Friday, July 31, 2009

Economist: "China numbers are fake"... And Bank Failure Friday.

As faithful readers know, I have made several posts warning about the 'supposed' economic growth in China and have questioned the wisdon in pinning our hopes of economic recovery on China's growth.

Now noted economist Marc Faber, in his latest Gloom, Boom and Doom report, states that "China's economy is growing at 2%, not the 7.8% its government claims."

A growing number of investors turned bullish on China after its markets began to rise last March. But as we have noted here, China has been throwing massive amounts of stimulus money at it's economy.

As Faber notes, “if you throw money at the system, lots of things go up in value — but maybe they go up for the wrong reasons. What disturbs me today … is that the lows in March and late last year, sentiment was incredibly bearish about everything.”

Now, Faber observes, “there’s this incredibly bullish sentiment when insiders are actually selling and the technical picture of the market doesn’t look that great.”

China is in the midsts of a massive bubble buildup. Watch for a global impact when it bursts.

Bank Failure Friday

After seven failures last Friday in the United States, another five banks failed today brining the year's total to 69.


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Thursday, July 30, 2009

Why Interest Rates Will Collapse Real Estate Prices

We've discussed this before, but it's worth re-iterating.

Rising interest rates will collapse real estate prices in Vancouver.

And make no mistake, interest rates are going up.

Last week the govenor of the Bank of Canada (Mark Carney) urged that "Canadians should be preparing for the day when their borrowing costs eventually return to more normal levels."

Canada's historic 'normal' is 8%. That represents more than a doubling of current rates.

Real estate prices can be set to whatever level the seller desires, however the value of a house will eventually settle to the price that buyers can actually afford.

And since very, very few people buy a house with cash, what people can afford will be determined by interest rates.

A doubling of interest rates will slash what people can afford in half.

Charles Hugh Smith ( has produced these charts to demonstate the see-saw relationship between housing prices and interest rates (click on image to enlarge).

In the graph above, a low interest rate (in this case 4.5%) will produce a monthly mortgage payment of $1,850 on a $500,000 mortgage.

But if the interest rates doubles, in this case to 9%, then...

... then a monthly payment of $1,850 will only allow a buyer to assume a $250,000 mortgage.

Which brings us back to the original issue: "The value of a house will eventually settle to the price that buyers can actually afford."

In the absence of a vibrant economy that generates more income for buyers to assume larger mortgages at higher rates, buyers are forced to reduce the size of a mortgage they can assume.

And a voracious demand for global capital is on the cusp of forcing interest rates back to historic norms (if not higher), it means a return to 'normal' interest rate levels will wipe out the market for average Vancouver homes that sell in the current bubble inflated $800,000 to $1.5 million range.

Buyers will only be able to afford mortgages at half the current amounts... a stalled economic recovery will guarantee this.

(lower, if rates spike to 11% or higher)

Canadians snapping up $600,000 plus mortgages today because they can 'finally' afford them with these historic low interest rates of 3% are making the worst financial decision of their entire lives.

Not only will 'normal' interest rates reduce other homes to half of what they paid for theirs... when these Canadians go to renew their mortgages after their 1-5 year term expires... they will be in a massive underwater position and they will default on their own mortgages.

It's an outcome that will only further depress market prices.

Their only hope lies in interest rates returning to low levels very quickly once they rise to this point.

And that's not going to happen.


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Wednesday, July 29, 2009

The Capital Trap

When you think about it, interest rates are the story in real estate now... and they are the story in the foreseeable future.

The current mini-boom in real estate sales/values is the artificial creation of the Bank of Canada's stimulus efforts.

The lowest central bank rate in history has Canadians back on the home-buying binge re-creating rising prices and multiple offers from the bubble years. All despite the fact that we are in the middle of the greatest recession since the Great Depression.

But it is these very interest rates that are dooming many buyers who are making the worst financial decision of their entire lives.

The Bank of Canada has lured them into a Capital Trap.

The first key concept here is that a house is only worth what someone can afford to pay for it. The second key concept is that very, very few people buy a house with cash.

The vast majority of real estate purchases are financed with mortgages-- with debt.

And credit is lent to homebuyers at a rate of interest... a rate that is currently at historic lows.

We've all read about the $2 trillion Federal deficit for this fiscal year and I have posted many entries about it. At the right is a US National Debt clock showing the exploding interest on that debt that the US government must service.

But that's only one element you have to consider. Every other government on the planet (yes, even the Chinese government as I posted here recently) is also anxious to borrow huge sums of money from someone to fund their exploding deficit spending.

Don't forget the corporations, local governments, agencies and real estate buyers who want to borrow money.

The point is: the demand for surplus capital far exceeds the supply of global surplus capital.

And as the voracious US government demand for debt servicing continues to grow, surplus money looking for a home is drying up even as the demand for surplus capital skyrockets.

The net result is interest rates will have to rise--and soon. While it is impossible to predict exact dates, simple laws of supply and demand dictate that rates will soon rise and will rise steeply as the shortfall between what governments want to borrow and what's available to borrow becomes visible (not to mention private demand for capital).

Most observers, which include the governor of the Bank of Canada (see post earlier this week), agree rates will double from the current market rate of about 4% to at least 8-9%.

Real estate prices can be set to whatever level the seller desires. However the value of a house will eventually settle to the price the buyers can actually afford.

And since since very, very few people buy a house with cash, when interest rates double, house prices will drop in half, regardless of any other conditions.

Interest rates are driving the buying frenzy/mini-boom now. And shortly interest rates will drive the market collapse.

Tomorrow we will discuss why house prices will be dropping by half in the very near future.


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Tuesday, July 28, 2009


If Real Estate is to keep it's bubbly levels, the economy MUST recover and recover quickly.

But as faithful readers of this blog know, I am not optomistic about that occurring.

One of the main reasons is that fact that I believe our economy is going to be forced to undergo a major, painful transformation.

Currently 70% of our economic output depends on consumer buying. No buyers, no recovery.

Which is why the Canadian and American federal governments have been pumping 'stimulus' into the economy at a furious pace. Historic low interest rates are designed to encourage Canadians and Americans to get back into buying.

The problem is that we are at the end of the credit boom – certainly the nine-year boom and maybe the 60-year boom. Has any society ever created so many ways for people to go into hock?

In 2003, Americans had 1.46 billion credit cards, or five per person. Home mortgages total $9 trillion, and some initially don't require borrowers to repay all their annual interest. In 1946, households had 22 cents of debt for each dollar of disposable income. Now they have $1.26.

Behind these numbers lies a profound social upheaval: the “democratization” of debt. Everyone gets to borrow. But this process may now have reached its limits.

The biggest boon has been the expansion of homeownership, up from 44% of households in 1940 to 69% today. (Three-quarters of household debt consists of mortgages.) At heart our appetite for credit reflects a continental optimism. We presume that today's debts can be repaid because tomorrow's incomes will be higher.

The origins of today's credit culture date to the 1920s with the advent of installment lending for cars and appliances (stoves, refrigerators, radios), says economist Martha Olney, author of “Buy Now, Pay Later.” Attitudes changed. In the 19th century, “it was thought that only irresponsible families bought on credit,” she says. “By the 1920s, it was only foolish families that didn't buy on credit and use it while they were paying for it.” In the mid-1920s, 60% to 70% of cars were sold on one-to two-year loans.

After World War II, credit became part of the mass market. In 1958, Bank of America introduced a credit card that (in 1976) was renamed Visa. The combination of aggressive merchandising and government laws prohibiting racial and ethnic discrimination in lending led to a huge expansion of borrowers. One reaction to the anti-discrimination laws was the use of impersonalized computer-driven credit scores to determine loan eligibility. Now, U.S. businesses buy 10 billion FICO scores annually.

Credit is about more than selfishness and impatience. “Once consumers step onto the treadmill of regular monthly payments, it becomes clear that consumer credit is about much more than instant gratification,” writes historian Lendol Calder in his book “Financing the American Dream.” “It is also about discipline, hard work” – the attributes necessary to repay the debt and borrow more.

Ironically, our optimism feeds our stress.

The trouble is that no society can forever raise its borrowing faster than its income – which is what we've been doing. Sooner or later, debt burdens become oppressive. One reason for thinking we've passed that point is that the last spasm of credit expansion was partly artificial. To soften the 2001 recession the Federal Reserve embarked on an audacious policy of easy credit. From December 2001 to November 2004, it held its key short-term interest rate under 2%.

A real-estate bonanza ensued. From 2000 to 2005, sales of new and existing homes increased by nearly 40%. In hot metropolitan markets, prices more than doubled over five years. Nationally, the increase was 57%.

The frenzy depended heavily on low interest rate mortgages. In 2005, about half of new home loans had variable interest rates (often with low, introductory teaser rates) or required only interest payments.

What the Fed giveth, the Fed taketh away. And between June 2004 and 2006, the US Federal Reserve raised short-term interest rates from 1% to 5.25%.

And that's what caused the bubble to break in the most bubbly US cities. This forced real estate prices to drop a bit, which triggered the first subprime mortgages to default, and the dominos started to fall.

This turn of the credit cycle could signal signals a dramatic change.

The end of the decades-long rise of personal debt to income is going to have profound reprecussions.

It's not just that debt service (which is at aa historic high, nearly 19% of disposable income) has been stretched too far, credit standards have been stretched too far as well. And those standards are in the process of being pulled back.

In additiona much recent debt has been contracted at artificially low interest rates. As rates rise, buying will drop.

Toss in rising unemployment, and a contraction of the credit cycle in unavoidable.

For an economy that is 70% dependent on consumer buying, that becomes a death knell. Without that prop, the current economy cannot function and it cannot be resuscitated.

And if it can't be resuscitated, it must be restructured. A major, painful transformation may be our only option.

It won't be pretty.


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Monday, July 27, 2009

San Diego in 2004 mirrors Vancouver in 2008

"America's finest city."

That's what San Diego calls itself. And with good reason. The wonderful city's bay-side location and perfect climate make it a very attractive place to live.

And the parallels to Vancouver don't end there.

From 2001 through 2008, more than 8,000 condominium units were built in downtown San Diego. That's double the number of downtown units constructed over the same period in Los Angeles, a city three times its size.

San Diego was a construction boom town, drawing on it's scenic beauty and temperate climate.

Flush with easy credit, developers and home buyers were eager to invest.

At the height of the frenzy, hopeful purchasers queued up outside sales offices to plunk down deposits. There were occasional arguments over who was first in line. No one wanted to miss out with condo values riding an elevator to the sky.

Near the peak, in May 2004, median resale prices of downtown condos hit $647,500, a 56% increase in just three years, according to San Diego research firm MDA DataQuick.

The Los Angeles Times even profiled one savvy flipper who made a $91,000 profit in less than two months in 2005 by reselling a 560-square-foot studio for $340,000.

"There was a little bit of a mass hysteria mentality. . . . People thought they would be priced out of the market," said Bradford Willis, 47, who signed a contract in 2004 to purchase a $341,000, one-bedroom condo in a planned luxury development. Willis said he bought on speculation because there was little existing inventory on the market at the time, much of it priced above $500,000.

Sound familiar?

And now? Nowhere, nowhere is the real estate collapse more dramatic than in downtown San Diego.

Irrational exuberance has long since given way to buyer's remorse. Median resale prices for downtown units stood at $370,000 in June. That pricey 560-square-foot studio? It was foreclosed and resold this year for $162,000, down more than half from its 2005 sale price.

Downtown San Diego, a 2.2-square-mile area, is now awash in condos. About 400 new and occupied ones are listed for sale, and more than 450 are in some stage of foreclosure and will eventually be put on the market. An additional 1,000 units that were under construction when the market soured are slated to be completed this year, adding to the glut and putting further downward pressure on prices.

So far this year, 159 new homes have been sold downtown, according to DataQuick. At that pace, it would take several years to sell all the units recently completed or being finished this year. Developers are holding units off the market.

But haven't Vancouver condo builders been smarter?

Nor really. They just have the good fortune that the full effects of the busting bubble have not hit Vancouver yet.

Take Nat Bosa, prominent Vancouver condo builder, for example. He is one of the developers who led the condo charge in downtown San Diego. The LA Times notes that Bosa overestimate San Diego's potential, betting too heavily on the urban revival triggered by the 2004 completion of the Petco Park baseball stadium, home to the San Diego Padres.

San Diego has been a disaster for Bosa.

In Vancouver it is the urban revival of the yaletown/expo lands and the trigger of the Olympic Games hype. Is Bosa several years removed from a similar disaster here?

For some developers in San Diego, rather than dump units at fire-sale prices, developers are converting their projects to rentals, at least until the market improves.

Again, sound familiar?

The bubble started to burst in San Diego in November of 2005. By May of 2006, prices started to rise again. From November of 2006 to May of 2007, prices fell a little more and then plateau'd/rose until November 2007...

It was only at this point, in November of 2007 - two years after the bubble started to break - that the market truly plunged downward.

Vancouver is only a year into the start of it's break.

The only thing that will prevent Vancouver from suffering a similar fate is a dramatic recovery in the economy and buyers becoming flush with cash and easy credit.

Do you think that's going to happen?


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Sunday, July 26, 2009

Sunday Funnies - July 26th, 2009

(Click on image to enlarge)


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Saturday, July 25, 2009

An International Perspective.

There is a annual worldwide investment symposium that has chosen Vancouver as the site of their convention this year. Coincidently they are in town just as the Bank of Canada has declared the recession over.

Care to guess how that declaration is being greeted?

Ian Mathias, managing director of Agora Financial, reported from the symposium on his website yesterday...

"07/24/09 Vancouver, British Columbia. 'The Recession Is Over,' reads the headline of The Globe and Mail today. The staff leaves the paper in front of our rooms here at that Fairmont Vancouver. When we cracked the door open to retrieve the rag, the headline caught our eye… and we thought of just tossing it back in the hallway. If there is any one single theme of this year’s Investment Symposium, it’s that despite the warm feelings and 'green shoots' of summer, this contraction is far from over.

'I think this is really serious, and it’s just beginning,' Doug Casey said during his presentation yesterday. 'Forget about the green shoots. They are weeds. This is the biggest thing since the Industrial Revolution. Stocks will be a good value when dividend yields are around 10%'.

'Real estate? Way too early. Bonds? The bond market is much bigger than the stock market. Interest rates are being artificially depressed. They have to go back up to higher levels to encourage people to save and get out of debt. When interest rates assert themselves, the bond market will collapse, which isn’t good for the stock market, or real estate, either.'

So what’s Doug doing? Going long precious metals, shorting U.S. Treasuries and buying real estate in Thailand and Argentina.

'We are looking for eight signs before we get bullish again,' added Eric Roseman in his presentation:

1) Unemployment must stabilize
2) Home prices must stabilize
3) Domestic consumption must rise
4) Bank lending must grow
5) Toxic assets and bank balance sheets must be fixed
6) Auto sales must stabilize
7) Credit spreads must narrow
8) The dollar has to decline

'Only the last two have occurred. That gives us a very bearish outlook going forward.'

By the way, what did the G&M mean in their 'recession is over' headline? Heh, the Canadian central bank predicted that the economy would grow 1% in the current quarter. Forgive us, but our faith in central bank forecasts ran out a long time ago."


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Friday, July 24, 2009

Carney has a warning for you...

The Governor of the Bank of Canada said this week that he figures the Canadian economy bottomed some time between April and June and is now on its way up again.

This comes one month after he told a gathering in Montreal that, "the markets might be premature in their enthusiasm about improving economic conditions, and are underestimating how long it will take for the global economy to heal."

Just a few weeks ago, this slump was being compared to the Depression of the '30s. Now, everything's fine – or, at least, that's how the Bank of Canada's latest pronouncement is being interpreted.

Assuming that the bank is right (and its predictions are far more optimistic than most, including those of the International Monetary Fund), the picture it paints is not a quick return to the good old days. When you read Carney's monetary policy report, his introduction states any recovery will be "more muted than normal."


That's central bank talk for continued high unemployment and more downward pressure on wages. Not exactly a slump; not exactly a boom. More like a sloom.

At the best of times, an economic turnaround doesn't translate quickly into jobs and wages. Even when the economy has technically started to grow again, employers – anxious to get their profits back up – continue to lay off workers and squeeze payrolls.

Economists call this a lag and it can take time. After the recession of the 1980s, it took seven years for Canada's unemployment rate to return to pre-slump levels.

A "more muted" recovery will take longer.

The Bank of Canada doesn't attempt to predict how long.

Second, there are the what-ifs. What if the rickety nature of, say, Eastern European finances triggers another banking crisis? What if investors become so spooked by the size of the U.S. federal deficit that they start a run on the American dollar? What if the Canadian dollar rises so high vis-à-vis its American counterpart that it makes our exports impossibly expensive?

To its credit, the Bank of Canada mentions all of these, although it tends to do so in the numbingly incomprehensible language favoured by bureaucrats ("escalating concerns about current account and budgetary imbalances").

So what gives?

Is Carney trying to play the public, albeit for honourable reasons?

Given that economies are motivated by psychology (what John Maynard Keynes called "animal spirits"), it appears the central bank is trying to walk a fine line with its public pronouncements.

Does it want to boost public morale so that consumers will spend their money instead of hoarding it (consumer spending eventually translates into jobs)?

Or is Carney trying to lay the groundwork for something he knows is coming and needs an to prepare the public for a freight train he cannot stop?

Quitely buried in many of these newsreports was this little gem here.

"Ultra-low interest rates will not last forever and Canadians should be preparing for the day when their borrowing costs eventually return to more normal levels," says Bank of Canada Governor Mark Carney.

Focus on two key words here: "preparing" and "normal".

Normal, by the way, is 8%.

That's a jump from 0.25% to 8%.

Given the grief that will cascade down upon the Bank of Canada for the pain this sort of jump will wreak on Canadians, Carney can now say "we told you the recession was over" and it becomes the justification for the unstopable rate hikes.

It's Carney's 'out'.

Regardless of the motivation one thing is clear... you've now been warned.

As Carney said, "Canadians should prepare".


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Thursday, July 23, 2009

The Recession Is Over... supposedly!

Bank of Canada Governor Mark Carney came out today and declared that "the recession is over".

Oh boy, oh boy.

Guess we will be wrapping up the blog, throwing everything we have into real estate purchases, and getting back on the bubble gravy train.


But wait... isn't this the same Mark Carney who insisted, back in 2008, that Canada would not be hit by a recession in the first place?

Wasn't this the same Mark Carney that said our country wouldn't feel the same economic pain that was hitting the United States?

So what we actually have, then, is great news from the brilliant minds who never saw this coming, did nothing to prevent it, then denied it was happening.

And if the bank's new forecast proves correct, Canada's first recession since the early 1990s lasted three quarters, making it one of the shortest downturns on record. The shortest recession ever in the midsts of the greatest worldwide economic downtown since the Great Depression.


And Carney's prescient comments hearlding the end of the recession come out on the same day we are told that we are on the verge of a commercial real estate crisis.

Touted as "the other real estate bubble", investors are being warned that commercial real estate’s decline is a significant issue facing the economy because it may result in more losses for the financial industry than residential real estate. This category includes apartment buildings, hotels, office towers, and shopping malls.

It seems that US banks have been charging off (effectively assigning to the write-off bin) their commercial real estate loans at the fastest pace since the late 1980s. As the economy has struggled, developers and landlords have had to rely on a helping hand from the US Federal Reserve in order to try to get credit flowing so that they can refinance existing buildings or even to complete partially constructed projects.

From Vancouver to Manhattan, we are seeing rising office vacancies and declines in office rents. The issue for the financial sector is that the loans on their books have had to be written down to reflect the sorry state of commercial real estate. Though the US banking industry has for the most part turned in a stream of impressive profitability this quarter, the concern amongst investors is how much more of these loans are going to have to be written off.

The insurance industry is also impacted by the commercial real estate situation. Some of the leading insurance companies have invested about 10-12% of their assets in commercial mortgages. If the value of commercial properties were to continue to decline, then the write downs in mortgage loans on the books of these companies would severely impact their shareholders – not to mention their customers.

And the economy?

I see another 'revision' in Mark Carney's future.


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Wednesday, July 22, 2009


In 2008, when the Canadian housing scene started to seize up and contract, the federal government began throwing everything they could at the problem. After 15 years of digging our country out of a massive deficit, the Conservatives plunged the nation into it's greatest deficit ever with the stroke of a pen.

Every knows that we are now $50 Billion dollars in the red. But there is a massive amount of hidden leverage that is poised to crush the Canadian taxpayer.

The Bank of Canada lowered the prime lending rate to 0.25% in a desperate attempt to resuscitate the economy, and the real estate market.

And borrowing to buy houses has taken off dramatically this spring.

But while many banks were flogging that it was a great time to buy a home, did you know that not one of them has increased their mortgage holdings?

Between the beginning of 2007 and 2009 Canadian Banks increased their total mortgage credit outstanding listed on their books by only 0.01% (see CMHC chart below - click on image to enlarge).

Why is that?

The reason may be found in the growing danger of holding these mortgages.

The only growth in real estate by our Canadian Banks in the last few years has been in the securitization of Canadian mortgages.

Banks have been very eager to package up mortgage debt and sell it off as securitized products.

But after the debacle that evolved in the United States from securitization (a practice that is credited with laying waste to the world economy), how can these products sell today?

They sell because, in Canada, the government of Canada insures 100% of any losses of a mortgage loan (not just the 20% down payment) through CMHC insurance. This means that mortgage securities are as secure as government bonds, yet pay a higher premium.

And just how profitable is the securitization of these Canadian mortgages for our banks? The largest market for Mortgage Backed Securities (MBS) is the 5-year fixed single residential home mortgage. The average term has swelled over the past two years and the majority of issues are for ams over 30 years. Some pools of MBS were issued at 9% but pay investors only 4% - a difference that represents how risky and profitable these loans are. CMHC charges 0.2% for the insurance, which leaves up to a 4.8% profit for the bank.

Securitization has accounted for 90.5% of all growth in total Canadian mortgage credit outstanding since 2007. Its market has grown from 100 billion in 2006, to 130 billion in 2007, to $295 billion by mid-June 2009.

So banks are gung-ho to approve mortgages, but are not increasing their holdings (read their exposure of risk) to mortgages.

CMHC plans to expand securitization of debt to 370 billion by the end of 2009 as per the conservative government's request.

All of these securities are traded on an open exchange and insured by the Government of Canada.

Currently TD has issued $59 billion in securities outstanding, CIBC $51 billion, BNS $32 billion, RBC $45 billion and BMO $27 billion.

Is it any wonder so many first time buyers are having their banks preapproved their mortgage requests? Many individuals are being granted 500-800K for their first home purchase if their household income ranges from 110-170K.

And why not? The banks don't care. You either qualify for securitization or you don't. Their is no emotion or extra thought put into the loan by the bank since it bears zero risk. Investors don't care who you are since the security is backed by the government.

This situation is stunningly similar to the one that evolved in the United States from 2002 - 2006. A mad rush of mortgages were issued because everyone was profiting from securitization, but none of the front line institutions bore any risk.

When Canadian real estate began to nose dive (losing 10% of its value by September 2008) all kinds of alarm bells started to sound. If losses surpassed 10%, it would mean that all the buyers in 2007 would move into negative equity. Cranking interest rates down to 0% in October of 2008 along with the expansion of government backed securities allowed mortgage rates to reach an all time low. The resulted in a house boom in the middle of the worst Canadian recession since the Great Depression.

The Canadian government has moved 'all-in' on their gamble that the economy can be resuscitated.

On Jan 1 2009 CMHC allowed non regulated financial institutions to issue mortgage backed securities. Furthermore on January 26, 2009 CMHC allowed the securitization of line of credits, non amortizing & amortizing loans and readvanceable loans.

CMHC indicates in its plan that it will insure $813 billion via a combination of mortgage insurance and mortgage-backed securities (MBS) by the end of 2009.

Looking at 2008 and 2007, one can clearly see that CMHC has drastically exceeded their planned figures. $812 billion is more than likely a minimum target. At this rate the Government of Canada will be insuring well over $500 billion in securitized mortgages and lines of credit by the end of 2010. It will also have issued over $600 billion in outstanding mortgage insurance.

At the zenith of the US housing bubble, prices peaked around $250,000 US while incomes were around $47,000 US.

In Canada, prices are now at #326,613 and incomes are $44,000.

And unlike the United States, if this house of cards collapses, it won't be Bear Sterns and AIG that goes under... it will be CMHC. And who guarantees CMHC?

The Canadian government does.

A $50 billion dollar deficit is peanuts compared to the risk we are exposed to. And if the economy worsens with another slide in real estate values... our nation could be exposed to a collapse in confidence that will parallel the stock market in 2008 when Bear Sterns was about to fail.

Can you say Canadian peso?

(hat tip to America/Canada blog for much of this information)

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Monday, July 20, 2009

Canada's Emerging Credit Quagmire

CMHC was formed as a crown corporation in Canada after World War II to address the shortage in housing. It's mandate was to make home ownership accessible to all Canadians.

CMHC primarily achieves this by delivering mortgage insurance and mortgage backed securities.

CMHC was once an ultra conservative crown corporation.

But starting in the new millennium, pressures started to build on CMHC to change the way it does business. And those changes are creating an alarming set of conditions that should alarm all Canadians.

In 2001 GE Capital was permitted to join CMHC in the Canadian mortgage insurance industry to provide competition in the marketplace.

GE Capital began insuring Canadian mortgages and issuing NHA-MBS (mortgage backed securities insured by the Government of Canada). In response to this competition, CMHC began loosened that conservative approach.

As late as 2002 total outstanding mortgage debt in Canada (approximately $467 billion) was predominantly issued to only good credit candidates and people with proper down payments. More importantly, CMHC only insured a small portion of this debt.

In 2003 CMHC decided to remove price ceiling limitations on the value of the homes that it would insure. It meant that CMHC would not insure any mortgage regardless of the cost of the home.

In 2007, after years of lobbying, the now defunct AIG group successfully lobbied the newly elected Conservative government to allow AIG to insure high risk Canadian mortgages, issue mortgage backed securities on these loans and exchange them on the open market.

At the same time, the Conservative government launched a radical 35 year amortization campaign and 0% down payment policy.

A few months later 40 year amortizations were permitted.

These radical changes supercharged the real estate market.

Buyers, who couldn’t previously get into the market, flooded in. Historically high home prices continued to gain steam. High risk borrowers surged forward and throughout 2007, the average home buyer who took out a mortgage had only 6% equity in their homes.

6% equity! And that’s not just the new buyers, that's the national average down payment for all mortgages including buyers who moved up.

In 2008, as Canadian home prices started to get slammed with the worldwide bursting of the housing bubble, Canadian home prices started to dip.

CMHC admits that it was ordered to approve as many high risk borrowers as possible to prop up the housing market and keep credit flowing.

42% of all high risk applications were approved, a 33% increase over 2007.

And that was before the dramatic lowering of interest rates to their lowest point in history.

A stunning situation is developing that has some analysts suggesting Canada is in a far more precarious position than the United States was in 2006.

Tomorrow we will take a closer look at it.


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Sunday, July 19, 2009

Sunday Funnies July 19th, 2009



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Saturday, July 18, 2009

Two profiles: US Banks, CMHC

Two snapshots of institutions on either side of the 49th parallel for you today.

First we start with with our favorite whipping post, the US Banks.

As our Prime Minister commented on last year, the recovery will not begin until the US Banking system stabilizes.

So what's the outlook?

Yesterday there were four more bank failures on Bank Failure Friday bringing the total to 57 for the year. Unfortunately that may only be a drop in the bucket compared to the tsumani of failures on the horizon.

A report in (see article here), notes that the banking industry is bracing for continued losses from consumer loans due to the rising unemployment rate and an expected wave of commercial real-estate losses.

At a Senate Banking Committee hearing in Washington on Thursday, Sen. Jim Bunning (R-Ky.), repeated a comment relayed to him by Federal Deposit Insurance Corp. Chairman Sheila Bair that another 500 banks could fail "unless something dramatic happens."

So much for stabilizing.

Meanwhile there is the Canada Mortgage and Housing Corporation (CMHC).

As I have already stated the Canadian goverment, in a desperate attempt to prevent a repeat of the US real estate collapse, has thrown massive fiscal stimulus and ultralow interest rates at the Canadian economy in a desperate attempt to supercharge real estate and forestall the collapse of values.

Not only could such a development put the Canadian economy is jeopardy, but the Canadian goverment could be facing a supreme risk as well.

Consider... Canada’s housing insurance agency, run by Ottawa and accountable to the Minister of Finance, provides endless amounts of cheap insurance for high-ratio loans (with minimal down payments). In doing so, CMHC allows Canadian banks to pass off the risk of these home loans to the federal government.

Presumably this allows them to be more willing lenders.

Currently CMHC guarantees about $630 billion in mortgages, an amount of equal in size to half the Canadian economy.

Half! That's an astonishing amount of money.

And what assets stand behind this? Down payments worth about $8 billion (plus the book value of the real estate).

So what happens if the real estate bubble bursts and asset values crash? For starters it will mean that up to 98% of its liabilities will not be covered. Moreover Canada will be facing a situation worse than that which faced US mortgage giants Freddie Mae and Fannie Mac, which lost 90% of their market value.

Some of you have asked why the government is moving heaven and earth to keep the real estate market afloat. That's why.

But as economic recovery takes longer and longer to come into play, we have a situation where the current average home price can only be supported at artificially-low interest rates. And our Canadian banks only make those loans because they are backstopped by a federal government now running its worst-ever deficit.

Over $600 billion in mortgage risk belongs to the taxpayers – and Ottawa is already tapped out. So what is going to happen when interest rates rise?

What we have is Canada's own little subprime crisis in the making. The Bank of Canada has ushered in interest rates that are comparible to the US subprime-style teaser loans.

I say this because the Bank of Canada knows that these rates will be doubled or tripled in the years ahead. Yet, by dropping their key lending rate to the lowest point ever, they have created a situation that allows 3% mortgages to further inflate house values.

And just like the US subprime teaser-rates, when the mortgages reset at the higer rates... a wave of defaults and foreclosures will result.

When that first wave hits, the banking system will seize up, credit will stop dead in it's tracks, and the goverment will be pushed to the brink of insolvency.

A series of dominos are building. And when they start to tumble, the result is going to be devestating.

The housing crisis has not been avoided in Canada. It's only been delayed as officials pray for a swift economic recovery that is not coming.

One only has to look at the US Banking system's failure to stabilze for that evidence.


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Friday, July 17, 2009

More bad news in the US economy

It seems increasingly likely that CIT Group, a major lender to small businesses in the United States, will file for bankruptcy protection soon.

Small businesses are seen as keys to economic recovery but now a major company that lends to thousands of small and mid-size businesses is about to go tits-up. Not good news for an economy in recession and bleeding hundreds of thousands of jobs a month.

In a last-ditch effort to avoid bankruptcy, CIT was trying Thursday to line up $2 billion to $4 billion in rescue financing from its debtholders within the next 24 hours.

Many retailers fear the impact of a CIT bankruptcy because the loss of financing could seriously disrupt the flow of merchandise.

Three prominent retail trade groups sent letters to financial regulators this week warning that the failure of CIT would rip a hole in the industry supply chain. Dunkin' Donuts said the ability of its franchisors to open new stores or expand operations could be affected. And New York bankruptcy lawyer Jerry Reisman said he received more than two dozen calls from panicked stores and apparel manufacturers, some of which said they may not have the money to pay their employees today.

CIT plays an important behind-the-scenes role in the retail industry. When stores place orders for merchandise, they typically have two to three months to pay for the goods. Suppliers hand those IOUs over to lenders such as CIT - a process known as factoring - which in turn provide suppliers with cash upfront to make their merchandise.

If that system were to be disrupted, industry experts say, the result could be barren store shelves and a ruined Christmas for many US retailors.


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Thursday, July 16, 2009

Who ya gonna trust?

Canadian Real Estate Association president Dale Ripplinger tells us “the worst of the recession may be behind us.”

On the basis of this heady news, "potential buyers who moved to the sidelines late last year when economic uncertainty peaked are returning to the housing market."

The government engineered cheap mortgage rates have created a mini real estate frenzy and, according to the CREA, prices have just reached a new all-time high, surpassing the record set in the second quarter of 2008.

To these shills, er... economists... buying at the peak right now is the thing to do because tomorrow there will be a new peak.

So, faithful reader, who are you gonna trust? These salesmen... or your own logic.

Is the recession behind us?

There will be no recovery in Canada until there is recovery in the land of our largest trading partner, the United States.

And what is happening in America?

The US Bureau of Labor Statistics preliminary estimate for job losses for June at 467,000, which means 7.2 million Americans have lost their jobs since the start of the recession. The cumulative job losses over the last six months have been greater than for any other half year period since World War II, including the military demobilization after the war. The job losses are also now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all job growth from the previous expansion.

The first major mistake these 'salesmen' are making is viewing this recession like previous ones.

This isn't like past recessions. If you are going to compare circumstances you have to compare this recession to those that started with the bursting of a giant speculative bubble. When you do you, see slow recoveries. The reason you see slow recoveries is that asset values at bottom are so low that investor confidence returns only gradually.

But even those who predict a more gradual recovery as investors slowly tiptoe back into the market, will be proven to be wrong.

This recession is very deep.

And in a recession this deep, recovery doesn't depend on investors. It depends on consumers who, after all, are 70% of the U.S. economy. Consumers have been crushed in this recession and until they start spending again, you can forget any recovery.

The problem is, consumers won't start spending until they have money in their pockets, or until they feel reasonably secure.

They don't have the money, and it's hard to see where it will come from.

In recent times, Americans found myriad ways to fuel spending, even as incomes stagnated: borrowing against the once rising price of their homes and tapping plentiful credit cards.

No longer. They can't borrow like that because one out of ten home US owners is under water - owing more on their homes than their homes are worth. American homes are worth a fraction of what they were before, so say goodbye to home equity loans and refinancings.

The paycheck has returned as the primary source of spending, and pay is eroding even for those who have jobs. This process is nowhere near complete, and, until it is, the economy will barely grow, if at all, and may well oscillate between sluggish growth and modest decline for the next several years until the rebalancing of the excessive debt has been completed. Until then, the private economy will be deprived of adequate profits and cash flow, and businesses will not start to hire. Nor will they race to make capital expenditures when they have vast idle capacity.

US unemployment continues to rise, and number of hours at work continues to drop. Those who can are saving. Those who can't are hunkering down, as they must.

Meanwhile in Canada unemployment is also rising quickly, over 2 million people are out of work and household debt equals almost 140% of disposable income.

A new federal report warns our budget deficit will top $50 billion for at least a couple of years, and then Ottawa’s finances will be in the red for a decade. This, says economist Dale Orr, will add $200 billion to the federal debt, wiping away what 15 years of the GST and higher taxes were supposed to eliminate.

Don't you remember those times?

Our immediate future will be one of slashed government spending. And as our goverment must borrow more and more, interest rates will soar back to double digit rates as the mushrooming debt becomes more expensive to finance.

Economic growth alone (if there is much) won’t balance the books so governments will have to raise taxes – BC is already pounding the war drums on cutting services in health care due to lack of funds.

And this economy can't get back on track because the track we were on for years -featuring flat or declining median wages and mounting consumer debt - simply cannot be sustained.

Low interest rates and government stimulus can only delay an economic reckoning until the economy begins to recover. But that economy won't "recover" because it can't go back to where it was before the crash.

It means there is still a lot of "economic adjustment" ahead of us, regardless of what these polished R/E salesmen... err... economists may say.

In other words, there are many more reasons today to expect the downturn to continue than to expect a turnaround.

You only have to look at what is happening around us to see this yourself.


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Wednesday, July 15, 2009

"Blue Horseshoe Loves Anacott Steel"

There are days I like to pick up three or four newspapers and put my feet up in the backyard and simply read.

Today was one of those days. And it is amazing to see the similarity in news articles sometimes.

You can understand it for a major event, but it never ceases to amaze me when I see it for something like real estate.

Don't get me wrong, I understand what is happening. About 10 years ago I got a major lesson in 'public communications' when I took on a cause I cared about. I found it fascinating to watch the intimate behind-the-scenes moves that a major government bureaucracy undertook as it artfully managed both the press and their political masters.

And I was a quick study. The reality is that most reporters are lazy. Once you recognize this, and you tailor your information to spoon feed those journalists you develop a successful relationship with, PR truly becomes a game.

Almost weekly a comment was made here, a phone call there, and suddenly what I said today would appear in tomorrow's newspapers written by someone else.

It is truly an artform.

And that's what public relations has become... an artform.

The problem comes when you tread that very fine line between artful public relations and machiavellian manipulation.

Yesterday I posted an article on David Lereah. For those who do not know, David Lehreah was the chief economist for the US National Association of Realtors. David was the consumate machiavellian PR hack who did more than issue rosy forecasts. He regularly trumpeted the infallibility of housing as an investment. In countless interviews, on TV and in even in his fateful 2005 book, "Are You Missing the Real Estate Boom?", Lereah tirelessly pumped the housing market.

Lereah was so successful at prodding wary consumers into committing to making housing purchases that Time Magazine named him as one of the '25 People to Blame for the Financial Crisis'.

A dubious distinction to be sure.

But as one of the 'blog dogs' posted in response to yesterday's post... this is old news.

What makes him relevent, tho, is his forthright acknowledgement as a corporate shill on the part of the Real Estate Industy. Under the guise as a 'market economist', Lereah pumped the Industy as any other high pressure salesman would in many other fields.

Understand... he promoted a product (real estate), as a salesman, hidden under the guise of a fancy title (chief economist). And in doing so he dangerously treaded that fine line between promotion and deception.

It's important you understand this.

Because what is happening in Real Estate in British Columbia and Canada now is no different from what was going on in the United States in 2007.

A mere year after the US real estate market had begun a spectacular downward slide, Lereah pulled out all the stops as he manipulated the national media to promote the idea that "it appears we have established a bottom" to the real estate crash. And this was done in a desperate attempt to restore 'consumer confidence' and halt the downward slide.

A great many Americans dived into the housing market as they blindly followed the advice of Lereah and the National Association of Realtors... and in doing so, those Americans committed a catastrophic financial mistake.

Picking up the Globe and Mail newspaper today, I read headlines trumpeting a "Phoenix-like rise' in the real estate market. The Industry is giddy and proclaiming that "in Canada, buyers are back, sales are surging, and prices are edging up."

"Canada appears to have skirted the clutches of a lengthy, painful downturn. We can quibble about how stong and early the recovery will be, but the worst is over", says Michael Gregory, a senior economist at BMO Nesbitt Burns.

It isn't.

Faithful readers know I have written about this phenonmenon often.

In a desperate attempt to prevent a repeat of the US experience, the Canadian government has thrown massive fiscal stimulus and ultralow interest rates at the Canadian economy in a desperate attempt to supercharge real estate and forestall the collapse of values... a domino that would devestate the Canadian economy.

And lo-and-behold, a year after the start of the collapse in Canada, Canadian economists are making the exact same claims as the famous David Lereah was just over one year into their collapse.

You will recall it started back in February when Canadian R/E Industry shills started putting out stories on how first time buyers were diving into the market to take advantage of historic low interest rates - and how their peers were being 'left behind'.

Phone calls were make and virtually the same, identical stories were appearing in newspapers in Vancouver, Calary, Edmonton, Winnipeg, Toronto and Montreal, but tailored to profile individual couples in each market.

Each newspaper came out with these stories on almost the same day.

It has been a highly organized and coordinated campaign specifically targeted to manipulate 'consumer confidence' and it is being done with a level of skill that would have made Gordon Gekko (from the movie Wall Street) proud.

I can almost hear the phone call now... "Blue Horseshoe loves Vancouver Real Estate."


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Tuesday, July 14, 2009

Confessions of a shill...

Click on the image to enlarge the article...


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Monday, July 13, 2009

More on China

Longer break than anticipated... but I am back.

More on China.

Everyone seems to think that investments by China will help developing economies regain their growth momentum in the second half of this year, pulling the global economy out of the worst worldwide recession in six decades.

On July 8th the International Monetary Fund forecast that China’s expansion will accelerate to 8.5 percent next year from 7.5 percent in 2009. But more and more evidence is croping up to doubt this will happen.

The latest evidence came in last week's debt sale by China (yes... despite the fact that China owns the largest foreign amount of US debt - 790 Billion - China still needs to raise funds by selling it's own debt).

Last week China failed to attract enough bidders in a government debt sale for a second time on speculation record bank lending by Chinese banks will spark inflation in the world’s third-largest economy.

The Ministry of Finance sold 25.1 billion yuan ($3.7 billion) in bills of the 35 billion yuan it had sought, according to statements on the Web site of Chinabond, the nation’s biggest debt-clearing house. The government fell short of its target in a bond sale for the first time in almost six years on July 8.

The auction’s failure reflects concern that Premier Wen Jiabao’s 4 trillion yuan stimulus package will cause bubbles in stock and housing markets, forcing the central bank to tighten monetary policy. The People’s Bank of China this week pushed up money-market rates and drained cash from banks, the biggest investors in the nation’s $2.2 trillion debt market.

“The central bank’s open-market operations suggest concerns that the rapid surge in new bank lending in the first half of this year could fuel inflation,” said Tommy Xie, an economist at Oversea-Chinese Banking Corp. in Singapore. “Some people speculate the central bank will raise interest rates this year but I don’t think they can as global growth slows.”

So what we now have is two very interesting conditions emerging. A perfect storm for inflation in North America with the US Federal Reserve's unprecedented increase in the US money supply and China' rapid surge in new bank lending which is fueling an irrational surge in worldwide stock markets and setting the stage of inflation on the other side of the globe.

This is how you set the stage for worldwide events that slip away from one single central bankers control.


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Tuesday, July 7, 2009

14 is 10-7

The sudden death of a co-worker is always a difficult thing, especially when it involves a hard working, outgoing and good natured colleague.

And today it hits a little harder than when the news broke yesterday.

So no posts until Saturday.


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Monday, July 6, 2009


As this economic crisis took hold, all we keep hearing about is how China will keep the global economy moving.

Such are the glowing reports about China, that mainstream analysts are predicting that China will overtake the US economy as the largest in the world by 2020. Currently it represents about one quarter of the enormous US financial machine.

But I don't buy into that argument. China has some very serious problems.

Part of the recent optimism in world markets rests on the belief that China’s fiscal-stimulus package is boosting its economy and that GDP growth could come close to the government’s target of 8% this year. Some economists, however, suspect that the figures overstate the economy’s true growth rate and that Beijing would report 8% regardless of the truth.

While it is true that China's stock markets are surging, and it's true that China is buying commodities... there are structural reasons for this and they raise some serious red flags (pardon the pun).

First of all China has been pumping it's own stimulus money into the econony. To the point were some fear China's banks are veering out of control. The half-reformed economy of the People's Republic cannot absorb the $1,000bn blitz of new lending issued since December.

Money is leaking from stimulus projects directly into Shanghai's stock market (many are already calling it a huge, developing bubble). The money is also being used to keep bankrupt builders on life support.

That money is doing very little to help lift the world economy out of slump.

Fitch Ratings - an international ratings agency who provides issuer and bond ratings, research and surveillance on banks - has been warning for some time that China's lenders are wading into dangerous waters, but its latest report is even grimmer than suspected.

The China Government is so hellbent on meeting its growth target of 8% that it has given banks an implicit guarantee for what Fitch calls a "massive lending spree" . The agency says China's monetary stimulus since November is arguably more extreme than the post-Lehman printing of the US Federal Reserve, though less obvious to the untrained eye.

And all the money is funding an illusion of a booming economy.

Take China's current penchant for buying commodities. Our markets are hearlding this a sign the Chinese economy is in full production mode.

It isn't.

China has been on a buying spree to stockpile and build its inventories of metals, including 235,000 tonnes of copper, over recent months. China also bought "590,000 tonnes of aluminium, 159,000 tonnes of zinc, 30 tonnes of indium and 5,000 tonnes of titanium", said Yu Dongming, who works in the National Development and Reform Commission's industry department.

Many analysts believe this is one way China can diversify it's huge holdings of American dollars without bringing large atention to it's activities.

So much for commodities fueling China's economic engine.

Besides buying commodities, China's stimulus money is fueling other bubble conditions.

China's banks have issued a staggering 5.2 trillion yuan ($761 billion US) in new loans in January to April - equivalent to 17% of the country's gross domestic product in 2008.

But the pace of lending is faster than infrastructure projects could possibly be started up, Fitch Ratings banking analyst Charlene Chu said in a conference call. One warning sign, she said, was an admission in the central bank's quarterly report that regulators were looking into where all the bank loans are going.

"We know this is not being totally dictated by the government, because if it were they would know exactly where it is going," Chu said.

Recently China's bank regulators issued new draft rules that would impose much stricter controls on most loans - requiring lenders to hold onto the money and pay it directly to companies contracted to provide materials and services for projects.

The aim is to prevent funds from being diverted to other investments or misuse - a problem noted in a recent report by China's National Audit Office.

The surge in lending early this year was partly driven by the determination of banks to meet profit targets by ramping up the volume of loans to help make up for shrinking interest-rate margins, Chu said.

Meanwhile, the glut of money available has piled more pressure on loan profit margins, obliging banks to lend even more to keep up.

"This just becomes a vicious cycle," Chu said.

Beyond these bubble concerns are serious internal problems.

China's countryside people do not enjoy any of the economical advances in China. This means two things.

One, a mass immigration from the countryside to the big cities. China doesn’t encourage mobility and restricts the movement of the population through preventing essential services from "illegal immigrants". The result - those immigrants have to live in sub-human conditions in ghettos around the big cities. The number of those immigrants is estimated at 150-200 million.

Second, there’s a growing disapproval among the low rank factory workers that causes strikes and demonstrations, which are banned by the Chinese law. According to the security ministry, the number of demonstrations in China have risen from 30,000 in 1999 to 75,000 in 2004. The number of demonstrators has multiplied by 8.

Today's newscasts have coverage of one such violent clash with authorities.

Then there is China's own financial deficit

The "one child" policy has created a social problem, that is apparent in the old-young population ratio. As of today, 11% of China (150 million) are over 60, with estimates of 30% by 2050. While in 1980 there were 13 workers per a pensioner, in 2003 it went down to 3.

Of all the population, only 13% have pension plans. The financial deficit that was 4.5 billion US$ in 2000 has exploded to a 100 billion US$ in 2005.

The world-bank’s simulation has estimated China’s deficit in 2050 to be 1 trillion US$. Hundreds of millions of Chinese approaching pension age might become a real burden on the developing economy.

I could go on and on.

The bottom line is that China is not the looming economic superpower that will crush the United States economy twenty years from now.

Will it get bigger?: certainly.

Will it become the world's dominant power?: I don't think so.


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Sunday, July 5, 2009

Sunday Funnies - July 5th, 2009

(Click on image to enlarge)


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Saturday, July 4, 2009

The Fourth

Happy Birthday, America.

As the sun sets and Americans gather from sea to sea to celebrate their nation, the world is in the midsts of a financial crisis, the likes of which has not been seen since the Great Depression.

And I continue to maintain that we have suffered a deep and significant financial earthquake, the effects of which most people still do not fully understand or appeciate.

To be sure, it is NOT the prelude to another Great Depression.

History does not repeat itself.

The banking system will not be allowed to collapse as it did in 1932 exactly because its collapse then caused the Great Depression.

But understand this, dear reader. Events in the 1930s took years to play themselves out. It took from October 1929 until mid 1932 for the banking system to collapse. And it was only after that collapse that we entered the Great Depression.

So if this is not to be another Great Depression, let's also be clear that it is not comparable to some of the smaller, period crises which have afflicted particular segments of the financial system since the 1980s.

It is not like the international banking crisis of 1982, the savings and loan crisis of 1986, the portfolio insurance debacle of 1987, the emerging market crisis of 1997, nor the technology bubble of 2000.

This crisis is not confined to a particular firm or a particular segment of the financial system.

It has brought the entire system to the brink of a breakdown, and it is being contained only with the greatest difficulty.

What we are witnessing is a crisis with far-reaching consequences. It is not business as usual... but the end of an era.

But while some hearld the decline and fall of the American Empire, I'm not so sure that is fait accompli.

We are already seeing that those who insisted that India, China and Europe would keep the global economy moving (even as the United States choked and sputtered on trillions of dollars of excess consumer debt) may have miscalculated.

Europe, like America, is also in shambles. India is stumbling, and it is becoming increasingly clear China is not doing as well as predicted (more on that later this week).

To be sure... America is in for a royal economic shite-kicking and there is some serious pain ahead.

But on this Fourth of July, I would be willing to bet serious money that twenty-five years down the road China will not be supplanting America as the world's dominant nation.

I will try and explain why over the course of this month.


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