2.5%
That's the latest rate that one faithful reader advises can be had for a one year fixed term mortgage.
Critics have dubbed these rates the crack cocaine of the housing market enabling local addicts to re-inflate Vancouver's status as the most bubbly real estate city in North America.
As Scotiabank economists Derek Holt and Karen Cordes have warned, lenders have been providing "excessively generous financing terms" which has had the effect of "putting people into homes at an earlier stage than would have otherwise been the case." The net effect? "Two or three years from now - once short and long interest rates are probably higher ... a lot of those mortgages will not be as easy to carry as they are right now."
On that note, come with us now as we take a tour of the high life in Vancouver. Let's see what a million dollar home looks like in this bubble inflated world of ours.
First up, this house on West 5th Avenue in Kitsilano.
This 1926 home features hardwood floors, a large renovated kitchen, a bright two-bedroom basement suite, a white picket fence and a tree swing.
Sure, the yard is small, the view out the back is of a giant condo complex, the bedrooms are tiny - the master is only slightly more than 100 square feet - and it is just half a block off one of the city's busiest thoroughfares. But those shortcomings were quickly forgiven by the dozens of prospective buyers who streamed through the first open house saying, "Honey, I love it" while trying to imagine life without closets.
Think you'd be interested? Too late.
Five days after that open house, seven agents lined up to make their offers. The asking price was $959,000, but because of the competition, the bidding war pushed the price higher. Only two bids came in at less than $1 million. In the end, the home sold for a staggering $1.142 million - more than $180,000 over the original price tag.
Earlier this week on the Eastside, we were advised about a partly updated Commercial Drive bungalow with a two-bedroom suite and a new garage and studio. That dump drew 10 offers - most of them with no inspections, despite the fact that the 1920's era house needed a new roof, electrical upgrades and drain tile work, and had an old oil tank buried in the back yard.
The first showing was Thursday last week, and on Sunday it sold for $113,000 over the asking price.
Let's cruise up to North Vancouver now. Deep Cove to be exact. Here's a beauty for you.
This beautiful one bedroom palace was described as 'liveable' and in a "fabulous location nestled in the middle of Panorama Park. You can almost touch the cove waters... in the heart of the action, yet surprisingly private."
'Surprisingly private' because you're probably too embarrased to have anyone visit you... or your friends don't want any photographic evidence proving they did.
Selling price? Just over a million (I am told the land is assessed for $775K and the house for $35K.)
So mortgage rates remain at an all time low despite bank economists warning that the cheap money is encouraging reckless behaviour... reckless behaviour that is manifested in prices that continue to rage and by buyers who bid them even higher with low-cost mortgages.
How can this possibly end badly?
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You know our answer to that question.
But this week it was Scotiabank economists Derek Holt and Karen Cordes who were doing the asking.
In a research note released last week they noted that "lenders have been scrambling to get enough product to put into the federal government’s Insured Mortgage Purchase Program over the months, and that may have translated into excessively generous financing terms"
Excessively generous financing terms?
That's econo-talk, their way of saying the banks have been giving money to people they shouldn't be.
Ouch.
Sounds like Derek and Karen are biting the hand that feeds them (or in the vernacular of another local company we know... they're not 'team players').
But you gotta hand it to them. They're telling it like it is.
The report goes on to note that low mortgage rates are the dominant factor in the pent-up sales demand of the last few months. "I think that's having the effect of putting people into homes at an earlier stage than would have otherwise been the case," Mr. Holt said.
Ouch, again.
Holt goes on to question whether mortgages will remain this affordable in the long term.
"I do worry, longer term, not even that far out - two or three years from now - once short and long interest rates are probably higher ... whether a lot of those mortgages will be as easy to carry as they are right now," Mr. Holt said.
And in a blaze of insight, the Globe and Mail, in reporting the story, wonders "whether a spate of good deals on mortgage rates could mean Canadians are getting in over their heads."
Ya think?
"La, la, la, la, la..."
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The Rainforest Roundtable held it's monthly meeting last night.
Amid beer, B-B-Q and rain (fall is officially here), we were discussing the parents of one of our group.
As the youngest member of our little fraternity, Robert's parents are at the forefront of the Boomer generation and have only just retired last year. Their story is one that will most certainly be repeated over and over in the years to come.
Asset rich and cash poor, they are comfortable and their pensions allow them to make ends meet. But they are far from being considered 'rich' in so far as their bank accounts go... at least until now.
It has long been their plan to sell their spacious Kitsilano home and 'downsize'. Bought in the early 1970s for $86,000, the property was sold last week for $1.7 million dollars.
The sale was the culmination of a deliberate retirement strategy.
Our roundtable colleague freely admits his parents have never been great savers. Spending what they have and 'enjoying life', their plan has long been to use their massively appreciated home as their retirement fund.
After taking a scare over the past winter, they are overjoyed to see the market recover allowing them to capitalize on their plans to sell at the 'proper price'.
It is a retirement strategy common to many boomers.
Surveys consistently show about 85% of all the family net worth in the country sits in residential real estate.
59% of all Canadians are living paycheque to paycheque. In fact for many Canadians, if they miss one single paycheque by a single week, they wouldn’t be able to make ends meet at all. Compound that with surveys that show half of Canadians are incapable of saving 5% of their income, and the 'home as retirement fund' plan is common to many boomers.
Why? Because it's all about 'living the lifestyle'.
Statistics consistently show that a majority of Canadians have no retirement savings and don’t expect to get any.
They are like Robert's parents. Their house is their retirement fund. 85% of all family net worth in this country is tied up in the family home.
Can you see what looms on the horizon?
The first year of the boomer generation turns 65 this year. Our aging Canadian population is inching towards retirement. And the younger Gen X's are a much smaller group.
With each passing year more and more retiring Boomers will be enacting their retirement strategy just like Robert's parents. For the next 20 years wave after wave of boomers will retire.
Meaning that, with each successive year, we will see wave after wave of homes listed to finance underfunded retirement plans.
Who will buy them all?
This alone is going to trigger significant downward pressure on housing prices.
And then there is interest rates. Have we mentioned what this might do to the market?
You really don't need a market oracle to see how this is going to play out.
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Those of you who visit this site regularly know that we have harped ad nausem on the belief that the economic collapse that took place last year was a deep, economic earthquake... the repercussions of which we are still coming to grips with.
Will the ecomonic collapse and massive fiscal stimulus trigger high inflation and interest rates? Or is the economy in a spiral leading to further deflation and low interest rates for years to come?
In the past this blog has profiled the viewpoints of Bob Prechter and Peter Schiff. One is regarded as the leading deflationist speaker, the other considered the leading inflationist pundit.
Over the last two weeks two different interviews were conducted by Jim Puplava; one with Prechter and one with Schiff. The interviews gave these two a chance to clearly present their views and supporting evidence.
If you are so inclined, click on the links above to listen to the full interviews.
In summary, Prechter's key point is that there is an ocean of unpayable debt which must result in a deflationary collapse and depression (huge unemployment, big hit on the standard of living, etc.).
Schiff agrees that there is an ocean of unpayable debt, but disagrees on what the outcome will be. He expects a dollar collapse and an inflationary depression (huge unemployment, big hit on the standard of living, etc.).
Interestingly there is a lot more agreement between the “deflationists” and the “inflationists” than you would think.
Prechter claims that the creditors will not allow the Federal Reserve to “print its way out of the debt” and that the key evidence for this is that the Fed has tried really hard to keep from doing anything to really, really tick off its creditors.
Schiff claims that the Federal Reserve will keep “printing debt” until the creditors refuse to buy any more and that is when the printing goes into high-gear and there is a currency collapse (dollar plummets) and the inflationary depression really kicks in.
Personally we lean more towards Schiff's take on things.
Schiff claims that the government and Federal Reserve have been printing money and causing inflation non-stop for decades. That's how we ended up in the massive bubble conditions that currently exist (or, in the case of the US, are in the process of bursting). More importantly there's nothing to stop the American government and the Federal Reserve from continuing this process. Schiff cites very powerful reasons for the government to continue including:
Prechter, on the other hand, claims a major shift has taken place in the last year with credit contracting and a major change attitude to avoid debt.
Prechter claims the amount of monetization so far is puny compared to shrinkage in the amount of credit outstanding and that even if all of the bad debt was replaced with 100 dollar bills it would not create inflation because it would just replace what was formally in place.
Schiff's outlook seems to be more based on data and natural reasoning about cause and effect and is more in sync with the experience of the last few decades. Prechter, on the other hand, has been more accurate on what has happened the last 18 months or so. To date Schiff has been wrong in the short-term about the dollar and inflation.
So what can we conclude?
Neither seems to understand why USA creditors (China, Japan, etc) keep buying USA debt and neither has a grip on what will trigger these nations to step back.
Yet this is the key to the current economic situation. Everyone wants to know when and/or if it will change suddenly.
Regrettably there is no clear winner of this controversy right now, although we favour Schiff's outlook.
We are nearing two crucial points that will occur towards the end of this year. They could tell us which way things are going to go.
The first is that the Federal Reserve funds for monetizing debt is scheduled to run out in October. The Federal Reserve will then either have to:
The second crucial point will come when year over year commodity prices start rising in Q4 (unless there is another crash). The Consumer Price Index (CPI) should stop falling and start rising. These events will probably keep the U.S. Dollar on its downward collapse.
Any significant resumption of CPI rise will prove Schiff right short term. Prechter's outlook doesn't really allow for this, although he gives himself test of requiring all prices to rise to new highs.
At this point we will have a clear picture of whether Inflation or Deflation lies on the horizon.
Of course, both may be wrong and the ocean of debt may be supportable. In that case the North American economy will just muddle through indefinitely, with GDP growth and super low interest rates allowing the USA to work its way out of debt (or at least sustain the debt).
Personally we don't see that happening.
The key to the whole situation is the reaction of USA creditors to the continued piling up of USA debt.
How how long will they just grin and bear it?
Ultimately that is the bottom line.
Personally we can't see any outcome other than that the USA will continue to pile up and monetize debt. Eventually this will lead to a major dollar collapse when times get really, really bad.
How to plan and prepare depends on your assessment of the situation.
We truly do live in interesting times.
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No gloom and doom today... just a story of pure chutzpah.
Did you hear about the Malibu Colony, California couple who were devastated by Bernard L. Madoff's massive fraud scheme?
They were forced to surrender their oceanfront home to Wells Fargo Bank to help satisfy a larger debt as their finances collapsed.
Wells Fargo claims that it had an agreement with the prior owner which requires it to keep the home off the market "for a period of time".
But rather than let the house sit vacant, Cheronda Guyton (a Wells Fargo senior vice president who is responsible for foreclosed commercial properties) ensured the property was... ummm... well cared for.
Local residents said a woman they believe to be Guyton, along with her husband and two children, took up occupancy in home No. 106 in Malibu Colony shortly after Lawrence Elins turned it over to Wells Fargo Bank on May 13.
The residents said the family spent long weekends at the home and had guests over, including a large party the last weekend of August that featured a waterborne arrival.
"A yacht pulled up offshore, with one of those inflatable dinghies to take people back and forth to the shore," said a neighbour. "About 20 people got taken over in the dinghy."
After a wave of complaints from neighbours flooded into the media, Wells Fargo announced an investigation.
Yesterday the results of that investigation were released. "Our investigation concluded a single team member was responsible for violating our company policies," the San Francisco bank said in a statement. "As a result, employment of this individual has been terminated."
Hey... I'm sure it was fun while it lasted.
Last week we commented on how it was inevitable that interest rates were going to rise whether the Bank of Canada or the Federal Government wants it to or not (see Denials and Delusions).
The reason? Higher yields in the bond market (which is 14 times larger than the TSE S&P) translate within days – sometimes hours – into higher mortgage rates for consumers. And this happens whether or not the Bank of Canada has moved its overnight loan rate.
Need proof?
You may recall several news articles trumpeting that mortgage rates fell last week.
At TD Canada Trust, a five-year closed mortgage drops three-tenths of a percentage point to 5.55%. At the Royal, the five-year closed term falls three-tenths of a point to 5.49%. At BMO, a five-year loan also falls to 5.49%, but that represents a drop of .36 of a percentage point. These are all posted rates. The big banks typically offer discounts of at least a full percentage point on most closed mortgages.
But what prompted the drop?
Did the Bank of Canada lower it's historic rock bottom rate of 0.25%? Did the Federal Government put pressure on institutions to trim down rates?
Nope.
As CBC noted in their article, Canadian banks chopped their mortgage rates across the board by up to a third of a percentage point because the cost of borrowing in the bond market fell.
The Bank of Canada and the Federal Government had nothing to do with it.
Remember that because what can go down without intervention, can just as effortlessly go up without intervention. And if the cost of borrowing in the bond market rises, interest rates will shoot up instantly.
And the Bank of Canada or Federal Government won't have a say in the matter.
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Bob Rennie, dubbed Vancouver's Condo King, is known across Canada as the real estate wunderkid.
Considered the #1 Condo Project Marketer on the wet coast, Rennie has been the penultimate real estate bubble booster. Last year he even revealed his 101 Reasons You Should Buy Today in the Vancouver Marketplace.
What a difference a year makes.
In a stunning article in BC Business Magazine, Rennie has penned a column titled "Lowering the boom: Are the good times over for Canada's most privileged generation?"
It's a question Rennie answer's in no uncertain terms.
"The financial crisis that broke loose a year ago is not just a temporary setback; it’s one of those defining generational events that alter behaviours and attitudes forever."
Rennie forsee's a dramatic shift in our consumer society.
"Many of us have long presumed that a big inheritance was going to be coming down the pipes – a legacy from Ma or Pa that would clear the deck of any debts and solve all post-retirement problems. Yet this market meltdown, which has seen a huge erosion of our mutual funds, pensions and stock portfolios, has affected grandma too. Her portfolio – as conservative as it is (or was) – got whacked, and now she’s being forced to dip into her savings. Our inheritance."
And what does Bob see as the future for real estate?
"The early warning signs of the new, more frugal world order are everywhere... in the real estate world, we’re going to have to recognize the new reality and start looking at boomers differently."
Rather than Boomers shooting the moon on real estate purchases, Rennie correctly sees a massive scaling down, "selling the house and finding something smaller and more affordable, either to pay off their debts or to increase their cash position."
That, by the way, is one of the doomsayer predictions of the real estate bears: Boomers downsizing.
The theory is that, as the market begins to flood with all the huge 'McMansions' for sale by aging Boomers, the much smaller 'echo' generation will not be able to absorb all the inventory.
Result? A severe decline in prices.
It's a stunning about face for Rennie, whose company is currently marketing the Woodwards development in the seedy downtown east side. 'Be bold or move to Surburbia! The wait is finally over...' goes the marketing slogan. It appears Rennie is not quite as bold (or as bullish) as the ad copy and predicts a massive demographic shift in priorities.
"We’ve experienced the biggest financial collapse in our lifetime. We will have to institute dramatic changes in how we entertain ourselves, where and how we travel, what we drive, where we live and how we ultimately pass on wealth to our children."
Not only doesn't Bob see the economic recovery taking hold in the same way as the rest of the real estate community, Rennie is downright pessimistic about what he does see.
"For those praying for a return to yesterday, forget it. It’s gone."
This is an earth shattering statement from someone like Rennie.
Bob clearly knows that the bubble is about to burst and that the ever-expanding real estate growth of the last decade is going to come to a crushing end.
I just never thought I would ever see the likes of Bob Rennie publically admitting it.
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If the impact of looming huge government debt servicing isn't enough to raise your concerns about future huge interest rate hikes, then maybe this will.
Alan Greenspan has finally come out to warn against the other pending threat: government stimulus.
Finance ministers and central bankers from the Group of 20 economies met on Saturday and pledged to maintain policies designed to support economic growth (aka: more fiscal stimulus).
But Greenspan echos what we have been saying here for months... taking away the economic punch bowl in a democracy, particularly during times of high unemployment, can be very, very difficult to do. And with a recovery appearing to start, a continuation of the current policy will only fuel a surge in inflation.
Enter Alan Greenspan;
"The US economy may witness double-digit inflation in a few years unless the central bank tightens up its monetary policy," Alan Greenspan warned.
"Unless we roll in this whole degree of expansion, we will be in trouble,” the former chairman of the Federal Reserve told a conference in Mumbai via videoconferencing. “I am not talking 3-5 per cent inflation, I am talking double-digit inflation in the US.”
And double digit inflation will trigger double digit interest rates.
Greenspan predicted that inflation in the US could begin to pick up sometime in 2012 unless measures were taken to roll back the huge monetary base now.
But on the same day that Greenspan uttered this warning come reports that the job outlook hitting it's worst level ever in the United States.
Further disuading political action to end the stimulus are reports that consumer credit fell by a record $21.6 billion, or 10 percent at an annual rate, to $2.5 trillion. According to a Federal Reserve report released yesterday in Washington credit fell for a sixth month, the longest series of declines since 1991.
Politicians won't want to halt the flooding of cash into the system. It's a toxic mix: huge debt to be financed and looming inflation; a concoction that can only trigger sky-high interest rates for years to come.
And sky-high interest rates - as we have clearly spelled out this week - will devestate the Lower Mainland housing market.
Which, by the way, brings us to another Greenspan quote that is almost tailor-made for Lower Mainland real estate bugs. In a one-year anniversary special on the financial crisis this week, Greenspan told the BBC, "Financial crises are all different, but they have one fundamental source. That is the unquenchable capability of human beings when confronted with long periods of prosperity to presume that it will continue."
Gee Alan, are you questioning the mantra that Real Estate in BC will keep going up, up, up?
Nahhhh, couldn't be. The future looks bright for BC real estate, right?
Maybe we shouldn't be pointing out what appears so obvious.
As one reader said to us in a recent email, perhaps we're being too negative here with our 'whispers'.
Perhaps we should stick our fingers in our ears and chant "la, la, la, la, la" to all the signs we can clearly see around us.
"La, la, la, la, la."
There... doesn't that feel better?
I mean, why prepare for what's coming. The BC and Canadian government's will bail us out if real estate collapses, won't they?
"La, la, la, la, la..."
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Won't our government keep rates low now to prevent a catastrophic collapse of the economy and the real estate industry?
Others make similar arguments centered around the belief that the Bank of Canada (or a Conservative or Liberal government) won't ever allow interest rates to rise because of the harm it would do to the economy.
Nice sentiment. The problem is... the Bank of Canada or the Prime Minister won't have a say in the issue.
For the past 10 years, the Bank of Canada (and other western central banks) have been able to 'stimulate' the economy by lowering their own central rates. But we now face a looming crisis that cannot be controlled by manipulating by the central bank rate: the crisis of debt.
The latest forecast by Dale Orr Economic Insight realistically concludes the Canadian Federal Government is about to add $160 billion to the national debt. That means Canada’s debt will soar to $620 billion within seven years. The deficit this year alone will be between $47 billion and $50 billion.
To properly appreciate what this will do to interest rates, we must understand how our nation funds it's debt.
Coincidently, Garth Turner just wrote about this last night. I defer to his excellent summary:
That's why rising interest rates are inevitable. It will be the only way America, the U.K., Canada et al can procure the necessary funds to finance their burgeoning debt levels. And it will all happen whether the Bank of Canada or the Federal Government wants it to or not.
More significantly it won't be a 2-3 year phase either. Increased rates of 8% - 12% (or higher) will be with us for more than a decade, thus affecting all Canadians whether they currently have one year variable or 5 year fixed term mortgages.
That's why the governor of the Bank of Canada recently warned Canadians that "the age of ultra-low interest rates will be ending soon," and that "Canadians should prepare for more normal rate levels."
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On Saturday we talked about rising interest rates.
The posted 5-year bank mortgage rate has NEVER been below 5% going back over 60 years. Never... until now.
The housing bubble that has developed the past 9 years has been driven by artificially suppressed interest rates, a course of action which has intensified since the market collapse in 2008.
You can currently get a 5 year fixed mortgage rate of 3.79%, a lure which is triggering record real estate sales while we languish in record unemployment and the worst recession in 80 years.
Canadians are being sold an image that real estate has entered an age of 'affordability', but how long will that age last?
A $580,000 home with a $30,000 down payment (which is 5% down) results in a $550,000 mortgage. At 3.7% the monthly payment (including property taxes) is going to be $2,910.21.
If rates go up a measly 2%, the monthly payment jumps to $3,598.95, almost $700 per month more.
If rates return to the historic norm of 8%, our $550,000 mortgage will require a monthly payment of $4,479.35, almost $1,700 per month more than today.
The result?
The Lower Mainland will almost certainly be hit with a tsunami of defaults and foreclosures. Having already purchased the maximum they could afford at these historic low rates, who will be able to afford a jump of $1,700 (or more) in their monthly payments?
But that is only one aspect of the catastrophe that will ensue.
Consider the plight of the potential home buyer, the one who might purchased our fictitious $580,000 home with 5% down in the era of increased interest rates.
In today's market he qualifies for that $550,000 mortgage loan only because he can (barely) make the $2,910.21 monthly payment at 3.7%.
When interest rates rise, he can still only afford to qualify for a mortgage where he pays approximately $2,900 per month.
The only way he can buy that $580,000 home is if the price comes down - dramatically.
If interest rates rise to 8%, The maximum mortgage he can afford will be $365,000. Factor in his 5% down payment, and that $580,000 home must be reduced to $385,000 if it is to sell to our buyer.
That's a reduction of almost 40%!
If interest rates rise to 12%, the selling price of that home must drop from $580,000 to $274,000, a reduction of almost 50%.
And if interest rates creep back to 15% or higher - just like they did in 1980, '81 and '82 - the selling price of homes in the Lower Mainland will have to drop by 60 - 75% if they are to sell to buyers who must assume large mortgages.
When you combine all of these factors: (1) buyers from the last four years who will default and be foreclosed on as rates start to rise, (2) banks selling foreclosed properties for whatever they can get, (3) potential buyers who will only be able to secure mortgages for 40% - 50% less than the current 2009 market values, and (4) a second surge of inventory from homeowners who can still make payments at the higher rates but who will then default because plunging property values have rendered their bloated mortgages un-renewable...
And you have a potential storm that could utterly devastate the Lower Mainland real estate bubble.
It all comes down to this.
Do you believe interest rates will remain at these historically low levels for the next 35 years?
If the answer is yes, then buying in the current market is a smart move.
If the answer is no... then you can clearly see how the Lower Mainland is being set up to to suffer the mother of all housing collapses.
Which brings us to this interesting article in today's London Telegraph newspaper, Interest rates 'could rise sharply early next year' – and by more than in previous cycles.
Under these circumstances, plucking the cheese from the Lower Mainland's mortgage traps is nothing short of Mission Impossible.
Happy Labour Day!
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