Entries from May 2012 ↓

Why I do it

Why do I often run pictures of scantily-clad bodies, suggestive mammals and people who can’t help being dorky humans? Other than needing help? It’s my love of metaphors, of course, and all this hormonal stuff is meant to embody and portray our profoundly unhealthy love of stuff. This is the most consumptive and entitled society ever. The massive debt I touched upon yesterday proves it. We’re just too horny to quit.

Ask Larry MacDonald. He writes for Canadian Business magazine, is a homeowner, and apparently hates me. We housing permabears who warn of a real estate correction, he says, are dangerous, since this very blog could destroy his net worth.

“Actually, I do have a fear of Armageddon,” MacDonald writes. “Namely based on the risk that the thicket of gloomy blog posts/tweets eventually whip up homeowner anxieties enough to precipitate waves of selling in a self-fulfilling prophecy. Moreover, the risk of such an outcome could be climbing with the mainstream media picking up on the theme.

“As a homeowner, I admit not only to a vested interest, but also to wishing the perma-bears would just go back, frankly, to their lairs for a really long nap. Their proclamations substantially risk devaluating a major asset of mine. Furthermore, if Canadian housing were to crash similar to what occurred in the U.S., there will be a rather traumatic impact on the Canadian economy and all our living standards.”

Well there ya go. That was easy. Stop writing about the risks of inflated houses, extreme leverage, subprime bankers, endless mortgages and house lust, and everything will be cool. Anxieties quell, the media goes back to sleep and prices can up forever.

I’m hearing this a lot lately. Hardly anybody talks about solid fundamentals supporting real estate valuations in Canada, because there aren’t any. The economy’s crawling. Commodity prices have swooned. The feds are back into major budget deficits. Household incomes have fallen behind inflation. Our demographics suck. And even with cheapo mortgage rates, affordability has plunged in the last few years.

Days ago I shared with you RBC’s latest survey showing the average bung in Toronto (with a whopping 25% down) takes almost three-quarters of a family’s after-tax income to carry, while the same house in Vancouver requires 111% of what the average household takes home. If this is normal in Larry MacDonald’s world, I don’t want to move there. And blaming guys like me for telling people they’re idiots doesn’t alter the fact they are.

So, of course, house prices will fall most everywhere, as they are now in amusing places like BC. It’s why a small but growing number of people are getting ready, instead of moaning. By selling now at or near the frothy top, finding that personal greater fool, they’re making paper equity real. This achieves three goals. They dodge risk. They diversify. And all that equity can spin off income, whether it’s to help pay rent or go long and finance retirement.

As I keep saying, two groups are most in danger. The virgins with little, if any, skin in the game, and the wrinkly Boomers with too much. The first will get swept away with even a modest correction, ending up with big debt and an illiquid condo. The second, house-rich and money-poor, will find that plan of selling the house to pay for retirement could fizzle fast and end up yielding a fraction of what they were planning on.

Some people counter by arguing that the world’s just too scary to have money anywhere but in a house. Europeans are revolting. Markets are volatile. Savings pay nothing. Stocks are death traps. And who the hell can understand the bond market? A column in the Globe and Mail this week even answered the question of where to put money from selling a house with this answer: high-yield savings accounts.

See what I mean? Most people are doomed. It’s why Canadian bank profits are up smartly – fat mortgage lending portfolios on one hand, and billions stuck in savings accounts, GICs and TFSAs stuffed with cash. I suspect a lot of people know in their gut that housing values are unsustainable, but lack basic knowledge of what to do with liquidity if they get out.

They have no idea savings in the bank paying 1% (at the highest tax rate) can earn 5% from the same bank in its stable preferred shares (at the lowest tax rate). Or how real estate investment trusts turn commercial rents into cash flow, non-correlated to the stock market. Or that a boring and conservative balanced portfolio with 60% fixed income returned 6.6% annualized over the past eight years – which included the global financial meltdown. In fact, I doubt nine in ten of your relatives even know what ‘fixed income’ means. Try it. You’ll see.

This is why I do it. I don’t quit. There is nothing right or responsible about confirming people’s prejudices, bad information or hormonal urges. Real estate is a cult, and needs to be seen for what it is – shelter. It’s not a financial plan. It’s definitely no retirement strategy. The sooner you learn that, the better your odds of having a great life and coming back as a primate.

Then horny works.

Guess what?

Do you have a HELOC? Millions do. In fact one of every two dollars Canadians borrowed last year came as part of a home equity line of credit.

No wonder. These things turn your house into a bank. After most people (well, 70% of them) decided to stuff big amounts of their net worth into real estate, this was the next logical thing to happen. HELOC horniness. If you toil in a Home Depot, make granite or cement countertops or import Japanese toilets that squirt hot water on parts of your body you’ve never met, you should worship these suckers. But maybe not for long.

The reason? F and the peckerettes are at it again.

HELOCs scare these guys. They’re terrified you can walk into any bank and walk out with a secured line of credit representing up to 80% of the value of your home, and get it at prime – currently just 3%. This means every time house prices go up, there’s another little pot of paper equity which can be turned into real cash with a HELOC. There’s that new kitchen. The deck with a hot tub which can hold up to eight full-sized Amazons. The media room with speakers that melt heads.

And this is exactly what people have been doing – borrowing their buns off.

HELOCs have exploded 170% in the last decade, and the big banks now have almost $190 billion in outstanding home equity lines of credit on their books. It’s a massive part of the debt binge we keep hearing about, mostly because they’re so easy to get and cheap to own. HELOCs, you see, are not amortized – there is no decades-long term for interest calculation on which blended payments are based.

In fact, you can make interest-only payments for as long as you want, which means the cost of a $200,000 HELOC is a mere $500 a month. And if you use the money for a really smart investment, like buying a condo on which you will lose money every month, the interest is even tax-deductible.

In fact, home equity lines of credit have played a major role in setting us up for the coming condo implosion. This is exactly where an army of investment geniuses are getting the 20% they need to make Brad Lamb throb. After all, I hear you can buy a condo in downtown Toronto with $59,000 down and make 282% on your money! Hey, hon, let’s get three!

Enter the peckerettes.

Weeks ago the bank cop, OSFI, floated the idea that letting people drain off 80% of their equity to rack up more debt was  insane. With real estate values at historic highs and mortgages at generational lows, the risk of a market correction was obvious. And look what similar behaviour brought in the United States. When people started ‘spending the equity’ that a crazy rising housing market brought by turning their homes into ATMs, well, it was time to stick a fork in. The middle class was done.

Now it looks like the feds will be acting. Soon the maximum amount people will be able to suck out with a HELOC will be 65%, and those folks with an outstanding loan for a higher LTV (loan-to-value) amount might be forced to amortize them.

This has brought howls of anguish from mortgage brokers. This comment was published in the evil trade mag, Canadian Mortgage Trends:

“Wow !! I’m flabbergasted at these knee jerk reactions of the federal government and the OSFI that are forced upon the banks. I honestly don’t think that Flaherty and his ¨Thinktank¨ in Ottawa have fully assessed the ramifications of these regulation changes. Most Canadians are in a ¨House rich, cash poor¨ situation. Where will people get their cash to pay for :renos, tuition, investments ?? If the govt doesn’t want a major part of the Canadian population to become a burden of the state in their old days, they shouldn’t cut off the valve on one of the few remaining cashable assets that Canadians have !!”

Will this have an impact? Probably so. After all, 15% of $183 billion in outstanding HELOCs is $27 billion, which represents one hell of a lot of vibrating Japanese toilets. And this home equity thing is just one aspect of the new OSFI regime. As I have been warning you since March, if the full reforms come into play, borrowers will face far more scrutiny about their personal finances, properties will be appraised more conservatively, homeowners will have to requalify for mortgage renewals and banks will be banned from handing out down payments.

See what a mess we’ve gotten ourselves into? I just wrote a whole damn post about equity lines of credit.

I am so ashamed.