Entries from July 2008 ↓

Mortgage crisis coming?

Calgary prices crash $40,000.

Ray Turchansky, Canwest News Service

Lost amid concern over United States government agencies moving in to support mortgage lenders Freddie Mac and Fannie Mae plus IndyMac Bankcorp, was a warning that Canada could soon face its own mortgage crisis.

Peter Hall, vice-president and chief economist with Export Development Canada, said in a report that in addition to U.S. housing woes, housing starts were down 56% year-over-year during May in the United Kingdom, 18% during the first quarter of the year in Spain and 17% year-over-year in May in France.

Hall noted that housing starts in Canada are “soaring on the strength of the domestic economy and a huge dollop of very sell-timed fiscal stimulus,” and that a continuing excess of housing starts over requirements means “Canada’s turn may come soon” for a housing crisis.

The report came in the wake of the Canadian government’s attempt to avoid a housing crisis by no longer insuring mortgages with less than 35-year amortization periods and less than five-per-cent down payments as of Oct. 15.

Homebuyers with less than a 20% down payment are required to have their mortgage insured through the Canada Mortgage and Housing Corporation — a Crown corporation — or a handful of private firms that have entered the mortgage insurance market.

In 2006, the government extended the maximum amortization period from 25 to 40 years, adding hundreds of thousands of dollars in interest costs. Last year, 37% of mortgages taken out were for longer than 25 years.

Soon after the Canadian changes were announced, the United States Federal Reserve Board tightened up its mortgage lending policies. As of Oct. 1, the Fed will require lenders to verify a borrower’s income in determining repayment ability, to take a lender’s ability to repay a loan from income into consideration, to establish escrow accounts for property taxes and homeowners insurance in certain cases, and basically to advertise rates and payments with clear notice if a rate is not fixed.

One reason U.S. lenders were willing to give mortgages to people with an unproven ability to make payments was that the lenders were able to package the loans with others and sell them to other institutions. Had the lenders been forced to hold the debt themselves, which is somewhat the case in Canada, lending would have been less reckless.

Rather than abating, the U.S. housing problem grows worse by the day. Resets from low-interest “teaser” rates to market rates that are higher are just now peaking, with foreclosures expected to flood the market with homes for sale early in 2009.

People unable to afford mortgage rates reset at five or six per cent never should have been allowed to take on house payments in the first place.

It was quite another thing when the Alberta government established the Heritage Fund Mortgage Interest Protection Program in 1982, to compensate homeowners for payments greater than 12.5%.

Back then, first mortgages were running at 16% to 18%, causing many families to take on second mortgages at 22%.

Things have deteriorated so badly in the U.S. that the Treasury Department will extend credit if needed to prop up Freddie Mac and Fannie Mae, two government-sponsored enterprises (GSE) that hold nearly half of all American mortgages.

The GSEs each include a debt component and an equity component, with the latter falling in value as investors sold off shares due to concern over rising mortgage defaults.

Famed U.S. commodities investor Jim Rogers called the Treasury plan an “unmitigated disaster,” saying the mortgage lenders are “basically insolvent,” and taxpayers will be left footing the bill.

At the same time, U.S. government agencies stepped in to take over IndyMac Bankcorp, after helping to bail out Bear Stearns. That leaves about 90 financial institutions — out of about 7,500 in the U.S. — on a watch list to go under.

The government intervention to save mortgage lenders was expected to boost stock markets, but the Dow Jones industrial average fell, and that deepened investor fears.

Meanwhile, portfolio manager Adrian Mastracci of Vancouver-based CKM Wealth Management offers some sound tips for homebuyers:

• Consider a condominium or townhouse as a starter home, before buying a detached house.

• Remember that in addition to the purchase price of a home, you may have legal and realtor costs, expenses for moving, renovations, furniture, repairs, maintenance, property taxes, insurance and utilities.

• Save 20% for a down payment to reduce extra fees, consider taking money from your registered retirement savings plan through the Home Buyers Plan, and forego making non-registered investments because you would need an 8.9% return to do better than paying down a 5.75% mortgage if you’re in the 35% tax bracket.

Edmonton Journal

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Too late

Downtown Toronto condos, where overbuilding has the wheels coming off – except for new buyers who can get a free Honda car thrown in when they take the plunge.

Henry Paulson is a pretty bad liar. As a gonzo Wall Street merchant banker he was respected in the private sector for his forthrightness and drive. These days he’s the US Treasury Secretary, equivalent to Ottawa’s minister of finance. He was directed by the White House to get out in front of American network TV cameras this week to deliver two messages:

(a) Everybody chill. The banking system’s sound, but…
(b) expect more banks to fail and the coming months to be scary.

If he lied better, he’d probably have skipped the second part. To his credit, he didn’t. As Paulson plainly states, the real estate market has not yet hit bottom which means the economy will continue to weaken; financial markets will continue to stress as the credit balloon deflates; and high energy prices make it all worse, harder, deeper, longer.

As many as 90 US banks will go belly up, we expect. The banking system will survive, but America will not be stronger for it. Meanwhile mortgage giants Fannie Mae and Freddie Mac are probably just months away from being taken over by Washington, which will make the real estate crisis the worst in world history.

What does this mean for us?

Good news & bad. The bad part you already suspect – our housing market will follow the same trajectory, a fact which is becoming more obvious every day, despite the attempts by companies like Royal LePage to paper it over with saccharin-soaked MLS listings. Also bad is the loss of export markets thanks to a too-high dollar and a moribund America. This means more jobs will disappear and southern Ontario cities will have their industrial guts ripped out as more families meet financial crisis. And even if oil prices decline twenty bucks a barrel, energy costs have already done a number on inflation, which means interest rates may rise before long – just in time to mess up everything a bit further.

The good news is, well, sort of good news. If the situation in the States gets impossible (banks shut for several days to prevent a run on deposits, stock trading suspended to prevent a crash, the American dollar a basket case), some people believe commodity-rich Canada could do well. One is John Riley, head of US-based Cornerstone Investment Services who thinks gold, oil and agricultural commodities could become forms of alternative currency to the Yankee greenback – giving this country a kick while American takes a beating. Sort of.

In order to profit, of course, you’d have to maintain a stake in those things, through direct ownership (gold, for example), or the stock market (energy companies, ag products, resources). What this also suggests is, you don’t want to own bank stocks, US dollar-denominated securities or a position in any of the industrial giants. Ditto for non-essential retailers like Best Buy. Wal-Mart, on the other hand, will be beating business back with a pointed stick.

While a lot of this is conjecture and postering – both by politicians and financial forecasters – the fact remains Canada and the States have been on a years-long debt binge, now crashing. We put too much money in one asset class, real estate, and most of that cash was borrowed. Some consequences have arrived, more are coming.

I just spent time chatting with a gal recently out of her job as a credit officer with one of the major Canadian banks. Her role was to approve or reject applications for residential mortgages brought to her bank by Toronto mortgage brokers. Most of them, she said, were junk. Borrowers could not prove their incomes and many had revolting credit histories. But the bank’s policy was to lend money based on the asset, not the buyer. “As a result,” she told me, shaking her head, “I was instructed to approve at least $50 million in mortgages for people I knew would not be able to pay.”

By the way, did you know Canadian banks don’t bother sending appraisers any more to inspect most of the houses they finance? They just look up the postal codes, and approve on that basis. Even when it’s no money down. So much for conservative, buttoned-down Canuck bankers. Too bad they forgot this rule: All booms end badly.

Hard to believe our federal government spent three years watching this real estate disaster unfold in slow motion to the south of us, and did nothing until one week ago. When it was too late.