What it means

On Wednesday the Bank of Canada won’t raise rates. But it will set the scene for an increase. That comes in 2022. Maybe next month, some believe. More likely April, others say. The tightening cycle, most agree, will contain six to eight bumps over maybe 20 or 24 months. What is now 0.25% will end up being closer to 2.50%.

Here’s what it means.

For investors, stocks will react negatively to higher rates. They always do. But they always get over it. Already the markets have absorbed the end of our CB’s bond-buying blitz as well as the news the Fed will soon start to taper.

Higher rates come because of inflation, which results from an economy growing so fast that demand outstrips supply. Look at the jobs numbers. We created over 150,000 new positions last month and still the business community is screaming for help. This is the essence of inflation, now approaching 5% for the first time since I could do one-handed pushups with Dorothy on my back (ask her).

In short, stocks feed on growth and expansion and profits. Higher rates are just the price to be paid for that. Markets are look headed for new record highs in 2022, regardless of what the CB does.

For investors with B&D portfolios (the correct kind) higher rates are no issue. Having a healthy weighting of rate reset preferreds mean a benefit when the cost of money rises, since it increases their capital value. Plus you get a 4% dividend. Plus a tax credit. Also ensure you have some floating-rate bonds in an ETF, as well as corporates. Don’t buy VBAL or another fund with an overweight govy bond position or misery will ensue.

For borrowers, not good. Five-year mortgages have already surged far above the 1.5% available from brokers last summer. There’s more to come. Variable-rate mortgages have historically saved borrowers money, but they will tick higher with every central bank increase. If you want stability, lock in.

Ditto for LOCs. Most lines of credit, secured by real estate or not, are variable-rate demand loans tied to the chartered bank prime rate. Prime will increase over time as the Bank of Canada moves, and could be close to 4.5% by this time in 2023. That is a huge move. On a $250,000 line interest-only payments almost double. If you borrowed to invest,  payments are deductible from taxable income. If you borrowed to reno the kitchen, well, sorry.

For savers, finally, some relief. Sort of. GIC and HISA rates will increase along with the prime, But this means guaranteed investment certificates will top out around 4% – a huge jump, but not enough to preserve purchasing power. Inflation will still nibble away at returns in a registered account and together with tax will decimate them in a non-reg situation.

For real estate, well, it’s complicated. The mortgage rate increase experienced this autumn (caused by bond market anticipation of CB moves) has already lit a fire under prospective buyers, advanced their purchasing decisions, drawn demand from the future, and given us the highest number of sales in November history.

The question is what 2022 will bring when the cheapo pre-approvals have expired and people are borrowing home loans at 3-4%. Will the market wobble and prices deflate? After all, we know all about the inverse relationship between rates and house values.

The answer depends on inventory. These days there are more buyers than houses and with the feds about to goose demand with more incentives and easier rules, conditions are unlikely to change. Once the CB starts to tighten, expect another flurry of desperate offers, then a period of consolidation. If owners start becoming sellers in the second half of 2022, cashing in their windfall gains, the chemistry will change. More supply at a time of rising finance charges will change everything.

Finally, consider this: rates will rise. They must rise. There is no other effective counter to inflation nor swelling asset values, both of which destroy the value of currency. If there is political interference from a profligate, irresponsible, debt-embracing and spendy federal government attempting to bend monetary policy, watch out.

In the next economic downturn, without tightening now, there would be no quick lever to pull in order to save us. No ability to drop rates. No way of unleashing credit to counter recession, or worse.

Then we’d be discussing off-grid cabins in NB, with cord wood and moose meat. Say, have yours yet?

About the picture: “If Cats are good to go on the blog, I feel compelled to submit Charlie, our resident serial killer,” writes the blogger known as IHCTD9. “He keeps the old farmhouse free and clear of any unwelcome furry guests. You can tell he’s all business, but still – he’s a good boss. Charlie maintains high expectations of his staff, but still melts into a puddle with a little chin scratch. You can’t keep him away from an empty cardboard box, or a pile of Christmas wrapping paper. He enjoys snacking on a wide variety of delicacies ranging from apple-pie and ice cream, to pulled pork, and Zesty Doritos. As a stray, he chose us 12 years ago, expertly working his way into the house, and into our lives. I’m glad he did.”

Blood in the streets

You will hear more about this.

Forty-seven years ago, out of the blue, a thunderbolt hit the Ontario real estate market. The government got fed up with rising prices. Bitching constituents. Political heat. Despite the fact five-year mortgages cost 10.9%, house prices were ramping. In Toronto the average property sale price was just over $50,000. It was an outrage.

So in Ontario the Conservative-dominated legislature announced a speculation tax. Bang. Just like that on the 9th of April. Flippers would have to send 50% of their gain to the government. Here is what the 30-page document – which chilled the housing market for 11 years – looked like.

It’s in the news again this week as a Toronto councilor vows to push the province into a repetition of history. This time the average local property sells for $1.1 million and households earn $110,000 (before taxes). So in 1974 politicians sprang into action when it cost four times income to buy property, but in 2021 there’s been no tax action at 10 times. Meanwhile the decades-long collapse in interest rates has resulted in 2% mortgages and more than a trillion new dollars in home loan debt.

Here’s an interesting statement offered by prominent real estate lawyer Bob Aaron when the CBC spoke with him about that day four decades ago:

“That was April 9, 1974 — the worst day of my career,” said Aaron, who remembers fielding endless calls the next day. They were from buyers trying to get out of purchases and from sellers wanting to make sure the deals were still going through. “There were years of litigation after that. There was … blood in the streets when people saw the equity in their home was just evaporating overnight.”

Why has the housing market not been hammered back into reality by politicians in this new decade, when valuations have blown past every measure of affordability?

You know. They know. We all know. Residential real estate is an investment class now, not a place to live. The financialization was made complete when the feds allowed 5% down payments, let people use RSP money to buy properties, backstopped the banks and oversaw the drop in mortgage prices to 1.99%. That’s when the fiction really took hold that everybody could and should own, and houses always go up. A corollary to that was, ‘the government will never let rates rise,’ plus ‘they’ll do everything they can to keep the party going.’

The result: in 1974 real estate was 2% of the economy. Now it’s about 20%. During the 2008-9 credit crisis and again during Covid, interest rates were allowed to plunge and borrowing was encouraged as part of the economic recovery. In essence, politicians were offloading risk in order to leverage homebuyers. And people took the bait.

The psychological result is that we’re now a nation fully invested in the meme that a house, and only a house, is the sole way the common man (sorry, person) can profit and survive. Housing, we’re told, is a human right. And so governments – right up to the election campaign three months ago – pushed the agenda of properties-for-all. Thus we are about to get the FHSA, an enhanced shared equity mortgage plan, a rent-to-own scheme, a fatter newbie tax credit to pay closing costs, billions more for new units and a 25% spike in the taxpayer-insured debt limit (to $1.25 million).

In the US, same thing. The lessons of houses-for-all policies pursued by Clinton and Bush, which resulted in the 2006 real estate crash plus the 2008 credit crisis and Wall Street bank failures, have been lost. The Biden administration has committed itself to this: “through our regulated entities it is our duty to ensure that all Americans have equal access to safe, decent and affordable housing.”

Does that sound like a right?

In Canada, the Liberal government won office largely on this commitment: “Homes for everyone. As a country, we need to support Canadians in their goal of becoming homeowners. That’s why our Liberal plan will help renters become owners, help young Canadians afford a down payment faster, and help them reduce the closing costs that come with purchasing a home. By helping our young people unlock homeownership, we will grow the middle class and keep moving Canada forward for everyone.”

Here’s the vid:

But is any of this realistic? Should everyone get a house, regardless of their income, assets or financial stability? Policies pursued so far have made homes cost at least 10 times more than people earn, catapulted housing debt to over $1 trillion and launched millions of households on a one-horse investment strategy. Just imagine if what happened in 2006 in the United States were to occur here. Prices went down 32% nationally and in certain areas by 70%. It was an utter disaster – all in the cause of boosting the home ownership rate.

Meanwhile, did you hear about the new listing in Toronto? A strip of land 8 inches wide. Yeah, inches. The asking price is the same as for a complete home on the day the land spec tax hit Ontario. Forty-nine thousand nine hundred.

If you can’t see what’s coming, you will wear it.

About the picture: “Garth, here is little YoYo, the American Cocker Spaniel, enjoying the first real bit of snow here in Ottawa, all he needs now is a cat or squirrel or a ball to chase to make his day. We are enjoying every day with our B&D portfolio, glad that we planned to be financially ok in our “older years”, thanks for all you do to help all of us so that we don’t have to survive on cat food, especially little YoYo!”