Bank Failure Friday

As faithful readers know, bank failures in the US escalated dramatically in 2009. In 2008 there were 25.

In 2009... 140.

The 2009 total was an average of almost three per week and the most failures the United States has experienced in one year since 1992.

Because the announcement of these failures (and the actual take-over by the FDIC) are always delayed until late on Friday afternoons, Friday has come to be known as 'Bank Failure Friday' on many economic blogs.

But 2009 was just a prelude to 2010.

How do we know?

Because the FDIC has already publicly announced that they are preparing for a greater number of bank failures than in 2008 & 2009 combined.

The FDIC has set aside $2.5 billion for the handling of receiverships, almost double that allowed in 2009's budget of $1.3 billion.

The overall operation budget for 2010 has been set at $4 billion, significantly higher than that for 2009, a revised $2.6 billion.

And why is the FDIC preparing for such a huge wave of bank failures?

It's all in the chart at the top of this post (click on the image to enlarge it).

In 2006, 2007 & 2008, the defaults on a large number of resetting subprime mortgages took place (they are shown in mid green).

As the short term teaser interest rate on these mortgages can due for reset to a higher rate, homeowners couldn't negotiate a new mortgage with a new, ultra-low teaser interest rate (as they had done in years past).

That's how subprime mortgages caused the real estate collapse in the United States. Housing values fell in a few cities and when the first mortgages that came due with their ultra low interest rates (set at a two year duration before a higher rate would kick in), homeowners couldn't secure a new mortgage. In the past, because the value of the property had grown, they had always been able to negotiate a new mortgage (with a new two year, ultra low teaser interest rate).

Forced to assume the mortgage at a substantially higher interest rate - they defaulted.

As the market was swamped with a bunch of foreclosures, it drove housing values down across the USA. That triggered the same scenario with other cities subprime mortgages.

As the foreclosures picked up steam, those households with more normal mortgages were trapped because declining real estate values (from all the subprime foreclosures) meant that when it came time to renew their mortgages... they couldn't because the value of the mortgage was substantially higher than the value of the property (called being 'underwater').

No bank is going to give you a $500,000 loan on a property worth $300,000.

Now, looming on the horizon, are Prime, Alt-A, Agency and Option Adjustable Rate mortgages.

These 'normal' mortgages dramatically outnumber subprime mortgages.

Many of them are like sub-prime in that they reset at a higher interest rate, the only difference being they reset after 5-7 years instead of two.

Thus they are just coming due now.

And those who didn't have teaser interest rates that reset are facing the brutal proposition of being 'underwater'.

The end result will be the same as subprime.

The mortgages will reset to dramatically higher interest rates and/or the value of the property has dramatically fallen so renewing cannot be done without the mortgage holders bringing down the principle to the value of the property (which means paying off about $200,000 plus on renewal).

End result: another wave of defaults and foreclosures... which is what is putting all these American banks at risk.

They key element for Canadians here is that subprime was a minor player in all of this. Subprime mortgages were simply the first type of mortgage caught in the interest rate squeeze.

Look at the graph. Subprime mortgages are almost non existent in 2009 and beyond. While about 21% of all mortgage originations from 2004 through 2006 were subprime, when you add up all the mortgages due to reset from 2007 to 2015, the subprime portion of total mortgages is miniscule.

In fact, in June 2008, the total number of subprime mortgages in foreclosure or REO represent (as a percent of total housing units) less than 1/2 of 1 percent of all housing units in the United States (0.44%).

Yesterday we noted how the Bank of Canada has come out and stated that within 2 years 10% of Canadian households will be in danger of collapsing from rapidly rising interest rates.

That represents a higher percentage of all total Canadian mortgages than subprime did vs. the rest of the American mortgage family.

They are the first domino that will be affected by a dramatic change in interest rates.

And just like in the United States, when that first domino falls it can bring down the entire pack.

In Canada we don't have 'subprime' mortgages. But we do have scores of people who have taken on massive debt with ultra low interest rates that will reset. All those five year mortgages will come due for renewal. And if 10% can't handle the shock of a return of interest rates to their historic norm (over the last 20 years, that's a five year rate of 8.25%), then it means we are in a far more precarious position than the United States.

The collapse of that 10% will dramatically lower real estate values when those properties are eventually foreclosed upon and resold. When that happens, a great many of other Canadians will be in a sever 'underwater' position and will not be able to renew... further collapsing the real estate market.

In 2005 and 2006 the majority of the American financial sector ignored the looming threat these numbers represented. The only ones sounding the alarm for what was coming (and the threat it represented to the greater economy) were the likes of Peter Schiff.

In 2010, in Canada, we are just as ignorant.

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Et tu, Mark?

Pontius Pilate was the Roman governor of Judaea from 26 CE to 36 CE; in this capacity, he was responsible for the execution of Jesus of Nazareth.

According to the gospels, Pilate refused to condemn Jesus of Nazareth but was forced to execute him by a hysterical Jewish crowd. In Matthew, Pilate acquiesces to the crowd's demands and washes his hands of the entire affair, reluctantly sending him to his death.

After re-reading last Monday's Bank of Canada speech, I can't help but wonder... is Mark Carney pulling a Pontius Pilate and washing his hands of the Canadian housing bubble?

As mentioned earlier this week, a significant portion of Monday's speech was dedicated to the housing market. Canadians are reminded several times that rate policy is to be used to control inflation, and that housing is only one factor of many that affects inflation.

• “As Canada’s economic growth moves towards its potential, it is expected that a robust housing market, supported by exceptionally low interest rates, will continue to work as an important engine pulling the Canadian economy out of recession. This has implications for monetary policy, which, as I’ve said, aims to achieve the Bank’s inflation target of 2 per cent over the medium term. It’s important to remember that this target is symmetrical; that is, we are equally concerned about whether inflation is above target or below target – as we expect it to be until 2011. The revival of the housing market is one factor that is helping us to achieve our inflation target, and it is a powerful means through which monetary stimulus affects the economy. Of course, we need to keep a close eye on the housing market, along with all other sectors of the Canadian economy, to ensure that we are providing the right amount of monetary stimulus. In setting monetary policy, we view housing – or the exchange rate, the energy sector, the auto industry, or any other factor – through the prism of our inflation target.”

As mentioned in Tuesday's post, after refusing to raise the bank rate to deal with the housing bubble, the Bank of Canada then very deftly laid responsibility for the developing mess in housing directly at the feet of Finance Minister Jim Flaherty.

It came at this point in the speech:

• “An array of supervisory and regulatory instruments can be used by the government to restrain a buildup of systemic risks. These include capital requirements for institutions, leverage ratios, loan-to-value ratios, terms and conditions for mortgage insurance, and a variety of other measures. These instruments can be targeted to risks to the entire financial system that stem from particular markets or institutions.
  
  Using these instruments to safeguard the whole financial system – not just individual institutions – is the essence of the macroprudential approach. Macroprudential supervision is one of several concepts in a current global initiative to strengthen supervision and regulation in the wake of the global financial crisis. In Canada, a system-wide, or macroprudential, approach is the shared responsibility of the Department of Finance and all of the federal financial regulatory authorities, including of course the Bank of Canada, the Office of the Superintendent of Financial Institutions, and the Canada Deposit Insurance Corporation. Ultimately, it is the Minister of Finance who is responsible for the sound stewardship of the financial system.”

That last line is the killer and it begs the question... what gives?

Carney has, for the past two months, been just like a little blogosphere perma-bear with the alarms he's been sounding on the damage that will be caused by the inevitable rise in interest rates.

He's warned Canadians that they need to be 'prudent' and urged them to remember that "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."

Now, in one swift move, he's dropped all of it at the feet of the Minister of Finance.

Why?

I wonder if it has anything to do with this little gem from Monday's speech?

• “Using the current path of household indebtedness, and alternative assumptions about how quickly interest rates may increase, the simulation generates a scenario indicating that, by the middle of 2012, almost one in ten Canadian households would have a debt-service ratio that makes them vulnerable to economic shocks.”
  

The day of reckoning is coming fast and Carney can see it.

In just over 2 years, the Bank of Canada forecasts that 1 in 10 of us will be in serious debt trouble.

And when the interest rate tide changes, the Canadian financial system is going to drown all of them and pull down many others as real estate values crash.

Seeing what's coming and sensing the inevitable fallout, 'Pontius' Carney has effectively said "pass the soap."

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Bubble? What bubble?

Every once in a while it's fun to compare real estate here on the wet coast with other areas.

One of the things you hear right now is that international demand is going to keep pushing Vancouver values up, up, up.

And who can disagree. Eight months of dreary, endless rain make Vancouver a destination paradise.

And if you had the cash... would you want to live here? Or some crappy local like Hawaii?

Let's compare the two, shall we.

Hat tip to Vancouver_Bear who points out that you can currently procure this little 3 bedroom, 2.0 bathroom, 1,568 sq ft single family rancher home in Kailua. It sits on over 9,000 sq. ft. of land and comes with swimming pool, updated kitchen, indoor laundry, and mountain views.

Asking price $725,000 USD. Here are some photos...

Beauty, eh?

Or you can plunk down an extra $625,000 over and above the 'asking' price of that Hawaiian home and get this four bedroom, 1 bathroom, 1300 square foot dump which could easily pass as the local crack shack. It sits on a 1/2 acre property adjacent to the 401 freeway and just north of Canada Way (another freeway) & Sperling.

Available now for only $1,350,000.

I wonder if the ladders are included?

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Not my responsibility!

The housing market in Canada has (so far) avoided a US-style collapse because the federal government of Stephen Harper's Conservatives in 2007 directed the CMHC to dramatically change its rules to create relatively very loose lending requirements.

Those requirements combined with an amortization period that was extended from 25 years to 35 years... and extended again to 40 years.

Then, in an effort to further prop up the real estate market (when affordability nosedived), the Harper government directed the CMHC to approve as many high-risk borrowers as possible and to keep credit flowing. This happened in 2008.

These efforts combined with the Bank of Canada's historic low interest rates is what has kept the Canadian economy from crashing and has prevented calamity in the real estate market.

But now that the initial crisis has past... who is responsible for trying to clean up the mess in housing?

Yesterday Bank of Canada Governor said, "Not me!"

As we have noted on this blog, Carney knows the ultra-low interest rate policy is creating a time bomb in housing. But he can't intervene because intervention right now will destroy the fragile recovery.

So what to do?

The first step was to begin a public speaking campaign calling on banks and Canadians to exercise 'prudence'. Carney then noted the obvious and said, “consumer borrowing cannot not grow faster than the economy forever.”

He also had a warning for Canadians: "We remind people that borrowing is for the period you are going to borrow, not just for the moment you take out the loan... It's not my job to give investment advice to Canadians. But on the general point anybody, anytime they borrow for a longer period of time, wants to [ask themselves], 'can I sustain that borrowing over the course of that time? What happens when interest rates ultimately normalize?'”

But raise interest rates? Nope - the general economy can't handle that right now.

So what to do? This week we found out.

Deputy governor Timothy Lane wrote a speech delivered by an adviser on his behalf in Edmonton.

“Some observers – those who see a housing bubble forming – have said that since low interest rates have stimulated housing market activity, the Bank should now raise interest rates to dampen that activity. But that poses a problem.”

Mr. Lane said the bank understands the concern, but it uses its lending rate to keep inflation in check for the whole economy and the housing market is “only one of several factors” that influence inflation. Other sectors could be adversely affected if the rate jumped before the broader economy was ready, he said.

“If the Bank were to raise interest rates to cool the housing market now – when inflation is expected to remain below target for the next year and a half – we would, in essence, be dousing the entire Canadian economy with cold water just as it emerges from recession.”

So Lane made it clear that the Bank of Canada won't raise interest rates to cool the country's hot housing market. If any action is to be taken, it must come from the country's Finance Minister.

And Lane was specific about that action.

He said the government could increase capital requirements for lending institutions, adjust loan-to-value ratios and change the terms and conditions required to obtain mandatory mortgage insurance.

“These instruments can be targeted to risks to the entire financial system that stem from particular markets or institutions. Ultimately, it is the Minister of Finance who is responsible for the sound stewardship of the financial system.”

In one simple speech Carney has delivered a simple message.

The housing bubble? Not my responsibility.

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A slow motion train wreck...

So many topics to touch on... but only so much time in the day to sit down and talk about them.

So today I will focus on American events.

Bank Failure Friday returned last week when the FDIC released information regarding the first US bank closure of 2010 – Horizon Bank of Bellingham, Washington.

You can't really hit much closer to home (in relation to Vancouver) than Bellingham (Blaine is too small).

But it's the size and scope of the closure that is so astounding. If it is indicative of things to come it will be a very rough year for our American cousins and the FDIC.

According to the FDIC, Horizon Bank had $1.1 billion in deposits and balance sheet assets of $1.3 billion; yet the FDIC’s estimated cost to close the bank is $539.1 million.

Say wha???

That means the real market value of Horizon’s assets is believed to be about $561 million – 41.5% of the value claimed.

Ay carumba!

As has become the norm, the FDIC had to enter into a loss-share transaction with respect to $1.0 billion of the assets purchased, meaning there is significant concern the assets will turn out to be worth even less than presently estimated.

This cost of closing this bank amounted to 49% of the value of Horizon’s deposits – the highest relative cost seen so far in this crisis.

By way of comparison, the cost of closing the first three banks in this crisis (in late 2007) was about 5.7% of deposits.

Perhaps you now have a keener appreciation of the importance of the FDIC's 'Interest Rate Advisory' for banking institutions.

That's the FDIC's stern warning for US Banks to prepare to "manage interest rate risk." Soaring rates will further depress market values which will further undermine the real worth of the bank's assets and balance sheets.

It does not bode well for the year ahead and we will watch the banking developments with keen interest this year.

But banking isn't the only story you should pay attention to.

Last Friday also bore witness to the stunning announcement that another 661,000 jobs were lost in the United States.

This at the height of the Christmas hiring period.

The broad U6 category of unemployment statistics rose to 17.3% (that's adding all the Americans who did not show up in 'official' statistics because they have stopped looking for work).

That is the stat that really matters. It means that December was the worst month for US unemployment since the Great Recession began.

Can you see what is coming next?

The home foreclosure axe usually drops for homeowners a year or so after people lose their job, and exhaust their savings. After six months they drop off the unemployment rolls. Six months from now that axe will start dropping.

That's what 2010 is going to be all about Charlie Brown. And that's despite the fact that foreclosures are already setting new records.

Realtytrac says defaults and repossessions have been running at over 300,000 a month since February in America. One million American families lost their homes in the fourth quarter. Moody's Economy.com expects another 2.4 million homes to go this year.

Meanwhile commercial real estate is a disaster. Check on this article in Time magazine.

"It's not that everything's fine in the commercial real estate business. Everything's awful and will probably get more awful. But unlike 2008's Wall Street panic, this particular financial unraveling looks as if it will play out over a period of years, not weeks."

Headlining the news is Tishman Real Estate in New York City. They will miss payment on a commercial loan of over $5 billion on a massive New York apartment complex, the 2nd largest default in commercial real estate loans in history.

As this unfolds, California declares an economic emergency. They are the biggest concern but there are another 40 states in deep trouble. Hawaii can't even afford to hold a congressional election.

Meanwhile apartment vacancies hit record highs.

Really?

Riddle me this... if foreclosures are skyrocketing... and rental vacancies are soaring... where are the people going?

Does it suprise you that homelessness is rising dramatically?

And then there is consumer credit. Consumer credit in the US last month dropped a record $17.5 billion.

This despite the fact that many cash-strapped US homeowners are doing exactly what their UK counterparts are doing: "New research from Shelter, the homeless charity, [suggests] that as many as 1 million people have used their credit cards to pay mortgage bills or rent demands in the past year."

And what is that going to lead to?

"You would have to be relatively desperate, at least in the short-term, to go down this route. Many of those people are likely to end up defaulting on their credit card bills, or on their mortgages, or both," quotes the article.

Against this backdrop, does anyone really think American quantative easing is going to end in March?

All the talk about the US Federal Reserve draining the excess reserves is comical. That's why gold shot up on the weekend.

And that's why it's going to shoot even higher. Watch the next big spike to take the metal to over $1,650 an ounce.

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Sunday Funnies: January 10th, 2010

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Succinct

Yesterday's Vancouver Sun had an article that succinctly summarizes the current state of Vancouver's Real Estate bubble.

The article insightfully notes that the main trouble with real estate is that while prices are rising, incomes are not.

And the main culprit for this imbalance is that rock-bottom borrowing costs continue to lure buyers, and investors are rushing in — despite a shortage of listings — for fear that if they don't get into the market now, they'll miss their chance.

And what are the dire concerns/consequences?

From the article:

• "It's absolutely not debatable that housing prices cannot rise faster than incomes over the long term," said Will Strange, professor of real estate and urban economics at the Rotman School of Management. "Sooner or later, incomes have to rise, or home prices fall, for balance to be attained."
• "If I didn't personally have most of my wealth tied up in housing, this would not be the time that I would choose to jump in," Strange cautioned.
• "At the same time, interest rates have nowhere to go but up, which could leave some buyers in a position similar to U.S. homeowners, who had houses worth less than their mortgages after the subprime bubble burst and prices crashed."
• "We're certainly urging people to error on the side of caution," said Bruce Cran, president of the Consumers' Association of Canada. "If you're paying an amount of money, whatever that might be, that you couldn't sustain if interest rates rose by say 25 or 30 per cent — I can see that being a problem for a lot of people."
• "Don't buy [a house] because you think the price is going to go up."

Couldn't have said it better myself.

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America's Bank Failure Friday hits close to home...

It's the start of a new year, and thus a new Bank Failure Friday count.

And on this first Friday of the year, we have one lone casualty... but it hits close to home.

Not too far south of us Horizon Bank of Bellingham, Washington was closed today by the Washington State Department of Financial Institutions, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver.

As of September 30, 2009, Horizon Bank had approximately $1.3 billion in total assets and $1.1 billion in total deposits.

The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $539.1 million. Horizon Bank is the first FDIC-insured institution to fail in the nation this year, and the first in Washington. The last FDIC-insured institution closed in the state was Venture Bank, Lacey, on September 11, 2009.

Just think... housing values are booming here. And 20 minutes south of us, the real estate collapse is pulling down banks.

Bubble?

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Snapshots

Let's take a peek around the internet today, shall we?

First up is the lastest stats from the Real Estate Board of Greater Vancouver (REBGV).

December stats reveal that the bubble is blowing ever higher and the average price of a detached home in the Village on the Edge of the Rainforest now sits at an astounding $952,927.00!

(click on image to enlarge)

Will we hit a million dollars? Possibly.

Canadian Banks continue to ignore the warnings from Carney and Flaherty to be 'prudent' with lending. Offers to get you in for zero down, such as this one from TD Canada Trust, continue to exist.

And realty companies, like Royal Lepage, continue to pump the market by suggesting that buying now will result in an 7.2% increase in value of your purchase this year in the Lower Mainland... "so long as the expected mid-year rise in mortgage rates isn’t a dramatic spike."

But that's the rub, isn't it?

That's the entire essence of the warnings we have been blurting out for the past year: rising interest rates will destroy you if you buy now.

And the warnings continue unabated.

The National Post chides today that "happy times for interest rates can't last forever".

So dire is that potential problem that the Post notes that a simple 1% increase in rates could dramatically affect you bottom line. "For a home buyer, rate increases mean hefty payment boosts. For example, it will cost $3,252 more per year to pay down a $500,000 mortgage balance when the interest rate rises from 3.5% to 4.5% , assuming a five-year term and a 25-year amortization."

The 25-year amortization comment is particularly important given the fact the Finance Minister is sounding warnings that the permitted amortizations could be reduced from the current 35 year maximum. Before 2006, that maximum was 25 years.

It means those with a mortgage face the double whammy of increased interest rates plus a shorter amortization period when they renew.

A simple 1% rise in rates could translate into $3,252 increase in yearly payments on that $500,000 mortgage.

When you consider that the conservative estimation on what will happen to interest rates is that we will see a minimum of a 2.5% spike in rates, it means the cost of renewing adds up quickly.

With that theme in mind, Report on Business is also warning mortgage holders to "Fasten your seatbelts".

They suggest you have roughly six to nine months to get a personal plan together for dealing with higher interest rates.

Yikes! At least they try and offer several strategies to get ready.

And it's not just in Canada that warnings are being issued.

In the United States, the FDIC has now come out with an 'Interest Rate Advisory' for institutions.

US Banks are being reminded "of supervisory expectations for sound practices to manage interest rate risk (IRR)."

The warning is very specific:

"In the current environment of historically low short-term interest rates, it is important for institutions to have robust processes for measuring and, where necessary, mitigating their exposure to potential increases in interest rates."

The only real question is how high might it go?

And THAT, of course, turns us once again to the issue of the US Dollar and US Treasury sales to foreign countries - particularly China.

With that in mind, consider this article from 'The Business Insider' which lays out a series of charts showing clearly that "China's Dumping of the US Dollar has begun". The yellow line represets the plunging level of Treasury purchases by China.

(Click on image to enlarge)

To sell sovereign debt, the purchasing of that debt is going to have to be made very attractive.

And there's only one way to do that: increase the yield. That means higher and higher rates on home mortgages.

We've been through this before... in the late 1970s.

22% mortgages, anyone?

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More US Quantative Easing?

A report out from Reuters indicates that the US Federal Reserve is discussing re-entering the mortgage-backed securities market later this year if its buying power is needed to hold down interest rates.

The Federal Reserve is supposed to end its $1.25 trillion agency MBS purchasing program at the end of the first quarter of 2010.

Fed officials, however, "are prepared to contemplate changes if need be, depending on conditions in the economy, housing finance and in financial markets more broadly," according to a Market News story written by Steven Beckner.

"Among the options that has been discussed, say people in a position to know, is doing additional MBS purchases."

When the Fed stops buying at the end of the first quarter, rates in the market are widely expected to rise, pulling mortgage rates higher as well.

The question becomes... how long before confidence in the US dollar is lost when the massive debt is expanded at the same pace as last year?

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Fed Chairman's Non Mea Culpa

The big news yesterday was Ben Bernanke's non mea culpa for the US Federal Reserve on the housing bubble in the United States.

While addressing the annual meeting of the American Economic Association in Atlanta, Bernanke said that a lack of regulation, rather than low interest rates, was the main reason for the housing bubble which, when burst, was largely responsible for the recent global financial crisis.

Bernanke argued that the housing bubble began before the Fed pushed interest rates low and that the size of the bubble cannot really be explained by monetary policy alone.

Perhaps more importantly, however, Bernanke makes the extraordinary claim that regulatory and supervisory policies would have been effective means of addressing the run up in housing prices. What makes this claim so extraordinary is that it completely ignores the fact that regulatory and supervisory policies weren’t just ineffective at popping the housing bubble—they were actively fueling it.

“Clearly, for lenders and borrowers focused on minimizing the initial payment, the choice of mortgage type was far more important than the level of short-term interest rates,” Bernanke said.

Bernanke argues that exotic mortgages and rubbish underwriting standards that he thinks are “the key explanation” for the housing bubble. But he ignores the fact that these “alternative mortgage products” were created in response to regulatory pressure to expand home ownership.

In many ways it echos the ignorance that is going on in Canada right now.

In the United States the process looked something like this:

• Ultra low interest rates led to a scramble for yield by fund managers;
• Not coincidentally, there was a massive push into subprime lending by unregulated NONBANKS who existed solely to sell these mortgages to securitizers;
• Since they were writing mortgages for resale (and held them only briefly) these non-bank lenders collapsed their lending standards; this allowed them to write many more mortgages;
• These poorly underwritten loans — essentially junk paper — was sold to Wall Street for securitization in huge numbers.
• Massive ratings fraud of these securities by Fitch, Moody’s and S&P led to a rating of this junk as TripleAAA.
• That investment grade rating of junk paper allowed those scrambling bond managers (see #1) to purchase higher yield paper that they would not otherwise have been able to.
• Increased leverage of investment houses allowed a huge securitization manufacturing process; Some iBanks also purchased this paper in enormous numbers;
• More leverage took place in the shadow derivatives market. That allowed firms like AIG to write $3 trillion in derivative exposure, much of it in mortgage and credit related areas.
• Compensation packages in the financial sector were asymmetrical, where employees had huge upside but shareholders (and eventually taxpayers) had huge downside. This (logically) led to increasingly aggressive and risky activity.
• Once home prices began to fall, all of the above fell apart.

There was no one single factor that caused the collapse. Rather, an there were many, many failures occurring in a very specific order that contributed to what occurred.

Inadequate regulations and “nonfeasance” in enforcing existing regs were, as Chairman Bernanke asserts, a major factor.

But the regulatory and supervisory failures came about AFTER the 1% Fed rates had set off a mad scramble for yields. Had rates stayed within historical norms, the demand for higher yielding products would not have existed — at least not nearly as massively as it did with 1% rates.

In Canada we had the combination of low interest rates in the 2000's combining with the Federal Government expanding the amortization period for mortgages from 25 years to 35 and then 40 years. Direction to the CMHC to approve higher, riskier candidates and, in the last year, ultra low interest rates.

The non mea-culpa in Canada has been Flaherty and Carney coming out and warning Canadians that they have to be 'prudent' along with lending institutions... as if those above mentioned policies weren't directly responsible for what's going on.

In the US, Bernanke's failure to recognize the Fed's role in the crisis will prevent him from taking those measures needed to avoid another crisis.

In Canada, our official's artful dodging will prevent them from undertaking the harsh, short term actions now that could mitigate/diffuse the hard crash that is coming.

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Bull Speak

Welcome, dear readers, to another New Year.

With the first post of 2009 I started off this blog with the following;

"The battle between the so-called 'Real Estate Death Watch' doomsayers and the pollyanna R/E promoters reached a cresendo with the brutal crash of the Stock Market in September/October 2008... The Bears and Bulls of the Vancouver Market are gearing up, after their holiday break, for another round of cogitation to influence the hearts and minds of the Vancouver house buyer/seller."

The passsing of 12 months has done little to change that dynamic.

So let's start 2010's posts off with a salvo from one of the Bulls.

Meet James Schouw, Chairman of James Schouw and Associates. Schouw specializes in ultra high-end custom developments.

And he has a few comments for all the real estate nay-sayers out there who are surprised by the way real estate rebounded last year.

"To understand recent industry gains, it's important to look at often misunderstood real estate dynamics," said Schouw.

And what are those 'dynamics'?

To Schouw it all boils down to the net migration of people to Vancouver. People like it here, they are moving here, and supply/demand will ALWAYS drive prices upward.

In his op-ed piece in the Vancouver Sun, Schouw scoffs at those who believed the global economic and credit crises were enough to kill our beloved Vancouver real estate market.

Schouw contents that all the naysaysers simply did not contemplate the rate at which the population in Greater Vancouver grows.

That growth, and the resulting pressure on real estate, will always push prices up.

Schouw scolds that naysayers noting that people who wait out the market typically find themselves competing against almost 1,000 more people every week in need of a home in Greater Vancouver.

"In early 2009 I advised prospective buyers to beware the peril of waiting for news of the market bottom before buying a home because such statistical feedback tends to materialize too late to be useful."

Schouw goest on to lecture that, "contrary to some conventional wisdom, an individual or family doesn't have to be thrilled about the economy or the Olympics to participate in the housing market. They just have to be living. People need homes, and they can't just walk away en masse as they can with other investment vehicles."

Thus, according to the wisdom of Schouw, local housing demand - a function of population change - has continued to grow as it has done for years, along with most of Canada.

"Recent Statistics Canada data indicates that during the 15 months to July 1,2009, BC's population alone grew by 92,593, requiring almost 40,000 additional homes. That's a normal rate of population growth for BC, representing the number of births and new arrivals minus deaths and people leaving, and isn't likely to slow."

It's the old supply and demand argument. People moving here, scare land resulting in the predictable conclusion that you should "buy now - or be priced out forever"

Schouw even tosses in the Asian buyers line.

"Along with Greater Vancouver, which not insignificantly is the closest major North American commercial centre to Asia, global population is growing too, by the better part of 100 million every year. With the growth of commercialization, industrialization and wealth strongest in Asia, it's difficult to ignore the emerging importance of Canada's immense resources, especially on a per capita basis, including fossil fuels, water, minerals and agriculture."

And what about rising interest rates? Won't that bring down Vancouver's real estate bubble?

Not according to Schouw. Interest rates are irrelevant!

"As the city continues to mature into its world-class role, increasingly desirable to prospective residents from all continents, home ownership and rental will become less affordable, especially in the urban core. Local real estate will likely be increasingly wealth driven, as opposed to income driven. Income sufficient to finance a home is of little concern to wealthy families that don't need financing."

So there you have it.

Bubble?

Fears of a collapse?

Not according to Schouw.

"Greater Vancouver's real estate market will continue to be driven by the growing number of people that simply need homes. Speculation, the catalyst of a 'bubble', is largely absent from the market due to lingering fear from the lessons of 2008. A bubble will only materialize if overconfident developers and speculators manage to oversupply demand. For now, if you own Greater Vancouver Real Estate, relax and have a happy new year."

And if you don't own? Buy now... it can only go up, up, up!

The classic Bull Speak. Or BS for short.

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We'll drink a cup of kindness yet for times gone by...

Got sucked into watching the Juniors and now am off downtown, so nothing for you tonight.

To all who drop in, thanks for stopping by.

Happy New Year to all.

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Another Prognostication

Predictions are fun to make despite the fact they are so often wrong.

Now... we've already established that the theme for 2010 is Debt... debt and the recession.

In reality a severe recession would be a good thing for us.

After having gone through a decade of borrowing to consume, Canada needs to rebalance.

This recession was caused not by too much inventory but by too much credit and leverage in the system. And the world is in the process of deleveraging. It is a process that is nowhere near complete. While the crisis stage is over (at least for now), there is still a lot of debt to be retired on the consumer side of the equation, and a lot of debt to be written off on the financial-system side.

Total consumer debt is shrinking for the first time in 60 years. And the decline shows no sign of abating.

That's why the recession is the solution, not the problem. The problem was the bubble inflating, blowing up. Not the deflation. Now it's time to allow the pain, no matter how unpleasant it is, to correct the imbalances.

And it's not just consumers who are attempting to deleverage. The corporate sector is trying to deleverage too, as Bloomberg notes in an article today. The amount of corporate debt outstanding globally shrank for the first time in at least 15 years in the first half of 2009 as U.S. banks reduced the size of their balance sheets.

Tetsuo Ishihara, a senior credit analyst for Mizuho in Tokyo, analyzed data from the Bank for International Settlements and noted that “it’s unprecedented that the global debt market shrinks. When redemption's and buybacks are greater than new issues the outstanding size can shrink, which appears to have happened here.”

Financial companies in the Americas had $1.1 trillion of losses and writedowns since the credit crunch started in 2007, about 65% of the global total, according to data compiled by Bloomberg.

But in Canada, none of that deleveraging has happened... and it's all because of the Federal Government.

As this blog has already covered, the Feds slashed interest rates to dirt and empowered CMHC to expand their assistance into risker and risker home mortgages. It used to be that the mission of CMHC was to try and make home ownership affordable. Now their mission is to keep home prices high.

And this is where the government is making a huge mistake. The reality is that the best thing that can happen to our economy is for these high prices to come down.

But the government’s solution was to keep high prices through low mortgage payments subsidized by the government.

The free market solution would have been allowing the market to correct to bring us low prices.

If real estate prices go down, you don’t need to borrow that much money to buy a house. And if they do, it doesn’t matter that interest rates go up a bit, because your payment will be lower anyway.

But that didn't happen. Carney and Flaherty intervened and their actions have kept homes unaffordable. It ensures Canadians have to mortgage themselves to the hilt to buy a house.

Rather than help Canadians, Carney and Flaherty have made it worse. In 2010 we will see that this will become the foundation of our financial crisis.

The government looked at the problem as being one of falling real estate prices. That’s wasn't the problem, that was the solution.

The problem is that they went up to begin with.

The reality is that the world is just starting to go through a massive – and necessary – recession. Some think it is just ending. It isn't, its just getting started and we have barely gotten a taste of it.

What we really need is for the government to eliminate the deficit and go to a surplus. We need the government to stop spending money and depleting our savings (by taxing us to death).

We need consumers to stop spending money and rebuild their savings.

We need to have the government say to us, “this is the price we pay for years of indulgence and reckless spending, now comes the sacrifice. And there is nothing the government can do about it.”

We also need sound money.

Unfortunately that will mean we need high interest rates.

Kenneth Rogoff, Professor of Economics at Harvard, Former Chief Economist at the International Monetary Fund recently said, “It’s a question of how do you achieve the deleveraging. Do you go through a long period of slow growth, high savings and many legal problems or do you accept higher inflation? It would ameliorate the debt bomb and help us work through the deleveraging process.”

The developed world is drowning in debt and there are only two viable options – a global economic depression or very high inflation.

It seems policymakers have chosen the latter option and over the next few years we seem destined to experience the trauma of severe inflation regardless of Ben Bernanke's assurances to the contrary.

The American government is staring at total obligations of US$115 trillion, their debt to GDP ratio is off the charts and the American public is also up to its eyeballs in debt.

Inflation seems to be the chosen solution.

And that means Canada will be forced to deal with a readjustment that hasn't been prevented at all... just delayed.

It is notable that America is not alone in pursuing inflationary policies; most nations all over the world are printing money and debasing their currencies.

In this era of globalisation, no country wants a strong currency and everyone is engaged in competitive currency devaluations.

Given this reality, its hard not to agree with those who believe that this money and debt creation will cause an inflationary holocaust over the coming years.

Which brings us to our next prediction for 2010: Gold.

As we have noted before, Gold is not money... nor is it a hedge against inflation (it performs that role very poorly). What gold is, however, is a hedge against the mismanagement of the state - which at this time and place is the United States with it's world's reserve currency status.

It is almost a certainty that the United States will be forced to continue Quantitative Easing next year when they cannot find enough buyers for their $2.1 trillion Treasury sales.

As a result, gold's decoupling from the ups and downs of the US dollar may come as soon as next year as nation states and investors panic.

Because of that, I predict a gold price of over $2,000 an ounce by the end of next year.

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Whole lotta pain

Yesterday I talked about US debt and today the theme continues.

Specifically... US Treasuries and how few people acutally bought them in 2009.

Eric Sprott, the Toronto-based money manager whose Sprott Hedge Fund returned about 496% in the past nine years, has been trying to figure out that very question.

In a report entitled 'Is it all just a Ponzi scheme?', Sprott and David Franklin suggest that it's impossible to find who was the second largest buyer of Treasuries in 2009.

Of the $1.885 trillion dollars in public debt the US added in 2009, $704 billion (annualized) was bought by "Other Investors", a collection of buyers defined in the Federal Reserve Flow of Funds Report as the "Household Sector".

Interestingly, the $704 billion is 35 times more than this sector bought in the prior year, 2008.

Sprott and Franklin did some digging and here is what they found:

• Amazingly, we discovered that the Household Sector is actually just a catch-all category. It represents the buyers left over who can't be slotted into the other group headings. For most categories of financial assets and liabilities, the values for the Household Sector are calculated as residuals. That is, amounts held or owed by the other sectors are subtracted from known totals, and the remainders are assumed to be the amounts held or owed by the Household Sector. To quote directly from the Flow of Funds Guide,
  
  "For example, the amounts of Treasury securities held by all other sectors, obtained from asset data reported by the companies or institutions themselves, are subtracted from total Treasury securities outstanding, obtained from the Monthly Treasury Statement of Receipts and Outlays of the United States Government and the balance is assigned to the household sector."
  
  So to answer the question - who is the Household Sector? They are a PHANTOM. They don't exist. They merely serve to balance the ledger in the Federal Reserve's Flow of Funds report.
  
  Our concern now is that this is all starting to resemble one giant Ponzi scheme. We all know that the Fed has been active in the market for T-bills... they bought almost 50% of the new Treasury issues in Q2 and almost 30% in Q3.
  
  It serves to remember that the whole point of selling new US Treasury bonds is to attract outside capital to finance deficits or to pay off existing debts that are maturing. We are now in a situation, however, where the Fed is printing dollars to buy Treasuries as a means of faking the Treasury's ability to attract outside capital. If our research proves anything, it's that the regular buyers of US debt are no longer buying, and it amazes us that the US can successfully issue a record number Treasuries in this environment without the slightest hiccup in the market.

As we discussed yesterday, the actual number of US Treasuries sold to foreigners was next to nothing. As the Sprott report points out, the US Treasury and/or the Fed has been buying US treasuries themselves, in much larger numbers than they acknowledge.

The coming year of 2010 will be known as the year of the Debt.

It will bury entire nations. Nations like Greece and Ukraine, and states like California, and it will threaten to topple scores more.

As was posted yesterday, the looming question is who is going to buy the $2.06 trillion worth of US Treasuries next year?

China, Japan and the UK have increasing doubts about amassing USD denominated paper including Treasuries, Japan also plans to be as aggressive a seller as the US when it comes to debt. And of course there are many other countries who desperately need to sell sovereign bonds in order to pay for their already accepted and implemented budgets - not the least of which is Canada.

And that's just the nation states.

Corporations and lower levels of governments, in every nook and cranny of the planet, want to sell you their debt. Badly.

So the story of 2010 is going to be all about debt and the rapid rise in interest rates to cover it.

It's impossible to foresee at this point how high the rates may rise, but it looks patently obvious that it is going to be a lot more than a few percentage points... and there will be a lot of pain involved when they do.

A whole lotta pain.

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The Hangover

The week after Christmas is a time for 'the hangover'; general recuperation from post-feasting over-indulgence.

And it could well be that 2010 is viewed as a giant 'hangover' year. With that in mind I'd like to toss out a few thoughts for your consideration.

A few faithful readers wanted my advice about investing in this tumultuous time.

The first, and best, advice I can ever give is that you should never take serious investing advice from an anonymous Internet blogger.

As a portion the disclaimer at the bottom of this blog so eloquently states, "the author(s) of the posts on this site are not investment advisors and they do not offer investment advice. They try to provide some hopefully useful data with sources - especially concerning real estate - and then add their own analysis."

With that in mind, a few things for you to consider...

The number one issue that faces our country in the coming year, in my humble opinion, has already be pinpointed by our Finance Minister.

"Canada could face 'serious' economic consequences should the United States fail to address its bulging budget deficit", warns Finance Minister Jim Flaherty.

2009 will be remembered for two things: there was a huge credit and liquidity crunch, and then there was Quantitative Easing.

And Quantitative Easing was the way government played a shell game with the economy.

Right now the vast majority of us are oblivious to the debt monster hiding in the closet.

Consider this from Zero Hedge:

• In 2009, total supply of all USD denominated fixed income, net of maturities, declined by $300 billion from $2.05 trillion to $1.75 trillion. Accounting for securities purchased by the Fed, the stunning result is that net issuance in 2009 was only $200 billion.
  
  Take a second to digest that.
  
  And while you are lamenting the death of private debt markets, here is precisely what the Fed, the Treasury, and all bank CEOs are doing all their best to keep hidden until they are safely on their private jets heading toward warmer climes: in 2010, the total estimated net issuance across all US$ denominated fixed income classes is expected to increase by 27%, from $1.75 trillion to $2.22 trillion. The culprit: Treasury issuance to keep funding an impossible budget.
  
  As everyone who has taken First Grade math knows, there is no way that the ludicrous deficit spending the US has embarked on makes any sense at all. Out of the $2.22 trillion in expected 2010 issuance, $200 billion will be absorbed by the Fed while QE continues through March. Then the US is on its own: $2.06 trillion will have to find non-Fed originating demand.
  
  To sum up: $200 billion in 2009; $2.1 trillion in 2010.

Where is the money going to come from?

2010 is going to be a hangover year for the US economy. There is an upcoming explosion in US Treasury issuance. Fiscal 2010 gross coupon issuance is expected to hit $2.55 trillion, a $700 billion increase from 2009, which in turn was $1.1 trillion increase from 2008.

Unless the US consumer decides to dramatically ramp up purchase of some US Treasuries (and not just any: 30 Year Bonds or bust), the Bond printer will be forced to find vast foreign appetite for its debt.

We already know that China is a major question mark, and will aggressively be looking at pumping capital into its own economy instead of that of America. Japan will have its hands full monetizing its own sovereign issuance, let alone America's. And lastly, the UK - traditionally the third largest purchaser of US debt - is beset with problems worse than the United States and will not be doing much purchasing any time soon.

So the tipping point could be as close as 2010.

Which brings us to the first of the predictions for 2010. Look for:

1. the United States to announce a new iteration of Quantitative Easing, a move that will be met with massive disapproval.
2. Prepare for a major increase in interest rates. Carney and Flaherty can see it coming and have started pounding the warning drums in Canada. Many observers in the US are confounded by Ben Bernanke's complete lack of preparation from a monetary standpoint to a forced interest rate increase. This is what is fueling the fears of runaway inflation almost overnight.
3. Watch for an engineered stock market collapse. Stock Market investors have realized there is no more risk in equities because taxpayers have involuntarily become safekeepers for the entire stock market, due to Bernanke's forced intervention in bond and equity markets. When the time comes to hit the reverse button, the resultant rush into safe assets from the stock market will be dramatic. Will it be enough to generate the needed endogenous demand for US Treasuries? Doubtful. But you can rest assured that there will be an engineered sucking of money from equities into Treasuries on a giant scale nothwithstanding... and it will drive the market down by 30% or more.

Baby New Year will have a spinning head right from day one.

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Merry Christmas

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Twas the night before Christmas...

Happy Christmas to all.

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Jeff Rubin: Housing in for shock... prices to drop 25% or more?

Jeff Rubin was the chief economist at CIBC World Markets for 20 years. He was one of the first economists to accurately predict soaring oil prices back in 2000 and is now a popular commentator on oil depletion and its economic repercussions.

He argued that it wasn't sub-prime mortgages, but record oil prices that drove the world economy into its deepest post-war recession.

Speaking of mortgages, he has some advice for Canadians currently holding a mortgage.

Look at your current situation and ask yourself a long, hard question: just how big a mortgage can you carry?

• "When money is free, it’s hard not to borrow it, even if the lender keeps warning you to be vigilant against debt. That’s exactly what Bank of Canada Governor Mark Carney has been telling Canadians while at the same time keeping their cost of borrowing as low as it’s ever been.
  
  Today’s inflation rate is no more sustainable than today’s interest rates... And this time the inflationary fallout won’t just be in the energy component of the Consumer Price Index. The impact will be much broader...
  
  Stress test your floating-rate mortgage three or four percentage points from today’s level and take a good, long look at the resulting increase in your monthly mortgage payment. For some homeowners, that could be as much as another $1000 per month.
  
  Twenty years ago a similar shock to borrowing rates caused Canadian housing prices to fall by an unprecedented 25 per cent. I know because I called it.
  
  That call was as much about where interest rates were going as it was about where housing prices were heading. Based on current borrowing rates, today’s homeowners will be facing almost as large an increase as they did back then.
  
  So heed Governor Carney’s caution when you decide how big a mortgage you can really afford to carry. Because once the Bank of Canada starts raising your mortgage rate, it will be a very long time before they stop."

You all know I completely agree with Rubin on this, it's exactly what I, and the other members of the Rainforest Roundtable, have been saying all year long.

When it comes, however, the drop in real estate prices in Vancouver will be much steeper than it was 20 years ago.

I stand by my prediction of at least a 40% drop in single family home prices and a 50% drop in condo prices.

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Ignorance and Want

They were a boy and girl.

Yellow, meagre, ragged, scowling, wolfish; but prostrate, too, in their humility.

Where graceful youth should have filled their features out, and touched them with its freshest tints, a stale and shrivelled hand, like that of age, had pinched, and twisted them, and pulled them into shreds.

Where angels might have sat enthroned, devils lurked, and glared out menacing.

No change, no degradation, no perversion of humanity, in any grade, through all the mysteries of wonderful creation, has monsters half so horrible and dread.

Scrooge started back, appalled. Having them shown to him in this way, he tried to say they were fine children, but the words choked themselves, rather than be parties to a lie of such enormous magnitude.

"Spirit! are they yours?", Scrooge could say no more.

"They are Man's," said the Spirit, looking down upon them. "And they cling to me, appealing from their fathers."

"This boy is Ignorance. This girl is Want. Beware them both, and all of their degree, but most of all beware this boy, for on his brow I see that written which is Doom, unless the writing be erased. Deny it!" cried the Spirit, stretching out its hand towards the City.

"Slander those who tell it ye! Admit it for your false purposes, and make it worse! And await the end!"

"Have they no refuge or resource?", cried Scrooge.

"Are there no prisons?" said the Spirit, turning on him for the last time with his own words. "Are there no workhouses?"

The bell struck twelve.

Scrooge looked about him for the Ghost, and saw it not. As the last stroke ceased to vibrate, he remembered the prediction of old Jacob Marley, and lifting up his eyes, beheld a solemn Phantom, draped and hooded, coming, like a mist along the ground, towards him.


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Finally... an admission.

It's been interesting watching the reaction to Finance Minister Jim Flaherty's comments that that the Federal Government will, if necessary, further tighten the conditions under which the Canada Mortgage Housing Corporation insures mortgages.

But Flaherty made a significant comment today and it seems to have escaped notice in all the hand-wringing over what changes the Finance Minister could possibly introduce. Flaherty said,

• “The Governor (of the Bank of Canada) and I have both encouraged the banks to maintain their lending standards, that’s important. We don’t ever want to end up in a situation like the Americans ended up with — people getting into a lot of trouble with the interest rates on their mortgages.”

Did you catch the significance of the comment?

We'll come back to it in a second.

Flaherty's nascent attitude on dealing with the housing issue (increasing minimum downpayments, reducing amortization periods) is clearly at odds with what he really wants to do... which is nothing.

Everyone knows there are mortgage brokers out there, like this one, who are getting Canadians into the market with nothing down and spreading the loans over 35 years.

That's how payments have been made affordable.

Scotiabank estimates 18% of Canadian mortgages are for terms longer than 25 years, and 10% are amortized over 35 or 40 years.

Broker acquaintances suggest the 35 ams are even higher.

Flaherty and Carney are clearly trying to strike fear into the industry in hopes that the industry will clean up it's act when it comes to manipulating the 'lending standards'.

Personally I don't think it's going to work.

And as 2009 comes to a close, its interesting Flaherty and Carney feel they can no longer publicly ignore what is going on.

Perhaps more startling, however, was Flaherty's startling admission.

Did anyone notice that he finally acknowledged that the conditions surrounding the American housing collapse are not all that different from the conditions looming in Canada?

Flaherty did not dismiss the American housing collapse by blaming it on 'subprime mortgages' and an 'irresponsible banking system' like so many times before.

Isn't that the snake oil government and the real estate industry has been selling us all year long?

No... for the first time we have seen a Canadian official publicly admit what really caused the American collapse:

"People getting into a lot of trouble with the interest rates on their mortgages.”

In America it was teaser rates that reset, first with subprime mortgages and then with regular mortgages.

In Canada it is ultra-low emergency rates that will reset.

Bloggers like this page have been saying all year that Canada is really no different than the United States.

We have thousands of Canadian homeowners who have been using their homes as ATM's, just like the Americans. They have renewed their mortgages, maxed out their equity, and are clinging to low variable rates.

In addition, we have thousands of Canadian homeowners who have jumped into the market with little or nothing down and cannot deal with interest rates returning to their historic norms.

The American condition was rotten with these factors and what set the collapse in motion was a resetting of interest rates. First it took down the subprimers, then the regular mortgage holders.

Now that very condition threatens not only the Canadian housing market, but the Canadian economy as well.

Today's news is not that Flaherty may change the rules for mortgages. Today's news is that Flaherty finally admitted that the Canadian situation is no different from that in America.

But we already knew that, didn't we?

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