Down the Drain
If Chicken Little were here, he might be staring up at the sky, wondering just how much longer it would be until he could tell everyone he told them so.
Without a doubt, the last few weeks in the stock market have been pretty brutal. While the markets have made small gains over the last year, the last few weeks have seen the destruction of most of that value. In fact, the TSX had its worst quarter since the 2008 meltdown. I know most of my investments are down about 6 or 7% in the last month, which is something I’ve gotten used to over the last few years. Thankfully I’m a buy and hold type guy, but I imagine a lot of people are beginning to seriously think about pulling out in case there’s a big plunge.
And you can’t really blame them.
We currently have a lot of reasons to be skeptical about recovery, with very few signs that anything is getting better. The G20 summit, despite costing about a billion dollars, was essentially a bust. While a few countries are promoting additional debt management and fiscal responsibility, I wouldn’t be at all surprised if they simply continue to fire up the printing presses again when the time comes. You add to that a country on the verge of collapse (Greece) along with a world super power that has about 500% of its GDP in debt, and things have the potential to get a whole lot worse.
As for me, I think the Fed raising interest rates will be like pulling the big economic plug out of the bottom of the bathtub. Interest rates are at a historic low right now, and many people have locked themselves into mortgages they can’t really afford based on those rates. As they climb, it’s quite feasible you’ll see many families with mortgage payments that suddenly double. That’ll undoubtedly force a lot of people to default, and will flood the markets with a ton of houses, ultimately driving prices way down.
With everyone spending all their extra money servicing debt payments, you probably won’t see a lot of activity in the markets. In fact, I wouldn’t be at all surprised if people start dipping into their retirement portfolios to help soften the blow when the time comes.
Photo by David Blackwell on Flickr
The stimulus is just delaying the inevitable effects of the depression I believe we’re already in. I fully expect our Governments to keep throwing money at the various sectors and rewarding the incompitent until obvious and rampant inflation makes it impossible to continue.
If home prices plunge in Canada, I’ve a strong suspision that banks will be encouraged to forgive significant portions of outstanding mortgages, as happened in the States.
I’m not saying I support this, nor do I want to see families lose their homes. I just think that banks made the loans based on artificially inflated prices, and could offset
the losses the additional profit made from charging higher interest rates
on the lower principle balance.
Ultimately, the bond market will push short term interest rates up as sovereign debt worries mount and investors flee to safer assets. At that point, the central banks have very little control and the free market will begin it’s long overdue real correction.
Our leaders are trying to prop up the “old industries” and obsolete models from the pre-crash economy. It can’t and won’t work in the long run. The world needs to hit rock bottom before the ideas and innovation can finally take root as people create the much needed changes when they refuse to suffer any longer. It’s at this point that the true recovery can begin, and resources can be focused on nurturing these new inventions and industries instead of the old failed model of consumption and real estate speculation.
“If home prices plunge in Canada, I’ve a strong suspision that banks will be encouraged to forgive significant portions of outstanding mortgages, as happened in the States.”
Why would they though? Aren’t the entire mortgages backed by CMHC? Wouldn’t it be in the bank’s best interest to just let them default on it and collect the full amount from CMHC?
“Thankfully I’m a buy and hold type guy, but I imagine a lot of people are beginning to seriously think about pulling out in case there’s a big plunge.”
People are already doing that, that’s why stocks are the cheapest relative to bonds in three decades right now. Conventionally that would be a buying signal for stocks. On the other hand, if those fears are rational, what it’s actually a buying signal for is more likely to be canned food and ammunition…
“Interest rates are at a historic low right now, and many people have locked themselves into mortgages they can’t really afford based on those rates. As they climb,”
You’re buying into the Garth view of the future here. Which is certainly plausible, yes, but personally I think that it’s more likely that our next couple decades are going to look a lot more like Japan’s last couple decades than a return to “normality”.
http://www.globalpropertyguide.com/Asia/Japan/Price-History
Examine in particular the charts “Residential Urban Land Price Index” which show an almost constant and still continuing decline from 1991 to the present; and “Interest & Mortgage Rates” which shows a central bank rate of essentially zero and mortgage rates pretty much steady at 3% for the last fifteen years. For further elucidation, proceed to “Inflation Rate” which shows actual deflation more often than not, despite them trying pretty much all the same tricks that the US and Europe are trying now.
I think that this is the most likely model for what’s ahead worldwide in the next few years at least, and we’re not going to see a hyperinflationary collapse for at least 15-20 years, possibly more.
… of course, I could very well be proven completely wrong tomorrow; and I don’t mean that figuratively, as tomorrow’s reaction to today’s news that Moody’s put Spain’s sovereign debt rating on watch could very well be what triggers the disintegration of the euro as we currently know it.
I see it as a similar situation to the one covered in Too Big To Fail. Our Government knows it couldn’t cover widespread defaults on mortgages at a time when they’ve already run up huge debts as a percentage of their GDP.
Emergency measures would be drawn up and enforced by the highest authority. Our major lenders would be strong-armed and encouraged to take extraordinary measures. The banks would realize that widespread defaults, though covered by CMHC, would throw the economy into a depression. When there’s no one to lend to, or to provide services to, they would stand to see their own business models threatened and face the risk of failure or forced mergers.
“Wouldn’t it be in the bank’s best interest to just let them default on it and collect the full amount from CMHC?”
I don’t think that’ll happen either, actually. I think the feds will keep interest rates low to avoid defaults that would require either securitizing CHMC debt (more likely) or bank asset writedowns (vanishingly unlikely).
If they do manage to pull that trick off, then our current bubble will unwind rather slowly and trying to time a market crash is a fool’s game.
If not, well, a 40-60% decline in real estate prices over a couple years is probably a reasonable expectation. The followon shocks from that will be … significant.
That’s interesting data about Japan. I have to stew on that a bit. One key difference is that the private banks bore the brunt of the defaults in Japan. In Canada it would ultimately be the government, since CHMC actually only has a very small percentage of reserves in the case of defaults.
So if housing starts to tank, ultimately the tax payers are going to pay for it instead of the private sector, which could compound the problems.
“Our Government knows it couldn’t cover widespread defaults on mortgages”
Oh, I’m pretty sure that if necessary it’ll just create money out of thin air for CMHC reserves, and everybody will do their best to politely go along with that fiction as long as possible rather than face the consequences of the 40-60% price decline I mention above which is necessary to restore wage/price ratios to historical norms.
After all, it’s not as if they have anywhere better to put their money…
“After all, it’s not as if they have anywhere better to put their money…”
That’s true. In places like Vancouver, you’d need an even larger drop. Right now housing is about 9x the average income, and affordability is defined as approximately 3 historically. So you’re looking at more like a 65% drop to get back on track.
“So if housing starts to tank, ultimately the tax payers are going to pay for it instead of the private sector,”
That much is as 100% guaranteed as guaranteed gets, yes.
“which could compound the problems”
Only if securitizing CMHC debt (ie, “creating money out of thin air”) reaches a level to call sovereign default into question. That seems unlikely to me. Continuing low interest rates leading to exchange rate erosion seems more plausible. And given the alternatives, pretty much the best we can hope for.
Demographics could have a large role in keeping the Vancouver market somewhat stable.
It’d be interesting to see what percentage of home owners in Vancouver have little or no mortgage left considering many bought 20+ years ago.
If a good majority of home owners simply stay put as real estate prices correct due to higher interest rates, it could lead to supply shortages. This is because the number of Gen X and gen Y’ers beginning to seek more room to raise families could potentially outnumber the available supply of homes on the market. This could have a short term stabilizing effect.
Sorry for the formatting. It’s hard to navigate this little box on my iPad
I guess we’ll see. I suspect a lot of homeowners have their mortgages paid off, but I wouldn’t be surprised if the majority don’t. Unless you essentially inherited a house in Vancouver years ago, housing prices have been pretty unaffordable in most areas for a very long time. Given the nature of the speculative markets these last few years and the availability of cheap credit, I suspect many people opted for bigger and better. I’m going to hunt around and see if I can find out for sure.
The average amount down on a mortgage these days is 6%, and the most popular amortization is 35 years. I don’t think staying put is going to be an option for a lot of people in Vancouver, many of which have debt loads of around 60% of their income. As interest rates rise, many will be forced into cheaper accommodations due to debt burden, and to sell at a loss and rent.
It’s hard to say with any certainty exactly what will happen.
Averages are a funny thing though. If you take all of the service based and lower paying jobs and average them out with the higher paying jobs, you end up with a lower number.
Most of the people that skew the average down are likely not home owners and are renting.
I know it’s a small sample, but I can think of at least 20 people I know personally that own homes in Metro Vancouver. I’m pretty certain that most of them make a family combined income of over $100k, with the upper income earners making over $400k
These are not rich people, but they live comfortably and within their means for the most part(save for kids college, invest in RRSP’s etc). Several have wives in Nursing that also run consulting businesses on the side.
There are many hidden gems and self employed people in Vancouver that go under the
radar yet pull in handsome incomes.
I think I’m going to write a new WordPress plugin just to fix all your formatting problems!
Not to mention our multi billion dollar “underground” agriculture industry. 🙂
I’ve got to stop typing with my fists! Square peg, round hole. Can’t get used to typing on the iPad!
I can’t find anything conclusive, but two different people said about 1 in 3 people own their homes outright in Vancouver, the rest have mortgages.