Doomsday Defined?

It's been an intriguing week that was for those who follow the trials and tribulations of our real estate bubble in Canada.

If you missed it, there was a stunning development last week that has rocked the industry.

In a series of interviews, Finance Minister Jim Flaherty shocked everyone in R/E by alluding to far-reaching changes to the foundation of Canada’s housing market.

And the website Canadian Mortgage Trends (CMT) had a great post which summarizes the issue.

CMT notes that for 58 years, the Canadian government has offered mortgage default insurance to qualified Canadians. The idea has been to make homeownership more accessible, which in turn bolsters the broader economy. Now, the government’s direct support of that insurance is in question as Flaherty came out and said:

“Over time, I don’t think it’s essential that a government financial institution provide mortgage insurance in Canada. I think what’s key is that mortgage insurance is available at a reasonable cost in Canada. I think there is a role to regulate but whether we, the Canadian people, have to be the owners and shareholders of a financial institution to do this is a question. I don’t think it’s essential in the long run.”

CMT observes that Flaherty, with his comments, has put the government’s support of housing finance in doubt.

CMT then goes on to defend the status quo and I'll let you check out their article at your leisure.

There was, however, a stunning statistic that caught me eye near the end of the post.

CMT notes that, according to CMHC’s stress tests, a chilling statistic is revealed. CMT observes:

"As of Q3 2011, CMHC had $17.4 billion in capital set safely aside to cover claims. In a doomsday scenario, CMHC sources have assured us that it could handle obscene prime default rates on the order of 3.00% or more."

Now... CMT hastily downplays this statistic by saying that a 3% default rate is "three times the all-time high of 1.02% in 1983, which occurred after a year when fixed mortgage rates averaged 17.89%." Hence how they come to believe a default rate of 3.00% as 'obscene'.

Somehow that's supposed to make things alright.

But there's one small problem. When mortgage rates averaged 17.89% in 1983, the average mortgage was around $40,000 - $50,000. And the most recent average homes selling in the market were going for around $100,000 (and none of them for only 5% down or an amortization more than 25 years)

Much of the debt taken on during the late 1970's was acquired during a period when rates were over 15%. People KNEW what they were getting into.  Those that had problems were those who got trapped renewing their mortgages around the time rates topped out at 22% (yes... people had to renew a mortgage at 22%!).

The real takeaway is this: A DOOMESDAY scenario today is considered a default rate on the order of 3.00% or more. And any scenario under consideration where defaults reach 3.00% is classified as so unlikely that number is called 'obscene'.

Hmmm. Allow me, faithful readers, to draw you attention to Garth Turner's blog post today., He notes that currently "there are 220 foreclosures on the market in Edmonton alone, or about 5% of active listings."

Recall a post I made recently about The Boomer Trigger. 70% of Boomer's do not have adequate funds set aside for retirement.  Their plan is to sell their bubble inflated real estate, downsize and live on the difference.

The Boomer advantage in the current stagnating Vancouver market is that if they tire of waiting for their property to sell at current bubble rates, they can dramatically slash their asking price and still realize an acceptable profit.  The Boomer Trigger post profiled one such example where a seller knocked almost $1 million off his $2.3 million asking price.  In that he probably only paid $60,000 for the house in the mid 1970s, it wasn't a problem.

The new blog, Vancouver Price Drop, profiles another example of The Boomer Trigger.

This house, at 5638 Crown Street on the west side of Vancouver, is currently for sale:

On March 09 it was listed for $2,398,000 (MLS listing V934064).

On March 13 the listing price was dropped $100,000 to $2,298,000.

On April 04 it was cut to $2,248,000, chopping another  $50,000 off the asking price.

On April 13 another $50,000 was chopped off the asking price (now $2,198,000).

On April 23rd the listing was revoked and on April 25 the house was relisted for $2,150,000 (MLS listing V945487) and another $48,000 was taken off the original March 09 asking price.

Three days ago, on April 27, the price has been reduced again. It has come down to $1,988,000, a drop so far of $410,000 from the initial asking price.

In total it's 17% off the original asking price in less than 2 months.

Now, it's clear the sellers set the price to high to start.  But the price they choose was consistent with what homes had (and 'had' is the operative word here) been selling for in the neighbourhood.

But with all the bubble collapse talk going on (combined with the over 70% increase in available listings since the start of the year), the sellers are clearly very worried.

The number of price changes in a short period of time shows their desperation (hence the reason the listing was pulled and a new listing put out... an attempt to hide the desperation).

And the fact of the matter is... they can accept a much lower price.  It's the Boomer advantage. Accepting an offer at this point that shaves another $500,000 off the asking price is not out of the question.

Meanwhile all those who bought at those lofty prices in the past year, they have just seen their 'investments' evaporate by 17%.  And this trend will only pick up steam.

Later this year, new regulations being enforced by the OFSI (the banking regulator) will require loan to value ratios (LTV) being enforced when mortgages are renewed.

If "doomsday" is only a 3% default rate, it's not hard to see the grim reaper appearing on the horizon.  

Because if this trend gathers steam, the Boomer Trigger will leave a huge number of people who bought in the last 5 years massively underwater.

And they simply won't be able to renew their mortgages under an OFSI strictly enforced LTV ratio requirement.

If this were to come to pass, a default rate of only 3.00% would be a godsend.

We continue to watch with... (dare I say it?)... obscene fascination.

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Historical Perspective

The Globe and Mail newspaper came out with an article today the encapsulates what many bear bloggers have complained about.

Primarily how Governor of Canada Mark Carney's debt warnings are at complete odds with the monetary policy he is following.

The Globe notes how Carney, for years now, has used ultra-low interest rates to flood the financial system with easy money.

That policy kept Canadians buying homes while markets elsewhere in the world faltered.

The conventional wisdom has been that keeping those emergency low interest rates in place has been a risk worth taking, given the weakness in the non-housing side of the economy.

But as it becomes clear that it's entirely possible that Canada’s housing crash wasn’t avoided, but merely postponed, the Globe wonders whether history will be kind to the Bank of Canada Governor?

Carney is being heralded around the world. He chairs the Financial Stability Board, tasked with reforming global financial institutions.

He’s whispered as a candidate to head the Bank of England.

Wherever he goes, people laud him for saving Canada from the worst of the global financial crisis. On Tuesday, the Canadian Club honours him as “Canadian of the Year.”

But this adulation, as the Globe notes, can quickly shift as it did for the former Chairman of the US Federal Reserve, Alan Greenspan.

When Greenspan retired from the U.S. Federal Reserve in 2006, he looked like a genius. He had steered the world’s largest economy through the dot-com bust, 9/11 and a recession. All was good as the economy roared.

But two years later, with the U.S. housing bubble bursting and the financial crisis raging, Greenspan’s reputation was substantially diminished. His failure to see the mortgage lending bubble – and do anything about it – is now etched in his legacy.

A rattled Mr. Greenspan later admitted his faith in the financial system was shaken.

If Canada’s housing market crashes, will Canadians look back on all his verbal warnings over the past few years about debt?

Or will he be judged on the monetary policy he kept in place as his warnings fell on deaf ears?

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Thurs Post #2: Now it's the Royal Bank warning of a correction!

Canada's largest bank, Royal Bank, has now joined the chorus of real estate doomsayers by coming out and proclaiming that the Vancouver housing market is vulnerable to `significant downturn'.

Robert Hogue, senior economist at RBC,  says there are fundamental factors supporting what he acknowledges is a "volatile" market.

In an RBC report Hogue wrote that prices are expected to decline for two key reasons: high prices and the dependence on wealthy foreign investors.

Hogue says these factors:

"... make the Vancouver-area market more vulnerable to a significant downturn than other Canadian markets if an unfavourable economic scenario or unforeseen shock (such as a change in China's policy regarding capital outflow) were to unfold. The constant flow of wealthy buyers coming from abroad is poorly documented, leaving the dynamics of the city's market rather opaque and opening up the possibility that critical market developments could be missed. For this reason, and the fact that the extremely poor affordability levels, quite frankly, make us uncomfortable, we urge caution."

Tsur Somerville, director at the University of B.C. Centre for Urban Economics and Real Estate at the Sauder School of Business, is often chided by bear bloggers for his pro-bull market analysis. But even Somerville is changing his tune.

"Were the inflow of capital from immigrants and investors to dry up or be reduced, that would put downward pressure on housing prices."

Somerville wouldn't predict how much prices would drop but did say;

"I have no idea and given what we don't know, you can't really model the market. It's very hard to figure out what's going on in the Vancouver because there are all kinds of don't knows. We don't know how many of those buyers are foreign buyers, you don't know how many are strict investment, you don't know how many are permanent residents, and you don't know how many are occupying their units."

How's that for turning on a dime? Sommerville out and out admits you really can't model the Vancouver market.

Perhaps he should stop allowing himself to be quoted as an expert on the subject, then. But I digress.

Hogue, who hedges his comments by hesitating to call for an out and out collapse, does note that the market is subject to "extreme unaffordability" and says that a typical Vancouver-area homebuyer would need to spend 92% of their income to carry the costs of a two-storey home, and as much as 45%of their income for a condo.

That this market will correct, and correct significantly, is gradually becoming obvious to anyone who doesn't let hope cloud observation.

Can you see clearly yet?

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Frontline - Money, Power and Wall Street, Part 2

Watch Money, Power and Wall Street: Part Two on PBS. See more from FRONTLINE.

Episode Two: Systemic Risk. Bear Sterns collapses; regulators fear its effect on the financial system.

In this episode FRONTLINE investigates the largest government bailout in U.S. history, a series of decisions that rewrote the rules of government and fueled a debate that would alter the country’s political landscape. It offers play-by-play accounts of several secret meetings that permanently altered the financial system.

FRONTLINE finds plenty of blame to go around (Goldman Sachs and CEO Lloyd Blankfein take a particular bruising), but is most devastating in its dissection of the chummy collusion between bankers and the government leaders who should have been watch-dogging them.

Episode Three & Four will be released and posted here on May 1 & 2, 2012.

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Wed Post #2: Even more Carney warnings on interest rates

Bank of Canada (BoC) Governor Mark Carney used an appearance at the House of Commons finance committee to re-stress the central bank’s recent message that rates could have to go up despite global economic uncertainty.

The BoC, which has kept rates at a near-record low of 1% since September 2010, started mentioning last week that a rate increase might be needed because of a stronger economy and underlying inflationary pressures.

More intriguingly, Carney touched base on the real threat lying underneath the surface in Canada.  He stressed Canadians cannot keep borrowing so heavily against the value of their homes.

He said financial authorities were looking closely at levels of household debt and ways to contain the problem.

He also made it clear that too tight a clampdown could hurt economic growth.

So what is to be done?

“Authorities — the bank, the superintendent, CMHC, Government of Canada — are cooperating closely and monitoring the situation … there had been a number of measures that had been taken both by the superintendent, by the government. We have a heightened vigilance with the underwriting practices of the banks. So on a supply side there are a variety of measures that have been taken and are resulting in a slowing of the accumulation. There’s always more that could potentially be done. But these measures, there has to be an element of prudence in balancing the pace of slowing of this phenomena with the underlying growth of the economy.”

Many will howl in protest that Carney is being too slow to turn the taps off.

He knows the damage that is going to be caused and he is trying to cushion it as best he can.

But can you really engineer a soft landing?

I guess we're going to find out.

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Wed Post #1: Frontline - Money, Power and Wall Street, Part 1

Watch Money, Power and Wall Street: Part One on PBS. See more from FRONTLINE.

Episode One: Derivatives Spark a Credit Boom and the Mispricing of Risk.

A MUST watch Frontline special explaining the role of derivatives. Faithful readers will recall that Warren Buffet has called these derivatives "financial weapons of mass destruction."

Episode Two will be posted tomorrow.

Here is a summary of what this is about:

In 1994, a team of young, 20-something JPMorgan bankers on a retreat in Boca Raton, Fla. dreamed up the “credit default swap” — a complicated derivative they hoped would help manage risk and stabilize the financial system. Fourteen years later, they watched in horror as that global system — weighed down by the risk of credit default swaps tied to morgtage loans — collapsed.

The ensuing saga between that pivotal retreat and the start of the 2008 global financial crisis are “defined by daunting complexity,” writes Greg Evans in Bloomberg Businessweek today. But the first two hours of Money, Power and Wall Street, he adds, does an “exemplary job of walking viewers through [it].”

FRONTLINE’s four-hour epic on the global financial crisis goes inside the struggles to rescue and repair a shattered economy, exploring key decisions, missed opportunities and the unprecedented and uneasy partnership between government leaders and titans of finance.

“Money, Power and Wall Street is demanding — this isn’t Finance for Dummies,” Evans writes in the review. “But it’s a compact and thorough lesson.”

In the first hour, FRONTLINE takes you inside the rapid rise of credit default swaps, including the voices of those who created them. With the real estate market booming, bankers successfully tweaked the credit default swap to bundle up and sell home mortgage loans to eager investors. But despite the money flowing into banks’ coffers, credit default swaps also loaded the financial system with lethal risk. And when the housing bubble burst, the credit default swaps — originally designed to stabilize the system — brought the global economy to its knees. Regulators, who had often stood on the sideline and allowed Wall Street to police itself, saw the ugly consequences rapidly unfold before them.

In the second hour, FRONTLINE investigates the largest government bailout in U.S. history, a series of decisions that rewrote the rules of government and fueled a debate that would alter the country’s political landscape. It offers play-by-play accounts of several secret meetings that permanently altered the financial system.

“The program feels fresh and vivid — and takes no prisoners,” writes Evans. “FRONTLINE finds plenty of blame to go around (Goldman Sachs and CEO Lloyd Blankfein take a particular bruising), but is most devastating in its dissection of the chummy collusion between bankers and the government leaders who should have been watch-dogging them.”

As mentioned above, we will have Episode Two posted here tomorrow.

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Tues Post #2: Richmond continues to struggle - but not according to the mainstream media

Was it only January 2011 when we were comparing the red hot real estate market in the Vancouver suburb of Richmond to Holland's historic Tulip Mania?

Then came the Tsunami in Japan and as we predicted, Richmond was about to undergo a massive Paradigm shift.

Richmond has gone from a sellers market to a market where inventory is building up in a massive way.

In fact it was that growing inventory that prompted one seller we profiled to accept an offer almost $1 million lower than his asking price (an amount which was 40% less than that original asking price) in order to sell in that stagnating market.

And make no mistake, Richmond is stagnating.

As VREAA noted two days ago,  Richmond inventory has hit all time highs. Richmond detached home inventory is now over 1,021 homes available for sale.

It's been a deadly combination... increasing inventory and sales which have continued to tank month after month.

According to Richmond Realtor James Wong, the total number of homes sold in March, 2012 came in at a paltry 309 units, a drop of 5% from the total number of sales in February (324).

The total number of detached homes, townhomes and condos/apartments listed for sale at the end of the month totaled 2,330 units, an increase of 11% from February's total inventory of 2,100.

Wong pointed out the silver lining when he noted that the supply of homes in Richmond at the end of March resulted in an Months of Inventory total of 8.24 months, a slight decrease compared with the previous months figure at 8.82 months of inventory.

But the problem is that the overall supply of detached homes, townhomes and condos increased those listings overwhelmed the increase in sales.

And while Wong tries to spin the positive on the news at the end of his report, bear blog followers pass on a different story entirely.

VMD tells us:

“There are more and more people over at the Chinese [internet] forums reporting price drops in their neighborhoods (be it Richmond condos or Coquitlam SFHs). More people are voicing their skepticism that Vancouver RE market will continue to go up. Many already accept the view that Van RE price will decline at least a couple % this year.

People are noticing the glut of thousands of upcoming Richmond condo units, and are advising against buying at this time. A few people are saying their close/trustworthy Chinese Realtor friends are saying the RE market isn’t looking good; however the other Realtors (whom they’re not close to) are still trying to paint a rosy picture.

Sentiment is changing, even among the HAM.”

Of course don't let all these 'facts' get in the way of believing in the future of the real estate in Richmond.

And naturally it's the Vancouver Sun who leads the cheerleading charge.

Recently the Sun provided us with 24 Reasons Why Richmond Real Estate is Booming.

Booming?

You simply can't make this stuff up.

So here, for your entertainment purposes, are the Vancouver Sun's top 24 reasons Richmond real estate is 'booming':

1. ASIAN INVESTMENT: With a mountain of money trying to get out of Hong Kong and china in expectation of economic collapse, the stability of Richmond real estate has drawn many investors to purchase property sight unseen. Reports of tour buses being taken from property to property, and strangers offering briefcases filled with money at the door are no longer uncommon.
2. SPORTS FACILITIES: Richmond has invested in all-weather sports facilities at a variety of local parks, as well as the much-hyped Richmond Olympic Oval, which hosts a wide array of sporting events, both amateur and professional.
3. SALMON: If you like fresh salmon, being able to walk down to the fishing boats and buy it fresh out of the water is a big plus.
4. BEDROOM COMMUNITIES: While Richmond has a reputation as an Asia-centric area, there are a growing number of communities that are entities all to themselves. The cultural contrast between Richmond Centre and Steveston couldn't be any starker, #5 Road's 'highway to heaven' presents a community of different communities, there are Ukrainian enclaves, Asian suburbs, spillover New West suburbs, and a growing number of young urban professionals around the Canada Line. The River Green development by the Olympic Village will be a small city of its own when it's completed.
5. SUMMER FUN: On summer weekends, thousands of people invade Richmond to take part in events, amateur sports, walk the docks and buy fresh fish.
6. FOOD SECURITY: Richmond is the last place in Metro Vancouver where food is locally grown in commercial quantities.
7. PLENTY OF DEVELOPMENT: Richmond's city council has a reputation for being developer-friendly, recently having allowed the construction of B.C.'s first wood-constructed six storey apartment building, which was consumed by fire before it could be completed.
8. THE DAILY MASSEY TUNNEL JAM: While home prices in nearby areas such as Ladner and Delta are comparably inexpensive, the dependence of commuters on having to make it through the Massey Tunnel during peak hour is a big turn-off for many.
9. THRIVING ARTS SCENE: From the often-photographed derelict houseboats of Finn Slough to the gigantic heads on display at Lansdowne Centre as part of the recent Biennale, to movies on the beach at Gary Point, to packed houses at the Gateway Theatrem Richmond has formed a growing local arts scene that fees the cultural needs of locals and immigrants alike.
10. GEOGRAPHY: The simple fact of it is that nobody is producing new land in the city of Vancouver. The only way to build is up, which means there's a high spillover into areas like Richmond. With Surrey and Burnaby still fighting the stigma of being seen as working class cities, Richmond's increasingly big money has helped it shed the tag of an immigrant town.
11. FOOD! Lovers of fine food have a lot of munchie options in Richmond, from some of the best Chinese restaurants in the world to hip new modern eateries.
12. LOW PETTY CRIME/HOMELESS RATES: While there's certainly crime and homelessness in Richmond, the numbers are far lower than elsewhere in Metro Vancouver, especially downtown.
13. THE CANADA LINE: A new Skytrain line directly into the heart of Richmond has spearheaded much of the recent development in the city, giving commuters a way into downtown Vancouver in 25 minutes while residents of Coquitlam, Langley and Delta find themselves often fighting bottlenecked traffic.
14. PARKS AND TRAILS: Walking the dyke is a regular go-to outdoor activity for Richmondites, but with Richmond Nature Park, Garry Point, and Terra Nova as places to go to get away from it all, it's easy to get intentionally lost in nature south of the airport.
15. CLIMATE: While Richmond gets as cold as anywhere else in Metro Vancouver during the winter, it generally receives less snowfall, less rain, and much less smog than other parts of town, due to the jet stream coming directly off the water, rather than over the Lions.
16. ABUNDANCE OF TEAR-ME-DOWNS: There are plenty of homes in Richmond that were built on the cheap in the last forty years, with no architectural appeal and large lots. These can usually be easily demolished and turned into townhomes or large modern family homes with little local protest, whereas similar development in Vancouver can be frought with bureacratic impediments.
17. OLYMPIC EXPOSURE: Having Richmond shown to hundreds of millions of people around the world during the recent Winter Games has given the city no end of interest from companies and immigrants looking to move somewhere new.
18. OPEN SPACE: Though much of it is listed under the ALR, Richmond has no shortage of open space that can be (and often is) turned into developed land. The infamous Fantasy Gardens was recently bulldozed to make way for a new development at Ironwood, which is one of Richmond's thriving new communities.
19. AVAILABILITY OF PURCHASE OPTIONS: Recent development in Richmond has vastly increased the real estate inventory available to prospective buyers, with waterfront views and modern facilities being a big draw.
20. COMMUNITY EVENTS: Weekend festivals such as the Ship To Shore tall ships event give locals a regular diet of things to do that cost little or no money. The annual Children's Festival, regular musical events and summer outdoor movies add to the fun.

Now keen observers will note this is only 20 reasons from a list that was supposed to provide 24.

Where are #'s 21, 22, 23, and 24?

Unfortunately if you follow the link above and click your way through the '24' reasons, you will discover that there are only 20 listed.

Presumably the last four are a take on the Location, Location, Location mantra.

In this case it would be... Gullible, Gullible, Gullible Gullible. Because that's the only way to describe the mindset that believes these factors off set the reality that is occurring in Richmond.

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Tues Post #1: Vancouver Price Drop

Interesting new site on the Vancouver real estate blogosphere scene you might want to check out.

Vancouver Price Drop has been put together by a keen Lower Mainland Real Estate observer who has been diligently charting listings and price changes and has now taken to posting some of the larger price drops on this new site.

The first 'weekly drop', as it is titled, is now available with 10 properties profiled.

Examples include the above pictured home at 1406 W 40TH AV, Shaughnessy, Vancouver West. The realtor description says:

Fantastic 58×145 oversized south-facing corner lot with magnificent 1925 Georgian home! Don’t miss viewing this masterpiece – over 3200 sq.ft. of living area on 3 levels with 4 bedrooms, 4 bathrooms, and flooded with natural light from south and east. Perfect home for entertaining with giant family deck through French doors, pool, and lots of yard space to play in. This truly is the perfect family home. This character home was built with first-growth timber and is warm and friendly to live in. Recent upgrades include new roof (2008), exterior paint (2010), bathrooms (2009), French doors (2006), etc

The property has seen two price drops in the last two weeks (the first slashed $719,000 off the asking price, the second a further $200,000) for a total of 26% off the original asking price.

It will be interesting to check back as the weeks and months move on.

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Meanwhile... in Australia

Yesterday we talked about articles being published in New Zealand about their belief for trouble ahead for the Canadian Housing Bubble.

Meanwhile, over in OZ, comes another sign the Australian housing bubble is in serious trouble.

Insurance company Genworth Financial pulled the IPO of its Australian unit, sending its shares plunging by over 20% and its default risk soaring.

The IPO, which was supposed to take public up to 40% of the company's Australian mortgage business, and has instead been delayed to 2013 after “elevated” losses this year.

Said Bloomberg:

"the company cited deteriorating market conditions in the Aussie mortgage market. Specifically, the company noted elevated loss experience in Australia as lenders accelerated the processing of later-stage delinquencies from prior years through to foreclosure and claim at a higher rate and severity than expected, particularly in coastal areas of Queensland that experienced natural catastrophes and regional economic slowdowns and among certain groups of small business owners and self-employed borrowers.”

Like Vancouver, Australia has been leaning hard on Asian buyers from China to support it's bubble.  And just like Vancouver, the country is suffering as investment from China evaporates as excess funds for investments disappear as China executes it's own soft/hard landing in real estate.

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A New Zealand take on the Canadian Real Estate bubble

Neville Bennett taught economic history for many years at the University of Canterbury in New Zealand and is currently a Director of the New Zealand financial company, Socrates Investments.

In an opinion column for interest.co.nz, Bennet joins the growing international chorus who can see what most Canadians cannot; the precarious situation Canadian Real Estate is in.

Here is what Bennet has to say:

I am reminded of the NZ stock market bubble in 1987 when people crowded to watch the chalkies in Christchurch and everyone was in share clubs. The market led the TV news at night. Canadians are desperate to get into the market and subprime mortgages are a strong sales component.

Canada has weakened lending criteria too much. Private debt is huge in NZ and Canada (about 150% of GDP). Private debt also lowers consumption and deepens recessions.

Canadian real estate has surged in sympathy with other markets and a regime of low interest rates.

But a central driver is Canada Mortgage and Housing Corp (CMHC).

It is a huge, crown corporation fully backed by the Government. Until 1999 it had quite tough requirements, including a 10% deposit. Since then it has insured mortgages without limit, without deposits, with amortization of 40 years and the possibility of paying interest only for the first ten years.

Naturally CMHC’s balance sheet ballooned. Mortgages insured went from C$200 billion to $515 in the decade: 80% of the mortgage insurance market. MBS (mortgage-backed securities) went from $40 billion to $326 billion (more later).

This ought to give taxpayers the shudders as CMHC has an exposure of $840 bln or the equivalent of 145% of Canada’s public debt.

CMHC seems to be highly geared: it had only $11 bln of assets in 2000, and most of its assets now are MBS insured by itself. It seems as leveraged as Fannie Mae which had US$2.3 trillion in guarantees backed by a mere $44 bln in assets as it folded. CMHC is very vulnerable to a small fall in house prices.

Consumer confidence rises when house prices rise. Consumers borrow to expand their spending. In less than 10 years, consumer spending has risen from 58% to 65% of Canadian GDP.

In 2011 homes became ATM’s, and the average homeowner had only 34% equity in their home, a fall from 55% only 4 years ago. Meanwhile, Canadians owed $1.53 for every dollar they brought home. Canadians have pulled $220 bln out of their homes in revolving home equity lines of credit (HELOCs): on a per capita basis, this is about three times as much as the Americans borrowed at the peak of their boom.

Vancouver is being driven partly by massive buying from Chinese investors and residents.

I have not been able to quantify this, but my guess is that Chinese buying is very significant on the margin, especially for expensive properties in western suburbs where the median price is C$2 million.

Vancouver is the world’s second most unaffordable city (after Hong Kong). It's median price in 2010 was C$602,000 which is 9.5 times the median household income of C$63,100. It is a very stressed market at present.

Toronto is also a crazy market, especially as condominiums are being constructed in vast numbers. Buyers rush to every listing and gazump each other.

There is concern about a correction.

Sales fell in January and foreclosures increased tenfold.

National prices have been flat for a year. Houses now cost about 5-years income rather than the traditional 3 years. In Vancouver it is 9.5-years’ income but consumers are sorely tempted when banks offer five year loans at 2.99%.

The Bank of Canada is worried but it has kept interest rates low because American rates are low and if Canada raises them it would provoke a major rise in the Loonie (Canadian Dollar) which would murder exports and manufacturing. But some action by the Bank seems necessary to deflate the bubble and also rein in inflation which is running at 3%. Another problem is an estimate that a 2% rise in interest rates would mean that 10% of Canadians would be spending 40% of their income on debt servicing.

CDO again.

Mortgage-holders are especially vulnerable because the public have been advised by pundits to go to variable rates. 500,000 switched last year. Variable rates are now 40% of the market. This rate is linked to the Bank of Canada’s overnight rate, which could increase sharply with tremendous knock-on effects for householders.

The financial system could be affected by covered bonds. Like their American cousins, Canadian banks have been bundling portfolios of low-risk mortgages into covered bonds. This started in 2007 when $2 bln were issued but it is now a $50 bln business. Thinking of US CDOs, I wonder how good the Canadian covered bonds would be if houses corrected by 20% (which many predict).

What amazes me is the growth of subprime. True they call these mortgages “alternative” or “non-prime”, not “subprime” but the weakness is identical.

CMHC has started to refuse to insure mortgages without a small deposit, and banks will not issue mortgages to anything not insured by CMHC. Banks are rumoured to be rejecting 20% of applications because of lack of CMHC insurance.

This has created a market opportunity for the enterprising. Home Capital Group, Equitable Group and Councel Corp, according to CBC, have stepped in to lend to people unable to get CMHC insurance. They charge 6% rather than 3%. CBC reported the subprime market is worth $85 bln, almost 10% of the market. The President of Home Capital estimates than non-prime are worth $200 billion or 20% of the market. Significantly, as happens in the crescendo of bubbles, about 50% of new mortgages are now subprime.

The low interest environment is an inducement to subprime activity.

Many people are not worried that a falling market would create a systemic financial risk because the taxpayer has not insured subprimes. I think this is short-sighted.

Any market fall would shake out the most vulnerable first, which would bring a flood of property onto the market and create a near panic and deep losses. A recent study by the Bank of Montreal found that 4 out of 10 borrowers stated they could not repay their loan if interest rates rose slightly.

Canadian investment in residential investment is now just over 7% of GDP: every time in history when this level is reached there is a crash within 2-3 years.

Professor Shiller of Yale who predicted that 1987 crash and the 2006 US property crash says Canada is “due for a US-style drop”.

Of course everyone says a 'US-style drop' simply can't happen here.

And they are right... it's going to be worse.

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Popping the bubble

Yesterday's available inventory for sale in Vancouver crested 17,000.

As one contributor to the comments section noted:

To be fair, inventory always expands in the first 4-6 months of the year and then subsides in the later half. The real story is the fact that there has never been this much inventory at this time of year, and the pace of expansion has been startling compared to other annual cycles.

rp1 then noted:

It normally takes multiple years of inventory accumulation to equal a bust. This year it started high and went higher. When a downturn comes, that will happen year after year. Whether or not the price declines really depends on the MOI.

In the late 1990's people bought even though the price was falling because costs were low compared to rent. People are doing the same in the US today. But it also depends on how many people have money during the bust. Many people have already bought, and many incomes are tied to the real estate industry. This obviously makes a bust much worse.

Does anyone know what the all time high for inventory in Vancouver was? What the all time high for MOI (month of inventory) was?

What do you think it will take for sellers to begin lowering their prices?

Post in the comments section or via email... I would love to hear your thoughts.

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Thurs Post #2: Vancouver Inventory hits 17,000 mark

After starting the year at 10,671 listings, total Vancouver inventory crossed the 17,000 threshold today.

Inventory is up almost 70% since the start of the year.

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Thurs Post #1: The Unfinished Fight of Johnny Canuck

Reprieve, reprieve... curfew shall not ring tonight.

As the local hockey team avoids elimination with their first victory of the 2012 playoffs last night, we bring you this Johnny Canuck video.

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Wed Post #2: Canucks vs Kings - Game 4

Tonight the Vancouver Canucks will play Game 4 of their first round NHL playoff series against the Los Angeles Kings.

Vancouver fans have viewed these playoffs as a chance at redemption for last year's disappointing loss in Game 7 of the Stanley Cup final.

Unfortunately after three consecutive losses, the Canucks (President Trophy winners as the best team in the regular season for the second consecutive season) are on the verge of elimination.

Rather than imbued with the spirit of the Canucks propaganda (see above video shown at Game 1 and 2 in Vancouver's Rogers Arena), most Canuck fans were severely disheartened after the team's loss on Sunday (the 100 Anniversary of the Titanic disaster).

That sinking feeling had Canucks fans redesigning the team logo...

The team has outplayed the Kings in each of the first 3 games.

If any series was ripe for a 0-3 comeback, it would be this one.

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Wed Post #1: Details Of The $291 Trillion In Derivatives To Which American Taxpayers Are Exposed

The following article was posted on Seeking Alpha and is reproduced here.

Investors buy derivatives for one of two purposes: either they're speculating about the performance of the market in the future, or they're hedging against the possibility of a loss. The way in which you intend to use derivatives influences your derivative investment strategy.

If you're hedging, you'd buy derivatives as a kind of insurance policy. By having derivatives in place for a nominal fee, you can be certain of buying or selling at a certain price, and you don't have to worry as much about fluctuations in the market. Many corporations use derivatives to hedge against fluctuations in interest rates, foreign-currency exchange or the cost of raw materials.

Speculation is a different side of dealing in derivatives. Investors who engage in derivative speculation have no real interest in the underlying commodities, but instead are trying to predict the behavior of the stock market to make a profit. Unfortunately, derivatives can be manipulated in ways that make speculation dangerous to the economy. The government has some regulations in place to protect against speculative manipulation of the market, such as prohibitions against naked short selling, but it can still be a dangerous practice for the economy.

Recall that Warren Buffet once famously called derivatives "financial weapons of mass destruction" and the sovereign debt problem risks detonating these time bombs.

How big is America's exposure to these "weapons of mass destruction"?

Here is what Seeking Alpha had to say...

Details Of The $291 Trillion In Derivatives To Which American Taxpayers Are Exposed

The entire US GDP is less than $15 trillion each year. The gross notional amount of derivatives issued in the USA is more than $291 trillion. Does that sound like a lot? Apologists for derivatives dealers don't like it when we talk about derivatives in terms of the notional totals. Large numbers, like these, discussed publicly, frighten too many people. According to the apologists, gross "notional" is misleading, because it does not include "hedges," offsets and the limits on interest rate risk.

In fact, the total amount of derivatives cannot be accurately presented in any other form but gross notional obligations. The risk to society cannot be judged in any other way. That's why the FDIC, US Comptroller of the Currency and the Bank for International Settlement (BIS) all use gross notional.

Final net obligations can only be determined when and if derivatives are triggered. The net can be significantly lower, but neither we, nor the banks themselves actually know exactly what that is. It depends upon the balance sheets of every counter-party, and the extent to which interest rates will change in the future. Not even the banks have full information about either topic..

There is another number called the "net current credit exposure" (NCCE) that some erroneously claim represents the risk imposed by derivatives. According to the Office of the Comptroller of the Currency (OCC), the NCCE for American bank derivatives amounts to about $370 billion. That's a huge amount of money, but it's not $291 trillion.

Unfortunately, NCCE provides no information about ultimate exposure to loss. It merely measures the net cost of unwinding the contracts, before the occurrence of any trigger event. NCCE is the current market value of the contracts, and nothing more.

There are also a number of "value at risk" calculations that the banks provide. These are not standardized, and are based upon vastly different models and assumptions, from bank to bank. Unfortunately, a very high level of inconsistency and lack of any standards for measurement causes such models to be highly unreliable. For example, during the 2008 credit crisis, similar proprietary models used to determine subprime credit risk failed, in the infinitely smaller subprime mortgage market.

In reality, it is impossible to know the true risk of $291 trillion in New York issued derivatives (ignoring the additional $417 trillion issued out of London). A sudden very large increase in interest rates, alone, could trigger trillions of dollars in payments. One could argue that the Federal Reserve could force interest rates down at any time, but that is not entirely true.

If the US dollar came under heavy selling pressure, for an extended period of time, as has happened to the British pound, Chinese yuan, Japanese yen, German mark, Austrian shilling, Argentine peso, and a host of other currencies in the course of history, the Fed would be able to defend the dollar only at the risk of inducing widespread systemic failure.

That is why interest rates cannot rise for many years, regardless of whether that destroys its status as the world's reserve currency, and/or creates extreme levels of inflation or hyperinflation. It is also one more reason for the government to lie about the true inflation rate, to avoid pressure to raise interest rates (see shadowstats.com.)

All the too-big-to-fail (TBTF) banks, with the exception of Morgan Stanley (which uses its SIPC-insured division) are using FDIC-insured depository divisions to house derivatives. That provides them with lower collateral requirements because FDIC depositary units usually have higher credit ratings than investment banks and/or bank holding companies. It also means that, ultimately, the American people will pay for losses.

While no one can determine the exact exposure, it is safe to say is that the risk is astronomical, and imposes a grave risk upon American taxpayers. It is not surprising that FDIC staff is not thrilled with US bank derivative exposures. In fact, Sheila Bair, who until recently ran the FDIC, is as disgusted with the Federal Reserve slush fund and the banking cartel as you and I. A few days ago, she penned a satirical article heavily critical of Fed policy and published it in the Washington Post.

The FDIC staff doesn't like the fact that the Federal Reserve keeps allowing banks to put their derivatives inside insured depositary institutions. This is mostly for the same reason the banks want to put them there. Insolvency laws provides priority to derivatives counter-parties over the FDIC. If and when a bank is liquidated, the FDIC will be on the hook to repay depositors, but the failing bank will be stripped of all assets.

The US government's full faith and credit guaranty means massive amounts of new US Treasuries will need to be sold, massive numbers of new counterfeit dollars will need to be printed under color of law, and significant tax hikes will need to be levied to pay the bill.

FDIC opposition, however, has had little to no effect on keeping derivatives out of insured units. The Federal Reserve, and not the FDIC, has the authority to approve the practice and it keeps doing so. The FDIC staff can complain privately, and issue regulations forcing disclosures, but little more. But, because of the disclosure requirements, more detailed information than ever is now available concerning derivatives.

In fact, FDIC has made far more information about derivatives public, over the last 3 years, than the Fed and OCC ever disclosed over decades. The numbers reveal a frightening concentration of risk. Five large "TBTF" US banks hold 96% of derivatives issued in the United States.

But the Bank for International Settlements in Switzerland reports that about $707.6 trillion worth of derivative obligations have been issued worldwide as of the end of 2011. That leaves about $417 trillion worth of derivatives that are not accounted for, in the FDIC records.

The surplus derivatives have been written mostly in London. Part of the exposure is held on the balance sheets of foreign, mostly European banks, including Deutsche Bank, PNB Paribas, Credit Suisse, UBS et. al. But, a large number of seemingly foreign derivatives is also hidden inside bank divisions, owned by American institutions, who do business in London. Such derivatives are not reported to the Fed, the OCC or the FDIC. Lenient British banking laws insure that these opaque obligations are not subject to public scrutiny.

Ultimately, if London-issued derivatives eventually cause massive losses to a UK bank division, the US based bank that owns it would end up being closed or bailed out. Ultimately, just like the derivatives issued in New York, the American taxpayer and dollar-denominated saver will pay the bill. Unfortunately, in spite of this, details about London-issued derivatives are not publicly disclosed or I cannot find them. If such data exists, a British lawyer or someone knowledgeable enough about UK regulations and bureaucracy would be needed to ferret it out.

Even in the absence of London data, however, investors should find this incomplete article enlightening. It is useful to obtain a general picture of the risk of investing in shares of the five big derivatives dealers. Here's how the dollar amounts break down, as of December 31, 2011 in thousands of dollars.

JPMorgan Chase (JPM)

Description		Amount
	Total Derivatives	70,268,515,451
	Notional amount of credit derivatives:	5,775,740,000
	Bank is guarantor	2,920,886,000
	Bank is beneficiary	2,854,854,000
	Interest rate contracts	53,708,319,000
	Notional value of interest rate swaps	38,805,453,000
	Futures and forward contracts	7,033,041,000
	Written option contracts	3,841,178,000
	Purchased option contracts	4,028,647,000
	Foreign exchange rate contracts	8,799,397,451
	Notional value of exchange swaps	2,934,191,451
	Commitments to purchase foreign currencies & U.S. Dollar exchange	4,521,035,000
	Spot foreign exchange rate contracts	116,741,000
	Written option contracts	674,276,000
	Purchased option contracts	669,895,000
	Contracts on other commodities and equities	1,985,059,000
	Notional value of swaps	453,521,000
	Futures and forward contracts	137,101,000
	Written option contracts	746,259,000
	Purchased option contracts	648,178,000

Bank of America (BAC)

It should be pointed out that BAC has recently moved a nominal value of about $22 trillion worth of derivatives from Merrill Lynch, into its FDIC insured division. This does not appear to be showing up, yet, in these numbers. The total for BAC's FDIC insured division is now closer to $72 trillion.

Derivatives	50,407,550,785
Notional amount of credit derivatives:	4,720,320,266
Bank is guarantor	2,342,544,257
Bank is beneficiary	2,377,776,009
Interest rate contracts	40,832,704,946
Notional value of interest rate swaps	29,707,570,138
Futures and forward contracts	8,203,345,962
Written option contracts	1,430,677,395
Purchased option contracts	1,491,111,451
Foreign exchange rate contracts	4,676,887,004
Notional value of exchange swaps	1,425,870,031
Commitments to purchase foreign currencies & U.S. Dollar exchange	2,839,430,866
Spot foreign exchange rate contracts	254,990,960
Written option contracts	204,427,019
Purchased option contracts	207,159,088
Contracts on other commodities and equities	177,638,569
Notional value of swaps	76,992,166
Futures and forward contracts	343,077
Written option contracts	44,438,807
Purchased option contracts	55,864,519

Citigroup (C)

Derivatives	52,620,696,000
Notional amount of credit derivatives:	2,975,096,000
Bank is guarantor	1,439,748,000
Bank is beneficiary	1,535,348,000
Interest rate contracts	42,568,376,000
Notional value of interest rate swaps	31,525,209,000
Futures and forward contracts	3,279,189,000
Written option contracts	3,842,701,000
Purchased option contracts	3,921,277,000
Foreign exchange rate contracts	6,488,019,000
Notional value of exchange swaps	1,349,909,000
Commitments to purchase foreign currencies & U.S. Dollar exchange	3,910,599,000
Spot foreign exchange rate contracts	518,436,000
Written option contracts	601,793,000
Purchased option contracts	625,718,000
Contracts on other commodities and equities	589,205,000
Notional value of swaps	116,124,000
Futures and forward contracts	36,180,000
Written option contracts	215,205,000
Purchased option contracts	221,696,000

Goldman Sachs (GS)

Derivatives	44,195,386,000
Notional amount of credit derivatives:	499,741,000
Bank is guarantor	203,723,000
Bank is beneficiary	296,018,000
Interest rate contracts	41,737,737,000
Notional value of interest rate swaps	29,901,018,000
Futures and forward contracts	4,361,219,000
Written option contracts	3,553,371,000
Purchased option contracts	3,922,129,000
Foreign exchange rate contracts	1,945,805,000
Notional value of exchange swaps	1,623,260,000
Commitments to purchase foreign currencies & U.S. Dollar exchange	134,300,000
Spot foreign exchange rate contracts	2,912,000
Written option contracts	89,612,000
Purchased option contracts	98,633,000
Contracts on other commodities and equities	12,103,000
Notional value of swaps	11,885,000
Futures and forward contracts	0
Written option contracts	111,000
Purchased option contracts	107,000

Morgan Stanley (MS)

According to the US Comptroller of the Currency, the Morgan Stanley holding company has about $52 trillion worth of derivatives obligations, but only $1.7 trillion show up in the detailed FDIC statistics. It is not worth listing that small fraction as it would give an incomplete and misleading picture. Unlike other banks, MS is storing most of its derivatives in its SIPC insured investment bank, rather than its FDIC insured commercial banking division.

The reason it is doing that are unclear. Unlike the FDIC, which opposed the addition of $22 trillion in Merrill Lynch obligations to FDIC insured Bank of America's balance sheet, diligent search indicates that the SIPC does not bother keeping track of derivatives. If we did have details on the MS derivatives, the company would rank number 3, slightly above Citigroup.

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