Friday, October 19, 2012

Will the Real Estate market recover like it did in 2009?


Last night I was having a discussion with a co-worker about the current real estate market downturn.

He wanted my opinion on whether or not we might see a market rebound like we saw in 2009? Naturally I told him I don't believe the market will rebound this time.  

I took him through the logic.

Between August 2008 and March 2009, the average home price fell by 8.5% according to the Teranet-National Bank House Price Index. The decline was sparked by the 2008 financial crisis. But by November 2009, the market had already recovered.

What allowed things to recover?

A large part of the reason for the quick rebound was massive government intervention.

The Bank of Canada moved fast to slash interest rates to unprecedented lows, allowing banks to continue lending to businesses and consumers.

The federal government established a $125-billion program to buy mortgages it had already insured from banks and financial institutions, providing even more liquidity. Ultimately the Fed's bought mortgages worth a stunning $69.4 billion.

The Bank of Canada and the Federal Government did this because they were gambling that what was happening was your garden variety severe recession.

Normally these recessions last 3-5 years.

But this isn't a normal recession.  We still do not fully appreciate the breadth and depth of what is going on. What we are experiencing is a one-in a multigenerational crisis, one that will probably last up to 15 years.

The Federal Government and the Bank of Canada have started to recognize this.  Mark Carney has sounded warnings and alarms so often over the past year that some have begun to tune him out as you would the infamous little boy who alway cried wolf.

But the time has come for more than just warnings. And the government is scrambling to de-engineer what they started.

Demographia, an urban planning research firm and consultancy in the U.S., argues that prices become unaffordable when they exceed three times income. Canadians seized on the government intervention from 2008 and have managed to increase the country’s household debt to personal disposable income ratio to a record high of 163%.

Carney and Flaherty know this cannot continue.  The economy is not about to recover adequately anytime soon which means incomes cannot rise to deal with the record high debt.

And that debt is of massive concern.  Because of that concern, there will be no intervention by the federal government this time around.

So what will happen?

First off, you have to understand house prices are at the level they are because of government policy - not because they are 'worth' these values.

The housing market in a precarious position: we have a massive gap between prices and incomes, worsening affordability, and an indebted nation of homeowners unable to withstand economic shocks.

The federal government has no choice but to continue undoing  the mortgage changes that facilitated the boom. To avoid it would be extremely irresponsible... and they won't change course.

Most Canadians simply do not appreciate just how artificial our housing boom is and what this change in thinking by the government means for house values.

This is a boom that has been created by the artificial stimulus of excess credit. And the altering of the access to that artificial stimulus is going to have profound effects.

Consider how we got here:
  • Prior to 1999 you needed 10% for a mortgage and that mortgage had a maximum amortization of 25 years.  CMHC also had limits on how much you could buy with their insurance.
  • CMHC then lowered the down payment to 5% down with price limits depending on the area. Amortizations were 25 years. There would be no price limit on what they would insure if 10% or more was put down.
  • By Sept. 2003 CMHC allowed 5% down on 25 yr amortizations but they removed all price ceiling limitations. Now any mortgage would be insured regardless of the value of home purchased. 
  • March 2004 CMHC began allowing Flex-Down products which permitted the 5% down to be borrowed and 1.5% closing costs to be borrowed (essentially zero down, but 95% insured.
  • March 2006 you had  0% down, 30 yr amortizations. This became 0% down, 35 yr amortizations later in the year.  Interest only payments were allowed for 10 years.
  • November 2006 CMHC began allowing 0% down, 40 yr amortizations along with interest only payments for 10 years. 
  • Canadian banks ramped this up by allowing up to 7% cash back offers is you would take on a mortgage with them.  You could basically get paid if you bought a house.
All of these were exacerbated by the emergency actions taken during the financial crisis.

As we mentioned earlier, the Bank of Canada moved fast to slash interest rates to unprecedented lows, allowing banks to continue lending to businesses and consumers. The federal government established a $125-billion program to buy mortgages it had already insured from banks and financial institutions, providing even more liquidity. Ultimately the Fed's bought mortgages worth a stunning $69.4 billion.

CMHC had their lending cap increased.  CMHC went from $100 Billion in insured mortgages in 2006 to $600 Billion in 2012.

We have reached the upper limits on how current incomes can be levered into higher and higher debt loads. Worse... the limits are being reversed denying many access to the ability to take on those upper level debt loads.

More significantly... there is less room to manoeuvre on other policy tools.

The overnight rate is now 1% compared to 3% in August 2008. Cutting rates to stimulate the market is hardly an option. Banks have less flexibility, too. A five-year fixed rate mortgage is roughly 3.8% today, down from 5.7% in late 2008.

Finally the argument that that foreign investors, predominantly wealthy Chinese citizens, are buying property here because Canada is a safe haven in a turbulent global economy and that this will defend the strength of the housing market is being shown not to be the salvation many once thought it was.

The credit spigot that has allowed so many Canadians to buy homes at boom levels is being turned off. 

Sales activity has slowed down and prices responded by initially plateauing and now they are beginning to fall.

There will be no intervention this time around.  This isn't 2008/2009 all over again.

The fact of the matter is that all booms created by excess credit go bust. Ours is a classic excess credit boom.


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  1. Spot on Whisperer. We are in far more trouble than almost anyone knows and there is little salvation that lies ahead other than periodic fiscal interventions that will only further impair our domestic balance sheet. I am not just doubtful that the Conservative pledge to eliminate the deficit is now impossible, I am certain beyond doubt Federal debt will begin to march higher for many years to come. We all need to come to grips with that idea because what it really means to the average person is that taxes will need to rise or that some program funding will be cut further. And yet little room exists there as large cuts have already been implemented on the spending side while it seems we are locked into political promises to hold down both the GST and Corporate tax rates. The only outcome is that deficits will rise along with unemployment and demands from the provinces for greater transfers to paper over the holes in their own regional budgets. This is going to be a stressful time for the government as our own home-grown recession slowly evolves and many years could pass before we come back into balance.


    1. Hi Farmer, Craig Sterling here. As always, you are on the money. Interesting (for me) to see that the Canada situation appears still to be a slow-motion drop compared to UK/US... even the estimable Garth Turner thinks there will be a melt, rather than a crash, in Canadian RE... to me, that suggests a lot of the smarter speculators will get out relatively unscathed, leaving the chumps who bought in 9/10 and can't just sell to suffer the most...

    2. No doubt Craig. We don't often use the term "underwater" when we talk about Canadian real estate but that is indeed what we are already beginning to see in some markets as those who bought with low down payments in the past two years find themselves in negative equity. They are the bag holders already and the crew that was caught up in the euphoria of rising prices who wilfully ignored the warnings of acquiring excessive debt during a time of easy credit.

      There is continuing concern at higher levels as well and now Mr Carney is warning that uncertainty and a lack of confidence are themselves posing a risk to growth. Just the belief that conditions will deteriorate for Canadians is enough to reinforce a negative feedback loop in the business community that can lead to a slowdown. I agree, yet we cannot ignore the signs we are seeing now with regard to household debt nor neglect to reflect on how diminishing consumption dollars might impact the wider economy. Part of the process of finding solutions is openly acknowledging the challenges we face. If you did not read his recent speech you can find it here:

      This is a very interesting read and as usual a candid assessment of the global macro picture. It remains unclear how Canada will fare based on circumstances outside our control however what we do know is that there is some urgency our business leaders take steps to reinvest and remain competitive as the global deleveraging cycle comtinues. Times are slow but the world is not coming to an end. I think Mr Carney has hit the right note in expressing catious optimism while he notes that our country remains in relatively good shape compared to others. We are still therefore in a good position to take evasive actions while learning from the mistakes of others and in this regard we have the advantage by being late to the credit excess party. Improving our productivity while focusing on emerging markets and regions of continuing economic strength are indeed crucial so I look forward to hearing how these goals can be fostered and promoted from the standpoint of monetary policy.

      We await this coming weeks release of the Monetary Policy Report for signals of what actions the bank might be prepared to take.

  2. So, what you are saying is, that you think it might not recover this year, but probably next then.

    1. For those of you who think the housing market will recover next year, then please buy all the property you possibly can right now. If you can't understand what is currently going on when it is spelled out word for word for you, then you deserve to learn your lessons the hard way.

    2. Agreed, if that's your train of thought and if this is what you believe, then go ahead and buy. No one is stopping you. You have all the freedom in the world to spend your money however way you want ;-) Go ahead and prove your case correct!

    3. "You have all the freedom in the world to spend your money however way you want"

      Yes. Totally agree. As long as Gvmt dont put a single dime to rescue the helpless wanna be flippers.

      They wanted fast growing assets and wanted to live to dream instead of 2 weeks paychecks ? Great. Have fun.

      But dont you dare touching my paycheck now.

  3. We can't spend what we don't have. It's not "different this time". Economic fundamentals DO matter after all... who would have thought?

  4. Wow, thanks for the insightful editorial and keep up the good work. I read your blog almost everyday.

  5. This has to be one of the best posts this year. Thanks for doing a great job at providing the history of the rule changes. I didn't know that prior to 1999, we had to have 10% down payment. I've always thought it was 5% max. It would be great if government increased it back to 10% down payment. Maybe that's the next step they will take.

    1. The end of cash back mortgages (4%, 5% or 7%) is already written on the walls.

      They will kill this before they pump the down payment to 10%. Actual home prices make it virtually impossible for young adults to gather 50k, 60k, +, ... prior to buy. Thats a lot of money even on two incomes.