25

As in 25%, As in 25 years...

Once upon a time, back in 1989, to buy a house in Canada, you needed to put down 25%. In the last housing bubble (1989/90), prices collapsed once the early 90s recession kicked in and as interest rates soared in an effort to kill inflation.

As prices soared, in 1990, 5% down payments were introduced to make houses more "affordable" (sound familiar?), with mortgage insurance to theoretically insure the lender (ie bank) from the risk of a loss. In 1992, the RRSP Homebuyers Plan was set up (post price collapse) to make it easier to make a downpayment, in an attempt to put a bottom in the Canadian housing market.

For decades, a 25% down payment was necessary. What was magical about 25%? It probably represented the hit that a bank would need to take to repossess your house and sell it via an agent. Banks don't want to be homeowners, and thus will take a hit to free up the capital. Plus, as anyone who has ever studied business knows, a bank is supposed to want the investor/owner to have some "skin in the game". Otherwise, at 5%, the bank is basically the real owner and the homeowner has little invested.

I don't believe that governments can stop the freefall that the economy is in right now, but that won't stop them from trying. I would look for:

1) An increase in the RRSP Homebuyers Plan at some point (tomorrow's budget?) from $20K to $25K. $20K in 2009 dollars is worth a lot less than $20K back in 1992. I doubt that this would cost much overall and it would be popular. Also pretty cheap given the billions that the government is likely to spend or waste in its stimulus package. The real estate industry is already lobbying for this.

2) The other thing that the government is loathe to do since it will get blamed for further hurting the housing market, is to curtail or end the 5% downpayment insurance scheme. I will admit that there are probably some people for whom a 5% downpayment makes sense. For example, a doctor who is ready to practice (and mint) and who has a lot of student loans. For most families, though, a 5% downpayment is risky. Perhaps the government will not tinker further with Overprime Lite, but I would imagine that the Big Banks are already planning to ask for more "skin". It all depends on how much these mortgage insurers are going to lose (ask Freddie and Fannie?).

3) Amortizations of 25 years were the maximum until recent years. Same logic as increasing the down payment. Too long an amortization means no skin in the game.

Before the housing market can bottom, I believe a 20% to 25% down payment is going to come back. I believe a 25 year (worst case 30 year) amortization is going to come back.

Can you imagine what this is going to do for first time homebuyers? The average Canadian house sells for about $300K (and much more in many major cities). A 25% downpayment on that runs you $75K. Right now, a 5% downpayment runs you only $15K, less than the price of a new car (assuming you actually bought it with cash). So if you are interested in the $300K house, you would have to spend years saving more money (pushing demand to the future), you could wait until prices fall further (again pushing demand to the future) or you could settle for a cheaper house, although not too many 25% houses that you could buy with only $15K ($60K house). Add about 5 or 1o years less amortization (ie higher mortgage payments) and you have a recipe for disaster.

Imagine a 25% in $800K Vancouver? Not many people could put down $200K!

Just this one change (that is apparently already happening in the US) could really kill the Canadian housing market, excluding all the other negatives out there.

Carney has lost it

PM Harper, October 2008:

"Canada is not the United States, the situation is very different. The fundamentals of our economy are strong," he said. "We have a budget surplus. We have an economy that continues to create jobs. We're not experiencing a crisis in our financial system."

Harper also said that Stephane Dion was scaring people. Then in December, Harper starting mentioning that a depression was a possibility (he is right on that front) as his government nearly fell.

Today's G&M:

The government official told reporters that the Harper government would run a $34-billion deficit in the fiscal year beginning April 1 and a $30-billion shortfall the year after.

We then lost about 100K jobs in November and December. We now have huge deficits. We are experiencing a crisis in our financial system. Maybe this would teach Canadian leaders to stop comparing ourselves (in a favorable light) to the rest of the world, especially the US, or stop making ridiculous statements in the face of one of the worst economic situations since the 1930s.

Nope!

Today's GM re Bank of Canada head Carney:

Even as the central bank said economic output would contract an alarming 4.8 per cent this quarter, Mr. Carney boldly predicted Thursday that Canada's economy will rally to expand 3.8 per cent in 2010... he said the recession that began in the final three months of 2008 will end faster than did the contractions in the early 1990s and 1981-82.

This dude made a prediction on October 23 (after the stock market crashed) that the Canadian economy would GROW in the first half of 2009 (+0.4%) after shrinking by 0.4% in Q4 2008.

What does he say today: Whoops, -2.3% for Q4 2008, -4.8% for Q1, -1.0% for Q2. With that type of disaster, you would think the dude would tone it down a little. Nope, magically, in July, the economy is going to grow 2.0% and immediately stabilize. Then, it will grow by 3.5% in Q4. Oh, and then it gets better: 4.7% in the first half of 2010 and 4.9% in the second half of 2010.

He is entitled to his opinion and he may ultimately be right, but what is he smoking? We are losing maybe 50-100K jobs per month, the economy is expected to have one its worst quarters ever, the housing and commodity markets are imploding and all of a sudden, on July 1st, people will start to spend like its 2007 again.

How will things magically stabilize?:

Monetary policy (pat on the back?), fiscal policy (as Harper goes against everything he and the Reform party ever stood for and goes on a spending frenzy) and consumer spending.

I will need to expand on this in an upcoming post, but if there is one magical bullet that sums up this whole recession, it will be this one stat: the savings rate.

For decades, the Canadian personal savings rate average about 10%. In the past 15 years or so, Canadians decided to stop saving (0%). Why? In a nutshell, they didn't have to. The stock market and real estate market soared. They got richer without saving, so why bother with actual saving money. Just lever up your house and mint money. Jobs and credit were plentiful.

Then in 2008, both markets tanked. People began to feel poorer as their retirement savings and their homes began to lose value quickly. People felt less secure in their jobs. And, rationally, especially in the fall of 2008, people began to spend less. Less spending on cars and gasoline and flat spending on other retail for now (November retail sales were down 2.4%). With layoffs now accelerating (even Microsoft is laying off), expect people to feel even less secure in their jobs (assuming they still have one) and for consumer spending to tank in 2009.

This trend started a little earlier in the US and is a worldwide trend. Since consumers undersaved for about 15 years (at least), to expect them to return to their 2007 spending habits in July of 2009 is insane. Certifiable, I believe. I will expand on all of this later, but to summarize: It will take years for Canadians to get the saving rate to 10% again, especially since all those layoffs prevent savings. Once Canadians get to something around 10% in 2011 or 2013 or whenever, they may not stop there, as they may feel a need to oversave to compensate for 15+ years of undersaving. The savings rate could go to 15% for all I know. All that savings is good in the long run and could help rebuild the banking sector one day, but in the short term, one person's saving is someone's lost income.

So if you are expecting a nice rebound to consumer spending to make this all better, forget it. I can buy some positive contribution to GDP from monetary or fiscal policy, but consumer spending is going to be a big drag for years to come. Ditto for housing and exports (all that saving is going to hurt the China/Indias of the world and any export growth to those countries).

This recession is going to be at least as bad as the early 90s or early 80s and will likely take both of them out. While I can maybe buy some type of positive number for sometime in 2010, 4%+ is la-la land and someone needs to hold Carney accountable for this.

WSJ article exposing the lies of the housing industry

Must-read excellent article by the WSJ on what happened to David Lereah, the cheerleader at the National Association of Realtors (CREA is the Canadian equivalent). The article talks about how he was supposedly "forced" to cheerlead all throughout the early days of the housing crash (06-07).

Very reminiscent of the kind of doggy doo-doo coming out of CREA, CMHC and the Canadian banks in 2008 and 2009.

http://online.wsj.com/article/SB123152099299568447.html

Every crash starts as a correction

"While Canada's housing market is anticipated to continue to move through a period of adjustment over the next six months, we should expect modestly lower home prices, not a U.S.-style collapse, which was brought on by a structural failure of the entire American credit system," said Phil Soper, president and chief executive of Royal LePage Real Estate Services…We are well into this inevitable cyclical correction."
-Royal Lepage, January 2009

"This report serves as yet another reminder that the Canadian housing market is squarely on the path of correction," TD Securities economics strategist Millan Mulraine stated in a note.
-January 2009

My thought:
When does a correction become a crash?

Unless you are dealing with a 1987 one-day 22% crash, at the start of any crash, you are likely to have pundits calling it a correction. Basically, every crash starts as a correction.

Throughout 2008, there were so-called experts calling the stock market drop, prior to September, a correction. Especially in May and August, when the stock market gave a false start. The same thing happened in 2006 with the US housing market.

"We've been anticipating a price correction and now it's here. The price drop
has stopped the bleeding for housing sales. We think the housing market has
now
hit bottom."
David Lereah, National Association of Realtor (US), September 26, 2006.

In early 2008, all the real estate bulls kept saying that housing prices would increase about 5% after years of double digit gains (moderation). Last winter, when prices start dropping, it was the snow in Toronto!

“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 (February) ever weatherwise for REALTORS® in Toronto.” (March 2008)

The MLS® residential average price is forecast to rise 5.3 per cent in 2008 and
afurther 4.2 per cent next year, pushing prices to new heights.
CREA, May
2008

Now these same clowns who didn’t see any of this coming, are telling us that this is just a regular correction. Royal Lepage is even resorting to using the word “inevitable” even though I don’t recall seeing any mention of its inevitability last year.

This is not a cyclical correction. You do not get US GDP going to -4% or -5% in a healthy correction (as is in Q4 2008). You don’t get 50% stock market drops worldwide on cyclical corrections. You do not have the biggest recession in a generation (and maybe longer) in a cyclical correction. You do not have trillions of dollars of write-offs in a cyclical correction. You do not have the nationalization of the worldwide banking sector in a cyclical correction. But I digress…

This is what I wrote back in March 2008:

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.

That statement was mostly correct, except that now that the damage is so severe, that even CREA and CMHC are saying that house prices will fall, but only modestly and only due to the inevitable correction.

I’m not sure who decides what is a crash and what is a correction…

I believe a real estate correction would be defined as a modest pullback in prices (up to 10% and the majority of the gains in the prior boom are preserved) and then prices go on to reach new highs in a few years.

There would be a gray area between 10% to 15% but once you get to 15%+, you are in crash territory. Also, it would take a decade or more for prices to go to new highs in nominal terms (in real terms, after deflation, it would likely taken longer if ever).

In my opinion, we are already entering the gray area, and this bust has only started. By mid 2009, I would expect so see the correction word vanishing.

What the heck is going on in Montreal and Ottawa?

Let's go all the way back to August 15, 2008, a relatively wonderful time when Fannie, Freddie and Lehman were still publicly traded and the banking sector was not owned by the US government. I made a series of predictions on the Canadian housing market, that for the most part, have come true.

• Expect to see negative numbers the rest of the year (Yes)
  
• Expect Toronto to go negative soon. When the mainstream media (based primarily in Toronto) gets this, expect to see a flood of housing doom articles. While the doom will be correct, it will be about years late. (Yes)
  
• Expect Ottawa and Montreal to participate in the housing crash by year end (Not clear yet, see below)
  
• Expect to see negative numbers worsen with an occasional upward blip (similar to a bear market rally in the stock market- ie nothing goes down in a straight line) (Yes)
  
• Expect to see bottom calling on these inevitable blips (Yes, plenty of that)
  
• Expect to see a negative 6-9% by year end (-10% in November)

Somehow, despite the incredible worldwide carnage in stock markets and housing markets everwhere, despite the worldwide deleveraging, the Montreal real estate market continues to show 3% YoY growth in real estate prices in November and December. Ottawa showed 7.7% YoY growth in November but went negative in December (-1.2%).

Was I wrong then?

Montreal: The socialist interventionist Quebec economy kept on keeping on. I have heard ludicrous arguments on how Quebec (with its aerospace and infrastructure spending) will make it through relatively unscathed. All three parties in the recent provincial election kept promising more government. What gives? The Quebec economy is the true supertanker economy (using the famous Abby Joseph Cohen phrase from the late 90s- ok, maybe just a tanker since it is not that big). It takes a heck of a long time to get the tanker rolling (it took until 1996 for things to pick up here in Quebec in the last boom) but at the same time, it takes longer to slow things down (similar to much of Europe). Just when you think, decoupling or "we're better than Ontario", we get hit and worse, it takes us years longer to get back up. People here are less invested in the stock market and more likely to have faith in the government to take care of us. People here don't follow events in the rest of Canada or the US as much as they follow what is happening in France.

Finally, I think the impact of a worldwide recession is starting to seep in here as well. Housing sales have been crushed by about 30% in November and December. Yet average prices have moderated only a little and are still nicely positive. I suspect that since few buyers and sellers do anything at all in November/December (most houses are sold in the January to April timeframe here as many people move on July 1st- don't ask), the sales give an indication that something fishy is up, while the few houses that sell are merely following the prices from the past few months.

This spring, when people in La Belle Province fully realize that jobs are being cut here too and that our provincial government is going to run massive deficits that further bankrupt us, I suspect that they will begin to panic as much of the rest of the world has already.

Ottawa: Due to its relatively small size, I suspect that the monthly data is too volatile to use 1 month as a good gauge. However, sales have tanked in November and December. Much of what I said about Quebec applies here too as the federal government has a tanker effect here too. Don't believe all that stuff about how the federal government will protect the local economy. Remember that there were 45,000 government jobs cut in the mid/late 90s. Not surprisely, the housing market in Ottawa stunk at the time (while it sailed along just fine in the rest of Canada). It just takes longer in Ottawa, too. Plus, even in Ottawa, not everyone works in the federal government in Ottawa (high tech) and I suspect that like most Canadians, people in Ottawa save too little and are in too much debt.

Conclusion: The prediction may have been technically wrong, but I suspect that it was just a tad premature .

When do we go to get all 6 NHL markets in Canada negative? It looks as if Ottawa is already negative and only needs January to confirm. I suspect that Montreal will go negative as soon as the housing market hits its busy season in February. By April (when sellers and buyers usually get desperate), I expect to see carnage in the Montreal housing market as buyers will have tons of selection and will either lowball or will still hesitate given the economic backdrop. Sellers will get desperate as the window to sell begins to close.

By February or March, when all 6 are negative, then what will CREA do to spin?

Happy New Year!

Happy New Year to all!

Overall, 2009 is looking a lot more difficult to forecast for the stock market (for me, anyway). My views on 2008 were clear (check in the archives if you wish) as I knew that we were headed into severe bear market territory. This year, I am not quite sure. I will publish an outlook at some point soon but this is still a work in progress.

The bear market rally scenario that I outlined back in November remains intact. I am 17% long currently and looking to continue to get longer. I am not sure if the rally peters out in February or if it extends until April. I will have to keep working on my thesis and see how things play out.

One thing is clear to me: The real economy is tanking and will continue to tank for 2009. There is too much complacency in Canada regarding the economy and a certain smugness that it is not as bad here as the US. We are starting to see signs in Canada that things are falling off a cliff here too. Car sales were horrible in December in Canada (after remaining strong until early fall). Home sales plummetted in November. The job market fell apart in November.

2009 will also be a horrible, horrible year for housing in Canada. Don't believe the industry garbage that Royal Lepage put out today, from the G&M "Housing market braces for correction, not crash", January 6, 2008:

Average Canadian house prices will fall by another 3 per cent in 2009, but
the drop will add up to a “correction,” not the sort of “crash” that has crushed
the U.S. market, real estate brokerage Royal LePage Real Estate Services said
Tuesday. Nationally, the average house price will fall to $295,000, from a
projected level of $304,000 for 2008, the Toronto-based firm forecast. This
follows a 1.1-per-cent dip last year from $307,265 in 2007.
Royal LePage also is betting that that the number of houses sold across the country this year will fall by 3.5 per cent to 416,000, although it expects to see both price and activity gains in several markets, including Regina and Winnipeg, where prices
remain below the national average.

What a joke!

• 3% drop in prices! We are currently dropping at 5% or 10% depending which numbers you are using, and things are only getting worse. The carnage in the housing market accelerated this fall, when sales dropped precipitously. Inventories are building. Double-digit negatives are a given.
• 3.5% drop in sales. I think that is a typo. It should read closer to 35%! November sales dropped by 42% from the prior year.
• Price and activity gains in Regina and Winnipeg! Regina's housing market is going to plummet. It was the last bubble and using Potash stock as an indicator (down 70%), that local economy is in for some serious pain. The average house in Saskatoon has already dropped $40K (14%) since summer.

Given everything that happened in the fall of 2008, these types of predictions by industry groups should not be taken seriously at all. The banks are in on this crazy talk too:

Michael Gregory, senior economist with BMO Capital Markets, said despite the
slowdown in Canada “we won’t even come close” to what is happening in the
U.S. He pointed to stronger employment numbers and income growth here as well
as banking system that “continues to make mortgages” available to Canadian
consumers. But he cautioned that if unemployment numbers rise in Canada,
there will be a larger fallout for the Canadian housing market. “Anyway you
slice it, if you don’t have a job, you can’t get a mortgage and you can’t buy a
house.”

Talk about talking out of both sides of your mouth! Everything will be fine, unless unemployment goes up. Of course, it will go up. We are in a severe recession! Our unemployment rate is about half of what it was in the last Canadian recession (early 90s).

Amazing how anyone can put out such garbage in 2009, and there are few in the mainstream that are challenging it!