The Secret of Oz

Had a chance to watch "The Secret of Oz: Solutions for a Broken Economy" last night.

Interesting.

It's a follow up film by Ben Still to an earlier work titled, "The Money Masters: How Banks Create the World's Money".

In 'The Secret of Oz', Still argues that the United States is headed for a deep depression unless lawmakers address the root of the problem: mounting interest payments on the national debt.

Still wonders if the solution to America's economic troubles can be found in the pages of L. Frank Baum's "The Wonderful Wizard of Oz"?

It is well known in economics academia that "The Wonderful Wizard of Oz" – written by Baum in 1900 – is loaded with powerful symbols of monetary reform which were the core of the Populist movement and the 1896 and 1900 presidential bids of Democrat William Jennings Bryan.

The yellow brick road (gold standard), the emerald city of Oz (greenback money), even Dorothy's silver slippers (changed to ruby slippers for the movie version) were symbols of Baum and Bryan's belief that adding silver coinage to gold would provide much needed money to a depression-strapped, 1890s America.

Still's film picks up on Baum’s symbolisms and spells them all out – The yellow brick road, the silver slippers, the Emerald City, the mindless Scarecrow, the heartless Tin Man, the cowardly Lion. Even the witches and flying monkeys have meanings.

Still attempts to present a way the United States can rise up from unworkable debt based math and return quickly to a prosperous future. For Still it requires "pulling back the curtain on America's financial history and viewing it as it is, not how the men behind the curtain box it and present it."

The film focuses on the belief that the people - not the big banks - should control the quantity of a nation's money. The bottom line: No More National Debt.

All money is created out of debt, but nations don't have to borrow money from banks. Sovereign nations can create their own money - debt free - just as Abraham Lincoln did.

The premise is routed in the actions taken by US President Abraham Lincoln.

The film is doing very well on the film festival circuit. It's been accepted by 8 film festivals and has won at 3. It won the Silver Sierra Award for Excellence in Filmmaking at the Yosemite Film Festival, the Award of Merit at The Accolade Competition in La Jolla, California and the Silver Screen Award at the Nevada Film Festival.

It's worth taking a look.

The film is available on Amazon.com and is popular enough that it has found it's way on to other forms of exchange.

It you get the chance, check it out.

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Sunday Funnies - December 20th, 2009

(Click on image to enlarge)

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Get Ready for Real Estate to Really Catch Fire

Sound incredible?

Consider....

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

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

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

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

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

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

And their actions have been wildly successful.

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

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

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

The Conservatives have done this once already.

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

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

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

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

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

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

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Financial Heroin

This could possibly be another double post day (aren't you lucky) so check back later today if you are so inclined.

I came across this on Zero Hedge and had it emailed to my by a faithful reader. For those of you who are interested, it is today's 'must read'.

It's titled 'Financial Heroin' and comes to us from Don Coxe Advisors LLC, distributed by BMO Capital Markets on December 16th, 2009. The full report is below for you to peruse.

Here are some condensed comments:

• If Ben the Heroin Hero stops the infusions in time, he will deserve to be mentioned in the same breath as Paul Volcker—a real hero….
  
  Because he will have done the brave thing—at the risk of the loss of his job and of the Fed’s independence.
  
  Already the Pelosi Congress is considering legislation that would (1) subject Fed monetary policies to review by the Congressional Budget Office, and (2) strip the Fed of its supervisory authority over financial institutions, handing that power to a new agency created by Congress—presumably in the image of its Creator. The same politicians who applauded so vigorously as Fannie and Freddie debased the lending requirements for mortgages and expanded their balance sheets so recklessly, now seek to apply that expertise to supervision of the entire banking system.
  
  Last week, Volcker, the man who has done more than anyone in modern history to design and deliver sound regulation to international banking, told a London audience what he thought was good and what was bad about today’s banks.
  
  Volcker said the “single most important contribution” they’ve made in the last 25 years was introducing ATMs. ATMs meet, he said, the test of being “useful.” Apart from that, he had nothing good to say about commercial banks that behaved as investment banks. He agreed with the head of Britain’s Financial Service Authority that such banks are “socially useless.” He said derivatives, such as credit swaps and collateralized debt obligations, had taken the economy “right to the brink of disaster.” He noted that the economy had grown faster during the 1960s when such instruments didn’t exist.
  
  One shocked member of his financial audience challenged his dismissal of modern finance, and the magisterial Volcker huffed, “You can innovate as much as you like, but do it within a structure that doesn’t put the whole economy at risk.” He reiterated his support of Soros’ view that “proprietary trading should be pushed out of investment banks to hedge funds where it belongs.”

On weapons of financial mass destruction:

• Volcker is right. The collateralized debt obligations, collateralized mortgage-back securities, and other computer-spawned complexities and playthings were not the solutions to basic needs in the economy, but to unslaked greeds on Wall Street. Without them, banks would have had no choice but to continue to devote their capital and talents to meeting real needs from businesses and consumers, and there would have been no crisis, no crash, and no recession.
  
  Bernanke would doubtless concur, although he doesn’t dare say so in public. He is engaged in a multi-trillion-dollar rescue operation to save the global economy from collapsing under the weight of toxic derivatives and bad trading bets.
  
  When will he take the risk of stemming the heroin flow?
  
  As the 1970s demonstrated, the longer central banks wait to scale back on above-trend money growth, the worse the ensuing inflation — even when the economy slides back into recession. It would seem that the appropriate year-end advice for levered bettors on US stocks and corporate bonds is, “Enjoy yourself, it’s later than you think.”

Lots has been spent: yet it is seemingly never enough:

• After previous deep recessions, the snapbacks were dramatic, as inventory liquidation turned to inventory accumulation, and layoffs turned to callbacks. Despite all those trillions spent and all that monetary stimulus, the US economy has moved only from the critical care ward to the ambulatory convalescent wing.
  
  With winter coming on, Bernanke, Obama & Co. could soon be of the same view as the despairing Lady Macbeth: “Nought’s had; all’s spent.”

And how to invest in the face of an endless bubble:

• In brief, as long as you don’t try to delude yourself that you’re a value investor when you’re buying the typical non-commodity and cyclical components of the S&P or the Russell 2000, you can console yourself in the knowledge that this particular bubble may not be ready to burst for some months.
  
  However, the amount of Bernanke pumping needed to keep it afloat is increasing, which suggests even he can’t keep this bubble alive much longer if the real economy fails to take wing. Despite a huge upside breakout of the Monetary Base in the past two months, the S&P has moved up just a tad. Even that move is suspect, because it has been accompanied by a plunge in short sales of non-financial stocks, and lackluster volumes.

Here is the full report...

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Santa Baby?

Double dipping today so you get two posts for the price of one (make sure to see the post below this one on 79.9% interest rates).

Wandered over to Garth Turner's site and caught this post on Economic Forecasting.

Garth is very bullish on the strengthening of the US dollar. He opines that with all the troubles in the world (Dubai, the European basket cases of Greece, Italy, Iceland et al), the US dollar is still the global reserve currency and perceived to be the safest of safe havens offering total liquidity and shelter from debt storms.

He insists there will be no double-digit inflation in the States, "no matter how damn much money they print" and that the US dollar will strengthen based on a growing realization stateside about the severe threat presented by the continuing accumulation of debt.

Turner notes there is "a growing political appetite to (a) raise taxes and (b) slash Washington’s spending. In some form, both of these will happen, especially if Republicans win a few key seats next year. This will be very bullish for the greenback, even though it means more years of slow growth."

Turner also says that Washington has hundreds of billions in bonds to sell each year – the majority to offshore investors. Thus the US has a huge incentive to stabilize the dollar and the easiest way to do that is with monetary policy and a quick little rate hike.

But will that do the trick? Or is there a looming problem that Bernanke and Co. have failed to plan for?

We've talked about it here before, the fact that the United States (and other western governments) need to borrow a massive amount of money to fund their deficits.

Interestingly, the Governor of the Bank of China just came out with a couple of thoughts on that issue.

He said that it is "getting harder for governments to buy United States Treasuries because the US's shrinking current-account gap is reducing the supply of dollars overseas."

The economic crisis of the last year has played havoc on global trade.

And with with every country (especially China) keeping things going by printing money and implementing stimulus projects of their own to build bridges, roads and other internal projects; those countries are running out of non-domestic cash.

Internal infrastructure stimulus projects may fill the void at home brought about by the collapse in global trade, but they don't bring in western cash.

Exports do. And China's exports are down dramatically.

Without vibrant global trade, there aren't enough US dollars flowing in.

Where do you think China has been getting all those US dollars to plow into buying US Treasuries?

This is about to become a huge, critical issue for the United States. Now that Treasury monetization is ending, the US needs to constantly find foreign buyers of its debt to fund unsustainable deficits.

Foreign buyers who have US dollars.

According to Shanghai Daily, this could be a big, big problem.

Bank of China's Zhu Min said,

• "The United States cannot force foreign governments to increase their holdings of Treasuries. Double the holdings? It is definitely impossible."
  
  "The US current account deficit is falling as residents' savings increase, so its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world. The world does not have so much money to buy more US Treasuries."

And that's the crux of it: in cranking up the printing presses to create trillions of assorted securities, the US Treasury has soaked up the world's dollars.

And since US banks are sitting on all this money in the form of bank excess reserves and not lending, these excess reserves can not be used to buy Treasuries and MBS. This would be literal monetization as opposed to the figurative one which is what Quantitative Easing has been.

Since none of the money is flowing out to the world (aka China), the world is running out of dollars with which to buy Treasuries.

Holy Catch-22, Batman.

This looming problem is discounted by some critics who point out that China still has trillions in foreign exchange reserves.

But China has been selling mortgage backed securities at a furious rate... and it hasn't been buying treasuries. China's Treasury holdings have been flat at exactly $800 billion since May 2009. China has been doing what millions of high frequency traders have been doing: focusing on short term investments which can be liquidated instantaneously.

In essence Zhu Min is saying that the US should no longer rely on China for funding its bottomless deficits. And because of that Zhu told an academic audience that it was inevitable that the dollar would continue to fall in value because Washington would continue to issue more Treasuries to finance its deficit spending.

If that's the case, things are about to get much worse as the Fed has no choice but to turn the monetization machine on turbo... a development which will drive the US dollar far lower than anyone cares to admit.

Garth Turner insists the US will never allow it's dollar to drop, but America may not be able to control that destiny anymore.

Ertha Kitt crooned in her holiday classic, "I'm filling my stocking with a duplex, and cheques... sign your 'X' on the line"

But it appears China has no plans to hurry down the American chimney tonight.

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How about a credit card rate of 79.9%?

If you though a credit card interest rate of 39.9% by Capital One in the US sounded outrageous, try 79.9%.

According to USA Today, First Premier Bank is skirting new regulations intended to curb abusive practices in the industry by employing a strategy other subprime card issuers could start adopting to get around the new American rules.

In the past a company like First Premier would levy a minimum of $256 in fees in the first year for the privalege of using their credit card with a line of credit of $250.

Starting in February, changes to American law will cap such fees at 25% of a card's credit line.

So what are the weasels are First Premier Bank going to do?

In a recent mailing for a preapproved card, First Premier lowers their fees to the legal limit (charging $75 in the first year for a credit line of $300).

But the new law doesn't set a cap on interest rates so First Premier will rachet up their APR from 9.9% to 79.9%.

[For a $300 balance, a cardholder would pay $20 a month in interest]

"It's the highest on the market. It's the highest we've ever seen," said Anuj Shahani, an analyst with Synovate, a research firm that tracks credit card mailings.

The bank said "no final decisions" have been made regarding any rate changes for existing cards, but you can well imagine a sense of panic developing in any consumer who has one now with an outstanding balance.

The offer from the bank states there are no hidden fees that aren't disclosed in the attached form. That's where the 79.9% interest rate and $75 annual fee are listed. There's also $29 penalty if you pay late or go over your $300 credit limit.

And they hasten to add that they guarantee a 60-second status confirmation and that "... you might have less-than-perfect credit and we're OK with that."

LOL... gee, I wonder why.

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O tidings of comfort and joy...

You may have seen them if you occasionally read the comments section of this blog.

Some like to chide me for being so negative and repeating, ad nausem, my warnings about debt and rising interest rates. The number of comments pale in comparison to the dozens of the emails I get on that theme, but I love to read them.

So it makes me wonder if similar letters and emails are now being sent to Bank of Canada Governor Mark Carney.

'Cause let's face it... his public statements lately are inter-changeable with the posts of those in the blogosphere.

And yesterday the Governor had more tidings.

Speaking to a business audience in Toronto, Carney delivered this clear and unequivocal warning to Canadians:

• "Responsibility starts with the individual. Our advice to Canadians has been consistent: We have weathered a severe crisis—one that required extraordinary fiscal and monetary measures. Extraordinary measures are the means to an end: the return to the ordinary. Although we expect the recovery to be gradual and protracted, these measures are working. Ordinary times will eventually return and, with them, more normal interest rates and costs of borrowing. It is the responsibility of households now to ensure that in the future, when the recovery takes hold and extraordinary measures are unwound, they can still service their debts."

As we are found of reminding faithful readers, 'normal' interest rates over the last 20 years mean a rate of 8.25%.

Yikes.

The implications for many recent homebuyers in the Village on the Edge of the Rainforest who have taken out variable mortgages at rock-bottom rates and maximized the amount they could borrow are clear: any rise in interest rates risks putting a financial squeeze on a large number of debt-laden Vancouverites.

Even the Mortgage Brokers Association of B.C. is starting to take notice as they said yesterday that, "Canadians are potentially leaving themselves wide open for significant financial obligations once interest rates begin to rise."

Really, who could have known?

But it didn't end there. Carney once again focused on a fact we quoted yesterday from The Globe and Mail:

• "The ratio of mortgage debt to household incomes in Canada recently hit a record 70%, up from 65% a year ago. And 40% of home buyers are opting for short-term, variable-rate mortgages, which will eventually ratchet up, leaving some owners in deep financial trouble."

To this Carney told Canadians that the nation “must be vigilant” in containing the threat rising rates would have on increasing the debt-servicing costs for Canadians who have taken on increasing levels of debt.

Sorta rings hollow because what is coming is serious business and I think it's too late to be 'contained'.

Consider the bold prediction earlier this week from economist and author Jeff Rubin. He predicted the jump in interest rates could be as steep as 3% to 4% over the next two years as the Bank of Canada struggles to contain inflation caused by increasing energy costs.

3% - 4%! Yikes again.

That type of increase could add up to $1,000 to the monthly payment on a $400,000 Vancouver mortgage.

And everyone I know that has bought a house in the last three years is carrying much more than a $400,000 mortgage.

None of them can afford even a $500 increase in their monthly payments, let alone $1,000 or more.

While the Globe and Mail can publish joyous, helpful little articles like this one that urges Canadians to "Wrestle Down That Debt While You Can", the reality is that its too late, the damage has been done.

Maybe that's why Carney had this Christmas message for banks:

• "Similarly, lenders have responsibilities. Financial institutions should actively monitor risk stemming from households and not take false comfort derived from mortgage insurance and past performance of household credit. As our simulations suggest, the overall credit profile of Canadian households could well shift if debt continues to grow at current rates."

Oh... it will shift alright. And it's going to create a dire situation for banks. Under one of Carney's 'stress test profiles', the BOC hypothesises that:

• "the consequences for financial stability from the potential impact of a more severe economic downturn on households could result in a hypothetical increase in unemployment that could produce loan losses for financial institutions representing about 10% of their Tier 1 capital."

And as faithful readers will recall, Sprott Asset Management predicted that if the Canadian banks’ tangible assets were to drop by 3%, their tangible common equity would effectively be wiped out.

Double Yikes!

But bloggers have seen this scenario coming all year. And did anyone catch American Karl Denninger on BNN yesterday?

He was asked to be on the Canada's Business News Network to talk about housing. After his appearance he wrote about it on his blog:

• "[I did] a bit of research after the show [and] I came up with the following....
  
  Canadian family income as a whole ("families of 2 persons or more") is allegedly $70,000 (approximately.) The average house price? $325,000.
  
  That's a multiple of 4.64, or dramatically into bubble territory (the maximum for affordable housing is roughly 3x, so this is 154% of the maximum!)
  
  It's worse in places like Vancouver - there the ratio is over 10 (!) for single-family homes and about 8x for all residences.
  
  Let me be clear, strictly on the numbers: Canada is in for a housing bust WORSE THAN OURS.
  
  Beware Canadians..... you can argue over the timing of the outcome here, but if you think the 'bad event' won't happen and act on that belief, don't cry when a year or three down the road I start piping up with 'I told you so!'

And some think I'm too negative when I call for a collapse of over 40% in the value of Vancouver houses and over 50% in the value of Vancouver condos.

God rest ye merry gentlemen... Let nothing you dismay.

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Hark how the bells, sweet silver bells, all seem to say... throw cares away?

Another day and another flurry of Canadian housing bubble stories in the mainstream media.

Among the treatsies yesterday was this Globe and Mail offering titled 'Housing Market Has Big Cracks' which tells us, "it is probably a real estate bubble that will eventually burst - two years after the rest of the world... Too many appear to be blindly following Americans down a path of excessive debt, enticed by low rates."

Oh my!

Even worse are the statistics that follow.

"The ratio of mortgage debt to household incomes in Canada recently hit a record 70%, up from 65% a year ago. And 40% of home buyers are opting for short-term, variable-rate mortgages, which will eventually ratchet up, leaving some owners in deep financial trouble."

Meanwhile the Montreal Gazette notes that we have gone 'From Great Depression to Bubble of a Bubble' in a span of only 12 months.

You don't say.

And with all these mainstream media musings, we should expect to see the regular cast of R/E apologists moving to crank it into overdrive to counter all this 'negative talk', shouldn't we?

Enter stage left...

First up: Canadian Real Estate Association economist Gregory Klump.

He pooh-pooh's the chatter and reminds us that "consumer confidence has been increasing."

Really? What about record levels of unemployment?

Balderdash says he.

In the United States they may view 10% unemployment as starting down the road to economic apocolypse, but our buddy Klump sees the glass as half full.

“If we have 10% unemployment, that means 90% of people are employed,” Klump said. “People are re-entering the market – they have the confidence to take advantage of bargain-basement prices. There's been a release of pent-up demand, and that has a long time to play out. Prices have gone as low as they are going to go.”

There you go!

Next comes the discrediting of the naysayers.

Towards the end of the Gazette article referenced above comes this little tidbit:

"One senior real estate industry veteran, who asked not to be identified, wonders whether economists are now calling for a crash to grab themselves headlines. 'They are all piling on the bubble story now,' he said."

Spotlight hogs, one and all.

The best of the week comes from our old friend Phil Soper, president and chief executive of Royal LePage Realty.

They conducted a survey of 1,225 Royal LePage real estate agents and brokers across Canada.

[No pesky, headline-grabbing, negative economists in that group]

Tell us Phil... what did your survey of folks with a vested interest in real estate 'consumer confidence' reveal for us?

Well... real estate agents/brokers tell us "20% of agents and brokers said they are not hearing any concerns from buyers."

[Gee. 20% of buyers believe they are doing the right thing. Does that mean 80% of agents and brokers are hearing buyer's say they are making the mistake of their lives? I digress, back to Phil...]

"Buyers remain nervous about the economy but few believe house prices will drop again."

[Hmmm... no jobs, no money, and 80% of buyers believe they are screwing up royally but they conclude real estate prices will keep going up. With that sort of irrational logic at play, I now understand why there are so many people buying]

"Canadian real estate markets are enjoying a strong recovery as 2009 draws to a close and appear poised for healthy growth in 2010. Our survey shows that consumer confidence is edging towards normal levels.

[Now... just to keep things straight... that's the same survey that says only 20% of buyers have no concerns about the economy?]

"Canadians clearly believe that the worst of the recession is behind them and that the real estate market is on the path to sustainable recovery."

[Wow... that's quite the leap]

"The most obvious sign that market conditions are improving is found in the significantly higher unit sales volumes. That said, we have seen some significant recent increases in home prices, which is unusual at this time of year. Paradoxically, the recession is contributing to the unexpected rise in year-end house prices. On one hand, Canada's low interest policy has stimulated demand. On the other, many Canadians who might otherwise feel comfortable putting their homes on the market don't yet have the confidence in the state of the economy's recovery to list their homes, which is contributing to the current supply shortage."

Sooo... the nervousness of the shepple had created an artificial shortage of housing which has duped a certain percentage into engaging in bidding wars for the reduced supply which has, in turn, created a sense of recovery?

Thanks for clearing that up for us, Phil.

The bottom line is that Phil has chatted with his coworkers and their enthusiasm conclusively proves we "are on the path to sustainable recovery".

Marvelous. Let's summarize Sopel's holiday message to Canadians, what is he telling us?

That realtors and brokers all seem to say... "throw cares away!"

How festive of them. I'll retire to bedlam.

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Do you see what I see?

It seems articles on the Canadian housing bubble are starting to pop up everywhere in the mainsteam media.

Yesterday there was this one by David Rosenberg, chief strategist for Gluskin Sheff & Associates Inc, observed that "if being 15% to 35% overvalued isn't a bubble, then it's the next closest thing."

Meanwhile Bank of America Merrill Lynch, in its 2010 investment outlook, warned that Canada was "likely inflating a housing bubble" and that the "Bank of Canada may be underestimating the inflationary impact of a red-hot resale market."

So what do you know... it has become fashionable to acknowledge the presence of the 1,000 pound gorilla in the room.

Now what?

Yesterday's post covered off how both Carney and Flaherty aren't about to do anything about it.

And their inaction comes just as we learn that Canadian household debt has hit 145% of disposable income. Not only is this an all-time record, it's more debt than families in the United States had in 2006 when their real estate market collapsed.

Even more disturbing is the fact that, relative to incomes, Canadian housing prices are higher than they were in America when their R/E market collapsed.

The reality is... our situation is not all that much different than what America was facing. And, as has been posted numerous times on this blog, the factor that looms as the lynchpin for disaster is that our emergency, record-low mortgage rates are producing the exact same effect as teaser rates did on US mortgages.

Which brings us to this interesting little story in the Wall Street Journal.

Brian Fitzgerald, a WSJ writer, finds himself in the same position that one in four American's with a mortgage is in: he is underwater.

And the way he looks at purchasing a home now is dramatically different than it was when he made the decision to buy in 2006.

Do Canadians today see things the way he saw them in 2006?

Fitzgerald's New Jersey house is currently worth about $30,000 less than the current balance on his mortgage.

Fitzgerald stresses that he was not a home flipper or boom-era borrower who opted for an exotic loan with no documentation. In buying his house, he was making "a life decision."

Fitzgerald, you see, is remarkably similar to so many Canadian families who have purchased a home over the past three years. And his comments on how he came to be in this significant underwater position should send chills down the spines of those Canadian families.

• "We started thinking about buying in 2004... we probably could have held out a few years in our sizable apartment in Metuchen, N.J., a bedroom community about 35 miles outside of New York City. But we knew interest rates were hovering at historic lows. It was impossible, working at The Wall Street Journal, to not read those headlines every day. At the same time, people all around me were buying homes and refinancing their mortgages to capture these relatively inexpensive home loans. It was like a race, and everyone else was crossing the finish line while I was still putting on my sneakers.
  
  When we started looking, one of the first things that struck me was how expensive even run-of-the-mill two-bedroom homes were–$450,000, $625,000 and more. A house going for less than $350,000 was rare, and what we found in that range would give pause to even the hardiest of fixer uppers. It was distressing. These weren't impossibly large homes either, at least not to this lifelong apartment dweller. Buying in tony Metuchen was out of the question.
  
  We weren't oblivious to the fact that people were stretching to buy homes. We were adamant about getting a fixed-rate loan. Rates really had nowhere to go but up, so why would we want an adjustable rate?
  
  We were concerned about the down payment... we [ended up] plunking down only 7% or so on the down payment. [As a result] we were faced with a steep insurance fee. I was naively insulted by this PMI – the idea that we were risky borrowers out of the box. So we opted for a "piggyback" loan, a second loan that would cover the rest of the down payment and allow us to avoid the PMI. We would pay about the same per month, and when our home's value rose, we would refinance and combine the two loans into one. A lot of the people I turned to for advice were recent homebuying colleagues facing similar questions, or longtime owners who were doe-eyed by low interest rates. I don't recall anyone saying 'Dude, wait a few years.'
  
  We negotiated a bit on the price and closed the deal in May 2006 for about $328,000 at a 6.12% rate. At the time, I didn't know that the second loan was a de facto home-equity line of credit. I knew it would be a higher rate–a little more than 2.5 percentage points higher. But the loan amount paled in comparison to the main mortgage, so I wasn't overly concerned.
  
  What we didn't foresee was home values–ours included–dropping so steep, so fast. Zillow.com now estimates our home is worth $270,000.
  
  The price drop sometimes feels like an apparition. On paper, my home is considered less valuable than what I am paying for it. In reality, it is the same home (warts and all) that I liked when I signed the papers. I can afford the mortgage and insurance payment, even with my wife at home raising the kids. That is a luxury I can't put a price on. I wouldn't call us comfortable like a nice pair of jeans, I would call us comfortable like the same pair of jeans after Thanksgiving dinner.
  
  Financial consultants would scream at me for how much of my net pay the loan sucks up. I could hold the least expensive mortgage in America, and I'd still be in trouble if I was laid off... if I knew in 2006 that in 2009 I'd be able to get the same home for a 20% discount AND still get a low rate, I never would have pulled the trigger."

Speaking to two mortgage brokers over the weekend, Fitzgerald's situation parallels the situation many Canadian buyers are in. They have also finagled their way around their downpayment by juggling finances to - for all practical purposes - borrow the money for the downpayment... similar to what Fitzgerald did.

Thousands, if not hundreds of thousands, of Canadian families are currently echoing Fitzgerald's comments in their lead up to purchasing their homes over the last three years. The similarity in the comments is undisputable.

• They probably could have held out a few years,
• They knew interest rates were hovering at historic lows,
• People all around them buying homes and refinancing their mortgages to capture these relatively inexpensive home loans,
• It seemed like a race, and everyone else was crossing the finish line while they were still putting on their sneakers,
• When they started looking, it seemed even run-of-the-mill two-bedroom homes were expensive, homes in their price range would give pause to even the hardiest of fixer uppers. It was distressing.
• They weren't oblivious to the fact that people were stretching to buy homes and they felt they had to do the same,
• They were concerned about being able to even make the down payment.
  

All those things are being said by similarly pressured home buyers in Canada today.

And mark my words... the only thing that will change three years down the road when Canadians compare themselvest to Fitzgerald's situation will be the amount their homes drop in value and how high interest rates on mortgages have shot up.

In three years many Canadians will be saying, "if I knew in 2009 that in 2012 I'd be able to get the same home for a 40% discount, I never would have pulled the trigger."

And if the market only collapses 40%, we will consider ourselves lucky.

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Follow the pea

It's the Christmas season and time to navigate the holiday party circuit.

Headlining much of the party chatter angst is every one's favorite topic - real estate.

But this year the fears and trepidation that were all too commonplace this time last year are gone. Replaced by a re-birth in speculative frenzy bordering on religious fervor.

Hobnobbing over eggnog I am amazed at how everyone is convinced that the Village on the Edge of the Rainforest has escaped the market meltdown fate of our American cousins.

R/E defenders trumpet that - despite a near Depression - real estate only suffered a modest drop in prices, prices which have since rebounded.

There is a palpable sense of invincibility growing again, a faith in the manifest destiny of the Vancouver market.

Once again I find myself holding court as the lone naysayer in a room filled with re-born real estate evangelists.

Particularly amazing is how so many have glommed onto the report released by the Federal Reserve Bank of Cleveland titled "Why Didn’t Canada’s Housing Market Go Bust?"

That report concluded that it was primarily the lack of a subprime lending industry in Canada that kept the housing market in this country from imploding. When combined with the oft-repeated mantra of the superior Canadian banking system, it is stunning to see how it has people gushing again about a non-stop, upward trajectory for real estate.

I shake my head.

First of all our vaunted Canadian banks aren't quite as secure as we may like to believe.

Faithful readers have already seen the post on the Sprott Asset Management report which clearly outlines how our Canadian banks barely escaped the 2008 meltdown.

They received $65 billion in liquidity injections from the Insured Mortgage Purchase Program (IMPP) (meaning CMHC purchased insured mortgages from Canadian banks to provide additional liquidity on the asset side of their balance sheets), the Bank of Canada provided them with an additional $45 billion in temporary liquidity facilities and there was also assistance from the Canada Pension Plan (CPP) through the purchase of $4 billion in mortgages prior to the IMPP program for a total government expenditure of $114 billion.

All five Canadian banks are levered at an average of 31:1. According to Sprott this implies that if the Canadian banks’ tangible assets were to drop by 3%, their tangible common equity would effectively be wiped out.

But despite this precarious position, Canadian banks are still facilitating mortgages for both current mortgage holders and eager new buyers whereas in the United States potential buyers struggle for financing and foreclosures reign supreme on current mortgage holders who need to renegotiate.

How can this be?

The Federal Bank of Cleveland says it's all due to the lack of a subprime lending industry in Canada.

Au contraire mon frere!

The only reason our real estate market hasn't tanked like it has in the United States is because of the way our government has intervened in this crisis.

While both countries have slashed interest rates to dirt to stimulate both the economy and the real estate market; in Canada we have also have the CMHC.

The CMHC publicly admitted that it was ordered by the Federal Government to approve as many high risk borrowers as possible to prop up the housing market and keep credit flowing.

• In 2008 some 42% of all high risk applications were approved, a 33% increase over 2007.
• Between the beginning of 2007 and 2009 Canadian Banks increased their total mortgage credit outstanding listed on their books by only 0.01% -- possibly the smallest amount of change in post WWII history.

Because of the way these mortgages are being securitized by CMHC, credit is flowing from our banks into the real estate industry. And all of these mortgages are backed by the Federal Government.

• The Canadian mortgage securitizaton market has grown from $100 billion in 2006 to $295 billion by mid-June 2009.
• CHMC plans to expand securitization of debt to $370 billion by the end of 2009 as per the conservative government request.
• CMHC indicates in its plan that it will insure $813 billion via a combination of mortgage insurance and mortgage-backed securities (MBS) by the end of 2009.
• According to CHMC figures from 2008 and 2007 it is clear that CMHC has drastically exceeded their planned figures. It is expected that $812 billion is more than likely to be a minimum target.
• At these rates of progression the Government of Canada will in effect be insuring well over $500 billion in securitized mortgages and lines of credit by the end of 2010. The Canadian Government will also have issued over $600 billion in outstanding mortgage insurance.

The Canadian real estate market is flourishing while the American real estate market is floundering because credit is flowing to homebuyers in Canada.

In the United States, it is not.

I'll repeat the key statistic again: between the beginning of 2007 and 2009 Canadian Banks increased their total mortgage credit outstanding listed on their books by only 0.01% -- possibly the smallest amount of change in post WWII history.

It means our banks aren't on the hook for all the mortgages that have been issued, the Federal Government is. That's why credit is available for real estate in Canada when it isn't in the United States.

Uncle Sam is too busy bailing out Wall Street instead of Main Street.

The reality is that our so-called 'solid' real estate market exists only because of massive federal government subsidization. The whole industry sits on a precarious foundation of quicksand that is part of an intricate shell game of asset protection being played by the Federal Government.

That's why Bank of Canada Governor Mark Carney 'urges prudence' but won't take action to raise interest rates and why Finance Minister Jim Flaherty won't tighten up mortgage lending requirements as an alternative to BOC action.

I suspect many of my fellow party-goers, those who are all too ready to ooze that elusive 'market confidence' that officials were so desperate to restore last Christmas, will not fully realize what is going on until it is too late.

Classic 'marks' in what to me is clearly a 'confidence' game.

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Sunday Funnies - December 13th, 2009

(click image to enlarge)

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Poppycock

You may recall back in October we talked about Bank of Canada Governor Mark Carney going up to Parliament Hill and using a portion of his presentation to tell our elected officials what bloggers have been saying all year - that Canadians may be getting in over their heads in the purchase of homes.

The BOC, said Carney, would be conducting an 'analysis' just to be sure.

Well... the 'analysis' is out and Carney tells us that he has concluded that household debt is now biggest risk to financial system.

Quelle Surprise!

Especially given the Sprott Asset Management Report we profiled that shows how little asset prices would have to decline in order to wipe out the tangible common equity of our vaunted Canadian Banks.

Carney, recognising the looming potential disaster, once again laid the groundwork for his mea non- culpa by urging prudence among Canadians who are borrowing at super-cheap rates today but may not be able to afford higher payments tomorrow.

The BOC used a 'stress test' to show that rising interest rates between mid-2010 and mid-2012 would saddle a growing number of Canadians with unmanageable debt loads.

"Households need to assess their ability to service these debt obligations over their entire maturity, taking into account likely changes in both income and interest rates," the bank said.

[... meaning what? Dump that house/mortgage now to some other schmuck who might also ignore my warnings before it's too late?]

To banks, Carney had this to say. “Financial institutions need to carefully consider the aggregate risk to their entire portfolio of household exposures when evaluating even an insured mortgage, since a household defaulting on an insured mortgage would likely be unable to meet its other debt obligations."

Translation: a collapse is going to hurt us all.

That said, Carney took care not to create too much concern. He was quick to stress that Canadian banks currently have more than enough capital on hand to absorb potential losses, suggesting that even the worst-case scenario in the stress test would fall short of risking a collapse of the financial system.

Uh-huh.

Interestingly the world is starting to take notice that everything may not be peaches and cream in the Land of the Maple Leaf's banking system.

The respected financial website SeekingAlpha ran a story today saying, "Who Says There Were No Canadian Bank Bailouts?"

"[Canada] essentially put $15 billion of capital into the Canadian banks that participated in [a unique] $75 billion CMHC program. How is [this funding] any different than the pref share offerings via the American TARP program, other than the fact that Canadian taxpayers didn’t receive any purchase warrants on Canadian bank shares as compensation? Let’s not forget, the TARP was originally designed to take assets off U.S. bank balance sheets so as to free up capital.

There is only a subtle distinction between injecting capital into a bank and relieving it of assets so that it can avoid a capital injection. Kind of like your Dad temporarily buying your bike from you when you ran out on money in University, and then selling it back to you six months later when you were flush from a summer job.

The notion that Canada’s 'free market' took care of itself over the past 15 months is poppycock."

So is the idea that our nation, particularly the City of Vancouver, isn't sitting on a massive housing bubble.

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Time to deck the halls

Today's a day for decking the halls, so a short post of various thoughts for you.

Ludwig von Mises was a German economist who predicted the 1930s Depression. During the 1920s he was snubbed by economists world-wide as he warned of a looming credit crisis. It's interesting to read his thoughts today.

Mises's ideas on business cycles were spelled out in his 1912 tome "Theorie des Geldes und der Umlaufsmittel" ("The Theory of Money and Credit"). Not surprisingly few people noticed, as it was published only in German and didn't exactly rate as a beach read in the Fatherland.

Taking his cue from David Hume and David Ricardo, Mises explained how the banking system was endowed with the singular ability to expand credit and with it the money supply, and how this was magnified by government intervention.

Left alone, interest rates would adjust so that only the amount of credit that is voluntarily supplied and demanded, would be used.

When credit is force-fed beyond that (call it a credit gavage), grotesque things start to happen.

Mises noted that government-imposed expansion of bank credit distorts our desire for saving versus consumption. Government-imposed interest rates (set artificially below rates demanded by savers) leads to increased borrowing and capital investment beyond what savers will provide.

Under ordinary circumstances any random spikes in credit would be quickly absorbed by the system; the pricing errors corrected and the half-baked investments liquidated, much like a supple tree yielding to the wind and then returning.

But when the government holds rates artificially low in order to feed ever higher capital investment in otherwise unsound, unsustainable businesses, it creates the conditions for a crash.

Everyone looks smart for a while, but eventually the whole monstrosity collapses under its own weight through a credit contraction or, worse, a banking collapse.

This is the critique many are leveling at Alan Greenspan and Ben Bernanke for the chain of events that has transpired since the dot com crash of the late 1990s. A severe recession was put in abeyance as the Fed interfered with the economic cycle leading to today's conditions.

Perhaps his most poignant observation Mises makes is that, "there is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a voluntary result of the abandonment of further credit expansion, or later as a final and total catastrophe of the currency system."

We keep hearing from Carney, Bernanke, et al that they cannot withdraw the stimulus because the 'recovery' is too fragile right now. And consensus is that any withdrawal will trigger a deflationary spiral.

In a week where Allan Edwards forecasts the bear market to finally bite back, when Richard Russell speculates that the next downturn will be 'vicious', and Meredith Whitney believes the US government is "out of bullets" (see yesterday's post)... well Mises makes for some interesting reading.

Better make sure that eggnog has some rum in it.

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Delusional

Last Autumn, when the markets were melting down, I made an observation that I still hold to today.

What occurred in 2008 was a significant financial earthquake and we still do not completely appreciate the full repercussions of what occurred.

I believe that statement holds true today.

It's one of the primary reasons I am still extremely bearish on the outlook for real estate in the world's most bubbly city: Vancouver.

On Tuesday we saw financial markets tumble as credit-rating agencies slashed Greece and Dubai government related debt.

Looming on the horizon will be downgrades to similar debt issued by the United Kingdom and the United States.

It has too.

The fiscal imbalances and accumulated debt that has built up from trying to rescue our economy from the financial crisis is piling onto an already massive amount of government debt.

As David Rosenberg, chief economist and strategist at Gluskin Sheff in Toronto, said yesterday, "Anybody who thinks we are through this credit collapse is delusional. It is ongoing."

That message was echoed by this week on CNBC by Meredith Whitney, a former analyst at the investment bank Oppenheimer & Co. Inc.

Whitney, who has her own firm now, is renowned for calling out the problems with banks' toxic assets before the issue became widespread.

And what she forecasts for 2010 is anything but positive.

Whitney said that she believes government is running out of ways to help the economy as the US faces major issues regarding credit and employment.

"I think they're out of bullets," she said.

Whitney keyed in on the main reason that all the improvement we are seeing is, in fact, a false recovery. Despite being able to borrow at near-zero percent interest, banks are not taking that money and putting it back into the marketplace.

Consumer lending dropped 1.7% on an annualized basis in October, the ninth straight monthly decline. Whitney noted that consumers are "getting kicked out of the financial system" as the stimulus money is cycled to the banks bottom line and feeds a speculative frenzy in the stock market.

"What's so frustrating is you have an administration that is arguing such a populist (ideology) and not appreciating all the unintended consequences that the consumer and small businesses have far less credit," Whitney said.

With consumer spending making up about 70% of gross domestic product, the inability of even credit-worthy consumers being able to be able to borrow will put a severe headlock on future growth.

And that means there will be no economic recovery - at least not on a scale both the United States and Canada need to see.

"I have 100% conviction that the consumer is not getting any better and there's not more liquidity," Whitney said.

"I don't think you can cut taxes enough to stimulate demand," Whitney said. "For a 2010 prediction, which is so disturbing on so many levels to have so many Americans be kicked out of the financial system and the consequences both political and economic of that, it's a real issue. You can't get around it. This has never happened before in this country."

When you combine a failed 'immaculate economic recovery' with a need to service massive amounts of government debt, you soon realize that we are in the midst of a huge paradigm shift in North America.

The average Joe simply does not appreciate what our economic future holds for us.

As Rosenberg said, "Anybody who thinks we are through this... is delusional.

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Get a grip

"The folks who are worrying about an early rise in interest rates should get a grip. Please."

That's the way a scolding story in the Financial Post started off (Let's relax on interest rates - December 8th)

The Financial Post wants you to know that, despite fears in the US that the job market might be strengthening, there is every indication that the Federal Reserve will keep interest rates low for at least the next six months, if not for a couple of years.

The real question, says the FP, "is whether or not the Fed's policy of low, low interest rates will encourage matching rates in Canada and promote a housing bubble in this country."

Promote a housing bubble? Sigh.

At least the article contains a nugget or two of accurate assesment. Noting the "dire condition of the U.S. economy", the Post says "our [Canadian] economy has not been hit as hard as that of the U.S. The single most notable difference is that Canadian home prices have remained stable and, in some cities, have even gone up."

Exactly. The only reason Canada is different right now is because of the irrational housing bubble. There are no strong fundamentals, there is no emerging manufacturing base building a foundation for down the road. All we have are stable home prices that have not collapsed... yet.

But with the brewing storm in Europe over Dubai, Greece and UK debt combined with an American economy that is in 'dire' straights, the requiste immaculate recovery is still a long ways off.

We've managed to juggle this charade and keep all the balls in the air awaiting a strong recovery to fill the void.

How much longer can we continue to do that?

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The 'B' Word

Today's post is brought to you by the letter 'B'.

It could be 'B' as in Bubble, as more and more people are starting to acknowledge here in Canada.

As faithful readers know, Bank of Canada Governor Mark Carney’s pledge to freeze record-low borrowing costs through June 2010 is single-handedly responsible for the stunning recovery in home prices.

'The Cabel' disputes this assertion, insisting that the state of the housing market is simply reflecting what Carney has called “an element of pent-up demand” (Carney speech to reporters Nov. 19).

“Rates are exceptionally low, affordability has improved in part because of the low level of interest rates and part because of some former price adjustments, and we are seeing a housing-price response,” said the Governor.

Pundits insist that they don’t believe that there’s a bubble, that most of the market action is from typical Canadians trying to buy their first home or move up. Rising prices? That's just an unintended consequence of the current low, low rates.

But when Canadians are waiving conditions and paying 10% (or more) than a home's asking price you know it's not a regular market - particularly when we sit in one of the worst economic times since the Great Depression of the 1930s.

The most notable thing here is that Carney insists that what's happening in the housing sector is simply an unintended by-product of his attempt to help the economy recover from its first recession in 17 years. Carney says he has given 'clear guidance’ on why he has taken the actions with interest rates he has.

“Rates are exceptionally low, they are exceptionally low for a purpose and we have given pretty clear guidance on how long we expect they will have to remain at these levels in order to achieve the inflation target,” Carney told reporters Oct. 22.

But Eric Lascelles, chief economist and rates strategist with TD Securities Inc., raises a point that more and more people finally raising. In Toronto Lascelles noted that the central bank hasn’t talked much about house prices, “to the bafflement of international investors.”

“It makes perfect sense that there is a good appetite for the housing market,” Lascelles said. What no one seems to want to address is “whether this is a bubble in the making or simply a recovery from earlier softness.”

David Laidler, a former visiting economist and special adviser at the Bank of Canada and now a fellow at the C.D. Howe Institute, a Toronto research group notes that “the worry has got to be that you might be getting a housing bubble out of this.” Laidler is a member of the institutes's Monetary Policy Council, which studies central-bank decisions and said in a Dec. 3 statement that a “possible unintended effect” of Carney’s commitment is “the buoyancy of mortgage lending, particularly variable-rate mortgages, and the housing market."

Unintended... there's that word again.

And it's that word that rankles the most.

Do people truly believe that the astonishing rebound in housing prices - with no intervention from the Bank of Canada - is simply an 'unintended' by-product of Carney's actions to recover from recession?

Maybe today's 'B' word actually stands for 'B' as in Banks.

In a fascinating report from Sprott Asset Management, the average leverage ratio of the Canadian banking system is analysed and compared.

Sprott notes that the average leverage ratio of the Canadian banking system is higher than that of the largest US banks in all periods reviewed.

Now each of the top ten US banks received common equity injections by both shareholders and the US government, thereby improving their respective leverage ratios during this economic crisis.

And the Canadian Banks?

• "Looking at the Canadian system more closely, all five Canadian banks are levered at an average of 31:1, which is actually the lowest leverage ratio during the three years that we reviewed. This implies that if the Canadian banks’ tangible assets were to drop by 3%, their tangible common equity would effectively be wiped out.
  
  Now, that doesn’t mean they would go bankrupt per se, but it does give us an indication of how little asset prices would have to decline in order to wipe out their tangible common equity. These leverage ratios worry us because they leave such a razor thin margin for error on the ‘tangible asset’ side of the leverage equation. We are always cautious about investing in companies that have zero or negative common equity - we’ve seen what happens to public companies that trade at those levels, General Motors being a good example.
  
  Acknowledging the leverage levels above, you may wonder how the Canadian banks escaped the 2008 meltdown unscathed. The answer is that they received significant assistance from the Canadian government. First, they received $65 billion in liquidity injections from the Insured Mortgage Purchase Program (IMPP), whereby Canada Mortgage and Housing (CMHC) purchased insured mortgages from Canadian banks to provide additional liquidity on the asset side of their balance sheets.
  
  Next, the Bank of Canada provided them with an additional $45 billion in temporary liquidity facilities. Finally, a Canadian Bank also received assistance from the Canada Pension Plan (CPP) through the purchase of $4 billion in mortgages prior to the IMPP program, for a total government expenditure of $114 billion."

When the Bank of Canada slashed interest rate to dirt they helped to artificially preserve real estate asset prices by creating another irrational housing euphoria in the country.

Unintended... Or a deliberate calculation to preserve the "razor thin margin on the tangible asset side" of the Canadian Banks leverage equation... a group the Canadian Government had just moved heaven and earth to protect?

Sprott goes on to note that,

• "for reference, the entire tangible common equity of the Canadian Banks in 2008 was $68 billion. Can you put two and two together?"
  
  "The Canadian government injected a sum through mortgage purchases worth more than the entire tangible common equity of the Canadian banking system! On top of that, the Bank of Canada provided more than 50% of the tangible common equity of the system in emergency liquidity facilities."

The Canadian housing market continues to baffle observers in the United States and around the world. We are daily fed propaganda that tells us that the dramatic performance of our nation's real estate during this worldwide economic crisis is all a result of the solid foundation of our nation's banks and the virtuous conservatism of the Canadian financial system.

Uh-huh.

The Sprott report is simply the latest that sumarizes the many concerns critics have had about what's happening with Canadian Real Estate, CMHC and the banking system.

Increasingly it seems we are only a couple moves away from the symbiotic relationship that exists between those two other well known 'B' words: Boom and Bust.

The 'Boom' is currently happening and observers are raising alarm bells.

Be wary. The next time you hear "give me a 'B'...", you might just see the market kick back the word investors dread the most... bust! A development which would lead to today's true 'B' word; a word that summarizes our thoughts on all this malarky about 'unintended' consequences .

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