What it means

Only in Canada would a quarter-point rate increase grip the nation. It’s weird. The folks in Venezuela (inflation 2,350% this year) would laugh at us. Such first-world problems we have.

However, there’s a good reason this week’s news matters. Consider those lines of credit secured by real estate that people have binged on. We owe an historic $211 billion in HELOCS. Astonishingly (says the federal government) four in ten people are paying nothing on them. Nada. Ziltch. Another quarter pay just the interest. So, two-thirds of borrowers haven’t been reducing their debt load by a penny – even during a time when the cost of money’s been incredibly low. What a losing strategy. Everyone should have known rates would rise. Now they are.

Home equity lines float along with the prime. A quarter point increase means families will have to fund $1.6 billion more in bank charges in 2018, or try to absorb that amount of additional debt. That’s what a lousy quarter point means. When surveys show us almost half the households in Canada have less than $200 after paying the monthlies, how can this not matter?

This week realtors went into overdrive trying to minimize the impact of central bank tightening, aided and abetted by their pimps in the media. “In the near-term, it will likely mean some belt-tightening among those with variable rate mortgages and lines of credit, and with more increases expected, some consumers will be scrimping further as the year goes on,” said the country’s largest newspaper. “But the demand for housing remains so strong that the higher mortgage rates aren’t expected to have a big impact on home sales.”

We’ll see. Higher rates have pushed the benchmark five-year rate to 5.14%. The B20 stress test now requires borrowers to qualify at that rate, or their offered bank rate plus 2%, whichever is greater. Last January rates were 2%, and no stress test. So, obviously, somebody is lying to you. And it’s not this blog.

It will take time for the new reality to sink in, and be translated into changes in market supply and demand. But it seems a no-brainer listings will increase and the pool of buyers shrink as credit is restricted and tens of thousands of purchasers are shut out. More supply, Less demand. Prices fall.

Here are some interesting thoughts from the capital markets guys at brokerage Macquarie. Because Canadians have self-pickled in historic heaps of debt, they say, this cycle of rate hikes by the Bank of Canada is “far graver” than most people believe. If rates rise just one more itsy-bitsy weeny quarter point, the impact will be 65% to 80% as severe as the one that crashed Toronto real estate by 32% in the early 1990s.

Those of you old enough to recall those days may remember house prices declining year after year after year. Nobody was buying. Properties turned illiquid. Real estate was seen as a risk-laden asset after a huge price run-up in the previous decade. I sold a commercial building to a dude who ran into trouble because of the recession and couldn’t pay the financing I’d extended to him. So we swapped out two condos in a brand new building on the waterfront, cancelling his mortgage. I sat on those for six years until I could recoup the money, all the while leased for negative cash flow because rents had tumbled along with prices. Once the storm hit, it took 14 years for prices to recover.

2018 is not 1991, of course. It might be worse. Canadians have never owed so much, nor been so leveraged into real estate. Macquarie points out that 30% of the whole economy comes from selling houses or cars, which is 50% greater than in the past. “The wealth effect from rising home prices has driven nearly 40 per cent of nominal growth in gross domestic product over the past three years, about two to four times the amount experienced previously when the BoC was hiking rates. Even as this has occurred, fixed business investment and exports have struggled, limiting the ability for a virtuous domestic growth cycle to unfold. This again is in sharp contrast to similar periods in the past when these were accelerating.”

In fact, 2% of all of Canada’s GDP has come from realtor commissions alone. Yikes. Imagine all the homeless Audis that will suffer as a result.

Well, add in the stress test and Macquarie warns the effects will be exaggerated. Buyers are expected to have 17% less purchasing power, “which jumps to 23% after incorporating the rise in mortgage rates since mid-2017.” So, all things being equal, houses should cost 23% less than they were when the rates started to move – which was mid-summer.

At that time the average Toronto detached was changing hands for $1.304 million. So are we on the way to a $300,000 decline as the market reflects the changes to credit and the cost of money? If so, why would anyone buy now?

Beats me. I’ve seen this movie before.

Mr. Obvious

The bank rate may have jumped just a little Wednesday but we passed a giant milestone. It says ‘5’.

The five-year posted mortgage rate at all of the banks has now jumped the 5% mark. With this week’s CB pop the Bank of Canada’s benchmark mortgage rate will also pass the five level. Add the B20 stress test and anyone borrowing will have to qualify at a minimum of 5.14%. In reality, most will have to pass 5.5%. By the end of the year that may well be 6%. So, get ready. Obvious consequences.

“It’s like that proverbial switch being flipped,” an east-end GTA professional appraiser told me two hours after Stephen Poloz puffed the cost of money. “This market is dead. Finished. Most of the work I’m doing now is for refinancings as people just try to stay afloat – and the values they’re still putting on their places are laughable.”

Likely fallout: house sales tank for at least a few months. The Spring 2018 market will be a shocking reversal from the last rutting season. Demand will be squished not only by rising rates and tougher lending regulations but by negative market psychology. When people expect prices to be lower in four or eight weeks, they stop buying. Meanwhile listings – already beefy – will bloat.

Repeated will be a pattern most Canadians never understand: when prices rise sellers retreat, worried about buying into a rising market even when they could maximize profits. Demand outstrips supply and the bubble builds. When markets tank, sellers panic and rush to bail out, worried they won’t get a fair price. Supply overwhelms demand, forcing prices lower. Boom. Bust. We never learn.

Well, the prime rate at the corner bank is now almost 3.5%. Variable-rate mortgages just went up. So did the rate on your home-equity loan or unsecured line of credit. Ditto for business loans. To follow may be credit card rates and maybe, possibly, remotely, a little titch more on deposit returns.

Add this to the list of losers published here yesterday: all the moisters, newbies and B of Mom clients who rushed in November and December to buy real estate in order “to beat” the stress test requirements. Congratulations, kiddies! You just qualified to borrow a higher heap of debt to buy a home at a price which will be less in six months. It’s like wandering down Yonge Street or Robson leaving thousand-dollar bills in the empty coffee cup of every homeless dude outside each Starbucks – but without the social redemption. Or buying Bitcoin.

The other two big stories this week are equally impactful. Let’s hope you heeded the advice of a certain pathetic blog to shun the fabled cryptocurrency, but  maintain your equity exposure.

Bitcoin, as of martini time mid-Wednesday (it’s what we do on Bay Street), had officially shed 50% of its capitalization in a single month. Waffling at the $10,000 level, it was worth less than half the value a week before Chistmas, when billions flowed into the cryptohole, much of it borrowed on millions of hipster credit cards. Like every other speculative, herd-fuelled, vapid bubble which preceded it (tulips, dot-coms, bullion, bungalows), this was bound to wobble and crater.

But ‘digital currencies’ carry a special risk, which is the impossibility of success. As the Bank of Canada just proved again this week, CBs have an iron grip on money which is never, ever going to be broken. No alternative, non-state, unregulated, web-based Snapchatty cash will become mainstream currency. So BTC was a roulette game. Pure specking. The outcome never in question. Get out.

So if the coin’s in a bubble, then aren’t stocks doing the same? The Dow on Wednesday crashed through the 26,000 mark and has surged 5.5% in just two weeks. That’s on top of a 25% gain last year, and it’s all being called a ‘melt-up’. Which it is, probably with more to come. The drivers of the market include Trump’s yuge tax cut, romping corporate profitability and the renewed global growth which has goosed job creation, inflation and – yes – higher interest rates.

The difference between equities and Bitcoin is that stocks actually represent an ownership stake in companies making money. BTC, on the other hand,  is an investment in man buns. But, admittedly, both are propelled by emotion, greed and testosterone.

The obvious choice is stocks, but held in a broadly diversified ETF to reduce risk, and in balance with other assets (fixed income) to reduce volatility. When equities inevitably correct, the safe stuff becomes more valuable and you get to sleep at night. Which is more than can be said for cryptomaniacs or slanty-semi owners tonight.