Saturday, June 19, 2010

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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