Canadian Banks Want WHAT?

I'll admit, I read this and was mightily confused. The big 6 Canadian banks are lobbying the Canadian government to tighten lending standards in order to prevent a housing bubble. The big question is why?

Higher required down payments and shorter amortizations would curb housing prices by cutting the amount most Canadians could bid for a house.

Such changes would also mean smaller mortgages and lower interest payments over the life of the loan - in other words, less money for the banks.

Don't get me wrong, this would be a fantastic idea to reduce risk to borrowers by allowing them less leverage by raising down payments and shortening amortizations. After all, it's CMHC that has to insure any home purchase where there is less than a 20% down payment. These actions would reduce the risk to the government. It would also reduce the number of prospective buyers as people would actually be required to save for a down payment. This would be a catalyst for a Canadian housing price correction (among others, such as the HST, rising interest rates, etc).

But why do the banks care?

The bankers' effort is all the more notable given the unique structure of the Canadian mortgage business. Banks get the profits from mortgages with their decades of interest payments, but have little risk of direct loss because of mortgage insurance.

Consumers cover the premiums and, because most mortgage insurance is underwritten by CMHC, the federal government ultimately takes the risk.

They aren't assuming the risk, the taxpayer is. I'll propose a few potential ideas of why the banks might suggest doing this:

1) They're actually worried about the secondary impacts of a housing bubble correction, and it's impact on other types of credit (non-secured loans, lines of credit, credit cards). The article assumes this is the big driver as well:

It's not the potential of big losses on mortgages that scares banks, says Mr. Routledge of Moody's. But if there were a spike in foreclosures in Canada, as has happened in the United States, consumers would likely struggle to make payments on other loans that aren't insured, such as credit card debt. Such a situation would also likely cause a big economic slowdown.

As Canadian mortgages are recourse, homeowners can't walk, and as such people should put their payments towards their house first. Banks may be a little leery of the prospect of people defaulting on their non-secured loans in order to make their mortgage payments, which banks would have to take a significant loss on (in many cases 100%).

2) Public relations. Banks sense the coming backlash worldwide as the US and the G7 in general are proposing banking taxes. This may be a game of "look we're responsible, don't tax us". Banks may also prefer to have the government take the lead in potentially pricking this bubble (so they can take the blame), as opposed to letting (eventually) rising rates correct things.

3) Counterparty risk of CMHC. Just because we assume the banks have "no risk" in their lending models doesn't mean that's the case. It's just been transferred to CMHC. If the banks realize that CMHC isn't prepared for the coming defaults and isn't adequately capitalized, changes will come. Either the CMHC will have to raise mortgage insurance premiums, the government will have to assume CMHC's losses in the form of deficits (and tax increases), or the goverment may decide to remove CMHC's taxpayer backstop (removing the banks no-risk play). I'm sure banks don't want to see an end to their no-risk lending model, so it's in their interests if CMHC doesn't implode.

4) Falling home prices might actually increase demand for mortgages amongst credit-worthy borrowers that are currently priced out of the market by marginal high-risk borrowers.

5) Do the banks have prop trades shorting the Cdn housing market? I'm not putting my tinfoil hat on here, but let's face it, we've seen this behaviour in the US before, pimping the product you're selling, while quietly positioning yourself for the opposite.

6) They're just really nice corporations that aren't interested in their own profits.

Of the 6, I'd think 1 is the primary reason, with 3 being a reasonable concern on the longer-term, and 2 in the near-term. But if this is the case, how much exposure must the Canadian banks have in their non-secure loans to justify taking this step?

It will be interesting to see how this plays out, and yes, this is yet another catalyst for a Canadian house price correction.

Lies, Damned Lies, and Statistics

"Oh, people can come up with statistics to prove anything. 14% of people know that."
-Homer Simpson

The latest US non-farm payroll report was all over the place. It's like they have a bunch of monkeys throwing shit at a dartboard, and whatever sticks is the number they come up with. The headline number was that unemployment dropped to 9.7%, even though there were 20K job losses.

The revisions are the ridiculous part though:

The figure for November was revised higher, however, to show a gain of 64,000 jobs. That was initially reported as a gain of 4,000.

Well, you were only off by a factor of 16. Seriously...why bother reporting the initial numbers when the "revisions" are orders of magnitude larger ? Wouldn't it be simpler just to say "We don't know, it's a complete guess"? Or at least clarify your initial statement, "We think that the economy added about 4 thousand jobs, give or take a few million or so."

I also find it amusing that the G&M reported only the November upwards revision, "Good news, yay...people are happy!", without mentioning that December was revised downwards nearly double the intial estimate, from 85K job losses to 150K.

All in all, revisions between Nov. (+60K) and December (-65K) resulted in a net loss of 5000 jobs.

Here's the scary part though...

The department also revised its past employment estimates to show that job losses from the Great Recession have been much worse than previously stated. The economy has shed 8.4 million jobs since the downturn began in December, 2007, up from a previous figure of 7.2 million.

You "missed" 1.2 MILLION jobs somewhere? Whoops. You can bet your ass that if the revision was the other way and they had overblown the recession and "found" an extra 1.2M jobs, this would have been a headline, instead of a throw away comment buried in the middle of the article.

On a more amusing note:

The federal government has begun hiring workers to perform the 2010 census, which added 9,000 jobs. That process could add as many as 1.2 million jobs this year, though they will all be temporary.

Clearly they need all the help they can get based on the "numbers" they've been releasing lately. Here's a start, maybe you should start hiring people who can count. Hell, I'm sure there's plenty of unemployed Americans with stats degrees that would be thrilled to show your current crack team of monkeys how.

Canadian Moral Superiority - Stable Banks

From my previous post you might assume I place the blame for the current Canadian housing bubble solely on the consumer, the truth is far from that, however. While it's widely proclaimed that the Canadian banks make prudent lending decisions, and that's why Canada has avoided a housing collapse as in the US, I would differ on that assessment.

It takes both irresponsible borrowers AND lenders to create a bubble; after all, if borrowers are taking on too much risk by overextending themselves, it's the lender that's saddled with the added risk of missed payments or default.

Well, sort of. At least that's how borrowing and lending is supposed to work. But due to "financial innovation", banks have found miraculous ways to mitigate their risk, often by securitizing mortgages and selling the MBS to other people. Keep in mind that the risk is STILL there...but they've paid rating agencies to say that it has vanished! Cool eh? Some poor bagholder gets stuck holding these junk mortgage backed securities that get rated AAA, and they get to take the loss...and on top of that the banks get paid to securitize the mortgages.

So...who's buying all this crap? Among others, CMHC. And they're buying LOTS.

CMHC's charter supposedly is to provide Canadians with affordable mortgages, so if a borrower who would otherwise not qualify for a typical bank mortgage (requiring a 20% down payment) but who would still like to buy, can pay CMHC insurance on top of their rate.

Ask the majority of Canadians what CMHC insurance is for, and I assume at least half would get it wrong. Is this to protect the borrower because he's taking a risky mortgage due to the high amount of leverage? Hardly. It's so that if the borrower defaults, the lender can get reimbursed via CMHC. As such, the creditworthiness of the borrower is now made a bit pointless...since CMHC is covering their risk.

When I say CMHC is covering the risk, what I mean is that the federal government is covering the risk, which is ultimately backed by you and I, the Canadian taxpayer.

OK, so higher risk borrowers get stuck paying the CMHC insurance, and this is the risk premium they pay, right? Except if that was the case, why can't banks just charge higher rates to these sketchy borrowers? While it makes a lot of sense that the highest risk borrowers should pay the highest rates, in practice there's a tipping point where this will not work because the highest risk borrowers are the ones least able to afford the higher rates. As such there is a line where a bank simply won't lend to you because you're too big of a risk of default.

If banks could make money charging higher rates to these borrowers, wouldn't they? Or is it more likely that CMHC is charging insufficient rates for mortgage insurance for the risk of default that they're (or should I say we're) insuring. Is CMHC adequately capitalized? Or do banks even care about the counterparty risk since CMHC is backed by the taxpayer? If and when we start seeing price drops and mortgage defaults, we'll find out.

For a good description of the CMHC time bomb, I highly recommend Jonathan Tonge's blog post "CMHC-Canada's Breaking Point"

Over 1999-2008 Canada's charter banks increased their residential mortage credit from $241B to $469.6B, an increase of 94.9%. Over the same period CMHC MBS increased from $23.5B to $197.3B, a staggering 739.6% increase.

Are Canadian banks "prudent" lenders, or have they cleverly managed to offload all of their risk quietly onto the taxpayer, who is already saddled with enormous household debt from credit cards, car loans, and monstrous mortgages, not to mention the prospect of higher taxes (HST), and increased borrowing costs.

Are the banks to blame? Or have they simply been enabled by irresponsible politicians who are goosing the housing market through cheap credit? What happens when the Canadian housing market inevitably implodes...how much is this going to drive up deficits (and subsequently taxes)?

Is it just me, or is this post full of unanswered questions? (yes that's another one). Seriously, I'm more agitated writing this NOW than when I started. The simple answer is, "We don't have the answers yet but the questions and potential consequences scare the shit out of me." Maybe it's time some of our elected leaders (I'm using that term loosely) started asking some of the same questions before this problem detonates. Tick tock...

Canadian Moral Superiority - Prudent Homebuyers

As Canadians, we pride ourselves on not being American, at least when it suits stoking our Canadian egos (hey you don't really want to get into a pissing contest with the sole superpower unless you're going to define the rules right?).

Case in point: the perceived "stability" of the Canadian housing market. We're lead to believe by Stephen Harper, Jim Flaherty, Mark Carney, and the mainstream media in general, that the reason we haven't had a US-style housing price collapse is because we have a combination of prudent, less risky banks, and responsible borrowers.

I'd challenge that on both points.

First off, let's start with borrowers. The average Canadian house price is 337,410 CAD. The median Canadian household income before taxes is 70,800 CAD. This leaves us with the average home to gross household income ratio of 4.77. Canadian housing prices are at record levels, seeing an unprecedented 19% increase YOY in 2009, despite the fact we just escaped the largest post-war recession to date.

At the peak of the US housing bubble, median US household income was 50,000 USD, with the peak housing price being 230,200 USD. This would put the ratio at the peak of the US housing bubble at 4.60. And yes, we're still inflating our bubble, US prices have collapsed significantly, bringing affordability back into many markets in the US. Meanwhile, the Canadian market continues to ramp to infinity thanks to cheap mortgage rates, panicked buyers that actually are buying into the "buy now or buy never" mentality that's pushed by the real-estate industry, and lazy media publications that print everything that's spoon-fed to them by the CREA (or the NAR in the US).

The rule of thumb (in the US) is that a house should cost no more than 3x household income. Keep in mind, this is the rule in a country that pays generally less in taxes, can deduct the cost of their mortgage interest from income taxes, and where consumers have the option to lock into a 30 yr fixed rate mortage, whereas Canadian consumers typically lock in for 5 year terms, and then face the risk of rising rates at renewal time. In general, the cost of carrying a mortgage in Canada should be higher than that of the US (and hence, it would be prudent to borrow less).

The scary part is, the prospect of higher interest rates, and the soon to be introduced HST on housing (coming in July), is actually motivating buyers to rush out and buy before these 2 events happen! Seriously, if you buy the day before the HST hits, and then try to sell the day after, do you really think that you can sell for the same price you paid, and just assume the buyer will pony up the extra 13% in taxes...or does the seller eat the difference?

As far as rates go, I swear it might be easier to explain the theory of relativity to some buyers than try explain the inverse relationship between mortgage rates and home prices.

Are Canadian homebuyers smarter than Americans?

If some dipshit jumps off a cliff and breaks his leg when he doesn't realize the water is only 6 inches deep, you laugh and say, "Holy shit dude! You OK?", you take him to the hospital, laugh about his stupidity and shitty luck and get the poor fucker fixed up.

If some other idiot that saw what just transpired does the EXACT SAME thing less than 5 minutes later...isn't your reaction more likely to be "Holy shit! What the hell is wrong with you?", and you leave the idiot screaming in agony just to teach the stupid ass a lesson.

That's us...idiot number 2.

Spending Freezes, Obama Style

I wish I could propose a "budget" like that in my personal finances and get some idiot to fund it.

Seriously, the math is staggering. The US is projecting spending $3.72T this year and $3.83T next year. To put that in perspective, they're spending 172% of revenues this year and 150% of revenues next. It's not like they "just missed", they're not even in the same ballpark.

While we're on these figures, the deficit projection for next year, seems to assume that government revenues will increase from $2.16T to $2.56T. This is a staggering 18.5% increase in revenues. I'm not entirely sure where that is coming from. I guess they're really counting on that immediate recovery that absolutely NOBODY is projecting. Good luck with that.

Seriously, what are the Vegas odds on this "actually" occuring? I mean REALLY. The 18.5% revenue increase is about as likely to happen as pigs flying. The only way they raise revenues that much in a year is if the US military seizes it from the sheep by force. And as for the second bet, it's pointless betting on this, not so much that that the US government will choose to reign in spending, it's a matter of when the bond market will tell the US government to reign in spending.

Mr. Obama's budget offers tax cuts for businesses, including a $5,000 tax credit for hiring new workers this year, help for the unemployed and $25-billion more for cash-strapped state governments.

Really? Businesses are not going to hire people because your bribe them to. You hire people because you need them to do the job you're paying them to...or you don't hire. The only thing this tax cut will do is reduce revenues to the government by cutting taxes being paid by companies who were going to hire anyways.

The deficit for this year would surge to a record-breaking $1.56-trillion, topping last year's then-unprecedented $1.41-trillion gap, a number which had dwarfed the previous record of $454.8-billion set in 2008 under former President George W. Bush.

Congrats, not only have you tripled Dubya's (record-setting at the time) deficit, you've managed to do this 3 straight years...

The deficit in 2011 would total $1.27-trillion, the third straight trillion-dollar-plus imbalance. The deficit would fall to $828-billion in 2012 but would remain at levels surpassing any previous deficits through 2020.

...epic fail. The US is lucky they can rely on the strength of the world economy to provide them all this money to waste in their time of...WHAT? THEY need money TOO? Well, FUCK ME!

The deficit for this year would be 10.6 per cent of the total economy, a figure unmatched since the country was emerging from World War II. The administration does not trim the deficit below 3.6 per cent of GDP for any year in the next decade, failing to meet its goal of lowering the deficit to 3 per cent of GDP by 2015.

Par for the course...of course it won't come to this, because SOMETHING will force a change of course long before 2020.

Mr. Obama's new budget attempts to navigate between the opposing goals of pulling the country out of a deep recession and getting control of runaway deficits. The administration insists that once the recession is history, the government will turn its attention to attacking the deficits.

WTF. "Technically" the recession already ended with 2009 Q3 growth. So deal with the deficit! Unless they're talking about when the NEXT recession ends...

This is my favourite part of the budget though:

In a bow to worries over the soaring deficits, the administration proposed a three-year freeze on spending beginning in 2011 for many domestic government agencies. It would save $250-billion over the next decade by following the spending freeze with caps that would keep increases after 2013 from rising faster than inflation.

Military, veterans, homeland security and big benefit programs such as Social Security and Medicare would not feel the pinch. Federal support for elementary and high school education would get what the administration termed the biggest increase in history. The Pell Grant college tuition program which would see an increase of $17-billion to just under $35-billion, helping an additional 1 million students.

A 3 year spending freeze, YIPPEE! Except it doesn't apply to about 90% of their expenditures.

Following such a courageous decision, I will BOLDLY propose my own 3 year spending freeze on the following:

Feminine hygiene products, tofu, beanie babies, Miley Cyrus albums, flights to Antarctica, plutonium, pocket lint, and time machines. (Actually, fuck that, I would totally buy a time machine if I could). It'll be tough, I know. I'll have to tighten my belt, but with some strong fiscal discipline, I think I can get by.

On a minor note, over the same period, I endeavor to fly first class wherever I go, leave my car idling whenever possible (and I'm filling up with the high octane shit now), buy a new car every 1-2 months, hire a personal chef, triple my alcohol consumption, and generally apply and max out every fucking credit card I can get my hands on.

But at least I have my spending freeze in place.