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May 12, 2017 | How Bad?

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Some people wonder if housing could take down the economy, chew up the stock market and blow up people’s RRSPs. Maybe even start a run on deposits, especially those of the smaller credit unions and trusts with big exposure to residential real estate.

On Friday the federal finance minister said a government bailout of troubled Home Capital Group was unlikely, but not out of the question. No contagion that we can see, he said. This meltdown is isolated.

Of course, it’s not. Moody’s, the big US ratings agency, nailed that one this week when it downgraded the long-term debt of all six big Canadian banks – TD, CIBC, Royal, Scotia, BMO and National. The reason was clearly set out: “Continued growth in Canadian consumer debt and elevated housing prices leaves consumers, and Canadian banks, more vulnerable to downside risks facing the Canadian economy than in the past.” That’s all true. And while the market is changing quickly, as this blog has been chronicling for a few weeks, the insanity continues.

Bloomberg’s regular consumer sentiment survey found that, for the first time ever, more than 50% of people think house prices will continue to rise from record levels. Only 10% believe a decline is possible. On Friday the Teranet-National Bank index recorded the sharpest 12-month rise on record for Toronto and Hamilton in April.

“This monthly advance takes the composite index to an all-time high for the 15th consecutive month. The April rise exceeded the countrywide average in four of the 11 metropolitan markets surveyed: Toronto (2.6%), Hamilton (2.1%), Victoria (1.5%) and Halifax (1.4%), leaving the indexes for the first three of these markets at all-time highs.”

Meanwhile we also know from the Bank of Canada and other sources that almost 40% of current economic growth is coming from residential real estate and related activities, like lending. That’s a record. And overall, somewhere between 15% and 30% of the entire GDP is housing. Also historic.

Finally, by now everybody probably knows personal debt has achieved an unheard-of pinnacle in Canada. Households owe $2.08 trillion, of which 65% is mortgages. That’s bigger than the entire economy, at $2.07 trillion. And every economist alive will tell you most of the debt will mature and roll over in the years to come at higher interest rates – given the expansion of the US and accelerating global growth. This is truly scary in light of the survey mentioned here days ago which claims most people could not find an extra $200 a month to handle any additional expense – which is a direct legacy of paying (and borrowing) too much for real estate.

Put all of this together, and the economic risks of a real estate correction could be substantial. Alarmists see the meltdown of the country’s largest non-bank mortgage lender, Home Capital, as the catalyst for a systemic financial failure of the kind that followed the bursting of the American housing bubble. In that country when about 8% of borrowers got into trouble, dominoes started falling fast. The result was a 32% drop in national prices, a 70% crash in places like Florida and Phoenix, the implosion of several venerable Wall Street investment houses plus a global credit crisis that came within  inches of causing a new depression. The stock market lost almost 60% of its value and people who panicked and sold at the bottom likely ruined their lives. In a perverse way, the fear of financial assets which resulted led millions of Canadians to embrace real estate, which has now been inflated into a straining, explosive, debt-filled dirigible of risk.

So what could happen? Is it time for tinned tuna, bumwad hoarding and gold bars buried under the garage floor? Could a housing correction/crash here cause bring a rerun of 2008?

No. That’s the simple answer. Nobody anywhere except here cares about the Canadian housing market, so it could drop by 50% and have zero impact on financial markets in New York, London or Beijing. There will be no credit crisis because of tears in Leslieville or woes in White Rock. But Canada could certainly be thrust into a recession if housing activity were to cave. The dollar would weaken, especially if the Bank of Canada responded by cutting its key rate, and inflation would jump with the cost of imported goods.

Canadian banks would see profitability diminished and share values would likely reflect it. Consumer spending would be curtailed, hurting the retail sector, car sales and employment levels. The consequences would be real and last a long time. Some losses on the TSX, a jump in the jobless ranks, a massive drop in middle class net worth as home equity dipped and the mother of all deficits in Ottawa as Liberal spending collided with falling tax revenues. Hardest hit would be the young and the leveraged.

But there’d be no run on the banks, no financial system collapse, no big bail-ins or bail-outs, no massive spike in the default rate, no federal mortgage forgiveness or adjustment program and tens of thousands of people leaving their jobs as realtors. Highly unpleasant. Not lethal. A lot of Boomers planning to retire on their house proceeds would be forced to stay working. Tons of moisters who bought condos and slanty semis would see all their equity erased. Recovery might take a decade – fairly quick for a housing cycle.

The best defence against being crushed is to have a balanced life. It’s the theme here. Always has been.

Don’t put all your net worth in one single thing at one address in one city. With investments, ensure you have stable income-producers as well as growth assets. Hedge against the Canadian dollar with a 20% weighting in US$-denominated investments. Keep about twice as much exposure to American and international assets as Canadian ones. Diversify – don’t buy individual stocks as you have no idea what the exact outcome will be. Maintain a 5% cash reserve. Eschew illiquid, low-yield, high-taxed GICs. Don’t panic, over-react or sell/buy based on emotion. If you’re a worrier, stay within the $100,000 CDIC limits. If you’re an investor, remember you have more than $1 million in coverage. Put together the correct portfolio now, then let it ride. Keep your hands off.

Housing will not do to Canada what it did to America. But you still won’t like it.

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May 12th, 2017

Posted In: The Greater Fool

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