubbly cities in Florida and California.
It wasn't a big drop. But it didn't matter, a small drop is all it took. When the value of some of these homes dropped in 2007, a ticking time bomb was activated.
And the subprimer's were the first hit.
When the subprimers went to refinance their mortgages after one year, they couldn't do it because the value of the house had fallen below what they owed on the mortgage. So when those 11% interest resets kicked in, it was game over - and the defaults/foreclosures started.
The first wave of defaults triggered a greater drop in housing values as foreclosed properties started to flood the market.
A small drop became a sizable drop. And the dominos began falling.
To the subprime mortgage holders, it really wasn't a big deal.
The subprimer's were never really invested. Most of the people who lost the houses didn’t lose any money because they never put any money down. Though their credit is damaged, and they could face legal action in some circumstances, they got to live in a new house for a couple of years, and some of them even managed to get some money with home equity loans or by refinancing.
And when the crush came, people just said, "Take the house. Good-bye. I'm leaving." And the cascade of foreclosed homes really began flooding the market (furthing driving values down).
Prior to this housing boom, loans were made by your local banker or building and loan associations or savings and loan. They had a stake in the risk of the loan. But as mortgages became securitized and Wall Street became involved, mortgages became very transactional and there was no relationship built with the borrower and the lender.
Lenders failed to act to make loans to credit worthy borrowers, and borrowers were willing to simply walk away from their obligations to a face-less Wall Street entity.
It was greed on both sides of the table, lenders and borrowers with everyone was gaming the system. Warnings were issued, and ignored, by the likes of Nathan Roubini, Schiller, Peter Schiff and Ron Paul.
This hitler inspired parody of the crash lampoons all these factors and has become a classic comic representation of the entire housing crisis...
Ultimately subprime was a very small fraction of the overall mortgage market. But the impact of subprime on the market was like a giant, first domino that triggered a cascading effect.
And with home values plummeting, and the housing sector - one of the largest and most vital parts of the American economy - grinding to a standstill, America was pushed towards recession.
Wall Street and foreign investors were stuck with millions of distressed properties. The unsold condos in Miami, the unfinished apartments on the Vegas Strip, the developments in Atlanta, and the collapsing California dream, it was all interlocked in a giant real estate ponzi scheme.
That’s the fascinating part of this whole debacle. Mortgages are sold in mortgage backed securities, so they’re pooled. The pools are part and parcel of those high-yield mortgage backed securities everyone gobbled up a few years ago, and are now stuck in the windpipe of the world's financial system.
No one wants to buy them, so no one can sell them.
Bonds marked triple-A are now quoted at 50 cents to the dollar, 40 cents on the dollar. Some of them, much less. Some are worth nothing on the dollar. And nothing on the dollar is the worst thing that has happened to Wall Street in a long time.
How many of these securities are out there? A trillion with a T-plus.
But the worst of the subprime fiasco is past, as you can see by this graph (click on image to enlarge)...As you can see, the huge wave of subprime mortgages resettings from "teaser" rates to market rates has virtually ended.
The problem is that subprime mortgages were never a significant part of the mortgage industry.
Looming on the horizon is a gigantic wave of regular mortgages whose terms reset after 5-7 years. With the value of real estate having plummeted over 40% in many areas of the United States, these homeowners represent a catastrophic mass of mortgages that cannot be renewed because of their current negative equity position.
Tomorrow we will look at that and the impact it will have on the economy.
In 1953 “Engine Charlie” Wilson, President of GM, was tapped by US President Eisenhower to become secretary of defence. At his Senate confirmation hearing he was asked whether he could make a decision in the interest of the US that was adverse to the interest of GM.
He said he could and then reassured the Senate that such a conflict would never arise. “I cannot conceive of one because for years I thought what was good for our country was good for General Motors, and vice versa. Our company is too big. It goes with the welfare of the country.”
In 1953, GM was the world’s biggest manufacturer. It generated 3% of US gross national product. It was also America’s largest employer, paying its workers solidly middle-class wages with generous benefits.
Today it will declare bankruptcy and before the sun sets the US taxpayer will own this once mighty corporation.
But why would US taxpayers want to own today’s GM?
Robert Reich, the US labor secretary under President Clinton, asks that very question in a Financial Times article.
Now Reich is just about the last person one might expect to criticize the Obama Administration bailout of GM. He is a unapologetic liberal, yet criticize he does.
And his logic is similar to the arguments made about the bank rescue operations.
Unlike some other commentators, who would be happy to see Big Auto fail. Why? Because Reich believes the social cost will be too great (if nothing else, for the hit it will deliver to GDP). Reich strongly disagrees with the bailout program, which he sees as wasteful and intellectually dishonest.
So... it a very public column Reich asks, why would US taxpayers want to own today’s GM?
"Surely not because the shares promise a high return when the economy turns up. GM has been on a downward slide for years," wrote Reich. "In the 1960s, consumer advocate Ralph Nader revealed its cars were unsafe. In the 1970s, Middle East oil producers showed its cars were uneconomic. In the 1980s, Japanese carmakers exposed them as unreliable and costly. Many younger Americans have never bought a GM car and would not think of doing so. Given this record, it seems doubtful that taxpayers will even be repaid our $60 billionn. But getting repaid cannot be the main goal of the bail-out. Presumably, the reason is to serve some larger public purpose. But the goal is not obvious."
"It cannot be to preserve GM jobs, because the US Treasury has signalled GM must slim to get the cash. It plans to shut half-a-dozen factories and sack at least 20,000 more workers. It has already culled its dealership network."
"The purpose cannot be to create a new, lean, debt-free company that might one day turn a profit. That is what the private sector is supposed to achieve on its own and what a reorganisation under bankruptcy would do."
"Nor is the purpose of the bail-out to create a new generation of fuel-efficient cars. Congress has already given carmakers money to do this. Besides, the Treasury has said it has no interest in being an active investor or telling the industry what cars to make."
"The only practical purpose I can imagine for the bail-out is to slow the decline of GM to create enough time for its workers, suppliers, dealers and communities to adjust to its eventual demise. Yet if this is the goal, surely there are better ways to allocate $60 billion than to buy GM? The funds would be better spent helping the Midwest diversify away from cars. Cash could be used to retrain car workers, giving them extended unemployment insurance as they retrain."
In Canada it is now estimated the total bailout to GM and Chrysler will reach $13 billion from the federal and Ontario governments alone (excluding the Americans). That means most of the additional federal deficit this year is directly attributable to the auto bailout.
Today is a sad day and my thoughts go out to all the families affected in factories, dealerships and parts manufacturers.
As faithful readers know, I do not side with the current optomists who would have us believe the global economic crisis is ebbing and recovery is on the way.
Instead your dilligent scribe sides with the likes of longtime market analyst Bob Chapman who calls green shoots "Poison Ivy" and economist Nouriel Roubini who says those green shoots are "yellow weeds". Both these analysts insists there's lots more pain ahead.
To read the daily papers we have gone from the the worst financial crisis, economic crisis and recession since the Great Depression to a consensus that the outlook is now becoming optimistic again.
How can this be? The problems of the financial system are still severe and many US banks are still insolvent. Our goverments continue to pile public debt on top of private debt in an attempt to socialize the losses and unemployment is growing by leaps and bounds as government revenue from taxes contines to drop.
The reality is that at some point the government's balance sheet is going to break, and if that happens, it's going to be a disaster.
As for the recent stock market rise, how can it be anything but a Bear Market? As the US economy keeps contracting and the financial system suffers unexpected or manipulated shocks, the markets will surely crash again in a repeat of the 1929 - 1942 pattern.
Joining the chorus to offer warnings of what is to come is highly respected market analyst Louise Yamada. Yamada was top-ranked among her peers in 2001, 2002, 2003 and 2004 when she worked at Citigroup's Smith Barney division. Since 2005, she's headed her own independent research company. She penned the bullish tome Market Magic, Riding the Greatest Bull Market of the Century.
But as Randall Forsyth reported in the May 25 issue of Barron's Up and Down Wall Street column, Yamada bull ride has come to an end. She paints a picture of what is to come that is anything but bullish:
"It is almost uncanny the degree to which 2002-08 has tracked 1932-38", Yamada writes in her latest note to clients. She then offers her "Alternate Hypothesis" and compares this structural bear market to 1929-42:
the dot-com collapse parallels the Great Crash and its aftermath, followed by the 2003-07 recovery, similar to 1933-37;
then the late 2008 - early March 2009 collapse tracks a similar 1937-38 trajectory, after which a strong rally followed much like today;
then in November 1938, the market dropped 22% followed by a 26% rise and a series of further ups and downs - down 28%, up 23%, down 16%, up 13%, and a final 29% decline ending in 1942;
from the 1938 high (analogous to where we are now, she says), stock prices fell 41% to a final bottom.
Optomists claim we have already hit the final bottom to the market. Yamada disagrees. She says structural bear markets typically last 13 - 16 years so this one has a long way to go before "complet(ing) the repair process." She calls the current rebound "a bungee jump," very typical of bear markets. Numerous ones occurred during the Great Depression, 8 alone from 1929 - 1932, some deceptively strong.
It's yet another voice warning you, dear reader, to take care that you understand exactly what is going on around us.
Outstanding Video Clip for you:
Robert Rodriguez – Reflections & Outrage.
Some very rare truth telling in this five minute clip and a must see.
Last Tuesday I commented on the updated projections from our illustrious Finance Minister regarding the deficit.
Canada has gone from a $15 billion surplus in 2006 to a $40 billion deficit in 2009-10. This represents the most rapid and intense deterioration of national finances in the country’s history, a swing of more than $50 billion in a year.
A key component of that stunning swing in finances: the auto sector bailout of Chrysler and GM. Just how much money are we ploughing into this automotive black hole?
It works out to... wait for it... almost $1.5 million dollars per job saved.
That's right a mil and a half per job saved.
The government says it is a transitory debt we are occurring and that we will likely be out of it in two years.
Bullsh*t.
There is no way they can believe that and they are fools if they think any of us believe it. Transitory deficits are small ones that are incurred in extraordinary circumstances to deal with a short window of time. These deficits the Conservatives are creating will not be transitory deficits.
We are dealing with an economic problem that will be anything but short term. The circumstances of the auto bailout are certainly not extraordinary, those businesses have been foundering for years. And finally... this deficit is huge, it's not small.
$50 Billion this year and perhaps $40 Billion next year mean this so called 'transitory deficit' will quickly become a structural deficit. Remember how long and how difficult it was to overcome the $44 Billion deficit left over from Mulroney?
Yesterday we talked about Creative Destruction.
The term creative destruction was popularized by Austrian economist Joseph Schumpeter in 1942. It describes the process whereby constant innovation sustains long-term economic growth through improved productivity. This process of creation effectively destroys old products, companies and industries that are unable to compete with the new.
Creative destruction is not unique to recessions; it is a constant driver of capitalism. However, the destruction side of the theory becomes magnified in recession as low demand squeezes out companies which, in theory, are less competitive.
Steven Davis, a professor of international business and economics at the University of Chicago Booth School of Business, said the solid employment and productivity performance of the United States of the past 25 years has been driven to a considerable extent by America's success at 'creative destruction'.
Prof. Davis said the U.S. was particularly successful at evolving in the face of an economic shock because it had flexible labour market policies and low regulation in some markets, such as retail.
"This is why, after the major oil price shocks of the 1970s and the global downturn of the early 1980s, the U.S. recovered in terms of unemployment and economic growth much more rapidly than, say, continental European countries did," he said.
America had the ability to maintain productivity by slashing its workforce, this is crucial to allowing your country to be one of the first to recover from a recession.
The easier it is to fire people, the more willing and the less stressful it is for employers to decide to hire people. In the U.S., if you get a couple of big orders, you start hiring people because you know that when you don't need them you can lay them off again. It all sounds rather callous. But an efficient economy is one where the devil sort of does take the hindmost.
Canada has historically underperformed the United States in productivity. In 2008, Canadian productivity fell 1.3% compared with growth of 2.9% south of the border. In 1996-2000 U.S. productivity grew an average 2.5% a year compared with 1.6% in Canada.
Pedro Antunes, director of national and provincial forecast at the Conference Board of Canada, said solid productivity growth is crucial to maintaining a strong economy.
"The reason it's crucial is we are competing with the rest of the world and if we want to pay our salaries and have a real increase in wages, we need to ensure that productivity growth is over and above that. Otherwise, we are eroding our competitiveness."
The auto bailouts are nothing less than a giant anvil around the necks of all Canadians, and Central Canada in particular.
We need to embrace the creative destruction process, which means allowing for the destruction side as well as facilitating the creative side, of the economy.
$1.5 million per job pumped into the systemic failure of GM and Chrysler are funds which we can ill afford and which deprive, penalize prevent the creation of something better in its place.
The United States of America, the great bastion of capitalism, is having a crisis of confidence on a scale that few common Americans appreciate.
And within that crisis of confidence, a debate is emerging that will form and shape the 21st Century.
First it was President George W. Bush, now it is President Barack Obama. Both Presidents have returned America to a Keynesian economic philosophy.
What does that mean? Keynesian economics is a term that means diddly to the average American and Canadian.
John Maynard Keynes (June 5, 1883 – April 21, 1946) was a renowned economist from Britain whose many ideas on economic and political theories as well as on governments' monetary policies influenced America during the Great Depression. He advocated a government that played an active role in the lives of people regarding business, economy, etc. His ideas are the basis for the school of thought known as Keynesian economics.
Keynes spearheaded a revolution in economic thinking that overturned the older ideas which held that free markets would certainly allow full employment for all workers who agreed to lower their demands for higher wages. Shortly before the end of the Great Depression his ideas were wholeheartedly put into practice by leading Western economies. During the 1950s and 60s, the success of Keynesian economics was so resounding that almost all capitalist governments around the globe utilized its policies.
Keynes's ideas became less influential in the 1970s, after attacks from Milton Friedman and other economists who were less optimistic than Keynes about the potential for interventionist government policy to complement the free market.
The adverse economic conditions of the seventies, most especially the 1973 oil crisis and the recession that followed, unleashed a swelling tide of criticism for Keynesian Economics.
By 1979 Monetarist principles had displaced Keynes as the primary influence on Anglo-American economic policy and America saw a return to the free market principles that made it the bastion of capitalism.
'Creative Destruction' returned as a guiding force of capitalism. Officially Creative Destructions denotes a "process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one."
Creative destruction occurs when something new kills something older. A great example of this is personal computers. The industry, led by Microsoft and Intel, destroyed many mainframe computer companies and rendered them obsolete. In doing so, entrepreneurs created one of the most important inventions of this century.
But today Keynes's ideas are enjoying a revival, with Keynesian thinking being behind the plans of President Barack Obama and other global leaders to rescue America's treasury and economy.
But is that what we really need right now?
Can you imagine if the computer revolution were taking place today? The government would be scrambling to bailout IBM and other giant mainframe computer companies because they were 'integral' to the economy.
The billions thrown at the likes of IBM would keep them from failing and that would have greatly hindered the development of the home computer and the technological revolution that sprang from it.
Can you imagine a world with no internet? No home computers? Such intervention would have probably profoundly devastated its development.
And that, many fear, is what is happening now. GM, Chrysler, AIG, Bear Stearns, US Banks, Fannie Mae and Freddie Mac. The list goes on and on.
Let other car companies pick up the pieces and start anew. Let other investment bankers fill the void. Critics argue that the United States must let 'Creative Destruction' run it's natural course and allow capitalism to destroy the value of established companies that enjoyed some degree of monopoly power and allow them to fail.
This process frees up capital and labour so it can be redeployed and put to better use elsewhere.
Companies that once revolutionized and dominated new industries – for example, Xerox in copiers or Polaroid in instant photography – have seen their profits fall and their dominance vanish as rivals launched improved designs or cut manufacturing costs.
Should we have prevented that?
Creative destruction is a powerful economic concept and explains many of the dynamics of industrial change; the transition from a competitive to a monopolistic market, and back again.
It lies at the heart of evolutionary economics.
The problem is Creative Destruction can also hurt.
Layoffs of workers with obsolete working skills can be one price of new innovations valued by consumers. And while a continually innovating economy generates new opportunities for workers to participate in more creative and productive enterprises (provided they can acquire the necessary skills), creative destruction can cause severe hardship in the short term, and in the long term for those who cannot acquire the skills and work experience.
This destruction lies at the heart of the American Capitalist Experience and is crucial to the American economy reinventing itself. The problem is American is now abandoning this philosophy as President Barack Obama and other global leaders attempt to rescue America's treasury and economy with a revival of Keynesian thinking.
Like the giant forest that catches fire and burns to the ground as part of a renewal process that sees it return stronger and greater than before... so must the economy burn down the deadwood of the economic forest. When men interfer in the regeneration of forests by preventing forest fires; the amount of debris on a forest floor gathers greater and greater until it sparks an even more ferocious blaze.
Critics fear this is what both Bush and Obama are doing with the American Economy.
The US Republican Party currently founders for renewal after the folly of George W. Bush and his abandonment of American's finest capitalistic principles.
Don't any of them realize that restoring America to it's status as the world's greatest capitalist nation is the path to both the party's, and the nation's, salvation?
Monthly real estate sales may be increasing from their January lows and realtors may be boasting of multiple bidding wars and properties selling over ask price, but the big picture reality is that Vancouver Home values have now declined for a ninth consecutive month.
According to the Teranet—National Bank Composite House Price Index, which was released Wednesday, Vancouver prices fell 6.4 per cent between January and March. More significantly the March drop was the ninth consecutive month of decline on the financial institution’s measure.
The Teranet—National Bank index pegs Vancouver's market peak at June of 2008. Since then the market has declined almost 12 per cent.
So with all the hype from the real estate pollyanna's, should we expect to see a dramatic turnaround to that downward trend?
“I’m not making a forecast,” Simon Cote, managing director of property derivatives for National Bank Financial, said in an interview. “But if we look to previous business cycles, very seldom do we see the house-price index turn around in a direct V shape.”
He looks to the volume of sales as an indicator that the decline in values is stopping, and the sales volumes that are captured in the Teranet index were still low compared with a year ago, some 40 per cent below last year in Vancouver’s case.
“Until the year-over-year change in volume starts to pick up and be positive, even if it is low, it is going to be very difficult to see a turnaround [or stabilization] in the index,” Cote said.
The Teranet—National Bank index is calculated based on repeat sales of existing homes, known as paired sales, to capture direct examples of changes in value, rather than just measuring the average value of all homes that sell in a given month.
National Bank Financial uses the index as the basis to trade housing futures, builders or lenders to make bets on whether home prices will increase or decrease and hedge against volatility in housing prices.
It tracks housing prices in Vancouver, Calgary, Toronto, Ottawa, Montreal and Halifax.
“The Federal Reserve is now a government within a government. It is totally out of control. Congress doesn't control it. It's funded by the banks and we either have constitutional government or we don't."
Took the dog for a walk at the beach with a friend yesterday.
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