Scolding the consumer isn't working.

Bad, bad consumer.

Apparently the scolding isn't working.

On the weekend, The New York Times headline said it all: "Americans stop buying; trade deficit declines"

And for an economy that is 70% dependent on consumer spending, that's a huge problem.

Americans have been the world's champion consumers. Just lend them money and they will spend it. A least that's the way the world economy is supposed to function.

But when Americans stop spending it brings a hush to the entire planet.

The malls go quiet... trucks slow down... ships are idled... and finally factories are shut down. Clerks, drivers, stevedores and assembly line workers all go home.

From the Times, "For the first eight months of the year, the United States trade deficit with China is down by about 14% or $20 billion, compared with one year ago. The nation's trade deficit with Japan has shrunk by almost 20%, and its deficits with Mexico, Canada and the European Union are down more than 40%."

Any wonder the BC government is looking at a massive deficit?

"The huge shift stems mainly from the staggering collapse in trade. With credit markets frozen and Americans facing the highest unemployment in more than 30 years, the United States suddenly stopped shopping overseas at anywhere near the volumes that had become normal."

This despite the fact the US federal government is going into massive amounts of debts trying to get consumers to spend again.

They've given their citizens tax rebates, incentives, loans, and bribes. They've run a federal deficit three times higher than the previous record. And they have put at risk a sum of money equal almost to the entire US GDP.

Still those hardheaded consumers won't consume like they're supposed to.

Suddenly, it's the 'Age of Thrift.'

And if the consumer credit party is over, what will replace it?

Is it possible for North American businesses to grow and prosper under these conditions?

Sure it is.

North America has great businesses with great brands. And as the dollar falls, the solution is to gain global market share in some sectors.

But 70% of the economy is consumer spending. Until that changes, the North American economy is hostage to US consumer spending. When consumers stop consuming, the North American economy's wheels stop turning.

And in the contradition lies the ultimate solution.

Americans will have to cut back on their spending and it will be time for the rest of the world to do some of the buying for a while.

And since the United States has less than 5% of the world's population, it is the logical next step.

But rebalancing the world's economies won't happen overnight. Nor even in a couple years. It will take a long, long time.

In the process, North America has a very painful readjustment ahead of it. A readjusment that will affect all sectors of our society.

And real estate values are going to be very much a part of that 'painful' readjustment, even here in North America's most bubbly real estate city.

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Happy Thanksgiving!

To all who visit this site today, Happy Thanksgiving!

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Sunday Funnies - October 11th, 2009

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California debt sale - a sign of things to come.

A stunning thing happened on Thursday that should send shudders down the spine of any Canadian with a large amount of debt.

California was forced to raise the yield on the bonds it was selling because no one would buy them and it's a portent of things to come.

This is a theme we have harped on all year. Exploding government deficits right across the world mean that the need for capital is growing by leaps and bounds. And sooner or later that demand can only produce one inevitable outcome: higher mortgage rates.

Two days ago, it was California.

The once mighty US state, with a GDP that would rank it on it's own as the 6th or 7th largest in the world, was forced to raise the yields on the bonds it offered for sale because it's multi-billion dollar debt sale failed to find sufficient buyers.

California originally planned to sell $4.5 billion in debt, but only managed to sell $4.138 billion - and then only after they raised the interest rate they were willing to pay.

It's something we will see repeated again and again in the months and years to come. The global competition for money will intensify and force governments and business to raise yields on their bonds. And higher yields in the bond market will translate into higher mortgage rates for real estate consumers.

The message for you and I is crystal clear: tread very carefully and eschew debt.

The converging trends on the horizon are a receipe for disaster.

Boomers will be dumping real estate in massive numbers over the next 10-15 years to fund retirement plans just as mortgages rates will be forced dramatically higher.

It means the real estate bubble in the Lower Mainland is going to burst in spectacular fashion as debt overwhelms us.

Houses are NOT affordable right now... low interest rates only make it seem like they are.

And locking in to a five year rate will not protect you from what is coming.

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A slow, agonizing bear market trap?

Click on the above image to enlarge.

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

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

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

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

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

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

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

And their return is critical.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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US Mint halts sale of certain Gold & Silver bullion coins because of 'unprecedented demand'

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UPDATE: Gold soars to record high; price hits $1,059.60 on intraday trading and closes at $1,055.40 US/ounce.
UPDATE @ 6:00am EDT: Gold futures up to $1,055 and Silver futures up to $17.77.

In a development that is already sparking a frenzy among gold bugs, the US Mint announced on Tuesday that they would no longer be offering 6 different bullion coin products it used to sell.

Affected by this decision are:

• one-ounce American Eagle Silver Proof Coins
• one-ounce American Eagle Silver Uncirculated Coins
• all American Eagle Gold Proof Coins (all weights, as well as the four-coin set)
• one-ounce American Eagle Gold Uncirculated Coins
• the United States Mint Annual Uncirculated Dollar Coin Set, which also includes a one-ounce American Eagle Silver Uncirculated Coin
• and American Eagle Platinum Bullion Coins (all weights)

The US Mint issued a press release stating that production of these coins has been suspended "because of unprecedented demand for American Eagle Gold and Silver Bullion Coins."

Gold bugs are already drawing parallels to Franklin D. Roosevelt’s 1933 Presidential Executive Order that prohibited “hoarding gold” and the move is being seen by some as the start of the slippery slope towards gold confiscation by the government.

Market turmoil is fueled by such rumours and speculation... fueled by fear.

And talk of inflation, hyper-inflation, dollar collapse, and new credit collapses are made even more poignant with this latest development from the US Mint.

Are events building into a powder keg awaiting a spark to ignite a speculative frenzy and firestorm?

Yesterday we had stories about oil being traded in euros and replacing the dollar as the currency of trade, a story credited for driving gold way up.

Then there is the current situation in Latvia, which has the potential to freeze up a large number of Swedish banks as this MarketWatch story outlines. If is feared that this could trigger a nightmare scenario that would have Swedish banks then pulling down other European banks, triggering Credit Crunch: Part 2.

On the periphery is the efforts of various US Senators to unearth a full itemization of the commitments the US Federal Reserve has made in secret to bail out the banks. This is in addition to a bill working it's way through Congress to open up US Federal Reserve books.

Gaining ground is the growing realization of the impact that Chinese Banks defaulted on billions of dollars in derivative contracts. In November 2008, top tier Chinese banks (Bank of China and Industrial and Commercial Bank of China) reneged on derivatives contracts and failed to come up with billions in collateral on dollar/yen FX trades, which were out of the money after the yen’s October appreciation. This should have been headline news in every financial newspaper, but it wasn’t. At the end of August 2009, China signaled that state owned oil consumers: Air China, COSCO, and China Eastern could default on money-losing commodities derivatives contracts without penalty.

Most credit support annex agreements would say that closing out these trades would be an event of default, and then the cross default on all the trades would kick in with the same counterparty. But the credit of the Chinese banks was better than many of their counterparties. Everyone was forced to renegotiate contracts with the Chinese banks.

From the perspective of the derivatives markets, this is earth shattering. What would have happened if AIG had done the same thing? (Hey, Goldman, UBS, and others…you want your collateral? Well... stuff it!)

Meanwhile some are worried about US unemployment combining with rising interest rates to create a situation similar in many respects to Argentina in 2001?

One thing is for sure: fear can be a powerful, irrational motivator. Perhaps that's why Barclays see's gold going to $1,500 an ounce.

For market speculators, October 2009 is shaping up to be a very interesting month as it does every single year.

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Hedge-Fund Bets On Hyperinflation... and has inflation 'officially' started?

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UPDATE: Barclay's targets Gold at $1,500
UPDATE: Gold continues climb with record closing high of $1,044.20. During day went as high as $1,049.70 (note: record high intra-day mark was $1,060 set in March 2008).

The hedge fund Hayman Advisors (HA) is drawing attention again.

HA is most famous for betting against subprime mortgages in 2007. When the US housing bubble popped, they made billions of dollars with their hedge. As a result, HA's economic views now received a heightened level of attention.

And the blogosphere is a tither about their latest, controversial letter to clients predicting that the U.S. may experience hyper-inflation.

Now the fact that many people think that inflation will follow the massive fiscal and monetary government stimulus that has been injected to fight the the recession and financial crisis is nothing new.

We've posted about it quite a bit.

But hyper-inflation?... that is the extreme.

Hyper-inflation would mean inflation in the ballpark of 30% per year -- at least. Generally hyper-inflation is measured by the month or day, not year, because the numbers are so high.

What has caught everyone's attention with HA's latest advice is their reference to a study by Peter Bernholz.

There have been twenty eight episodes of hyper-inflation of national economies in the twentieth century with 20 occurring after 1980. In his most recent book, Monetary regimes and Inflation; History, Economic, & Political Relationships, Bernholz analyzes the 12 largest episodes of hyper-inflation - all of which were caused by financing huge public budget deficits through money creation.

"In the 12 largest episodes of hyper-inflation the tipping point for hyper-inflation occurs when the government’s deficit exceeds 40% of its expenditures."

The study notes that according to the current Office of Management and Budget projections… the U.S. will run deficits equal to 43.3% and 39.9% of expenditures in 2009 and 2010, respectively. In other words roughly 40% of what the US government is spending has to be borrowed.

It prompts HA to ask it's clients, "has the U.S. reached the critical tipping point?"

The hedge fund's letter is attracting significant interest for several reasons. First of all because it's a hyper-inflation argument that doesn't seem wacky - it's rooted in historical observation.

Secondly it has nothing to do with the massive monetary stimulus by the Federal Reserve, which could cause additional inflationary pressures. So even if you believe that the Fed can control their side of the equation, the government spending might still cause inflation to get out of hand.

Skeptics counter that the U.S. has a more robust, developed and sophisticated economy than most places where hyper-inflation has occurred. They say that fiscal and monetary policy would be seriously altered to avoid incredible levels of inflation if the U.S. found itself facing such a predicament.

None-the-less, successfully keeping inflation as low as it has been in recent years seems highly unlikely with each passing day. And whether you buy into the fund's logic or not, its letter is an interesting one. It also provides analysis on China and Japan.

If you have some time to kill and interest, you might want to give it a read.

On another inflation note, the Reserve Bank of Australia became the first G-20 nation to raise interest rates yesterday. The RBA bumped interest rates up 25 basis points to 3.25%, a move observers were convinced wouldn’t come until at least November. Thus, Australia is implicitly declaring the end of its economic downturn.

The move is raising alarm bells because the first hike is seen as opening a Pandora's box of interest rate hikes around the world.

Chuck Butler of EverBank says that, “if the RBA went this soon, then we can expect Norway's Norges Bank to push its rate hike earlier on the calendar, maybe even later this month! And it won't be the only one! Look for New Zealand to hike rates this year, and who knows what other country will follow after that.”

And you will recall that Bank of Canada governor Mark Carney tempered his promise to keep our nation's rate at 0.25% only if inflationary pressures didn't start to emerge.

Well... they are now officially emerging.

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An Ominous Sign?

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UPDATE: Gold closes at record high $1,039.70 after touching $1,045.00 earlier in day.

We've talked about it often.

The US dollar's status as the world's reserve currency is the only reason the United States has been able to play fast and loose with it's finances and treasuries without triggering hyper-inflation and a dollar collapse.

But with each passing month, critics claim the status of the dollar as the Globe's de-facto reserve status is being threatened.

Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars

And now one faithful reader sends us news of another signpost on the road to calamity.

This morning's London Independent newspaper is reporting that Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading.

If true, this represents one of the most profound financial changes in recent Middle East history.

The Independent reports that these plans have been confirmed by both Gulf Arab and Chinese banking sources in Hong Kong. According to the Independent, Gulf Arabs – along with China, Russia, Japan and France – will end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.

Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.

The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states.

Some analysts believe this may help to explain the sudden rise in gold prices and sets the stage for an extraordinary transition from dollar markets within nine years.

One blogger we read dismisses the Ridiculous Hype Over Secret Oil Meetings.

Mike 'Mish' Shedlock says, "Pricing oil in Euros (or even sillier - a basket of currencies) will not cause anything to happen. If pricing unit changes do happen, they will be a result of sentiment changes in regards to existing dollar hegemony and not the other way around. Dollar Armageddon is not coming over a pricing unit, nor did the US invade Iraq for that reason. The story is nothing but meaningless hype."

Either way, gold futures at the time of this posting are up to $1025.70 per ounce.

Volitiliy reigns supreme.

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Snapshots

Click on the image above to enlarge.

A couple of snapshots of the Vancouver Real Estate market for you today. The above image comes to us from Fish. It's a stunning chart summarizing residential sales in British Columbia. Never in our Province's history had we ever seen a rate of collapse like the one we saw starting last fall. Conversely, never has a climb upward been witnessed like that which we are currently going through.

This drive upward in prices is even more dramatic and steep than was the climb in the bubble we witnessed throughout the 2000's.

And it's not just sales. Housing prices are spiking upward as well. A great chart that shows the drop and jump in values is this one from realtor Larry Yatkowski (as always, click on image to enlarge).

Unprecedented times to be sure.

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Sunday Funnies - October 4th, 2009

(Click on image to enlarge)

You remember this famous poster...

Well, hockey season started this week...

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Perspective

Click on the chart above to enlarge.

A few weeks ago we told you about a colleague who recently bought into the Lower Mainland real estate market. His story is not unlike many recent buyers who have taken advantage of today's 'affordability'.

Historic low interest rates allowed him to purchase a $579,000 home with $30,000 down and a 35 year amortized mortgage locked in at 3.79% for five years.

The monthly payment, including property taxes... just over $2,900 per month.

The house has two suites and the only way it can work for him is if he rents those suites out.

'Affordability'.

On Friday, the Bank of Montreal raised the 'affordability' stakes even higher when it launched a promotional push for its five-year closed variable mortgage at 2.25%, which it calls the “lowest rate in more than 30 years.”

Call it the crack cocaine fueling the mortgage market addiction.

Are home buyers being blinded by all of this?

As you can see by the chart above, rates have been slashed to dirt in a desperate attempt to resuscitate the real estate market.

The BOC rate dropped from 3.50% in March of 2008 to the current 0.25%.

This week the Governor of the Bank of Canada warned Canadians that rates will be going back up.

So let's set aside inflation concerns for a moment.

Let's set aside fears that we will see a return to the historic norms of 8.25% or a return to the late 1970's era of double digit interest rates approaching 15% and higher.

What happens when rates simply go back to what they were in March of 2008?

Jack the BOC rate up 3.25% and you won't be able to find a five year fixed rate for much lower than 6%.

Is a minimum $1,000 a month jump in payments still 'affordable'?

We hope so because denying a return to the rates we had in place only 18 months ago is pure folly.

And that is only the beginning of what is to come.

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So where are we heading?

So where are we heading?

As faithful readers know, we often profile US bank failures on Friday. This stems from our Prime Minister who early on in 2009 said, "there won't be an economic recovery until the U.S. financial system is repaired."

US Bank Failures for the year stand at 95 (will we break 100 today?).

But that pales to the list of over 400 banks who are teetering on the edge of insolvency. So dire is the looming problem that the cash-depleted Federal Deposit Insurance Corporation has hatched a plan to require banks to prepay three years of quarterly fees. The little accounting trick will generate $45 billion in cash for the FDIC, an amount it normally would've had to wait years to get its hands on.

It's an odd move because the FDIC could simply borrow money from the Treasury Department. This is well within the rules of the FDIC. The agency has a credit line with the Treasury to tap as much as $500 billion in emergency capital through the end of next year. But the FDIC is worried that if the agency, which has always been privately funded through bank assessments, borrowed money from the Treasury, it would look like a new bank bailout, eroding the sliver of confidence the public has regained in the USA's banking system in the past few months.

Instead the FDIC has arranged this 'dues pre-payment' option. But won't this hurt bank earnings or deplete lending?

It seems the FDIC is going to take advantage of an accounting quirk that allows companies to spend money on something but not actually tell their shareholders about the cost until the asset is gone. As Time magazine notes, "for you and me, it would be like shoplifting at the supermarket and then dropping off cash every time you decided to eat something. A can of beans might not cost you anything for years. The rule is supposed to match the revenue generated by the stuff a company buys with its costs, and it is called depreciation. But to anyone other than a CPA, it looks like a sleight of hand."

So US bank troubles continue and the FDIC is scrambling to prepare for an avalanche of additional failures.

Meanwhile the trend of strategic mortgage defaults in the United States gallops along, compounding the woes of the banking industry.

It all adds up to what we having been suggesting for months... that the underlying economy is still very weak and that the current stock market rally is nothing more than a bear market trap.

This means the North American economy is probably facing a continuing period of deflation over the short term. Even so, many leading deflationists think that – after a period of deflation – we will certainly get inflation.

The million dollar question is: when?

It's a crucial question. When it comes to investing, being too early is being wrong.

Someone who is positioned for inflation decades too early will get creamed. Likewise, someone who is betting on deflation for 20 years will get hurt if inflation kicks in next month.

One reader suggested in an email we might be even be facing a period of mixed-flation; inflation in some asset classes and deflation in others.

Given that speculators drove up the price of oil last year, it is possible that – especially in a stagnant economy – speculators could drive up the prices of some asset classes and drive others down.

We'll explore the issue more next week.

Let's wind up the week with Bank of Canada Governor Mark Carney's latest warning that there is "no guarantee rates will stay low" .

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Or is it the Looming Era of Deflation?

There has been an interesting trend developing lately in the bond market.

Some of the world's biggest bond funds have been buying longer maturity US Treasuries in recent weeks. With significant flattening on the long end of the yield curve, analysts believe this reflects the re- emergence of deflationary fears. Basically the treasury market is increasingly skeptical of the reflation effort taking hold in the North American economy.

If they are correct the United States will be at the center of an ongoing deflationary de-levering as opposed to an accelerating, inflationary growth period.

Those that hold to this opinion believe that deflation is being fuelled by continuing overcapacity, shrinking credit, reduced corporate spending and falling consumer demand.

Backing this up is data showing consumer prices falling at their fastest clip ever last month in Japan (no mean feat considering Japan has been fighting a losing war against deflation for much of the past two decades). Meanwhile Germany, Europe's biggest economy, has now suffered through four consecutive months of sliding prices, and the rest of the region that uses the euro is not faring much better.

Should deflation take hold, the result would inevitably be years of dismal economic performance, staggering unemployment, deeply pessimistic consumers and businesses that cease spending and focus on surviving.

“We are certainly in a deflationary state,” said David Rosenberg, chief economist and strategist with Gluskin Sheff and Associates in Toronto. “Of that, there's no doubt.”

“I think people still have no clue as to just how weak the economy is,” Mr. Rosenberg said.

The ultimate fear is that if you remove the massive stimulus being administered by governments, most economies are at a virtual standstill.

The end result? A decade of stagnation for the North American economy.

Perhaps that's why Bank of Canada Governor Mark Carney, in a speech to the Greater Victoria Chamber of Commerce on Monday, called on the private sector to step up and get the economic recovery going.

"The global recovery is in its earliest stages, and is almost entirely driven by public policy," Carney said. He then warned that governments and central banks have done all they can after putting in place "war-time spending on a peaceful calamity".

"It's now up to the private sector to start spending," Carney said. "Otherwise, the fragile recovery will weaken as government stimulus ends. Consumer and business spending will need to drive economic growth in Canada."

Oh my... it's back to scolding the 'bad consumer' again.

So are we set to trigger inflationary times as the end of the recession moves trillions of stimulus dollars into circulation and combines with the pressures of servicing massive amounts of government debt?

Or will the economy sputter with faltering demand, dropping prices, rising unemployment and plateauing interest rates because financially-stressed consumers are unable (or unwilling) to go back to their hyper-consumer ways?

It's hard to say. But one thing is for certain: deflation is far more destructive than inflation.

Just this past Monday, the City of Vancouver confirmed it will eliminate 60 full-time jobs in order to deal with a $61 million budget shortfall this year. The revenue woes are being blamed on the weak economy and federal and provincial budget cuts.

And that's only the tip of the iceberg.

If deflation takes hold, the stock market will suffer a massive correction, tons more businesses will fail and unemployment will skyrocket beyond what are already substantial highs.

And what will that mean for real estate?

Hundreds of thousands of newly unemployed will be unable to pay mortgages. Wave after wave of boomers will be retiring each year and desperately trying to sell their homes because that's where their retirement funds are stored. And the younger generation is unable to step up and fill the void because they lack both the numbers and the income from a floundering economy.

Back in February and March we made a number of posts about the possibility of a depressionary slide.

And while we lean towards the inflationary outlook (75% vs 25%), the reality is either scenario is still possible.

There is only one thing for certain. Neither inflation or deflation bodes well for real estate.

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The Looming Era of Inflation?

Last week at an economic briefing sponsored by Toronto accountants Hogg Shain & Scheck, economic forecaster Brian Beaulieu of the New Hampshire based Institute for Trend Research shared his view of the post-recession world.

The thrust of his presentation was that the recession may be ending, but a new era of renewed inflation and higher interest rates could be right around the corner.

Beaulieu made the cast that inflation will ooze back, fuelled by higher commodity prices, labour cost increases, and the need to service the huge government deficits rung up to deal with the recession.

By 2012, Beaulieu says the U.S. consumer price index could be increasing 6% a year, which would be the highest inflation rate in the past 25 years.

And yes, interest rates will jump - dramatically.

Beaulieu joins the ranks of doomsayers, like this blog, who have been echoing this theme for the better part of the year.

But as we scan the pages of the North American media, so many still warn of deflation and the threat of a decade long morass similar to what Japan is experiencing.

Why is that?

A follow up tomorrow.

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Greater Vancouver House Prices and Local Incomes

Click on the image above to enlarge.

This is a nice chart put together by the Vancouver Condo Info blog.

Using data from the BC Provincial Government website of BC Stats, our intrepid blogger has put together a graph which compares the increase in local incomes to the run-up in house prices from 2000 to 2007 (which is the last available year of local income statistics from Revenue Canada).

The house price data comes from the house sales data at BC Stats too.

House prices are dramatically outpacing increases in income.

Which brings us to the eternal evaluation of housing prices - regardless of your geographic location: There may be other considerations, but financially speaking, if home prices are out of line with rental prices, wages and wage growth, and jobs, then you are in a dangerous bubble.

And in the Lower Mainland the rental prices for homes are far lower than current mortgage payments while wages and wage growth haven't kept pace with the dramatic rise in prices.

How can anyone possibly think this trend will continue indefinitely and that housing prices will keep going up, up, up?

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When it comes...

"There is no doubt an eerie parallelism (exists) between the Canadian situation today and that in the States before the bust... The crucial question in my mind is: when housing prices start to fall, is a Canadian with no or negative equity (assuming he/she still has a job and the ability to pay) more likely to A) walk away (if there are no legal ramifications); B) keep paying thereby turning himself to a debt slave virtually for life; or C) declare bankruptcy? This may determine the velocity of the downturn - a crash versus a protracted deflation. Any feedback would be much appreciated."

This question was asked in response to Saturday morning's post.

We promised to address it today and as fate would have it, Garth Turner touched on this with his post on Saturday night. You can read his full post here.

In a nutshell, in all of Canada (except Alberta) Canadians will be in a significant bind.

Canadian mortgages are known as “recourse” loans, which means the bank has full recourse to collect not only on the debt, but the costs of the debt. If you execute a standard mortgage document, and miss mortgage payments during the term, or fail to fully pay it off at the end of the term, or do not refinance it satisfactorily, then the lender can legally gain title to the property, and sell it. Then they will sue you for the difference between the mortgage amount and the sale proceeds. You will also be sued for costs, including all legal activity, real estate commissions and taxes, and if you cannot pay this amount, banks will get a court order to garnishee your wages for what will probably be the rest of your miserable life.

This will happen even if your mortgage was CMHC insured.

It means that Canadians will, en mass, pursue the only alternate option: Personal Bankruptcy.

By declaring personal bankruptcy, the bank gets the house and you get a black mark that lasts for seven years. It will mean no credit cards, no loans, no new mortgage, no new car, no running for political office. It will mean difficulty finding almost any white collar job and even hassles trying to rent.

But it will get you out from your mortgage obligation.

The problem is that it's not an immediately implemented solution.

In British Columbia the foreclosure process can be A drawn out affair and then the bankruptcy process will take even more time to wind it's way through the system.

And because so many people will be forced to pursue this option (rather than simply handing over the keys to your home to the bank as in the United States), once it gets going the sequence of events could plunge BC real estate into a morass that compounds and intensifies the collapse (just look at how the collapse in confidence froze up the market this past winter).

When it comes to pass one thing will be certain.

It will be ugly.

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Sunday Funnies - September 27th, 2009

(Click on image to enlarge)

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Email: village_whisperer@live.ca
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Time Mortgage Bomb

According to CMHC, 30% of all Canadian mortgages are now variable rate mortgages, up from 3% in 1998. And fixed 5 year terms account for almost 70% of the mortgage market.

So why don't many Canadians take out a 25 year mortgage? They exist. Royal Bank even lists them on their residential mortgage rate page.

It's all about 'affordability', the real estate industry's favorite catchword.

A 7.85% rate on a $555,000 amortized over 35 years results in a monthly payment of $4,420.

You can currently get a 1 year variable rate for 2.35%, which translates into a monthly payment of $2,495.

That's almost $2,000 a month less in payments.

So who in their right mind would opt for a 25 year mortgage? Even a five year rate from Royal (4.19%) will set you back $3,070 a month.

And for all those suckers buyers rushing into the market right now because homes are 'affordable' (i.e. low interest rates), saving $500 a month makes all the difference in the world.

And besides, rates have been relatively low for the past 8 years. They will stay like this for a long time.

And therein lies the looming disaster.

$500 makes all the difference in the world. As rates start to go up, many variable rate mortgage holders won't lock into 10 or 25 year rates. It's too much of a jump.

They won't even lock into a five year rate.

They have rationalized 'affordability' to make the purchase. When rates jump up 2%, the one year variable rate will cost them $500 more. To lock into a 5 year rate will cost them another $500 over that (at least).

The same argument that keeps them in a one year rate, will keep them in that rate then.

Even if some do lock in to a longer term rate, it will be a five year rate - at best.

But the fuse on the Lower Mainland mortgage time bomb will have been lit. And when it explodes this is what it will look like.

As the San Francisco Chronicle reports, the Bay area is sitting on a $30 Billion dollar time bomb of homes purchased with loans known as option ARMs, short for adjustable rate mortgages (Alt-A).

From 2004 to 2008, "one in five people who took out a mortgage loan (for both purchases and refinancing) in the San Francisco metropolitan region got an option ARM," said Bob Visini, senior director of marketing in San Francisco at First American CoreLogic, a mortgage research firm.

With these mortgages, the interest rate will reset after 5 years to a dramatically higher rate. Buyers took them because Alt-A and Option ARM allowed them to enjoy an 'affordable' low interest rate for the first five years. At the end of five years (during the boom years), buyers were advised they could re-negotiate a new mortgage (with a new low five year rate) especially since the value of their home will have risen.

Problem is... housing prices in San Francisco have evaporated... and so has the chance to obtain a new mortgage. It means thousands of buyers in the Bay area are going to be forced to watch their mortgages reset at dramatically higher interest rates as their five year terms expire.

There are over 54,000 option ARMs issued in greater San Francisco with a value of about $30.9 billion.

"In markets where home prices were going up rapidly, more and more borrowers needed a product like this to afford something," said Alla Sirotic, senior director at Fitch Ratings. The loans became a tool for regular people to "stretch" to buy homes that were beyond their means.

Can you see the parallel to what may happend in Canada when mortgage rates start rising?

The sad thing is, if you can, you are in the minority.

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Is the 'vicious' dog included?

It's Friday so let's go for another installment of the 'Million Dollar Dump of the Day'.

Today's treatise is this 2,400 square foot palace at 1520 Avery Avenue in the Marpole district of Vancouver. Lot size is 49 x 122 (or 6039 sq. feet). From the listing details (and we ain't making this up), "Note: Tenant occupied please do not walk on ppty weekends or Thursday mornings, vicious dog!"

Hey, what respectable crack shack doesn't have the mandatory vicious dog?

Asking price: $1,188,000

Remember, homes like these are a "relative bargain" compared to the rest of the world, So act now.

MLS link to the listing, vicious dog quote included, is here.

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