Austerity? Enter Helicopter Ben.

As I said yesterday, a battle is brewing between those who believe in stimulus and those who argue for a return to austerity.

In several articles for his New York Times column, Paul Krugman has argued that those who push for austerity in the face of recession are either doing so for political expediency or out of a “crazy” fealty to archaic economic views. Krugman believes the trillions of dollars worth of deficit spending unleashed by the United States and European governments in the last 24 months is inadequate. He believes our only remedy is to spend more – no matter how much debt results.

Reading straight from the Keynesian playbook, Krugman argues that cutting government spending now will simply send the economy back into recession. He asserts that by flooding the economy with money, i.e. “stimulus,” governments can encourage consumers to spend. Once the spending creates better conditions, so the argument goes, the economy will be better positioned to withstand the spending cuts, tax hikes, and higher interest rates necessary to address the staggering deficits left behind.

Curiously the person leading the banner for a return to austerity is the recently reformed former Fed Chairman Alan Greenspan. In a recent Wall Street Journal editorial, Greenspan argued that the best economic stimulus would be for the world’s leading debtors (the United States, UK, Japan, Italy, et al) to rein in their budget deficits. Greenspan explains that because lower deficits will restore confidence, diminish the threat of inflation, and allow savings to flow to private-sector investment rather than public-sector consumption, the short-term pain will lead to gains both in the mid and long-term. Rather than redistributing a shrinking pie, this approach allows the pie to grow. Greenspan’s view has been echoed loudly in the highest policy circles of Berlin, Ottawa, Moscow, Beijing, and Canberra.

But while Alan Greenspan may have had a profound conversion, current Fed Chairman Ben Bernanke has not.

Insiders suggest that Bernanke is waging an epochal battle behind the scenes for control of US monetary policy, struggling to overcome resistance from regional Fed hawks for further possible stimulus to prevent a deflationary spiral.

Fed watchers say Bernanke and his close allies, key members of the five-man Board, are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed's balance sheet from $2.4 trillion (£1.6 trillion) to uncharted levels of $5 trillion.

The dispute has echoes of the early 1930s when the Chicago Fed stymied rescue efforts.

"We're heading towards a double-dip recession," said Chris Whalen, a former Fed official and now head of Institutional Risk Analystics. "The party is over from fiscal support. These hard-money men are fighting the last war: they don't recognise that money velocity has slowed and we are going into deflation. The only default option left is to crank up the printing presses again."

Mr Bernanke is so worried about the chemistry of the Fed's voting body – the Federal Open Market Committee (FOMC) – that he has persuaded vice-chairman Don Kohn to delay retirement until Janet Yellen has been confirmed by the Senate to take over his post. Mr Kohn has been a key architect of the Fed's emergency policies. He was due to step down this week after 40 years at the institution, depriving Mr Bernanke of a formidable ally in policy circles.

"The US recovery is in imminent danger of stalling," said Stephen Lewis, from Monument Securities. "Growth could be negative again as soon as the fourth quarter. There is no easy way out since fiscal stimulus has already been pushed as far as it can credibly go without endangering US credit-worthiness."

All these developments have prompted the Royal Bank of Scotland's credit chief Andrew Roberts to warn RBS clients to prepare for 'monster' money-printing by the Federal Reserve.

"We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe) and for the global economy. Think the unthinkable," Roberts said in a note to investors.

Societe Generale's uber-bear Albert Edwards said the Fed and other central banks will be forced to print more money whatever they now say, given the "stinking fiscal mess" across the developed world. he said.

In light of all of this... is it any wonder people are concerned for their financial future?

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Crossroads

So the OMG-20 confab is over.

And the world leaders have had a chance to reflect on the situation in the Western world's economy.

For the last two years the economic policy of the West has been all about preventing deflation and curing recession by pouring vast amounts of public money into the system in a belief it would ignite a new era of prosperity.

It hasn't.

At best the economy of the West has merely muddled along.

Of course this isn't the way it was 'supposed' to play out. Usually 'stimulus' applied after a steep recession leads to a snappy recovery, like it did in 1983-84 after the Reagan tax cuts.

But as I have said on numerous occasions, we still do not fully appreciate the depth, breadth and scope of the 2008 Financial Crisis. A deep economic earthquake has occurred. And the full reprecussions are still not appreciated or understood.

Do you remember when the West started pouring money into this?

Under George W. Bush, Congress was told that a "timely, targeted and temporary" spending program of $150 billion was urgently needed to boost consumer "demand".

When the Democrats assumed control in Congress, they continued with the idea.

And the stimulus produced a slight increase in GDP growth in mid-2008, but it didn't stop the financial panic and second phase of recession.

That lead to the second round of "stimulus". $862 billion worth in February 2009. At the time a pair of White House economists famously promised that this spending would keep the unemployment rate below 8%.

It didn't.

The US jobless rate is still 9.7% and the GDP estimate for first quarter growth has been reduced again, this time to 2.7%.

And what do the Americans want to do now?

Why... more 'stimulus', of course.

The problem is the Western world's Keynesian political consensus is falling apart.

In Europe, the bond vigilantes have attacked the finances of Greece, Portugal and Spain, with Britain and Italy next in line.

Politicians are scrambling away fromt the 'stimulus' mindset to one focused on cutting spending and raise taxes.

Britain has introduced an austerity budget and Germany's Angela Merkel sees vindication for keeping her country's stimulus far more modest than other Western nations.

In America many Republicans and Democrats are rebelling against a third round of stimulus. The original White House package of jobless benefits and aid to the states had to be watered down several times, and the latest version failed again in the Senate late last week.

Some will argue that the world has now reached a Keynesian dead end.

But other's suggest the spending/debt party may have only just begun.

More on that tomorrow...

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46 US State Governments Facing Greek-Style Deficits

In California they are gridlocked over how to close a $19 billion budget gap and are weighing the termination of the main welfare program for 1.3 million poor families or borrowing more than $9 billion in the bond market.

Illinois, tied with California for the lowest credit rating of any state, is diverting a rising portion of tax revenue to service debt.

Finances in Arizona, New Jersey, New York and other states show few signs of improvement.

In total Forty-six states face budget shortfalls that add up to $112 billion for the fiscal year ending next June, according to the Center on Budget and Policy Priorities, a Washington research institution.

“States are going to have to cut back spending and raise taxes the same way Greece and Spain are,” says Dean Baker, co- director of the Center for Economic and Policy Research in Washington. “That runs counter to stimulating the economy and will put a big damper on the recovery in the latter half of this year.”

It appears that across the United States, all that stimulus money is drying up and States don’t have a choice anymore, their problems are going to require major surgery.

The risk is that California ends up like Greece, with no one trusting that it can get its financial house in order, says Steve Westly, California’s Democratic treasurer from 2003 to 2007. “It has to be a combination of cuts and revenue increases,” he says.

Will the federal government hang the US States out to dry or will they bail them out like they did Wall Street?

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A Tale...

Interesting question raised by SethM on a real estate chatboard: what's wrong with this picture?

On the shores of False Creek, located directly across from the downtown core of the City of Vancouver is the luxury real estate development of Millennium Water aka the Olympic Village. Sales of units are stalled at 36 with none having sold after the first 2 days (it's been on the market now for 5 weeks). Worse, 11 pre-sale purchasures are trying to let out of their legal obligation to proceed with their purchase.



Meanwhile, about 15km south is a proposed real estate development known as River Green. Located in the Vancouver suburb of Richmond, the development is across the Fraser River from the Vancouver Airport (with the accompanying views of the airport and the airport noise). The development is touted as the biggest ever single development in the City of Richmond and is the start of what the City hopes will be a reorientation of its downtown out to the Fraser River waterfront.

The first phase of that development, 458 luxury-oriented units in six buildings with completion expected some time in 2012, set condo sales records as 'HAM' money flowed in.



So what gives?

The consensus is that the River Green development pre-sales are driven by Chinese buyers whose intention is to sell when it's complete. In this development a 2 bedroom typically sold for $900,000 + HST. The Olympic Village is already complete... so no speculative potential there.

Thus we have a current, completed set of luxury condos on the highly desirable False Creek perimeter located directly across from downtown and Yaletown... and those condos go wanting for buyers.

But condos which won't be ready for 2 years in a highly speculative venture across from a busy international airport are snapped up instantly by speculators!

Naw... this doesn't scream 'housing bubble' at all.

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Where's the HAM?

Coordinated media campaigns are always something to behold.

As previously noted, on June 12th we heard about how 'Hot Asian Money' (HAM) was maintaining property value on the west side of the City of Vancouver. Headlining the message was our buddy Cameron Muir from the BC Real Estate Association:



On June 21st the R/E propaganda machine gushed about records being set for sales from 'HAM':



So 'HAM' has created a buying frenzy, snapping up all the luxury properties in fierce bidding wars.

But like the old lady from the vintage Wendy's commercials I'm compelled to ask, "Where's the HAM?"

You've heard of one of the most luxurious and high profile properties in Vancouver, that collection of condos known as the Olympic Village extravaganza on False Creek, are now available for purchase.

On May 17th the newspapers trumpeted that in two days 36 units had been sold, "almost double the number anticipated."

But as VREAA noticed, five weeks have now passed and there are still only 36 units that have sold - and 11 of the pre-sale buyers are now trying to get out of their commitments to purchase.

Where's the HAM?

Last week I profiled the estate at 3639 Osler Street which had languished on the market for almost half a year before the sellers took a 34% haircut on their asking price.

No 'HAM' flavoured bidding war there.

And make no mistake... 'HAM' hasn't lead to a dearth of inventory. Click on this link and you will be taken to a website that lists all the houses for sale on the west side of the City of Vancouver. (Faithful readers from outside BC will enjoy this window into the absolute delusional world of Vancouver's housing bubble)

There are 805 detached houses listed.

Ranked for you in order of price, you will see the list headlines with an abode asking a cool $22 million.

There are 10 properties per page in this inventory layout. If you were to scroll through them looking for something under a mil... you won't find anything until page 72!

That's right, 711 detached houses currently up for sale on the west side of the city of Vancouver that have asking prices of more than $1 million dollars

(and yes... there are even more 'million-dollar-plus, homes for sale on the east side of Vancouver. Add to that even more million dollar condos and apartments).

711 detached homes.

There had better be one stupendously massive amount of 'HAM' pouring into Vancouver if it is going to support prices in this type of market.

Meanwhile the blog Vancouver Condo Info has also noted the rising real estate inventory. They provide a link to a Vancouver Asian newspaper who have been reporting this fact, presumably to the 'HAM'.

Along with the theme of rising inventory, VCI also took note yesterday of the very high number of price reductions occurring daily in the Vancouver Real Estate market.

Apparently daily price changes are ranging from 162 to 200 reductions. Even with the number of real estate listings in the Greater Vancouver area now nearing 19,000, VCI notes that we’re consistently seeing about 1% of total inventory drop their price every single day.

That means about 5% of all listings in Vancouver are reducing their asking price each week.

Somehow I'm just not buying into all the 'HAM' hype, sorry Cameron.

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Show me the money...

We keep hearing tales that Asian hot money is keeping real estate values high in Vancouver, but is it?

I'm sure the people that own this Dunbar house aren't buying into all that hype.

Courtesy of our friends over at VREAA, we bring you this 4 bedroom, 2 bathroom home at 4006 W. 38th Avenue.

From the listing description:

Beautiful, sunny and rare SW corner, 53 x 167 property (8851 sq ft) in the Southlands/Dunbar neighbourhood. Only 1 block from Pacific Spirit Park and a short stroll to Southlands/St Georges/Crofton schools. House is very pleasant - ideal for living-in or renting until ready to build, or... build your dream home now! The exceptional depth to this property allows room for a spacious house (w/ attached garage?), a pool? and still plenty of sunny yard, and/or a large garage (laneway house?). Endless possibilities, call to make this yours!

Endless possibilities? Perhaps. But there sure haven't been endless offers.

Gone are the bidding wars that saw properties snapped up in a couple of days. Apparently this property has been on the market for about 10 weeks.

On April 11th the asking price was $2,140,000,

On June 3rd the asking price was dropped to $1,980,000,

And on June 23rd it was dropped to $1,850,000.

So in 10 weeks we have seen the asking price drop about 15%.

Now let's be realistic... this isn't a 'luxury' property and maybe it isn't of interest to the so called 'Asian hot money'. But several months ago people were snapping up properties right, left and centre.

Not now. And prices are being slashed.

Is the Asian money angle R/E hype to keep sellers from slashing their asking prices and to protect the 'integrity of the market' or is it really flowing in and maintaining the bubblicious values?

More on this tomorrow.

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Back to Crisis Levels?

Germany's Deutsche Bank has a new and improved index of U.S. financial conditions and after analyzing current conditions they have concluded that US financial conditions have just collapsed back to the lows of the immediate post-Lehman crisis levels.

Meanwhile Bank of America Corp., the second- largest U.S. home lender, added 2,000 employees since April to work with borrowers having trouble paying their mortgages. The lender now has more than 18,000 workers in “default management,” a 60% increase since January 2009.

As housing goes, so goes stimulus. Expect to see the pressure to resume programs that support housing intensify as market trends deteriorate.

Meanwhile credit conditions or liquidity are once again tightening (spreads widening) as the economy is losing momentum from waning stimulus.

In other news, Freddie's most recent mortgage rates are out and they are the lowest in history. With the US Federal Reserve now looking at emergency interest rates staying low until 2013 or beyond, the only true recourse is even more monetary stimulus.

Albert Edwards, one of the most prominent uber-bears just got even more bearish: "Our view that this economic and market recovery will collapse like a pack of cards as soon as the steroid-like stimulus is reduced is gaining ground. Most forward-looking leading indicators now signal some sort of second-half slowdown. The only area of debate now seems to be in its magnitude. By the end of this year, I believe we will be back in recession."

Albert's vision is that we are entering a deflationary collapse, following by a reactionary episode in which the Fed ends up printing tens trillions in one last attempt to restimulate the economy, resulting in hyperinflation.

We certainly do live in intersting times.

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What comes next?

So as stats come out showing that the Real Estate market in Vancouver and Canada is stalling (albeit while contradictory reports flood the media that Asian money is buying up everthing in sight in the Lower Mainland of BC), it begs the question... how's the recovery going in the US?

Not so good, apparently (see chart above).

The US Commerce Department reported that new home sales in America plunged 33% to an all-time low in May following the expiration of the government’s homebuyer tax credit in April. If not for the massive downward revision to the April sales total, from an annual rate of 504,000 to 446,000, the monthly decline would have been more than 40%

Furthermore the May sales rate of 300,000 units is coming in well below the previous record low which was set in January of 2009 (339,000 units). In population-adjusted terms, the May new home sales total represents a decline of about 40% from the pre-2008 low of 400,000 seen in January of 1991.

In short... the situation in the United States is worse than ever.

And with Europe in financial dire straights, an important stage of the financial crisis of 2008 is about to play out.

Since the crisis began a debate has raged, a battle.

On one side are those who espouse Keynesian economics - combat the crisis by spending endlessly to avoid deflation and another depression.

On the other side are those that believe austerity is exactly what the system needs to purge the credit-crazed and real estate-mad phase we have been riding since 1980.

In Canada our Keynesian experiment involved massive bank bailouts, although listening to the malarky being spouted now, our country never threw a dime at the crisis.

We are told that the securitization phenomenon that let U.S. banks sell dubious mortgages to unsuspecting buyers never developed in Canada. Only about one-quarter of Canadian mortgages were securitized in 2007 (it was 60% in the U.S.), and they were solid, government-insured mortgages, not sliced, diced, leveraged subprime junk.

The 'solid' Canadian banking system saved the day, goes the platitude, and that's why in the U.S. (and elsewhere) near-zero interest rates haven't inflated housing prices. America's banking system is so sick that there just isn't much lending, while ours is healthy.

The fact is our government threw everything they could at the crisis in order to keep our real estate market juiced and our banks afloat.

• They changed mortgage rules from 10% down and a maximum 25 year amortization to zero down and first 35, then 40 year amortizations.
• Then came emergency interest rates.
• Next, a blatant blind eye has been turned to Canadian banks who are authorizing zero-down arrangements (with their 4% cash back offers) and allowing what amounts to liar loans.
• Then there is the way the government back funded the CMHC and ordered them to dramatically hike their high-risk loan exposure and approve Canadians for loans who normally never would have qualified.
• Then, at the height of the crisis, the Canadian government plowed tens of billions in funding to the banks by buying mortgages so room could be made for more to lend.

That's why credit continues to flow in this country. The Federal government is guaranteeing all that money.

We've thrown so much money at the problem that Kevin Page, the controversial Parliamentary Budget Officer came out and said that the Federal Government's orginally announced 2 year deficit (since expanded to 5 years) is now worse and that there's no way we’ll be balancing our books in 2014. Canada now has a deficit so large it is now structural and will probably be with us for an entire generation.

But because America and Europe have been spending like drunken sailors, record setting debt seems tame by comparision.

The question now is which way is the world going to turn?

Keep spending and ramping up sovereign debt or slashing debt.

A giant philosophical battle is about to intensify.

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Is there a Lehman Bros disaster looming in the Gulf?

I have been following an interesting discussion on another blog and it raises a fascinating point.

What are the ramifications of the BP crisis in the Gulf of Mexico from a financial perspective?

This is a line of thought that suggests the events in the Gulf could lead to an acceleration of the crisis brought about by the Lehman implosion.

Apparently a significant amount of liquidity in the global financial world is dependent on a solvent BP. BP extends credit – lots of it - through trading and finance.

So much, in fact, that the amounts, quality and duration of credit is on such a scale that a regular bank could only dream of. The financial muscle behind a company with 100+ years of proven oil and gas reserves dwarfs that with a bank (with few tangible assets) possesses.

What happens if BP goes under?

With proven reserves and wells in the ground, equity in fields all over the planet, nothing can match a major oil company in terms of credit quality and credit provision.

How many assets around the planet are dependent on credit and finance extended from BP? It is likely to dwarf any banking entity in multiples.

And at the heart of all that credit is a rat's nest of over-the-counter derivatives.

As a blogger posted, "Banks try and lean on major oil companies because they have exactly the kind of credit-worthiness that they themselves lack. In fact, major oil companies, conversely, spend large amounts of time both denying Banks credit and trying to get Bank risk off of their books in their trading operations. Oil companies have always mistrusted bank creditworthiness and have largely considered the banking industry a bad financial joke. Banks plead with oil companies to let them trade beyond one year in duration. Banks even used to do losing trades with oil companies simply to get them on their trading register... a foot in the door so that they could subsequently beg for an extension in credit size and duration. For the banks, all trading was based on what the early derivatives giant, Bankers Trust, named their trading system: RAROC – or, Risk Adjusted Return on Credit. Trading is a function of credit bequeathed, mixed with the risk of the (trading) position. As trading and credit are intertwined, we might do well to remember what might happen to global liquidity and markets if BP suffers what many believe to be its deserved fate of bankruptcy. The Intercontinental Exchange (ICE) has already been and will be further undermined by BP’s distress. They are one of the only 'hard asset' entities backing up this so-called exchange."

If BP does go bust (or even if it is just badly wounded) and the US entity is allowed to fail, the long-term OTC derivatives in the oil, refined products and natural gas markets that get nullified could be catastrophic.

These will kick-back into the banking system. BP is the primary player on the long-end of the energy curve. How exposed are Goldman sub J. Aron, Morgan Stanley and JPM? Probably hugely.

Credit has been cut to BP. Counter-parties will not accept their name beyond one year in duration. This is unheard of.

If BP falls, the very earth may shake as it hits the ground.

Mark Carney spoke this week on the perilous condition of the world financial markets.

And in the midsts of founding banks and faltering sovereign entities, we now have a major oil company on the verge of going under.

Another leg of the global economic “chair” is being viciously kicked out.

What will be the effects of a BP failure? Many speculate that it could easily be equal to that of a Lehman, if not more because the world is highly reliant on BPs provision of long-term credit to many core industries. Who makes good on all the outstanding paper that so many smaller oil, gas and electricity companies, airlines, shipping companies, local bus, railway and transportation networks that rely on BPs creditworthiness and performance for?

It doesn’t take a genius to figure out how this could all unwind. If BP has to be bailed-out, like a bank, the system will have to print even more unimaginable amounts of money.

The fact of the matter is that a BP crisis could unleash damage similar to the banking crisis. A BP failure through bankruptcy could make Lehman look small in comparison, and shake the world wide financial house of cards even more severely.

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Same distance, but world's apart

Pictured above, for faithful readers not from the Village on the Edge of the Rainforest, is a map of the Greater Vancouver area (click on the image to enlarge).

To the far left you can see the City of Vancouver proper. To the right, straddling the US border, are the bedroom communities of Abbotsford and Chillwack.

And while real estate is cheaper in the suburbs, Greater Vancouver is firmly locked in the absurd housing bubble that will wreak havoc on our Province when it pops.

Below these communities lies the 49th parallel - the US border. And on the American side, so close to the greatest bubble real estate market in North America, lies Watcom County in Washington State.

And how is real estate doing less than half the distance immediately south from Vancouver than if you were to travel east to Chilliwack?

It's a completely different world.

While real estate boomed in the lower mainland, the recently released 32nd edition of the Whatcom County Real Estate Research Report tells us that the bedroom community to Vancouver just over the border was well into the "bust" phase of the housing cycle at the end of 2009, with single-family sales down 50% from the peak and single-family permits down 75% from the peak.

And while longer term the county's housing market "will likely benefit from the locational advantages of the region, including an abundance of recreational amenities and its position as a lower-cost alternative to Vancouver and Seattle", right now it is sucking wind.

The number of Whatcom County homes sold last year (2,204) was the lowest annual total since 1995. The peak year was 2004, when 4,454 homes were sold. The median price last year was $259,900, the lowest since 2005. Last year, 186 homes sold for under $150,000, a 31% increase from 2008.

Meanwhile a few kilometres to the north lies the land of the million dollar single family homes.

Quite the contrast, isn't it?

Yet so many remain in denial about the perilous situation we are sitting in.

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Black Swan Alert...

We will file this one under the heading, 'Black Swan Alert'.

Arabic newspaper Al-Quds al-Arabi reports that 12 American warships, among which one aircraft carrier, as well as one Israeli corvette, and possibly a submarine, have crossed the Suez Canal on their way to the Red Sea.

Concurrently, thousands of Egyptian soldiers were deployed along the canal to protect the ships.

The passage disrupted traffic into the Suez canal for the "longest time in years." The Jerusalem Report confirms this passage.

Two other carriers are already deployed in the region, with the CVN-73 Washington in the western Pacific as of May 26, and the CVN-69 Eisenhower supporting operation Enduring Freedom as of May 22.

It isn't clear what the third carrier group may be yet but reports suggest it is almost certainly the CVN-75 Harry S. Truman (pictured above).

This follows reports by the Times newspaper of London that Israel has deployed three nuclear cruise missle armed submarines along the Iranian coastline.

HT: Zero Hedge.

These developments add credence to the rumours about munitions stockpiling on the British island of Diego Garcia in the Indian Ocean.

Back in March the Scottish newspaper, The Sunday Hearld, revealed that the US government signed a contract in January, 2010 to transport 10 ammunition containers to Deigo Garcia. According to a cargo manifest from the US navy, this included 387 “Blu” bombs used for blasting hardened or underground structures.

The suggestion was that these powerful US “bunker-buster” bombs were being shipped in preparation for a possible attack on Iran.

Experts speculated that the bombs were being put in place for an assault on Iran’s controversial nuclear facilities. There has long been speculation that the US military is preparing for such an attack, should diplomacy fail to persuade Iran not to make nuclear weapons.

Although Diego Garcia is part of the British Indian Ocean Territory, it is used by the US as a military base under an agreement made in 1971.

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Ostrich see, Ostrich do

Alan Greenspan is in the news again today repeating what should be the overriding concern of everyone in North America.

The former Federal Reserve Chairman has penned an op ed piece in the Wall Street Journal. In it Greenspan argues that the runaway Federal Deficit threatens to turn the US into the next Greece. He doesn't actually think that the US debt bears any credit risk, due to our ability to print at will, but that there is a substantial risk that borrowing costs will soar.

That last part is particularly important because as you all know, soaring interest rates are what would absolutely decimate the real estate market here on the Village on the Edge of the Rainforest.

1980 style interest rates on a $600,000 mortgage would push monthly payments up to over $11,000 per month. Not too hard to envision massive collapse under those circumstances.

When liquidating all those foreclosed properties, the only way banks could find buyers for these properties (assuming they could find buyers to make similar $3,000 per month mortgage payments) would be if the selling price of these homes came down to $165,0000.

Considering how many homes would be on the market, $100,000 would be a more realistic price point on these homes.

But a real estate collapse on that magnitude seems like science fiction to everyone today. But should it?

Look what is happening today. A simple 0.25% increase in the Bank of Canada rate, tighter mortgage rules and the looming HST have triggered a 10% drop in nationwide real estate sales and - in some cases - a 34% drop in the selling price of some high end homes.

With that in mind, is a drop of 80% in real estate values so outlandish if interest rates were to return to +20% levels?

Of course that's the rub. No one believes interest rates will ever go up significantly again.

And part of that rationalization is that the US Federal Reserve Chairman would never allow that to happen.

But here is the former chairman, Greenspan, noting that market participants are aware of America's towering deficit, yet yields continue their long march lower. Says Greenspan: "This is regrettable, because it is fostering a sense of complacency that can have dire consequences."

Greenspan knows that rates are set by the bond market - they can only be influenced by the Fed.

And the former head of the Federal Reserve is scared that while the bond market is currently driving rates down (creating the complanency he speaks of), this patter can - and will - change on a dime. When the bond market loses confidence in the US financial picture (which it inevitably will), interest rates will soar.

If he's worried, shouldn't we be concerned too?

But we're not.

And not only is Canadian complacency firmly entrenched, we're in outright denial that a problem even exists. And the perfect example of this denial was presented this week by Jay Bryan of the Montreal Gazette newspaper.

• "With yesterday's report that home resales are cooling and price increases shrinking, we can finally put behind us the horror of Canada's great imaginary housing bubble.
  
  This mythical creature terrorized credulous analysts and journalists in recent months, only a short while after some of these same unhappy people had been shaken by the equally nonexistent Canadian housing-market collapse.
  
  What really happened is that Canada suffered a short, steep drop in home prices as the recession hit late in 2008. This was immediately followed by a steep rebound as it became obvious that the recession's rock-bottom interest rates represented a rare chance to buy a home cheaply."

Bryan parrots the line that the politicians and banks have been bleating: that our real-estate rebound was possible because Canada's banking system (unlike America's) remained in good health. Cheap mortgage loans helped repair the modest damage to prices inflicted by the downturn. And that concern about the real estate market is nothing more than fearmongering by those "prone to panic attacks or the temptation to sensationalize."

Bryan argues that we can relax because our future is one in which skyrocketing prices will quickly cool as predictable market forces come into operation.

Joining in on the 'nothing to see here' mantra is Pascal Gauthier of the Toronto Dominion Bank. He says the housing bubble scenario promoted by those doomsayers makes little sense to experienced observers of the housing market.

Gauthier argues that there hasn'st been any sign of a bubble in Canadian real estate. What Canada has experienced was modest overvaluation with very little sign of speculation. The outlook, Gauthier believes, is for a modest fall in clearly overpriced markets, like Vancouver and Toronto, pulling down the national average price by a modest 7%.

Uh-huh. Sounds identical to the tale being told by American real estate defenders in late 2005 (hattip: Vancouver Condo Info).

I agree with Greenspan.

The current environment of low, low interest rates is fostering a sense of complacency that will have dire consequences.

Ignoring that fact is nothing more than burying your head in the sand. Especially considering the dramatic impact it will have on our housing market - and our lives.

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Seasons don't fear the reaper, nor do the wind and the sun and the rain... soon we will be like they are.

So, according to our buddy Cameron Muir in yesterday's post, Asian hot money is keeping our market 'firm'.

Now you know I dismiss this as more R/E spin-doctoring that attempts to contain seller panic on the current state of the Vancouver real estate market.

And who can blame them, it is a palatable fear.

Listings are exploding, sales are down almost 10% nationally, there has been a minor uptick in interest rates, factors which are combining with tighter mortgage rules & the looming HST to cast a huge pall over the market.

But Asian saviours? Who is our buddy Cameron kidding?

We saw yesterday how there was no Asian savior for the biggest sale in Vancouver last month.

This tony Shaughnessy mansion at 3639 Osler Street, a 15,000 square foot home on 31,000 sq ft of gated manicured grounds (complete with it's own indoor pool) languished on the open market for almost half a year - it's initial asking price of $16.8 million unrealized.

Isn't this the type of property Asian investors are supposed to be climbing over each other in a desperate attempt to secure in frenzied bidding wars?

Apparently not because after six months of no takers (and several price reductions) the seller finally had to accept a 34% haircut (a cool $5 mil) off the original asking price to complete the sale.

Make no mistake. The seller had the same fears about the market that our buddy Muir is now trying to quell. He saw the writing on the wall and slashed his asking price knowing that Asian hot money wasn't there to protect value levels for him.

And what of our sound Canadian banks who, we are told, have not engaged in risky lending practices?

As we discussed on Wednesday, a civil forfeiture case currently before the courts is calling into question those sound lending practices. Examples are being entered into evidence showing that million dollar mortgages have been granted to lenders who simply do not have the capacity follow through on with their requisite monthly payments.

And this at a time when interest rates - and monthly payments - remain at low emergency levels.

Perhaps even more disturbing is that we are privy to this information only because it comes to us as a by-product of a grow-op forfeiture court proceeding.

How many similar million dollar mortgages languish after having been approved to similar risky borrowers?

On one of the real estate chatboards a thread has been started on foreclosed properties currently available.

With interest rates producing the lowest monthly payments we will ever see on this level of debt in our lifetimes, defaults abound.

Take this 2800 sq ft, 5 bedroom, 3.5 bath home on a 50 x 112 lot on the fashionable west side of the city of Vancouver.

Our 'diligent Canadian banks' facilitated this loan to a borrow who turned out not to be the secure risk they like to boast about.

(click on photos to enlarge)

Purchased in 2000 for $544,000, the property now languishes in foreclosure for $1,388,000.

(A figure that has anyone outside of Vancouver staring in utter disbelief at these photos... which is why I give you one of the listing links here)

We don't know the tale of misfortune that resulted in the financial distress of the former owner - nor do we seek to rub our hands in glee at his plight - but it is not a stretch to see that this situation screams out as an example of banks granting HELOCs without re qualifying lenders to ensure they can afford the payments.

But daily we are fed the malarky from our banks and political leaders that this situation does not exist in Canada.

As the case before the courts proves, our Canadian banks - just like their American counterparts - have been irresponsible in their lending practices. Decoupled from risk by the policies of the CMHC, why wouldn't they be?

Taxpayer's are on the hook for mortgage similar to this one through CMHC. And given that over 95% of Canadian mortgages have been CMHC secured in this crisis, the Canadian taxpayer is at a tremendous potential risk.

More importantly Asian hot money has not intervened here to save the lender's (and the taxpayer's) ass in this case and it will no doubt take a 35% haircut on the selling price here to move this property under the current market condition.

And that will come out of our taxpayer pockets.

As the foreclosure thread on Real Estate Talks demonstrates, there are numerous other properties in the $600,000 range that also languish in foreclosure - their owners not quite the secure lending risks our (supposedly) diligent Canadian banks claimed.

You can see examples here, and here, and here.

Where is the Asian hot money?

This is all happening despite the fact interest rates haven't started going up in earnest yet.

What is going to happen when rates start going up? Think about that for a moment.

The financial crisis is on the verge of entering stage 2 of it's devastating story. People are beginning to understand that the 'recovery' is more smoke and mirrors from the manipulation of stimulus money than actual economic recovery.

The great Canadian commodities trader Jim Sinclair has branded this misleading recovery P/R as the 'Management of Perspective Economics' (MOPE). As the stimulus runs it's course and the necessary deleverging begins, we will see that the recovery isn't taking hold and the examples cited above will increase dramatically.

We are no different from the United States.

We have only delayed the tipping of the first domino's that will trigger havoc on our real estate market.

In the process we have deluded ourselves into believing those domino's aren't poised and ready to fall.

They are, and they will... regardless of the MOPE spewed by Muir and company.

Before too long now the public at large will come to understand this.

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Don't fear the reaper...

So the main story in real estate right now is the explosion in listings and the dramatic drop off in sales as interest rates inch up and credit rules tighten.

In California the real estate collapse first started to show at the top end of the market with high end properties suffering dramatic drop offs.

Are we starting to see that here?

It's possible. How else to explain the British Columbia Real Estate Association's chief mouthpiece, Cameron Muir. coming out this week to pump the high end of the market with this puff piece on Global TV:



Muir tries to calm the market with the rational that investor class Asians are keeping the market up and protecting real estate values here. This follows several other news stories this week promoting the same viewpoint.

That, btw, is you first clue that the 'story' is being engineered as an R/E PR operation. We saw this last year when the market dropped... real estate associations begin their PR campaign to re-assure sellers to prevent them from panicking and setting off a cascade of price reductions.

Personally I love this phase and find the whole gamut of media manipulation fascinating.

There are reports, on various real estate blogs, of high end R/E sales completing at anywhere from 5% - 14% below asking prices... a far cry from the tales of bidding wars of the last few months with houses selling far above asking.

But perhaps the most telling sale is this one documented on Larry Yatkowsky's site. A 15,000 square foot home on almost an acre of land at 3639 Osler Street sold last month.

In January the asking price was $16,800,000.00.

It sold in May for $11,080,000.00 - $5,720,000 less than asking or 34% less than what the seller originally wanted.

Did he grab an offer for 34% less than what he was asking because the market is clearly starting to tank?

It's still early in the process yet, but with Cameron Muir doing his Blue Oyster Cult impression already, events are clearly starting to show a shift in fortunes.

Asian money didn't prevent a collapse in California and it won't here either. Let's face it. Why buy a property at full value if you sense in a year you might get it at half off?

The 'wealthy Asian investors' are wealthy... not stupid. Which explains the R/E PR machine's need to begin trying to calm the panic amongst sellers.

Go ahead... take Cameron's hand. "You'll be able to fly."


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Harbinger

This item has been covered on a number of local blogs, but the item is significant and will prove to be a harbinger of things to come.

The newspaper story in question (which you can read in the Province newspaper here) tells us about a real estate property which is now before the B.C. Supreme Court. The case is a potentially precedent-setting civil forfeiture that calls into question the role banks play, knowingly or unwittingly, in the province's multibillion-dollar drug trade.

But while the newspaper story focuses on the role played by banks in financing the grow-op, our focus zeros in on a revealing section within the story... one that confirms what many bloggers have suggested is going on with mortgage approvals in this country.

Every week we are reminded that the reason Canada has not suffered a housing collapse like our American cousins is that our banking system has been much more diligent with mortgage approvals and our banks have properly managed risk.

Thus, supposedly, there are no subprimer's in Canada.

Numerous posts have been made on this blog discounting this. We have subprimers. The conditions just haven't sufficiently presented themselves for their carnage to be unleashed on our market - yet.

Which takes us to the recent Vancouver Province newspaper story.

As details of the forfeiture case come out, it appears that the courts have come across several circumstances where banks have refinance mortgages on million dollar homes for lenders who, allegedly, were unable to provide proof they had the means to make the hefty monthly payments (about $4,000 a month).

That's right... million dollar mortgages approved without adequate proof of income to pay said loan.

In one case a prospective lender asked the Bank of Montreal to mortgage the property in question for its full value ($976.000) on Oct. 22, 2008. In August 2009 Vancouver police raided the home and uncovered a massive grow-op. Two days later, despite the raid, the lender sought and received an additional $70,000 mortgage on the property from the Royal Bank of Canada.

Make no mistake... this is not a 'one-off' story.

In the United States a minor drop in real estate values combined with mortgage resets at higher interest rates triggered the massive housing collapse we have witnessed over the past four years.

Those two conditions haven't come to pass in Canada, yet.

But they will.

And when they do, real estate in bubble areas of our country will suffer the same results as real estate in the bubble areas of the United States. And as the market here collapses inward upon itself, story after story will start to surface about other highly questionable loans that have been made.

This article is simply a portent of things to come.

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Unsustainable

"Unsustainable."

That's the single word that summarizes everything you need to know about the next 20 years. The only question is how long can the charade be carried on before the piper has to be paid.

And the single word is provided courtesy of none other than Fed Chairman Ben Bernanke who told the House Budget Committee this week that the US Debt level was "unsustainable."

"Our nation's fiscal position has deteriorated appreciably since the onset of the financial crisis and the recession."

Bernanke went on to say that the budget deficit was necessary to help get the nation out of recession but will have to be addressed in the long term, particularly in light of the European debt crisis.

Sovereign Debt... the story of the next 20 years.

I note, with interest, that CNBC will be airing the BBC production of 'The Last Days of Lehman Brothers' today. For your enjoyment, this dramatized quote from Hank Paulson...


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Rationalization

"It's different this time."

That's the powerful phrase that, for many real estate bloggers, is the embodiment of rationalization in the housing bubble.

We all know it is just that... rationalization. But it's fascinating how easy it is to lose sight of that understanding. More on that momentarily.

In 1987 Paul Kennedy first published The Rise and Fall of the Great Powers: Economic Change and Military Conflict From 1500 to 2000. The book explores the politics and economics of the Great Powers from 1500 to 1980 and the reason for their decline.

Kennedy argues that the strength of a Great Power can be properly measured only relative to other powers, and he provides a straightforward and persuasively argued thesis: Great Power ascendency (over the long term or in specific conflicts) correlates strongly to available resources and economic durability; military "over-stretch" and a concomitant relative decline are the consistent threat facing powers whose ambitions and security requirements are greater than their resource base can provide for.

We would all like to think the U.S. will not suffer the same problems as those who came before it... the Soviet Union, Great Britian, France, Prussia, Austria-Hungary, etc.

The fact of the matter is that the U.S. is already dealing with too much debt and not enough money. The cracks in the economy are getting bigger, not smaller, as the “recovery” camp would have you believe. 40 million U.S. citizens on now food stamps — a new record. It was reported just last Friday that “Up to 300,000 Public School Teachers May Lose Their Jobs This Year Due to Local Budget Cuts.”

And since the individual U.S. states cannot print money, the U.S. federal government is going to try to save teaching jobs with an emergency federal spending bill. It will mean an additional $23 billion to the deficit. Illinois has reportedly stopped paying its bills. Contractors are owed $4.4 billion, and nonpayment may cause a wave of bankruptcies in that state. There are nearly 3 dozen other U.S. states facing similar severe budget problems.

In the latest report from Shadowstats.com, economist John Williams says look out for another nasty downturn in the economy because the money supply (M3) is shrinking. Williams writes, “... near-term economic activity will turn down, with major negative implications for the federal budget deficit, U.S. Treasury fundings, systemic solvency and the U.S. dollar. Such developments should place significant upside pressure on domestic inflation. U.S. difficulties eventually should dwarf the European sovereign solvency concerns”

So, what will perform well in this environment?

That, my friends, is the question I get peppered with half a dozen times each day.

Williams believes you better start looking for an exit if you are holding dollars, stocks or bonds. According to Williams, “the long-term outlook for the U.S. dollar and U.S. equity and credit markets remains bleak, while the long-term outlook for gold and silver remains extremely strong.”

Yesterday we talked about the BMO report "Go To Cash" which was advising it's clients to dump equities.

Reflections from the Doomer side of the net?

Hard to say.

No one can deny debt is out of control.

Some would suggest that this is no time for emotion to overtake reason. Reason being smart investments in tried and true economic vehicles which, under normal circumstances, are sure to be wise choices as the economy recovers.

Normalcy, we are cautioned, will return.

But evidence is mounting that - in the broader terms of history - we are at that turning point encounted by of the former powers. That same turning point which was undeniable for Prussia, Austria-Hungary, France and Great Britain.

In the face of all the mounting issues for the United States, in the face of all the mounting evidence... can we really deny what is happening around us.

Isn't it tantamount to saying it will be different this time... different this time for the United States?

Maybe it isn't fear and emotion.

Maybe it's just understanding that it probably isn't different this time?

Just a thought.

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BMO: Go To Cash... Now!

How bad is the evolving debt crisis in Europe?

Well... Bank of Montreal has some simple investment advice for it's clients.

Get out of equities and go to cash!

Ummm... can't get much more straightforward than that.

In fact that's the title of the report from BMO's Quant/Tech desk.

From the Report:

"We advocate switching out of equity positions and going to cash. The European sovereign debt crisis appears to be nowhere near over. The global credit environment is worsening. Cost of capital is going up and availability is going down. There are large gaps between where the credit market prices risk and where the equity market is priced. Equity is lagging the deterioration in credit conditions. Moves in currency, equity and commodity markets are mirroring the moves in the credit market. Global growth, in a credit-constrained environment, will slow. Profits will be squeezed by the higher cost of capital... We advocate a zero weight toward equity, and that investors convert their equity positions to cash."

The global credit environment is worsening and the cost of credit is going up. That's been my message for months now and we welcome BMO to the doomsayer bandwagon.

And when it starts to go up, it's going to go waaaay up.

It's not rocket science folks. That's why a major real estate purchaase you plan to hold, purchased over the last three years, has been the absolute worst move of your financial life.

For those who so desire, the BMO report is below.

Go To Cash

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You know what's coming...

Sigh.

I find it amazing that what seems so obvious escapes the consciousness of so many.

The latest to wake up and smell the coffee are the brilliant economists at the National Bank who have come out with the insightful conclusion that the impact of rising interest rates on the residential housing sector "could be dire" in Canada.


Really? Whodathunkit?

“Though the Bank of Canada has done well to set its rate normalization process in motion, the fact remains that the stakes at play are high, with home prices and household debt at record levels relative to income,” economists Matthieu Arseneau and Yanick Desnoyers said in a report. “The residential real estate sector, which is extremely sensitive to interest rate fluctuations, could have the wind knocked out of its sails if interest rates do nothing more than normalize.”

No kidding.

And what will happen if they do more than 'normalize'?

The impact on our Country, economy and government finances is going to be severe.

Once again, I shake my head.

Arseneau and Desnoyers are right, but where was this insightful analysis when the blogosphere was initially sounding the alarm last year?

Meanwhile the Toronto Star has taken these observations to their logical conclusion and noted that the CMHC is Canada's very own ticking time bomb.

The Star article concludes exactly what has been said here for the last 18 months... that the CMHC is "a potential financial disaster lurking just over the horizon, waiting to put us into the real world of true financial crisis."

Sigh... we are so screwed.

I am reminded of events in mid 2008. The United States was spiraling into recession and our politicians steadfastly maintained we would not be effected.

As world events continue to spin wildly, we continue to believe that we will not be impacted.

We are watching a 5.9% annual decline in the M3 money supply, the deepest decline since the early 1930s banking crisis. This is a post World War II record drop in the inflation-adjusted M3 and it signals an intensifying business contraction. Many observers believe we are heading for a renewed recession and it will set the stage for a U.S. solvency crisis and severe inflation threat.

Meanwhile British Prime Minister Cameron has come out and that the UK deficit is worse than 'previously thought'. That's British for "oh sh*t".

Tempering the UK announcement is word that that the U.S. government’s total debt will risee past $13 trillion for the first time in history later this month. The amount owed will surpass GDP in 2012, based on forecasts by the International Monetary Fund.

“Over the long term, interest rates on government debt will likely have to rise to attract investors,” said Hiroki Shimazu, a market economist in Tokyo at Nikko Cordial Securities Inc., a unit of Japan’s third-largest publicly traded bank. “That will be a big burden on the government and the people.”

THAT, my friends, is the understatement of the year.

Just as Canada could not escape the effects of the recession which swept over the US in 2008, nor will we escape the impact of the sovereign debt crisis that is bearing down on the UK and US.

As all this plays out, you don't want to be carrying debt... especially hundreds of thousands of dollars in mortgage debt.

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The Story In Your Eyes

About a year and a bit ago it was time to pull up the ottoman, grab a bag of popcorn and watch the saga play itself out.

Of course a great many were gleefully anticipating a Canadian-style housing collapse that would mimic the great American catastrophe playing out on our cousins to the south.

But it was frustrated despair that many felt as the Canadian story took an unexpected path - government intervention, emergency interest rates, CHMC directives to approve sub-primers.

A watched pot never boils. And with that thought, I am now reminded of the classic Moody Blues song, The Story in your Eyes.

"Listen to the tide slowly turning
Wash all our heartaches away
We're part of the fire that is burning
And from the ashes we can build another day"

For the past month and a half we have watched the media slowly begin to grasp the true condition of what has been driving our real estate market, watched the bond market start to drive interest rates up and listened to the Governor of the Bank of Canada 'tsk-tsk' Canadians for overdosing on the crack cocaine of the emergency level interest rates he has set out on the table.

The result?

As CREA’s economist Gregory Klump says, “with interest rates soon expected to rise, Canada is widely believed to be entering a typical demand-driven downturn due to recent prices increases and rising interest rates."

Typical? It will only be classified as 'typical' if the bleeding is minimized. Last month's statistics are out and the 'demand-driven downturn' has begun.

Detached houses prices are down 4.6% from April, listings are exploding and buyers are exiting en masse.

And yesterday... the Bank of Canada doubled their emergency interest rate from 0.25% to 0.50%.

This comes on the heels of StatsCan reporting that the personal savings rate of Canadians has plunged. We now spend, on average, 97.2% of what we earn.

Debt has postively exploded among Canadians.

Mortgage debt is at an all-time high and we’ve never owed so much on credit cards, lines of credit, car loans and/or home equity loans.

And this debt orgy has all been built up when interest rates are at the lowest point in history.

The email inbox reveals numerous comments that I am gleefully crowing over the hardships I expect to befall my fellow countrymen.

Nothing could be further from the truth.

"But I'm frightened for the children
That the live that we are living is in vain
And the sunshine we've been waiting for
Will turn to rain"

I focus intently on the obvious conditions which are brewing because to ignore what is coming is pure folly.

As I said Monday, understand what is going on around you. We live in extraordinary times, most of us just don't realize it yet.



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