Wednesday, April 28, 2010

No laws are more basic than the laws of arithmetic

So what is quickly developing as the central story in world finances right now?

Sovereign debt.

And yesterday there was a dramatic worsening of the eurozone sovereign debt crisis as Standard and Poor's downgraded Greece's credit rating by three notches to junk status, citing concerns about the country's ability to implement the reforms needed to slash its budget deficit.

The agency also cut Portugal's rating by two notches to A minus.

This, of course, led to heavy falls for European and US equities as investors sought sanctuary in German and US government debt, gold and the dollar.

The moves came towards the end of a European session that saw mounting uncertainty over whether Greece would secure financial aid in time to meet a refinancing deadline on May 19.

In view of the popular opposition in Germany to helping Greece, markets have grown increasingly concerned about just how Angela Merkel, Germany's chancellor, can push the country towards participating in a bail-out.

Jane Foley at said: "If Germany doesn't come through with a loan for Greece, it would seem unreasonable to expect cash-strapped economies such as Spain, Ireland and Portugal to help make good the shortfall - meaning that an EU loan could yet fail. Even if Germany does present a loan to Greece, there would be no guarantee that there would be an end to Greece's problems. Until Greece can prove it can live within its means its bond yields will carry an inflated risk premium on the open market reflective of higher default risk."

Five-year credit default swaps on Greek government debt, a measure of insuring against debt default, hit a record yesterday of 800 basis points, up from 710bp on Monday. The spread of Greek 10-year government bond yields over Bunds - the premium demanded by investors to hold Greek rather than German debt - hit a record wide of 718bp.

"Risks are mounting and governments should move swiftly to take additional corrective measures to improve their outlook and bolster market confidence."

What is most interesting is the way investors are seeking sanctuary in the the US dollar and US Treasuries.

Mark my words... it will be a shortlived strategy.

As has been stated on this blog earlier this year, the UK and the US are not that far removed from Greece and Portugal.

In fact on the very day all this transpires, US Federal Reserve Chairman Ben Bernanke is warning the United States that America's debt is unsustainable.

And perhaps the most significant quote was this little gem: "Failure to cut the deficits would push interest rates higher - not only for Americans buying cars, homes and other things - but also for the government to service its debt payments," Bernanke said.

Which brings us to our insular little world in the Village on the Edge of the Rainforest.

So many of the R/E cheerleaders living in denial and delusion have clung to Bernanke's comments about keeping the Federal funds rate low for an extended period of time, even as the economy appears to be recovering.

But as I have cautioned time and time again, that does not mean interest rates for the common mortgage holder won't rise.

Today Bernanke came out and said so.

What is happening in Greece and Portugal today will - soon enough - play out in the UK and the United States.

Many of the individual States in America are in dire financial straights. And the federal balance sheet, as Bernanke notes, is unsustainable.

"No laws are more basic than the laws of arithmetic: For fiscal sustainability, whatever level of spending is chosen, revenues must be sufficient to sustain that spending in the long run," Bernanke told President Barack Obama’s commission to tackle the soaring deficit yesterday.

The bond market is going to drive interest rates up.

And I don't think it's a stretch to imagine that if the Bank of Canada raises the BoC rate by 3% over the next six months that the bond market also won't drive up rates an additional 3% as well (we've already seen them boost rates 1% with no raises from the BoC).

That would be a rate increase of 6% added to the current five year rate of 6.25%; for a mortgage rate of 12.5%.

Perhaps that's why BoC Governor Mark Carney was telling a Parliamentary committee that Canadians should get ready for more expensive money and less expensive houses. “We see a marked weakening in housing over the course of our projection (into 2012), starting from the second quarter of this year and over the balance,” he said.

Central Bankers choose their words with extraordinary care.

And when Carney says he sees a "marked weakening in housing" between now and 2012, you should pay particular attention.

Perhaps he sees what a 12.5% mortgage rate will do to it.



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Tuesday, April 27, 2010

They did what?

And you thought twice in two weeks was a shock?

How about three for three?

Monday's, if you hold a mortgage, will soon be approached with absolute dread.

Yesterday the country’s largest bank, Royal, announced another round of mortgage-rate hikes. The rate on a five-year closed mortgage is now 6.25 per cent, an increase from the previous rate of 6.10 per cent. A one-year closed rate will, as of Tuesday, be priced at 3.80 per cent. All rates were increased by 15 basis points.

And all while the Bank of Canada rate hasn't moved a single point.

Canadian banks are preparing for an era of rising interest rates and these are just the early days of what is coming.

The bond market has now pushed rates up about 1% in just three weeks. And when the Bank of Canada makes it's moves (3% spread over 6 months to a year), don't expect rates to only move in tandem with the BoC.

They aren't now... what makes you think they will when Carney finally acts?

With that in mind I invite you to check out this well done youtube video by Vancouver Condo Info.

The video is a roller coaster simulation of the last 35 years of the Vancouver Real Estate market. The actual graph you're riding is the inflation adjusted value of a house in Vancouver BC based on data collected by Royal LePage and calculated by the UBC Centre for Urban Economics and Real Estate. Some of the peaks and troughs have been rounded to keep the train from flying off the tracks, but other than that slight modification it is a precise scale model of the red line on this graph.




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Monday, April 26, 2010

Don't be fooled...

"Don't be fooled by the quick recovery". That's Bank of Canada Governor's bit of sage advice to Canadians.

Carney went to great pains on this weekend to tell consumers, executives and investors that they would be wrong to conclude it is business as usual these days.

“Anyone who sits and looks at what happened and says, ‘Well, that wasn’t a Great Recession,’ hasn’t appreciated the scale of what was done to ensure an outcome that wasn’t as extreme as before,” Carney told reporters on Saturday. “Particularly on the fiscal side. Anyone who doesn’t appreciate the gravity of the last couple of years hasn’t thought through or appreciated the scale of what will be required to adjust fiscal back to normal.”

Think about that for a moment.

Carney is emphasising what we have been saying on this blog all year. And 'adjusting' back to 'normal' isn't going to be an easy process.

And what concerns Carney most of all?

Why... sovereign debt, of course.

“We’ve seen war-like spending in peacetime,” Mr. Carney said. And the fact of the matter is that the world economy still is being powered mostly by hundreds of billions in government spending and extraordinary monetary stimulus. The growing debt – mostly public, but also private, as consumers in countries such as Canada took advantage of record-low interest rates to borrow and spend – is fundamentally changing the makeup of the global economy.

“What we are seeing with Greece, and what we have been seeing over the last few weeks, are the indications of the limits of fiscal stimulus,” Mr. Carney said. “There are a number of countries that are having to make adjustments, or will have to make adjustments, to more sustainable fiscal paths and I think that is an increasingly shared realization.”

And two of the countries foremost on the list of those that are going to have to make adjustments are the UK and the United States.

“We have to look at that and think of how to rebalance our own economic activity,” he said, referring to the relative weakness of Canada’s primary trading markets in the U.S. and Europe.

Make no mistake... there are serious hard times ahead. We're in a false recovery, and no one is more acutely aware of that than is Mark Carney.



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Sunday, April 25, 2010

Sunday Funnies - April 25, 2010

(click on image to enlarge)


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Saturday, April 24, 2010

In BC... we are not Alfred E. Neuman

In the last post I talked about blissful ignorance, a comment triggered by Financial Post article which covered a recent poll by The Investors Group to find out if homeowners across Canada were concerned about the recent rate rises.

Now one thing stuck out in my mind.

Could people living in the Greater Village on the Edge of the Rainforest really be that ignorant?

Turns out Vancouver Sun columnist Pete McMartin was wondering the same thing. Working with Sun colleague Fiona Anderson, the pair advises that the Investors Group had seperate statistics on the issue for B.C., in general, and Vancouver in particular.

Seems we are not as 'blissful' as the rest of the country. And with good reason.

Among all respondents, British Columbians reported carrying the highest mortgages, with a median amount of $180,000, or $50,000 more than the national average.

But that median mortgage amount of $180,000 was for all of B.C.

Kevin Lutz, regional sales manager and mortgage specialist with the Royal Bank, said he figures new mortgages in the Metro area average around $350,000. Brian Peterson, president of the Mortgage Brokers Association of B.C., who canvassed some mortgage brokers in the Metro Vancouver area, said local brokers were telling him it was not uncommon to see new mortgages in the $400,000-$450,000 range, typically for buyers who are stretching their borrowing powers to the limit so they might get into the market.

I have 17 friends who are also stretched and each have mortgages over $500,000.

Make no mistake. The Vancouver real estate market is leveraged on cheap money and low interest rates.

Meaning... it's all about those rates.

Mark my words, if the variable rate rises to 8% (with double digit 5 year rates), Vancouver will make California's crash look like a dress rehersal.

I suspect Neuman's iconic famous motto isn't the mantra of the local mortgage carrying crowd.



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Wednesday, April 21, 2010

Blissful Ignorance?

On a day when the Bank of Canada makes news for what it doesn't say, and Macleans magazine states the obvious, the item that catches my eye is a poll by the Investors Group which concludes that Canadians "may be overly confident that they can take higher borrowing costs in stride."

You got that one right!

Discussing Canadians' apparent confidence to deal with rising mortgage rates, Peter Veselinovich (the Investors Group's vice-president of banking and mortgage operations) said: "Part of that may be because they are fully knowledgeable about what's going on because they have a financial plan, they've had discussions, they've looked at what their risk tolerance is and what their affordability tolerances are. Or part of it may be some blissful lack of knowledge."

The reason for the overconfidence/blissful ignorance?

No one believes rates will rise more that about 3%.

This also comes on the day we learn that, in the UK, inflation rose at a higher rate than expected. It's up sharply to 3.4% in March from 3% the month before.

Watch for a similar scenario to start becoming evident in North America as well. As we pointed out last week, reports are surfacing that significant inflation is working it's way through the inventory replacement process.

After summarizing his experiences, one volume importer of industrial hardware (mostly out of Asia), who just received his April ocean freight rate update, concluded that "anyone who tells me that there is no inflation on the horizon is delusional and in for one hell of a shock.”

That's going to be pretty much every person with a mortgage in this country.


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Tuesday, April 20, 2010

Can you see it yet?

Interest rates.

Have I mentioned that this is what the story of real estate in Vancouver will revolve around?

Garth Turner picked up on the theme last night and drew attention to some projections from TD economics which indicate that TD is expecting Bank of Canada Governor Mark Carney to raise interest rates on 11 separate occasions over the next two years, taking the BoC from its current 0.25% all the way to 3%.

Now that may not seem like such a big deal, but what are the ramifications for mortgages?

A 3% BoC rate would elevate the prime rate at the chartered banks to 5%, and have the same effect on VRMs.

On a typical $600,000 Vancouver mortgage with the prime Variable Rate Mortgage conditions change profoundly.

At the current 2.25% the monthly payment is $2,616 and the qualifying income is $94,200.

At 5% the monthly is payment jumps to $3,500 and the income required to service it is $126,000. That means a 2.75% increase in the mortgage rate means your income has to rise by 33% to afford the same house.

At a time when listings are exploding, and 7,000 boomers a day in North America are retiring (the vast majority of whom are dependent on selling their house to fund their retirement), what does this mean?

It means one hell of a lot of people will be unable to buy their house at that price. And boomers will have to significantly lower their asking price in order to sell. With a simple raise in the BoC rate to 3%, the asking price has to come down far more than most people are going to have planned (read 'expected') to complete the sale.

So often I hear people in denial claiming, "the government won't allow that to happen."

Hate to break the news, but they will.

As Turner notes, Carney won't hold the line on rates "because it ain’t his job to run the economy or protect us from ourselves. The central bank is there to safeguard the money supply, print currency, stabilize the value of the dollar, handle the federal government accounts and, above all, corral inflation. Already the cost of living increases exceed the bank’s target, thanks in part to the housing bubble. Failure to stomp out the flames of inflation now will only lead to a forest fire requiring water-bombers and far higher interest rates a year out."

Those would be interest rates like the 21.5% kind we experienced in the early 1980s.

Carney has to raises them now, or he has to raise them significantly later. And this doesn't even figure into the equation what the bond market will do (you remember them... the element responsible for the recent two hikes in two weeks to mortgage rates?)

Either way, the real estate story has begun it's next chapter.

Can you see finally see what's coming?


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Monday, April 19, 2010

A time to reap, and a time to sow.

Persusing the blogosphere, the sense of anticipation and glee from bears is palpable.

After months of self-doubt, the inevitable chain of events and how it will impact the great Canadian housing bubble now seems clear.

But like a watched pot that never seems to boil, be prepared to watch this play out agonizingly slow.

Now don't get me wrong. Those Canadians who have been lured by cheap money over the past decade have pushed credit levels to a record high. For every $1 of disposable income, Canadians owe a record $1.47 and we are fast approaching a day of reckoning.

And when it comes to real estate in the Village on the Edge of the Rainforest, that reckoning will be profound.

I once again re-iterate my prediction that we will see a correction that is a MINIMUM of a 40% drop in single family homes and 50% drop in condos. I believe the reality will be closer to 70-75% for single family homes.

But that reckoning will take time to play out.

Canadians can't simply walk away from mortgages. As the domino's fall, families will move and protect financial assets, delay, dither and extend before finally succumbing to the ultimate remedy - bankruptcy.

After all of this, the foreclosure process in this province can take more than a year and a half to play out.

It took almost 8 years for people to realize that we were in a Depression in the 1930s.

And the effects of the financial earthquake of 2007 will take just as long to be fully felt.

But make no mistake about what is coming. The future for the economy of Canada is written clearly on the wall.

For the first time ever during a recession, Canadians took on more debt during the downtime's. Our nation will rue the day it decided to make borrowing even cheaper than it was before 2008. Household debt has surged three time faster than income in recent years and now stands at a record high of more than $1 trillion. With debt levels this high, even a small hike in interest rates will be ugly for those whose incomes aren't rising fast enough to meet their day-to-day expenses.

Our nation has been astonishingly arrogant during this crisis.

Easier credit terms and fierce competition among lenders have created conditions that, even when the recession hit in late 2008, left Canadians far more confident than Americans. This was due, in part, to a fictitious belief in a better housing market and stronger financial institutions.

Consumer confidence in Canada is only about 20% below where it was in 2007 whereas it's 60% lower in the U.S.

The higher confidence level and stronger banks meant Canadians were far more eager to borrow during the recession than Americans, said Benjamin Tal, senior economist at CIBC World Markets.

In a recent report, Mr. Tal concluded that “Canadian consumer fundamentals are weaker than they have been in almost 15 years.”

“There's been a real frenzy just to get in [to a house] at all cost, because if you don't get in you may never get in,” said Scott Hanah chief executive of the Credit Counselling Society, a non-profit group based in Vancouver that helps people sort out their debts. His organization has seen a 10% increase this year in the number of people seeking help. “Last year we saw an increase in activity of over 50%; So to have a further 10 per cent increase on top of that is significant,” he added.

That's something that concerns officials at the Bank of Canada. If consumers run into trouble with their mortgage payments, that in turn can lead to “wider problems with other consumer loans, such as credit card debt,” David Wolf, a Bank of Canada economist, said in a speech in January. “Consumers may also have to curtail other spending to cope with their debt burdens, creating adverse spillovers to the real economy.”

We haven't avoided the day of reckoning which began when the housing market retreated over a year ago. We've only delayed it.

It will play out.

As of now, “no matter how you look at it, Canadian households are currently in a decent financial position,” says National Bank Financial Group. The cost to carry all that debt has actually fallen (as a percentage of disposable income) to 7.6%, from 10.2% in 1990.

But consumers are squeezed and even a small rise in interest rates will cause them to turn down the taps on their spending. Can you now see what lies ahead for the economic recovery?

A stagnant economy, inflation, higher interest rates and waves of boomers retiring with no savings except for their plans to cash in on the equity in their homes to fund retirement. It is a confluence of circumstances that can only spell disaster for real estate.

A survey last year by the Certified General Accountants Association of Canada showed 21% of respondents could barely meet the interest payments on their loans. The group is about to release a similar survey this year and, said the group's chief executive Anthony Ariganello, the level of those struggling to cope has climbed to about 23%... and the spectre of rising interest rates has only just begun.

Bulls have chortled that the bears have been wrong these past 12 months.

They haven't been wrong about the analysis... just the timing.

To everything there is a season, and a change of season's is in the air. After 10 long years, the era of cheap money is ending.

It's all about interest rates.


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Saturday, April 17, 2010

My God... the bubble's imploding!

Some excerpts for you from an article in the Financial Post by AJ Sull, president and chief investment officer at Pacifica Partners - Capital Management in Surrey, B.C.

Sull's points echo what has been written on this blog over the last year and a quarter.

  • In Canada, a significant amount of fiscal and monetary resources were committed to ensuring that the real estate market was stabilized. This helped to encourage Canadians to take on record amounts of debt and take advantage of the brief pull back in real estate prices. However, nobody seems to be asking the question: “What happens if interest rates go back to normal levels?”

    We are finding out that answer now as we have seen mortgage rates rise more than once within the last month alone. In addition, the federal government has begun to respond to the concerns of the banks to issue tighter guidelines for mortgage underwriting.

    Some observers are now coming to the conclusion that policy makers wasted the opportunity to guide the global economy away from the debt-consumption cycle. Amazingly, the US seems to be leading the world in bringing down debt and increasing savings because consumers there felt the impact of too much debt and not enough saving more than in most nations.

    As has been mentioned before, a surprising number of Canadians assume that they are not as reckless as Americans when it comes to piling on debt. The numbers seem to be showing otherwise. Part of the reason for this debt is that incomes in Canada have been stagnating relative to rising mortgage and credit card debt.

    In Vancouver, there seems to be a prevailing logic that “Vancouver is unique therefore prices are justified.”

    What makes a city unique is income, employment prospects and livability. At the elevated valuations we are seeing currently, it would appear that for prices to continue higher, Canadian real estate prices – led by Vancouver – will have to demonstrate the “Greater Fool Theory” – where sky high prices fueled by record amounts of debt can only continue if there is someone else willing to take on even more debt and pay even higher prices. This sounds like a recipe for trouble.

    As James Chanos, the renowned hedge fund manager who is shorting Chinese stocks - said in a recent television interview – it is not high prices that mark the existence of a bubble but rather high levels of debt punctuated with a lack of rational behavior. In his words, China is "on the treadmill to hell".

    Likewise, for Vancouver or other Canadian cities, it cannot be said that there is a real estate bubble just because prices have run up. That logic is linear and simplistic.That is too easy a hurdle to earn the bubble label. Rather, it is the herd mentality and the belief that somehow “this time is different.” Those four words are often said to be dangerous to one’s financial well being.

Sull is bang on. And the bubble is going to burst in spectacular fashion.

Rainforesters will be like Bowman starting at the monolith and only when it is too late will they gasp in realization: "My God, it was a bubble and it's imploding."

We can call it... 2010: The Real Estate Odyssey.


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Friday, April 16, 2010

China/Vancouver Real Estate: A Symbiotic Relationship?

Above is part of a Charlie Rose interview with James Chanos, hedge fund manager and founder of Kynikos Associates Ltd.

Chanos talks with Charlie Rose about China's economy, currency policy and the risk that investment will "dry up." He says China'a property bubble will burst as early as this year.

What grabs the attention of those in the Village on the Edge of the Rainforest is his comments at about the 1:30 mark of the interview.

He talks about all the 'hot money' that is going INTO China on this real estate speculation is from Chinese nationals outside the country; in London, Singapore, Vancouver and San Francisco.

It's a take on things that makes one sit up and take note. Pervasive has always held here that the situation was in reverse... that it has been 'hot money' from China inflating our Real Estate bubble.

Could it actually be a symbiotic relationship that is so intertwined that neither side sees it for what it is?

We will touch on this again next week.


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Thursday, April 15, 2010

Whither the Orphans?

As we discussed earlier this month, the US Federal Reserve's program to buy up Mortgage Backed Securities ended at midnight March 31st and the market was now on its own for the first time in over one year.

Bond fund manager's like Bill Gross have begun steering more of their money away from bonds as Washington unplugs the economic life support programs that kept rates low through the financial crisis.

Yields have started to climb and twice in a span of two weeks we have seen Canadian banks raise their mortgage rates despite no action from the Bank of Canada.

And looming in the background is the plight of the Orphans.

Several years ago the Harper government changed the rules allowing alternate lenders access to the Canadian mortgage market.

US players such as Xceed Mortgage Corp., GMAC Residential Lending and Wells Fargo were allowed access to Canadian markets to offer mortgages to high risk clients.

In other words they offered Canadian subprime mortgages to clients who could not qualify for CMHC mortgages.

But in the wake of the financial crisis of 2007/2008, the business of subprime loans has dried up. Prior to 2007, there were at least a dozen subprime lenders in Canada and it was the fastest-growing sector of the entire mortgage market cornering about 5% of the total market.

But most of those lenders have either changed their business or closed up shop.

Compounding the dilemma is the fact that in the meantime the rules around home loans have been tightened and the federal government has raised the minimum down payment required for Canada Mortgage and Housing Corp. insurance.

So what's to become of all those Canadian subprime clients?

No one knows for sure how big the problem really is because there is no central database tracking these mortgages. In a Financial Post story this week, Ivan Wahl chief executive of Xceed (one of the biggest players in Canada until it recently converted to a bank) stated the subprime market in this country grew to about $11-billion in 2006, the year before things started to implode.

When the credit crunch hit, most of these US companies bailed out of Canada.

And what of the Canadians who had mortgages through these companies?

They were informed that their mortgages could not be renewed and as these companies were closing their subprime businesses, they would have to find another lender.

But the little lenders who had been so eager for their business back in 2005 have disappeared. That left the big banks and insurance companies, but they won't lend to these unqualified subprimers.

The end result... our own looming subprime-mortgage mess.

Industry insiders say that, as an estimated 30,000 so-called "orphan mortgages" reach maturity, these borrowers will have no choice but to default and trigger a flood of foreclosures.

"This thing is a wave and it's just starting," says Eric Putnam, formerly with a subprime lender, now managing director of Debt Coach Canada, a company that provides financial and bankruptcy advice to consumers.

Now the subprimer's are only a small portion of the huge Canadian mortgage pie, but so were the American subprimers.

And since the vast majority of these subprime loans were made around 2005 - 2007, it means they're coming due over the next two years.

Should we simply let them fail and default?

They don't qualify for CMHC insurance because they present a severe risk. But will allowing them to fail be one small domino that triggers a similar fate as the US experience - especially given housing prices will come under pressure from rising interest rates?

The mortgage industry is so concerned about the situation that it recently approached the federal government with a request for a bailout.

According to Mr. Putnam and others, it wants the federal government to participate in a $1-billion fund to help finance the coming flood of orphan mortgages.

Is this fair?

And if these high risk, unqualified borrowers get CMHC insured mortgages, shouldn't other Canadians be entitled to the same treatment?

During the credit bubble, Canadian subprime lenders funded themselves through the asset-backed commercial paper market. The loans they made were packaged up and sold to securitization pools and then to investors in the form of ABCP.

But when the commercial paper market froze up in the financial crisis, lenders were suddenly left without a way to fund their businesses.

"Investors are no longer willing to continue on and these mortgages were not insured by the Canada Mortgage and Housing Corp., so the borrowers are not going to be able to move to another lender in today's environment," Mr. Putnam says.

It presents a disturbing dilemma for the Canadian taxpayer.


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Wednesday, April 14, 2010

Jumping the Shark

Do you recall the quote from yesterday's post that referenced the New York Times?

"Consumers are about to face a sustained period of rising interest rates."

Almost as if on que, the Royal Bank hiked their rates a quarter of a point. More significantly its the second rate hike in only two weeks!

And why are rates going up when the Bank of Canada hasn't altered their rate?

Because yields are rising in the bond market and it's the bond market, not the Bank of Canada, that funds mortgages.

And without the United States continuing with QE to infinity, the cost of money is rising.

Cameron Muir, our bud from the BC Real Estate Association, was on TV today saying that rates are beginning to 'normalize'. May I remind faithful readers that normal for the last 20 years would be a five year rate of 8.25%

And that's before you factor in inflation.

Which brings the conversation to an interesting post on Bill Fleckenstein’s website Ask Fleck:
  • “I am a large volume importer of industrial hardware, mostly out of Asia. I just received my April ocean freight rate update. Container cost up 5% from March and up 21% from April 2009. For my products, the YOY increase represents a 3% increase to cost of goods. Cost of steel as we know is going up significantly and these price increases for us – contrary to what the popular spin may be – are effective immediately. Obviously, as we are replacing fast-turning inventory, we are passing on these increases immediately. About a year ago, I reported to you that our business was extremely slow and our inventories very high. Despite price increases going on offshore, I pointed out that in our world, these increases would take time to trickle through due to the high inventory levels that we and our competitors were sitting on. Our position was that if we had it in stock, we would sell at basically any price for cash flow reasons. Any new inventory would be sold based on actual current cost. Needless to say, the purchases we made through the year were very minimal as we (correctly) were not optimistic about business looking forward.”

    “Now, business is still terribly slow but inventories have been depleted to the point that shortages are occurring. These shortages are exasperated by the fact that no one is buying any significant volume of replacement inventory. Our statistics would show that our purchases in March (for delivery this summer) are up about 400% from any given month last year BUT are still only about 30% of our peak going back before all hell broke loose. Can you imagine how this data can be spun by focusing on the former and conveniently ignoring the latter? We feel that we have hit bottom and have reasonable expectations to survive this debacle simply because we have downsized to about 20-25% the company we once were. Our domestic competitors and vendors overseas basically report the same. ... (The) bottom line is this: no one is (all that) busy but prices are literally skyrocketing. Smells like stagflation to me. Anyone who tells me that there is no inflation on the horizon is delusional and in for one hell of a shock.”

In an investment post by Jeffery Sault his readers are reminded that annualized inflation in India is running at about 15% and China is not all that far behind. In the Philippines, March’s inflation figure was just reported at +4.4%, up from the previous month’s 4.2%, with the cost of Philippine fuel/electricity/water up 14.6% over the trailing 12 months.

In North America, since January 2009 the price of copper is up 185%, crude oil is better by 118%, and rubber is higher by 167%. Moreover, from August of 2009 until now hog prices have rallied 75%, while cattle prices have lifted 19%. Such actions caused the Reuters CRB Commodity Index to travel above its 200-day moving average in June 2009 and stay there ever since (read: bullish and inflationary).

Meanwhile, economists continue to insist there is no inflation because wage inflation is non-existent.

If inflation were calculated like it was prior to 2000, it's existence would be evident. But we changed the rules, and pretend it doesn't exist.

Unfortunately it's effects still do.

Jumping the shark is an idiom used to describe the moment of downturn for a previously successful enterprise. The phrase was originally used to denote the point in a television program's history where the plot spins off into absurd story lines or unlikely characterizations. These changes were often the result of efforts to revive interest in a show whose viewership has begun to decline.

The phrase came from a three-part episode opening the fifth season of the TV series Happy Days in September 1977. In hindsight the consensus was that the show went downhill from this point.

Inflation is here.

Rising interest rates are here.

And I'm betting that, in hindsight, this is the moment people will say Vancouver Real Estate 'jumped the shark'.


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Tuesday, April 13, 2010

Uphill Climb

Interest rates.

As has been noted time and time again on this blog, the story of Vancouver Real Estate has been the story of interest rates... and as they go, so with R/E in the Village on the Edge of the Rainforest.

The stunning rise in land values in our humble utopia have been shaped by a historic 30-year decline in the cost of borrowing.

But as the New York Times noted on Sunday, consumers are about to face a new financial burden: a sustained period of rising interest rates.

It's a paradigm shift that is the inevitable outcome of ballooning sovereign debt levels and the renewed prospect of inflation as the economy recovers from the depths of the recent recession.

“[North] Americans have assumed the roller coaster goes one way,” said Bill Gross, whose investment firm, Pimco, has taken part in a broad sell-off of government debt, which has pushed up interest rates. “It’s been a great thrill as rates descended, but now we face an extended climb.”

The comments of Bill Gross are significant. He is a hugely successful bond fund manager and the co-chief investment officer of Pimco. He personally manages the company's flagship, the Total Return fund, which has $158 billion in assets.

Gross is highly influential and US Treasury secretaries call him for advice. Warren Buffett, the Berkshire Hathaway chairman, and Alan Greenspan, the former Federal Reserve chairman, sing his praises.

And with the collapse of Wall Street, Mr. Gross has emerged as one of the nation's most influential financiers.

In 1999, Mr. Gross warned in his monthly investment column that the dot-com bubble would soon burst. The next year, it did. Despite the market downdraft, Mr. Gross's fund ended 2000 up 12%, and that same year he and his partners sold Pimco to Allianz for $3.3 billion.

In an October 2005 letter to investors, Mr. Gross made one of the most prescient calls of the last decade, warning of the looming subprime mortgage crisis.

And for Gross the next big financial story is going to be the tale of interest rates.

Gross sees the run-up in rates quickening as investors steer more of their money away from bonds and as Washington unplugs the economic life support programs that kept rates low through the financial crisis.

Mortgage rates and car loans are linked to the yield on long-term bonds.

Besides the inflation fears set off by the strengthening economy, Mr. Gross said he was also wary of Treasury bonds because he feared the burgeoning supply of new debt issued to finance the government’s huge budget deficits would overwhelm demand, driving interest rates higher.

Nine months ago, United States government debt accounted for half of the assets in Gross’s flagship fund, Pimco Total Return. That has shrunk to 30% now — the lowest ever in the fund’s 23-year history — as Gross has sold American bonds in favor of debt from Europe, particularly Germany, as well as from developing countries like Brazil.

And as other bond traders follow Gross's lead, the results are starting to impact rates.

Last week, the yield on the benchmark 10-year Treasury note briefly crossed the psychologically important threshold of 4%. Though still very low by historical standards, the rise of bond yields since then is reversing a decline that began in 1981, when 10-year note yields reached nearly 16%.

From that peak, steadily dropping interest rates have fed a three-decade lending boom, during which consumers borrowed more and more.

But those days are ending.

And for young home buyers today (who can consider 10-year mortgages with a stunningly low rate of just 5%), it is inconceivable that rates could migrate to those days of in the fall of 1981 when mortgage rates peaked at 21.5% in Canada.

And while few are willing to forecast rates to return to anything resembling 1981 levels, to those tuned in on Wall Street the question is not whether rates will go up, but rather by how much.

The consensus in the high level financial community is clear. As Terrence M. Belton, global head of fixed-income strategy for J. P. Morgan Securities, summarized, “everyone knows that rates will go higher.”

Just try telling that to anyone around this town.


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Monday, April 12, 2010

Canucks are nuts!

Sometimes you feel like a nut... sometimes you don't.

Remember that jingle?

It was from an ad for Almond Joy and Mounds candy bars, manufactured by Hershey's, that ran during the 1970s.

I was reminded of it when I read this commentary from Karl Denninger on the US website market ticker.

Karl took a look at some Canadian real estate statistics and succinctly concluded that "the Canucks are nuts"

Noting that the average two storey house across Canada was going for $365,000 with an average price of $355,109 in Montreal, $562,150 in Toronto and a whopping $987,500; Denninger was compelled to ask the logical question. How is this supportable?

To properly carry mortgages on these prices, the average annual family income would have to be $118,000 in Montreal, 187,000 in Toronto and $329,000 in Vancouver?

Is it?

As Denninger candidly notes, this notion is "in a word, bullshit"

  • "The latest median household income I can find for Canada is closer to $53,000 - or about half of what it should be. That is, homes in Canada - on the whole - are selling for double reasonable 'fair values'. I'm willing to bet that in Vancouver they're overvalued by a factor of five - or more.

    I can't tell you when it will blow up, but I can tell you with absolute certainty that it will. If you have a nice big fat profit in your house up there in Canuckistan, you better sell now while you still have it.

    Ignore this warning at your own peril."

Now... where have you heard this advice before?

I'm happy to report that one colleague I work with recently heeded this advice and sold the home he originally bought for $64,000 for about $680,000. At 60 years of age he can see the havoc that the coming wave of boomers downsizing and rising interest rates are going to do.

Sadly, most 'canucks' cannot.

Almond Joy will be my treat of choice to give out this Halloween because I wholeheartedly agree with Denninger... most Canadians buying real estate right now are nuts.


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Thursday, April 8, 2010

And the band played on...

Some may be blissfully blind, but others appear to be gleefully blind.

And throughout it all, our American cousins shake their heads in disbelief.

Over at Rolfe Winkler looks at the Canadian housing bubble and declares, "so much for Canadian sobriety."

Winkler notes that the average price for a single detached home in the Village on the Edge of the Rainforest now exceeds $1 million, that prices have climbed 23.3% in just 12 months, and that prices are now nearly 3% higher than they were before the housing market crashed.

The Americans know where we are headed.

Of course the gleefully blind proudly proclaim that "because of the economic rebound. And the Olympics. And the warm winter [here]. Vancouver is different."

The rational is always, "it's different here".

Meanwhile Winkler makes the point that all R/E contrarians make:

"Household debt to income in Canada is now more than in the US. All the usual metrics to gauge whether housing is overvalued, eg House Price/Income or House Price/Rent are at levels up to over 30% from their long-run average. These are normally consistent with an overpriced market that is due for a correction; the question is when, as often these things persist for much longer than most people dare to guess. If Canada’s banks are behaving so responsibly, where are households getting so much leverage?"

Cause for concern?

Not according to the Bank of Canada who, according to Reuters, says "Canada's housing market is not in a price bubble but seems firmly valued."

That will be a quote for the ages.

This all comes just days after a CIBC study found that household debt - mostly mortgage debt - is growing three times faster than income.

And all of this comes at a time when many analyst share the sentiment that "the current rebound in the economy is a statistical mirage orchestrated by record amounts of monetary and fiscal stimulus that are simply unsustainable and actually risk precipitating a very unstable financial and economic backdrop in coming years."

One blogger I follow compares the current economic conditions to the Titanic disaster and suggests that we are at about same point in time as that famous ship was after it struck the iceberg.

Instead of a band playing on deck as the vessel took on water, we have the equivalent of an IMAX theater, complete with surround sound, to keep us occupied as we meet our fate.

Regretfully, I couldn't agree more.

May I have the next dance?


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Wednesday, April 7, 2010

Blissfully blind...

"It's all about interest rates."

The phrase has become almost a mini-mantra on this blog. I find myself repeating it almost on a daily basis when asked for my opinion from colleagues on interest rates.

And if you read this blog regularly, you know my thoughts on where they are going. The spectre of sovereign debt will almost assuredly push rates back to levels seen in the mid 1970s.

It's not an opinion many share.

Casual conversations reveal that most simply can't fathom rates rising all that much. People can see the Bank of Canada raising rates 1 or 2 percent... but no more than that.

The vast majority are adamant about that, despite knowing full well that our current 0.25% Bank of Canada benchmark lending rate is an emergency level.

It seems, however, that people are coming to treat that rate as 'normal'.

Oh we live in such an insular world, don't we?

Perhaps that's why double takes abounded today when I casually mentioned that the central bank of Austrialia raised it's interest rate for the fifth time since October.

More importantly the Reserve Bank of Australia's governor, Glen Stevens, sees interest rates returning to "average" levels and warns about rising inflation.

Now... on a day when the world sees Canada surging economy to be strong enough to push the Canadian dollar to par with that of the United States, does anyone pause to wonder what 'average' interest rate levels are here in Canada?

Over the past 20 years that would be... umm... 8.25%.

Inflation pushed those rates into the mid teens and up to 22%.

But why worry about things like that? It's not as if Canadians will be responsible for hundreds of thousands of dollars of debt for excessively long periods of time, right?

I mean, how much can things change in 35 years?


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Friday, April 2, 2010

To all who drop by this weekend...


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Thursday, April 1, 2010

April Fool's Day

Life is full of signposts and I wonder if today will represent one of those markers.

Beginning in January 2009, and every single business day since then, the US Federal Reserve has been buying up Mortgage Backed Securities.

The program, which ends today, will have transferred $1.25 trillion of MBS 'on behalf' of the US taxpayer. This now represents the single biggest asset on the Federal Reserve's balance sheet, and backing up such liabilities as currency in circulation.

Think about that for a second.

As you know, the US housing market is not faring well and is expected to continue to drop in value. This means the US Dollar is collateralized more than half by rapidly devaluing, and in many cases cash flow non-producing houses and excess reserves.

At midnight last night the Fed's MBS program ended, and the market is now on its own for the first time in over one year.

What happens next is anyone's guess.

But with the Federal Reserve having gone all in and then reraised tenfold courtesy of fractional reserve banking, it is difficult to believe that the Fed will allow house prices to drop further.

Which is what is going to happen in the market sets interest rates on it's own.

Are we going to see the Fed immediately reinstitute QE at the first hint of mortgages at or approaching 6%?

Let's face it, a 1% widening in mortgage rates will be the equivalent of a several hundred billion loss in household net worth.

Meanwhile there is the growing concern of the debt problems of individual states.

California, New York and other states are showing many of the same signs of debt overload that recently took Greece to the brink — budgets that will not balance, accounting that masks debt, the use of derivatives to plug holes, and armies of retired public workers who are counting on benefits that are proving harder and harder to pay.

California’s stated debt — the value of all its bonds outstanding — looks manageable, at just 8 percent of its total economy. But California has big unstated debts, too. If the fair value of the shortfall in California’s big pension fund is counted, for instance, the state’s debt burden more than quadruples, to 37 percent of its economic output, according to one calculation.

Jamie Dimon, chairman of JP Morgan Chase, has warned American investors should be more worried about the risk of default of the state of California than of Greece's current debt woes.

Dimon told investors at the Wall Street bank's annual meeting that "there could be contagion" if a state the size of California, the biggest of the United States, had problems making debt repayments. Dimon believes California poses a greater threat than does Greece.

If markets force the weak hands, as they always do, will it be Bernanke and the printing press to the rescue? Or will the bond market be allowed to push interest rates up to punishing levels as is the current Greek experience?

And then there is the Canadian situation.

The Bank of Canada warned in late 2009 that up to 10% of Canadian homeowners might be in danger of losing their homes when interest rates started to rise from last week's historic lows.

In the United States, subprime represented far less than 10% of the US housing market. It's collapse triggered complete chaos in the housing market. Is Canada heading down the same path as our neighbours to the south? Are we looking at a mortgage meltdown somewhere down the road?

On the day of fool's, there is much to ponder.


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