Friday, September 24, 2010

How can we be so blind?

Yesterday I mentioned that I had an encounter with James, a casual acquaintance of mine who happens to be Scottish (he's a tolerable guy though, so we overlook that).

I've known James for almost 20 years, but yesterday was the first time we had ever talked about real estate... and it was an intense 15 minute conversation in which he hit on just about every stereotypical defense for real estate.

'Real Estate never goes down, you can't ever go wrong buying and our solid Canadian banking system won't facilitate any sort of collapse here.'

It was almost a surreal encounter.

But it speaks volumes.

Mainstream Canada is still completely unaware. They have bought into the 'official' line that everything is alright.

And perhaps it is just as well. Can you imagine the panic to dump real estate were it any different?

The average Canadian is blissfully ignorant about what has happened... about what is happening... about what is about to happen.

They are completely unaware about how our Canadian banks barely escaped their own meltdown in 2008.

Few realize all five Canadian banks are levered at an average of 31:1 and that if tangible assets were to drop by 3% in value, tangible common equity would effectively be wiped out.

Nor do many realize that Canadian Banks were bailed out by receiving $65 billion in liquidity injections from the Insured Mortgage Purchase Program (IMPP) in 2008 - Canada's version of TARP - whereby the CMHC purchased insured mortgages from Canadian banks to provide additional liquidity on the asset side of their balance sheets.

No one seems to be aware that the Bank of Canada then gave our Canadian Banks an additional $45 billion in temporary liquidity facilities or that the Canada Pension Plan, through the purchase of $4 billion in mortgages prior to the IMPP program, raised the total government bailout to $114 billion.

And what about the CMHC being ordered by the Federal Government to approve as many high risk borrowers as possible to prop up the housing market (with entry level buyers) and keep credit flowing?
  • In 2008 some 42% of all high risk applications were approved, a 33% increase over 2007.
  • Between the beginning of 2007 and 2009 Canadian Banks increased their total mortgage credit outstanding listed on their books by only 0.01% - possibly the smallest amount of change in post WWII history - which was the only way we managed to keep credit flowing in our country while it dried up in the USA.
Canadians are oblivious.

They can't see how this all impacted the debt orgy. Aren't aware of how CMHC's obligation has grown from $100 Billion in 2006 to $776 Billion in 2010.

Last year the Conservative Government, after our nation spent 10 years digging ourselves out of a $45 Billion deficit with onerous taxes like the GST and years of cutbacks in government services, replunged us back into hock with a record breaking $50 Billion deficit.

If CMHC is forced to pay out on a mere 10% of that guaranteed $776 Billion, that amount would more that double that historic $50 Billion debt.

But the average Canadian is completely oblivious.

They sincerely believe that our secure, non-bailed out Canadian banks don't lend to 'risky borrowers'.

They are wilfully blinded to the ads all around them whereby someone with no money can go out and, courtesy of bank initiatives like this one that offers them 7% back, can get their 5% downpayment covered and actually get PAID 2% of the mortgage value to make that purchase.

Nothing down and get PAID to buy a house!!!

No... we don't see it.

We tell ourselves we aren't making the same mistakes the Americans did. And we do it with blatant ignorance.

But Americans can see it.

When I spoke to two tourists from Minnesota in August, they asked what the interest rate was on a 30 year mortgage here. When they found out virtually no Canadians have long term mortgages... that the vast majority have 5 year terms or less that reset at whatever the going interest rate is... they recoiled in shock. They instantly recognizing that all Canadian mortgages are set up exactly like American subprime mortgages: 2-5 year low teaser rates that reset higher once the teaser term is over.

But the average Canadian is oblivious.

We bailed out our Banks.

We allow people with no money to buy houses (which has driven up the price of our real estate exponentially).

We have a vastly higher percentage of Canadians juiced on teaser rate mortgages, mortgages they can afford now but for which the vast majority will not be able to afford when rates reset higher.

And when interest rates do climb higher, our real estate market will implode just as spectacularly as California, Phoenix or Florida.

That collapse has already started. As I have shown you in posts this month
  • Okanagan Real Estate has stagnated and properties are down 50%,
  • Victoria Real Estate, after three previous months of sales down by over 40% from the same month last year, are on target for a 75% decline this month,
  • Vancouver is on track for a fourth consecutive month where sales are 40% down from the same month last year,
  • Bob Rennie is selling luxury condos downtown at the Fairmont Estates for 40% off their March prices, and
  • in Surrey developers are offering units for 35% off their 2006 pre-sale price.
We are like the people in South East Asia who, on Boxing Day 2004, witnessed the sea drain from their shores.

Not sensing the danger, they ventured out to check out the tidal flats in wide-eyed wonderment only to realize, too late, the danger as they tried to flee for their lives from the crushing Tsunami barreling down on them.

The only difference is that the South East Asians didn't witness a neighbour go through the same situation 3 years earlier and then make the same mistakes.

Canadians saw the Housing Tsunami strike America, the UK and Europe. We have no excuse for not seeing this coming.

Yesterday my friend James revelled in calling me a doomer.

I perfer the term 'rational realist', myself.

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  1. Hey, thanks for you blog I really appreciate it. Can you tell me where you find your CMHC stats. I would like to hammer this point home with some people but I need access to "official" data and can't find it. Thanks again and keep up the good work

  2. This is probably the best post I've read so far on your blog. I'm sad to say that I totally agree with you.

    It's not just residential RE that is being hit, commercial RE is in badly affected as well. Here in metrotown, the third "metrotower" was under construction a few weeks ago. The construction work has stopped. I've heard that there was a clause in the contract that allowed the developer to stop the construction work after the first phase (underground and first level) if the economic situation changed. Here we are...

    Meanwhile, a few blocks away, the construction of the Jewel II residential tower is starting. I would be curious to know how many pre-sales they got for this one...

  3. Excellent post. Those photos are icing on the cake. Nature doesn't make exceptions for naivete, the market won't either.

  4. Great post again. I appreciate your blog and direct people to it as I can.

  5. Everything all in one post. This is getting bookmarked. Thanks!

  6. Eric, send me an email and I will see what I can do for you.

  7. the amortization schedule is so interest heavy for the first few years that it provides a lot of buffer for the lender even if the person defaults

  8. What is often overlooked by all the discussions about the introduction of fixed rate 40 year amortizations was the Harper governments decision to bring in greater "private sector innovation" into the mortgage securities market. Specifically allowing GE and AIG to enter that market in the 2006 and 2007 time span. The result of that policy shift was a kind of predatory race to the bottom, where the CMHC felt compelled to radically increase its securities in the face of sub-prime pumping styles of lending that those firms were encouraging.
    When the CMHC was a monopoly it could at least be easily regulated. Jim Flaherty, that highly decorated and respected finance minister (see propaganda post below), thought otherwise.

    PS- This link is kinda reminiscent of that Time magazine cover at the end of the tech bubble with Greenspan, Rubin and Summers that had as its title the "committee to save the world'.

  9. Wow...first visit to your blog. An American here who saw 1st hand people buying houses to re-sell..and then could not re-sell them for the mortgage. Unqualified borrowers suckered in by "teaser" rates that reset a few years higher and they could not meet the payments.
    Foreclosure, Bankrupcy, Banks Fail. PRICES FALL! Then wages fall, then producer prices stumble and fall it's called DE-flation, and it is UGLY. Savings earning 1-2% a year but costs increased even less. Who killed the great party? It was gereat fun...the hangover really sucks!! Do NOT follow after the U.S.