Monday, September 6, 2010

Where to now?

In the United States, the economy in general, and real estate specifically, is about to enter a critical phase.

Over the last 18 months, America has rolled out just about every program it could think of to prop up the ailing housing market. Tax credits, mortgage modification programs, low interest rates, government-backed loans and other assistance. All of it was intended to keep values up and delinquent borrowers out of foreclosure.

The objective has been to stabilize the market until a resurgent economy created new households that demanded places to live, thus reflating the housing market.

This, btw, is not too far off the mark from the strategy that has been employed in Canada.

But the economic recovery is nowhere to be found.

And as the anemic economy sputters and the stimulus wanes, housing sales in the United States have plunged again. In July US housing sales sank 26% from July 2009 and there is a growing sense of exhaustion with government intervention.

Politicians made a bet that a rising economy would solve the housing problem. But several years into the financial crisis they are out of options and they don’t really know what to do.

Now some economists and analysts are urging a dose of shock therapy: let the housing market float on it's own. And if it crashes, so be it. When prices are lower, these experts argue, buyers will pour in, creating the elusive stability the government has spent billions upon billions trying to achieve.

In Canada, after a brief hiatus, Canadians continued on with it's housing bubble due to direct government intervention. Lured by cheap money, we have carried on buying houses we can’t really afford.

And because we have taken advantage of historic low interest rates to maintain spending our nation now has the highest consumer debt to financial asset ratio among 10 OECD countries, including the U.S.

So dire is that debt situation that, according to the Canadian Association of Accredited Mortgage Professionals, 375,000 mortgage holders in Canada are already challenged by their current payments and may not be able to handle higher rates.

Think about that for a minute... interest rates at the lowest point in history and 375,000 mortgage holders have so badly plunged themselves into debt by buying the maximum amount of house they could afford that they may not be able to handle higher rates?

The Bank of Canada is well aware of the precarious position Canadians have placed themselves in and have spent the better part of the last six months issuing warnings to Canadians to be careful - and to prepare for an end to these emergency interest rate levels.

Now... the time may have come let the Canadian housing market float on it's own.

“The need to take the Canadian consumer away from the credit punchbowl remains a pressing one,” says Bank of America Merril Lynch, which is why you will see the Bank of Canada hike the interest rate again on Wednesday (and will keep hiking rates for the time being).

Minor mortgage rule changes, the HST and two simple rate increases by the Bank of Canada have plunged housing sales downward the past three months. And still there are calls for the Bank of Canada to keep raising rates.

The C.D. Howe Institute’s monetary policy council said last week that the bank should raise its“overnight rate (the short-term rate it targets for monetary policy purposes) from 0.75% to 1% on Tuesday and keep on hiking it until it reaches 2.25% a year from now.

In its statement, the monetary council said the recommendation “reflected a view that the Bank of Canada should continue to unwind the emergency measures adopted after the 2008 financial crisis.”

Carney spent the first half of the year issuing warnings of what was coming. And now that punchbowl is going to be gradually taken away.

Is it really so hard to see how things are going to play out?



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  1. I was going to comment yesterday that while I agree with you that logically things should go this way,....that we can't use logic as a guide to predict future decisions so all bets are off. Then I stopped, believing I was too jaded and cynical.
    Then I see today CBC reporting that economists are suggesting one rate hike, and then leaving it for a year. That actually wouldn't surprise me. The fact of the matter is that no one, governments, the fed/BOC etc, want people/the economy to feel pain...even if it's short term and is good in the long run. I think the mistake we make on these blogs is making predictions based on logic, when clearly logic stopped being part of the game years ago when Greenspan left the rate close to zero and couldn't see the bubble he was creating.

  2. what is your opinion on CIBC and other similar banks giving up to 7% cash back on mortgages now?

    that pays off the interest on the mortgage every year? do you think most people will realize that the 7 and 10 year terms do that while the other short term ones pay less then the interest on the cashback? do you think these banks are trying to get people into these higher interest rates for their 400k mortgage so they can eventually loose them?

    btw it says that the offer can be cancelled at anytime :)