Going under

Here’s a safe prediction for you: expect far more media stories in the coming months on people being eaten by their houses. The latest was a TV news piece in Ontario Thursday night about a woman who fears losing her home since she cannot make outrageous mortgage payments to her private lender.

Why borrow from a high-rate sub-prime mortgage broker? Because she didn’t qualify for a bank loan. B20.

Lately housing anguish and suffering is all around us. There are the Mattamay Homes Refugees who think it’s unfair they paid $1.5 million for unbuilt houses at the peak which are now worth less. They cannot close deals, they say, since their existing homes have fallen in value. The company says, tough.

Then there’s blog dog Derek, whose tale was told here, then repeated across Canada in most media outlets. Buyers who ponied up $2.25 million in a bidding war for his house last spring walked, got sued, lost and now face a $470,000 judgment, plus having surrendered their deposit. Derek told me last night he saw one of the buyers in court this week as writs were issued against their property. “We actually felt really bad for him,” D says, “as he really appeared to be a broken man. But we gave him every opportunity to just close on the house. Really would have been the smartest thing to do.”

You bet. The fools will spend half a million and have nothing to show for it. Closing would have been so much wiser, securing an asset which may eventually rise again.

But not soon. The numbers are getting worse.

New house prices in the GTA, for example, just dropped by the largest amount in eight years – since the financial crisis. A 8% year/year surge last year has turned into negative numbers now, as sale prices in February fell more than 7% year/year. The reason, Stats Can says, is a rise in mortgage rates plus B20. The real underlying reason’s even simpler: few can afford a new detached house going for $1.2 million.

The result is an 82% crash in single-family home sales from this time last year, to a level almost 80% below the 10-year average. Condos aren’t immune, despite the price surge there. Sales of new units have crashed 50% in a year, reflecting the exodus of speckers, flippers and amateur landlords who face negative cash flow.

Meanwhile, something far more sinister is happening. Families continue to siphon equity out of their houses to do things like pay existing debt. HELOC borrowing has not slowed down even as real estate sales crunch across the country. The latest stats show Canadians have withdrawn (and spent) more than $283 billion from their houses – a number which is escalating almost 8% a year.

As mentioned here before, more than four in ten of those families are not paying back their home equity loans, while a quarter make interest-only payments. Thus, the debt load continues to escalate monthly as the outstanding balances grow. It’s a disaster in the making, since most HELOCs are demand loans at variable rates. As the Bank of Canada moves higher (looks like May could bring the next increase) that $283 billion will require over $700 million in additional payments each year.

That’s a ton of money to rip out of family budgets and send to the lenders (the banks). In total, Canadians now hemorrhage about $8.5 billion a year on HELOC interest payments, or tack it onto their outstanding loans. As interest rates rise, so will the toll. And if real estate values tumble in any particular location, lenders have the absolute right to demand immediate repayment of all or a portion of the borrowing to maintain LTV (loan-to-value) ratios. Go ahead. Read the fine print on your HELOC. Inebriate yourself a little first. Or a lot.

The tales of woe have just begun and as they ripple across the MSM, spill onto FB and into Twitter, the meme will spread of just how much risk is contained in residential real estate. Don’t plan on a quick drop, followed by a rebound. Instead, a steep correction, then a lengthy melt.

Derek will look like a genius.

Fail bail

When the lights went out ten years ago, Wall Street banks folded like cheap suits. A financial crisis turned into a credit crisis that swept the world. I remember talking to the guy who managed the local grocery store in Oakville. “We’ve been told there may be no shipments next week,” he said, shocked. “Head office told us they can’t finance the loads.” So suburbanites were close to not having their Bran Flakes and organic broccoli, thanks to collaterized debt obligations and scuzzy financiers in America.

That’s the world now. A digitized, seamless, integrated interconnected web of mutual interdependence both comforting and terrifying. Money has gone virtual and the financial institutions which control those channels control our lives. If the web went down, with no electronic banking, ATMs, credit card authorizations or online shopping, you’d have to get by with the cash in your pocket.

So, how much is on you right now? How much currency do you keep at home?

Right. Screwed. And this is why no big bank can be allowed to fail. Which brings us to bail-ins, and what happened on Wednesday. Ottawa just published the final set of actions – two years in the making – that would materialize if RBC, BeeMo, Scotia, TD, CIBC or the National Bank went paws-up. That could be the result of a devastating housing collapse or a run on bank deposits caused by panicked consumers. It could be a domino effect from a global economic event. Maybe a war.

So, what would happen?

First, let’s deal with what you do not need to fear, and what some people have been trying to milk in order to line their own pockets. Here. For example, is Toronto-based gold flogger BMG Group’s scary take on what a bank bail-in would mean:

“Those at risk of a bail-in in the event of a failure are subordinated debt holders, bondholders, preferred shareholders and any accounts in excess of $100,000 not covered by CDIC insurance. Their bonds, preferred shares, deposits etc. would be converted to capital to re-capitalize the banks. According to the financial statements of the CDIC, they insured some 30% of total deposit liabilities, or $684 billion, as of April 30, 2014. The remaining 70% not insured would primarily be large depositors, including both large and small businesses, and other banks and financial institutions.”

So, says BMG, if you own bank preferreds shares (or an ETF holding them) or have more than $100,000 sitting in accounts at any one bank, your wealth could be seized by the government and turned into common shares in the bank with the money being used to help rescue that institution. Obviously the shares would be near-worthless.

And here is the almost-always spectacularly incorrect and very popular web site Zerohedge, also telling you to be scared:

Deep inside the announcement, in the section discussing “tax fairness and a strong financial sector”, we have official confirmation that Canada has just become the latest country to treat depositors as the bank creditors they are, and as such, they too will be impaired, or “bailed-in” the next time a Canadian bank needs to be rescued. This new “bail-in” regime is spun as benefitting taxpayers; what isn’t mentioned is that most of those taxpayers who will be “protected” also happen to be the impaired depositors (also known as creditors) in these soon to be bailed-in banks, which begs the question: just who or what is being protected here?

Finally, here’s Canada’s resident right-wing nutbar, Ezra Levant. In this crazed video he says the bail-in is Trudeau’s plan to steal your family’s money (actually it was Harper’s idea, but whatever…):

Now that we’ve gotten that out of the way, what is the truth?

Pretty simple. If a bank fails deposits will not be seized, even for big guys (as happened in Cyprus). No preferred shares will be forced to convert into common stock. No ETFs that own those preferreds will be impacted. You wouldn’t lose your chequing account funds, nor the money in your RRSP, TFSA or anything else [email protected] got you into. Sadly, your mortgage or HELOC would not be cancelled, either. Yes, shares in that bank would collapse on the stock market and stockholders would be Hoovered dry, but the institution would be recapitalized nonetheless.

Banks will be required to have enough capital in reserve, plus sufficient debt which is convertible into equity, to survive. If collapse happened, bank regulators would force conversion of those assets into common stock, allowing the bank to remain open and preventing any burden falling on taxpayers (that’s  called a ‘bail-out’).

So, unless you owned a high-yield bail-in bond, there’d be no impact should the earth open and swallow the CIBC. Here is how the feds see this structured:

The regulations set out key features of the regime, including that the rules would only apply to debt issued by D-SIBs (the banks) that is unsecured, tradable, transferable, and has an original term to maturity of at least 400 days. Such debt is held predominantly by foreign and domestic institutional investors, such as asset and fund managers, typically as a small portion of these investors’ overall portfolios.

The bail-in regulations do not apply to deposits, including chequing accounts, savings accounts and term deposits such as Guaranteed Investment Certificates, which will continue to benefit from the Canada Deposit Insurance Corporation deposit insurance framework. As such, deposits are not convertible under the regime.

Now, will one of our banks fail? If the answer’s ‘never’, you know where to invest.