Saturday, March 29, 2008

Garth Turner: The boom goes bust

A terrific article written by MP Garth Turner.

A key takeaway:

"So, how different is the Canadian experience?

Not enough.

In the period between 2000 and the market crash in 2006, U.S. home prices increased 74 per cent, while household income rose by just 15 per cent. In Canada, real estate prices jumped 70 per cent by the end of 2007, with family incomes ahead 14 per cent."

Garth has been early on this housing bubble, as he has been talking about a housing correction for years and now a housing bubble. Bubbles can often take on a life of their own, and the bubble goes on longer and stronger than almost anyone expects. The doomsayers can even add to the bubble. In the Nasdaq 5000 example of 2000, many brilliant (and ultimately correct) hedge funds were decimated as their shorted tech positions went parabolic. Their short covering (buying) helped to form the top. So while Garth may have been early, I believe that he is right. Yes, the US has a subprime problem, but Canada has its own problems, as he points out.

Here is the article in its entirety:

Garth Turner . The boom goes bust
How different is the Canadian experience from the conditions that caused the U.S. housing meltdown? Not enough.

Imagine listing your home for sale, but there are no buyers. You drop the price. Again. And again. The house across the street's now for sale. And the one two doors down, plus a dozen others in a two-block radius. Nothing's selling, and every time one home is reduced, all are affected. This property used to represent wealth. Now it's a wealth trap. Most of what you have is here, and with each day passed, it diminishes.

Imagine your first home - a dream in granite and stainless. You bought it from the region's largest builder, for 1.5 per cent down - enough to cover closing costs - and mortgaged the rest. Months later, the economy turns abruptly. Your spouse loses his job and the monthly payments - mortgage, taxes, utilities - are crushing. You decide to sell, but the realtor tells you the market's also turned. Your mortgage is now slightly greater than the value of the home. After paying commission, you'll have no house, no equity, and still owe the bank more than $20,000. How could this have happened?

Far-fetched? Hardly. For millions of middle-class Americans, this is a reality as housing values collapse in the first nation-wide housing meltdown since the Depression. In some markets, prices have crashed 30 per cent. In Phoenix, there are more than 20,000 new homes, vacant, unsold and unwanted. In suburban Detroit, million-dollar properties can't fetch buyers at $300,000. Downtown, prices plunged in the first two months of 2008 by 54 per cent, to a median of $22,000.

In Florida and California, homeowners establish web sites to try and sell their homes. Three million American families now have mortgages larger than their home values. Comfortable upper middle-class families with six-figure homes find their wealth evaporated as their properties languish on the market. So many foreclosed homes are for sale, it's estimated prices will not recover for years. In fact, a recent Credit Suisse report says prices must fall another 40 per cent in Miami and 26 per cent in Los Angeles before they become affordable.

The real estate disaster now in full flower to our south is a fascinating, gripping spectacle. It's time we looked closely. Because, one way or another, it's coming here.

Canadians, strangely, believe this country's immune from the housing contagion sweeping America. The myth results from three powerful forces. Denial tops the list, no doubt the result of having more than 80 per cent of our net worth in one asset, the family home. Add to that the excellent communications job done by the real estate lobby -- mortgage-lending bank economists and the CEOs of real estate marketing companies -- who claim home values will rise forever. Finally, our belief the Americans screwed up by giving subprime mortgages to unworthy people so they could buy unaffordable homes.

But this is not so. In researching my book, Greater Fool, I was reminded again of why all booms end badly. The inflating real estate market to the south became unsustainable when average prices exceeded the ability of average families to buy homes. This inflation in turn was the result of policy decisions made after 9/11 which gave America (and Canada) the lowest interest rates in a generation. Debt was cheap, and volatile stock markets represented unacceptable risk. So, real estate became the asset of choice.

If you have any doubt, watch a few past episodes of Flip This House. It's good real estate pornography.

Prices roared to new levels and to sustain the fire, mortgage lending practices went lax. No-money-down deals were common, and home loans with discounted rates were extended to buyers who now qualified, as the bar for home ownership fell. This all made sense while the market advanced, since growing home equity gave even dodgy buyers new money to use for refinancing loans as the introductory ones matured.

But as interest rates increased, the American economy softened and realization spread that real estate was overvalued, the bubble burst - and with a vengeance.

So, how different is the Canadian experience?

Not enough.

In the period between 2000 and the market crash in 2006, U.S. home prices increased 74 per cent, while household income rose by just 15 per cent. In Canada, real estate prices jumped 70 per cent by the end of 2007, with family incomes ahead 14 per cent.

In other words, we've seen an almost identical pattern of real estate excess - familiar to anyone caught in a bidding war, or staring in disbelief at a new MLS listing. The average home in Toronto is now over $400,000, while in Vancouver it tops $700,000. Last year homes in Saskatoon raced ahead more than 50 per cent in value. A young couple in suburban Toronto with a $450,000 price limit ended up buying a $700,000 home after losing 16 competing bids.

And the Canadian response to this affordability crisis? It's called the 40-year mortgage, which lowers monthly payments by extending the amortization 15 years beyond the traditional quarter-century and, in the process, grossly inflates the total debt to be repaid. In other words, this loan (now accounting for over 40 per cent of all new borrowings) allows people to buy homes they would not otherwise afford.

Meanwhile, down payments have become almost optional. One of Ottawa's largest new home builders routinely allows young couples to move in by paying just closing costs, and financing the other 98.5 per cent of the purchase price. With virtually no equity in the home and substantial carrying charges, any market downturn means they owe more than they actually own.

So, how exactly do American subprimes differ from Canadian 40-year mortgages? How are mortgage lenders here more prudent when they allow appraisals based on postal codes, rather than actual home inspections? Why should Canadian real estate values, as inflated now as were those to the south two years ago, hold when our families are no better off? As a global economic slowdown and an American recession take hold, what impenetrable barrier is wrapped around this country?

Meanwhile, what about the future? Won't nine million house-rich and pension-challenged boomers be forced to dump billions in real estate over the coming decade? Won't runaway energy costs and the uncertainty of climate change breed a popular taste for smaller, more efficient, more urban housing, rendering four-bedroom, three-car-garage suburban palaces unsaleable?

Most of all, won't those who understand what's clearly coming, and sell now, rejoice that they found a greater fool?

Garth Turner is the MP for Halton, Ontario. Greater Fool: The Troubled Future of Real Estate is his eighth book, published by Key Porter Books.

Thursday, March 20, 2008

At least TD and the G&M seem to be paying attention

From G&M today:
Canada begins tracking U.S. into slump, Heather Scoffield

It cites TD Don Drummond, chief economist for TD, who is a top economist in Canada, and one of the few that writes interesting stuff, IMHO. He states the Canada is tracking the US economy perilously close to recession. He expects Canada to register a negative GDP for Q1 and an ever so slightly positive Q2. TD even was talking about a negative December GDP before it was confirmed by Stats Can as a negative 0.7% (

TD, you are the new "go-to guy" in this recession/slowdown!

I asked this question last month ( and nothing seems to have improved since then.

While that may end up optimistic, in my view, especially if the commodity markets implode (, this is at least a realistic scenario.

Most Canadians haven't felt like a recession is here as consumer spending has remained strong. It is the export/manufacturing sector that is feeling it. Westjet and Air Canada claim to have not felt any impact yet ( The TSX prior to this week had bounced back nicely from the January mini-crash and outperformed the US markets. That may have changed this week! The Canadian real estate market has remained strong. That may be changing as we speak.

I think that the impact will begin to be felt very soon, especially if the TSX continues its recent slide.

Now, if only the other 5 banks and the mainstream media would wake up to the fact that Canada is not decoupling from the US and start considering this possibility seriously. The Bank of Canada is awake as shown by the 50 basis point cut earlier this month.

HGD, HXD, GLD, gold mutual funds, DBA, DUG

Commodity Markets Imploding

As written on Feb 19th

"All this liquidity being pumped in by the central bankers is going into the "hot games", which are the commodities. Many of the charts (ie wheat) look parabolic. Similar to Nasdaq in early 2000. I suspect that the next downleg in the market will be brutal and will take out the commodity stocks, even gold (which should decouple from the rest later in 2008). This will bring out a wave of margin calls, hedge fund blowups etc...This coming commodities bear market (perhaps it is only cyclical) will help sink the Western Canadian economy as well."

After today's 427 point smashing, it is clear that something is amok. Gold down $60 (!), oil down $6 and all commodities got smashed! The last place to hide in the markets is now being taken out. Everyone and his uncle was bullish on gold and commodities. Everyone knows that BRIC (Brazil, Russia, India & China) will keep prices high for many years. I am agnostic on the long term bull market in commodities. I am sympathetic to many of the arguments of the bulls but I also know that this run-up in most commodities has beaten all of the great all-time commodity bull markets. So I say, let's let the cyclical bear do its thing and then decide.

All of the hiding places are being destroyed. In a bear market, usually no stone is left unturned. Commodities are no different.

In fact, says that the basic idea is that there is little differentiation between a commodity coming from one producer and the same commodity from another producer - a barrel of oil is basically the same product, regardless of the producer. Therefore, the price is determined purely by supply and demand. Since there is little if any pricing power for producers (versus one another), over a very long period of time, the price should be close to the cost of producing the good. If the goods are sold below cost, then over time, producers stop producing. If prices are much higher than cost, producers try to sell more, which raises supply and ultimately depress prices. This is a long term story however.

Short term, commodity prices across the board have risen due to demand from final users AND more importantly of late, demand from investors (escaping financial assets for hard assets). Supply has been constrained in many areas partly due to BRIC and partly for a multitude of individual stories (weather, underinvestment over the past 20 years, etc...). There is often an inverse relationship between the US dollar and commodity prices in the short term. In recent days, the US dollar has shown
signs of bottoming or at least stabilizing. Also, there appears to be a rotation at play as investors sell their winners and invest in the losers (financials). Finally, when there are a lot of people hiding in commodities with huge profits in this environment, as soon as things look like they are heading south, you get a huge move down.

The move was discussed here last month, as the charts all looked parabolic. Now, if you were hoping for the commodities to save Western Canada from at least an economic slowdown, maybe think again....Also, remember that the TSX is approximately 75% financials, mining and oil stocks. It could get dessimated in a commodity bear.

Positions in HGD, HXD, GLD, gold mutual funds, DBA, DUG

Saturday, March 15, 2008

Now it is the snow!

This is Canada. With the exception of a small southern part of the West Coast, it is cold for about 6 months a year. Sometimes, it is brutally cold for weeks. It snows. Sometimes, it snows a lot. Someone should tell this to the CREA (Canada Real Estate Association).

Unit sales dropped by almost 10% versus February 2007 while new listings rose by 12%. Therefore, on the surface, supply increasing and demand decreasing. Could this be the long awaited bursting on the Canadian real estate bubble? Nah, it's just the weather?

“Snowfall in Toronto made it tough to show prospective buyers, and tough to process a listing,” said CREA President Ann Bosley. “It was one of the toughest months ever weatherwise for REALTORS® in Toronto.”

OK, we all know what happens in Toronto when it snows (remember January 1999 with Mel Lastman's army call-up). Well, then the West and Newfoundland stayed strong with $110 oil and record wheat prices, right?

Activity also softened on a month-over-month basis in Edmonton, Vancouver, Calgary, Saskatoon, and Newfoundland & Labrador.

Let's see what happens in the upcoming months. It is dangerous to extrapolate on one month's data. Let's see if the weather is used as an excuse again. Hmm, March was snowy again, in April there were floods because of melting snow, in May, it was rainy. In June, it was too hot....

The market will ultimately go where it wants to go regardless of the weather and what the CREA or I think. I believe that it will follow the US real estate market to the downside. The Canadian real estate market appears to be slowing down with inventories building (higher listings and lower sales equals higher inventories). This is in spite of the large interest rate cuts, $110 oil, record commodity prices, full employment and minimal contagion from the US problems thus far.

What happens if we get a full bear market, falling commodity prices, higher unemployment and a US and Canadian recession, as I expect? Just remember, the CREA or CMHC will never tell you that the real estate market is overvalued. They will never tell you that house prices will fall.

Prices have doubled in most Canadian markets since 2001, mortgage rates have increased over the past few years, the US real estate market is in a depression, the stock market is likely in a bear market, the population is aging, the US and Canadian economies are either in recession or near recession and a global debt deflation is underway.

Canada will be just fine. Housing will increase nicely at 5%. If you believe that, I have a few condos in Florida to sell you...

The Tory Deficit of 2008/09 and the end of Harper as PM

In the interest of full disclosure, I have never voted for the Tories, I hated Mulroney and I am not a big fan of Harper (although he is doing a decent job). I think Flaherty is a solid Finance Minister and while I believe that the GST cuts were stupid, I don't think he would have proposed them. That was a Harper political decision. The income trust decision was wise although it was a political mistake that they campaigned against them.

I have voted for the Liberals traditionally although I am a fiscal conservative by Canadian standards, I hate their National Daycare programs and I do not like the way Dion is shifting the party to the left. I prefer the conservative economic policies of the first 7 years under Chretien.

Canada is headed for a deficit and this could spell the end of Harper as PM.

PM Harper is a brilliant man who is always one chess move ahead of his opponents. However, this time, either he is thinking three or four moves ahead or he is making a serious miscalculation. Canada is on the brink of a recession and he had a brilliant chance to have his government fall with the February budget.

The official reserve in the February 2008 budget is for less than $3 billion. In addition, I am sure that Flaherty has a few billion hidden away as well. However, the margin for error is probably about $5 billion + or - a billion. If Canada goes into recession, all bets are off, however.

It is quite
normal for economies to go into recession. It is also quite normal for countries to run deficits in recession as revenues fall and expenses for social assistance increase. Interest rates usually fall which can help a little on the expense side.

Canada's history with deficits is not
"normal". The Trudeau and Mulroney deficits of the 1970s /80s were enormous and saddled Canada with a horrible mess in the early 1990s after a steep recession. Taxes were sky high, there was a lot of wasteful spending and deficits remained stubbornly high. Canadians became almost fanatical (and rightly so) about taming these deficits with some prodding by the Manning Reform party (of which Harper was a key member). The Chretien Liberals, with Paul Martin as Finance Minister, came to power with a pledge to reduce the deficit to 3% of GDP in their Red Book (which turned out to be a huge undertaking at the time). They proceeded to go much further and by 2000, those huge deficits turned out to be huge surpluses. Much of those surpluses were channeled to debt reduction, tax cuts and huge spending increases, all of which helped the economy. Canadians were estatic that the deficit demon was slayed and a virtuous cycle ensued. Canadians have enjoyed lower taxes, higher spending and continued healthy surpluses since. Some of the economic boom of the late 90s and 2000s was due to the tough decisions made in the 1993-1996 timeframe.

In 2000, Chretien and Martin made large income tax cuts and the purse strings re-opened for neglected social spending during the 90s. Luckily the tax cuts were timed perfectly to help Canada navigate through the 2001 US recession. By 2002, when the economic recovery began and Canada still had a surplus, the floodgates on spending began. Strong growth in the economy, in particular Western Canada, allowed Canada to have a surplus, increase spending and make a few small tax cuts.

Enter Harper in 2006, who was elected on a platform to cut the GST to 5%. Despite virtually no support from the business and academic communities and contrary to the trend in most other countries, the election promise was kept. Harper had managed to keep most of his campaign promises and do a solid job of governing the country. The economy was still relatively strong in the face of a looming US recession and the Dion Liberals have had a difficult time gaining popularity. All Harper had to do was put something that the Liberals could not accept and an election would have to be called. Sure, he is no shoo-in for a majority but a solid campaign could have done it.

Now, with the US recession worsening, it is possible that Canada will enter recession. Expect tax revenues to slow and demands for spending to increase. With a cushion of only $5 billion, a deficit is a definite possibilty. Since the Mulroney Tories left a $42 billion dollar deficit and now the Harper Tories may bring it back, it is possible that the Dion Liberals could exploit this development. They should campaign as such:
The Tories are irresponsible and only we, the Liberals, are the party of sound fiscal management. The Tories put us back into deficit for a 5% GST.

It could well be the demise of PM Harper as the current Canadian recession leads to a deficit for the first time since the 1990s. If the Liberals can actually deliver a good election campaign, they should capitalize on the huge mistake that Harper made.