Entries from December 2010 ↓

Five lies

Two years ago it was named the poster child of the housing crisis. Others have called it a dusty suburban wasteland. Endless rows of houses, most less than five years old, all big. If it weren’t for the relentless sun and wisps of desert dirt between homes, this could be Burbsville, Canada.

Maricopa has about 45,000 people living just outside of urban Phoenix. For Sale signs dot every block in every neighbourhood. Tumbling prices and hot, sunny days are two reasons a lot of Canadians are parking their cash here, snapping up homes like they were hi-def TV sets at Best Buy on Boxing Day. Half off, baby.

So, who cares about this loser town of subprime mortgage holders? Just about everybody, now, after the woman who will probably run for US president bought a house. Actually, it was Sarah Palin’s 20-year-old daughter who signed the papers. However speculation is the almost 4,000-square-foot McMansion will end up being a family compound.

But here’s the interesting part.

The house sold four years ago, just as the wheels were coming off the housing bubble, for $330,000 – cheap by Canadian standards for a big, new home with a three-car garage. It went into foreclosure at the beginning of 2010, and was bought by investors for $137,200 – a 60% reduction in value. They threw some paint around, and sold it to the Palin clan for $172,000.

Now wouldn’t it be interesting if the 2012 Republican presidential candidate lived in a foreclosed home that her family vultched?

In contrast, here’s Barack Obama’s house in Chicago:

He bought this in 2005, just when the Palin home in Maricopa was being built. The asking price was $1.95 million, and his third offer of $1.65 million was accepted. Actually the whole thing was controversial, since a political fundraiser of the then-senator bought the vacant lot next door (closing on the same day), then sold Obama a strip of land a few feet wide for $104,500.

All this may seem inconsequential, but it forms a social and financial backdrop to the two most important years in a few generations, which begin next week. The man-of-the-people transformational president in the mansion vs the plain-talkin’ pissed-off mama bear in the foreclosure. In many ways, the presidential election to come will be symbolized by real estate. And at this point, the granite guy is toast.

All of this is highly relevant for the Canadian housing market, jobs, and the whole constipated economy. There is no way we escape a real estate melt without an American recovery – and that’s unlikely for at least three years. As I wrote here a day or two ago, Canadians have fallen into a zombie-like repetition of the five big mistakes Americans made years ago.

We’ve pushed average home prices past the ability of average families to afford them. We’ve embraced lending standards so low people without money can buy houses. We’ve amassed historic levels of household debt. We’ve borrowed billions at sub-prime rates destined to rise. And now we’re sucking equity out of our houses to make ends meet.

These five realities make a lie of those who claim this country is populated with cautious, prudent, carrot-up-the butt, little boy scouts or buttoned-down bankers who only grant mortgages to virgins and Conservatives (quite often synonymous). In fact, why should similar actions have different outcomes?

Interestingly enough, I spoke to a career real estate agent on Boxing Day who said in his BC community home sales are down 40%, “with prices ready to follow.

“Trust me. I’ve been in this business long enough to smell the fear.”

Anyone who cannot understand that taxes and interest rates have only one direction in which to travel, pushing real estate in the other, must work for CTV. In fact, that network’s news operation turned out a piece days ago claiming 2011 “is going to be a good, balanced market,” with, at most, a one-half point increase in mortgage rates.

What most fail to understand is that while the cost of living, including home loans, will rise, this is not the fundamental reason we face an inevitable housing implosion. Oh, that was the giant threat a year ago (and the Bank of Canada did pull the trigger three times in 2010), but it’s now been replaced by debt. Families simply cannot sustain the higher debt service costs which upgrading a home involves. Higher house prices have brought with them the greatest mortgage burden in history, as the traditional down payment of 20% has shrunk by more than half for all new originations.

In other words, people who would never in their booziest, raunchy, cowboy moments buy a stock or a mutual fund with 95% financing, think they’re utterly safe in grabbing new house at its highest-ever price, with just 5% of the dough. How does this end?

Ask Sarah.

Refi

Best Buy. Home Depot. Chapters. PetSmart. Winners. Mark’s Work Wearhouse.

Drive through town on the highway. This could be any place. The big box stores loom over acres of parking and point their signs at the traffic streaming by. Most cars are new. Most houses are new. The roads, too. And the citizens.

This is one of the dozen towns and cities which hover on the fringe of the nation’s biggest and richest metropolis. From here commuter trains and buses stream into the core, while two major freeways and a toll highway clog with vehicles. You can imagine an entire town of seventy thousand having a shower, walking the dog, and then displacing each morning to somewhere else.

Young couples camped out overnight here to buy new homes. Sometimes in such numbers the cops were called to keep the queue off the road outside the sales trailer. Once in, they spent an average of 15 minutes buying an unbuilt home and arranging hundreds of thousands in financing. Few could find a new pair of jeans so fast.

This is upper middle Canada. The average house is four hundred thousand. Minivans procreate at night. The edges of town are rough and noisy as fields turn into cul-de-sacs. Everybody has cable and gas, HD TVs and a barbeque the size of a Dodge. Driving into the treeless subdivisions, you would swear it was the set of Desperate Housewives.

My lawyer lives here, and has for thirty years. Probably closes more real estate deals than anyone.

The day before Christmas I stopped by for signatures and talk. While the housing market’s still riotous, he said, another side of his business has been swelling uncontrollably. Refis.

“It’s simply incredible,” he said, putting down his half-rims and looking sage, “how many mortgage refinancing are happening. In 33 years of practice, I have never seen anything like it.”

But these refis are not to save money by remortgaging at a lower rate – after all, the cost of money will only be rising. Instead, there’s a stream of people coming into my lawyer’s office to increase the size of their home loans by adding  outstanding credit card debt.

“One guy came in last week to sign after the bank sent over the papers adding the outstanding card balance he and his wife had racked up – more than $100,000.” He had a look of co-mingled disgust and ennui. “I simply can’t believe how people are living now. Or what’s happening to this town.”

Of course, it’s not one community. It’s a thousand. Scratch a little at the thin veneer of middle classness, and out oozes a stream of debt. As you know, Canadian families now owe, on average, more than American households do –  interesting since they’re four years into a recession which has decimated personal finances. We have a trillion dollars in mortgage debt for the first time and are on the hook for $1.50 in loans for every dollar earned.

Routinely I talk to couples within ten years of retirement who have no corporate pensions, piteous levels of savings, a mortgage and (worst of all) no clue what they’re actually going to live on. Others have hundreds of thousands sitting, earning almost nothing, in the same banks whose credit cards are charging them 19% on unpaid balances. And the most common sin is committed by all those who dutifully opened TFSAs, giving them taxless gains on all their investments, but put the cash into dead savings.

No wonder Mark Carney’s flummoxed. The central bank boss has done everything but streak to try and get out the message that (a) he’ll raise interest rates in 2011, (b) this will be serious bad news for housing, and (c) anyone with piles of debt is toast. So, does that mean it makes sense to fold 19% credit card debt into a mortgage at, say, 3%?

In terms of cash flow, seems so. The move takes a big cash obligation and buries it inside real estate, bumping up the monthly by a relatively small amount. But every dollar of additional mortgage debt cancels out a dollar of equity. In addition, a simple debt is turned into an amortized one, which means you can make payments for years and repay precious little of the principal.

Most worrisome, however, is what happens if Carney’s thunder turns into lightening, torching the real estate market. A rise in mortgage rates of just 2% over the next year or so would have disastrous consequences, knocking out first-time buyers, causing renewal heartache and torpedoing house values which are now wobbling at historic highs. It’s then that those who turned equity into debt learn the consequences. The worth of your home may fall fast, but the mortgage does not.

In fact, using up home equity in a rising market was how millions of American families fell into negative equity in the crash which followed. Astonishingly, this group now includes 25% of all mortgaged homeowners – people who can’t even afford to sell their properties, since they’d need a fat cheque on closing day.

Imagine that happening in my lawyer’s town where, all day, he processes 5/35 mortgages for kids who think they deserve houses because they lined up all night.

If there’s one overriding reason we need to worry, it’s us.