The beginning…

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I just took a call from a woman in BC. She and her husband’s life savings are frozen, and may never thaw, since the money was ‘temporarily’ put by an advisor into high-quality commercial paper which is now illiquid. There are thousands more Canadians in the same boat, victims of a failed attempt by bankers to stem a disaster.

But this is not the big threat.

Canada’s major banks have already written off billions and billions of dollars as a result of bad investment decisions, the US housing collapse, a global credit crunch and a looming recession. I hear there are billions and billions of losses yet to be announced, and that this will be the biggest banking bloodbath in Canadian history.

But the threat is larger, still.

Most of the world’s banks are still carrying on their books hundreds of billions of dollars in loans, almost all based on residential mortgages and their derivatives, at 20 or 30 times their actual value. The leverage bubble that was built up during the real estate bubble which burst in the US and is wobbling in Canada, has turned toxic. It’s not about subprimes or lousy borrowers or over-inflated asset values anymore, this is now about money that actually isn’t there. Money like the retirement savings of the couple from BC.

This is the threat.

As a society we have allowed a tangible asset, real estate, to become valued far beyond its real worth. This was facilitated by easy money in the form of subprime mortgages in the US and 40-year amortizations in Canada. Rising prices meant borrowers had to finance more, and bankers were happy to do that. The average house downpayment in Canada is now just 15%, and more than half of new home buyers put down 5% or less, and take a mortgage which is four decades long.

So long as prices rise, with enough buyers to match sellers, it continues. But when houses become too unaffordable, or debt rises in price, or loans become harder to get, or when potential buyers balk and wait, then prices decline, sales fall and the value of all those sold-previously homes erodes. The thing to remember about real estate, after all, is leverage. It is no longer possible for most people to get a house without debt. They must leverage the asset in order to acquire it.

But here’s the thing about leverage. In a rising market, it amplifies your gains. In a falling one, it amplifies your losses. And with real estate, especially, the dollars involved are substantial – especially for those who got in with 15%, or 5%, or 1.5% down. (That last number is accurate for most new home buyers in my community.)

Where are we now?

• In January, sales of pre-owned homes in Canada fell 6%, or an annualized rate of more than 70%, says the Canadian Real Estate Association.
• The number of people saying they are very likely to buy a new home within the next two years has hit the lowest point in 15 years, says the Royal Bank.
• Home resales in Toronto last month crashed by 11%, says the Toronto Real Estate Board.
• The number of people trying to unload their houses has suddenly mushroomed. Listings soared to a new record in January across Canada, up 9% in a single month, says CREA.
• Meanwhile, three million families in the US now owe more on the homes than they have equity. House prices continue to collapse, and most experts think this will all go on for at least two more years.

I warned clearly last summer, and again in the autumn, that this was coming. We are on the verge of a correction in real estate values which will have implications for all. The global credit crisis which began in American residential neighbourhoods continues to fester. The Canadian financial fallout may be yet to peak. Billions more, ultimately the property of depositors and investors, will be erased. Once-valued assets will be judged nearly worthless. And everybody whose wealth became concentrated in a house will wonder how in God’s name this happened.

Trust me. You will have many to blame.

2 comments ↓

#1 Gavin Roberts on 03.06.08 at 11:23 pm

Good article Garth.
We are located in Australia and haven’t seen the efects yet.
There is still high demand for residential property and our interest rates are still rising.
Central bank rate is 7.25 and bankers have a premium above that.
Investors are happy because they currently get about 5% return with growth above 10%.
Best wishes
Gavin Roberts

#2 Ormond Beach FL Real Estate on 03.07.08 at 7:48 am

I did not realize this lending crisis affecting the real estate industry had spread to Canada and it is interesting to see how another goverment handles the situation.

I see much more tweeking as the goverment tries to correct the situation and the recession continues and general inflation has arrived.

All that said if you can afford it and have been saving to buy a home there are many great offers out there. It’s gonna take the upper middle class to pull us out of this one with home purchases and maybe vacation home purchases along with long time investors. I rather see a matching of deposit assistance for people not a zerol down option as it’s to easy to walk away. I also think they need to limit those types of loans to assure this doesn’t happen again.

Who is at fault, lenders, homebuyers, goverment not responding to economic issues years ago. Would not stopping the war for one year pull all the banks out of this mess. Enjoy your $600!