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August 31, 2017 | Getting it Wrong

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.

It’s been a bad few days for the doomers. Houston sinks into a watery morass, taking the energy biz with it and gas spikes. North Korea’s dipstick leader overflies Japan with a missile, Trump erupts, but markets go up and gold shrugs. Canadian housing sputters and limps, but the banks bring in new billions. The US is ripped by race issues and white supremacists, yet consumer confidence rises the most in 17 years.

The American stock market is at a record level, global growth is robust and there’s one thing central banks want for Christmas. Normalized rates. Those people who have spent the last eight years in cash, GICs or precious metals got it wrong. There was no rerun of 2008, nor will there be one. There’s no reason to believe markets will crash simply because the Dow has hit 22,000.

The Canadian residential real estate market represents far more risk than financial assets, which was one of the points of yesterday’s post. Wealthy people are different from the rest, and have a vastly smaller amount of their net worth in a single asset at one address. They’re diversified, whereas Mr & Mrs Front Porch are not. If 1%ers do not own businesses, they almost always possess business equity. The returns there over decades have far outstripped those of housing, a pattern expected to continue.

This week CMHC admitted the obvious. Changes to moister mortgages brought in last year have crashed loan volumes. Down an incredible 41% – right in the middle of the greatest housing boom in national history. “Volumes decreased largely as a result of the new regulations,” the agency said in an understatement. In fact, CMHC I left now with more than $100 billion in excess loan capacity, with new mortgage growth slowing to a crawl.

The reason is as explained here a few days ago. When the kids were suddenly compelled to qualify for insured loans at an effective rate for 4.64% (about 2% above bank rates), they couldn’t. The stress test worked. They failed. They lacked the financial resources – down payments or incomes – to afford the homes they wanted to buy.

So they decided to cheat and lie, usually with the help of families. Instead of proving to CMHC they could carry loans, they went around the agency. By amassing 20% down in money from other sources, they avoided having to buy insurance or face any test. And that’s why CMHC volumes crashed at the epicentre of our real estate mania. It’s also why banks suddenly saw uninsured loan volumes bloating at 14% annually, and why their regulator freaked. Untold thousands of people who can’t actually afford their homes have transferred their risk from the feds to the lenders.

Soon this ends. All buyers, regardless of how much money they have to throw at a property, will be tested as if mortgages cost a full 2% more than current rates. Meanwhile current rates will be rising. Those who say the moister stress test had no effect on dampening prices are correct. Those who say the new test will have the same effect are decidedly wrong. There is no place to run and hide anymore, save some slap-happy CUs and subprimers who want 8%.

Now, back to the doomers.

The Canadian real estate market’s a great example of what happens when money’s too cheap. Asset values inflate because borrowers have no discipline. When rates fall people don’t do the smart thing and pay down debt. They want more of it. They spend the bucks. Prices go up. The result is an economic nightmare – inflated assets (destined to correct, as they always do) and inflated debt (which ain’t going anywhere).

To stop the borrowing, central bankers withdraw stimulus, which is as unpleasant as it sounds. Rates rise, credit tightens, asset values correspondingly decline. People who bought at peak house levels with big mortgages quickly see the evil side of leverage.

The Bank of Canada started this process in July. It will continue in October. The Fed has been at it for a year. The Bank of England is probably the next to join. Because tightening cycles occur over long periods of time, there will be four to six more increases between now and the end of 2019 if history is any guide. And given the first paragraph of this post, what reason would there be to halt the process?

Recall that a recent by Forum Research found 34% of people polled said the single, itsy-weensie rate increase so far (0.25%) will hurt their finances. Of those, 12% said the impact would be “extremely negative.” In the 35-44 age bracket, the proportion of people saying any hike at would whack them rose to 44%. For people making eight grand a year, it was 39%. Among those making $100,000, 41% are scared.

In summary, the world is fine. But I’m worried about you.

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August 31st, 2017

Posted In: The Greater Fool

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