Entries from July 2014 ↓

Too big to bail

BIG 1 modified

“I have this question,” says Dave. “With the current landscape as it stands, regardless of how we got ourselves into this mess, are we in a “too big to fail” type scenario with regards to housing?

“In other words, if interest rates start climbing, and housing starts correcting, and people start having problems maintaining these mortgages, do you think the government will have to step in with stimulus programs that ultimately reward the home owners who leveraged beyond their means?”

A fair query. After all, while US home ownership levels fade and American Millennials embrace the freedom of renting, we have seven in ten families yoked to a house. Our kids get horny over bamboo flooring and polished concrete backsplashes. This week we’ve already probed Erinomics and learned why there are 105,000 new condos being built in Toronto alone. People have $1.2 trillion in mortgages and home equity lines of credit, plus another five hundred billion in debt amassed buying crap. Job creation sucks and wages are stuck. If rates rise, we’re pooched.

So, too big to fail?

It’s a political question, not an economic one. But let’s remember the Obama administration spent more than $2 trillion trying to stem the slide of the American housing market, and failed. In the end, people lost faith in real estate, sold it off, walked away, took the hurt. It declined in value 32% nationally. Today, more than seven years later, prices are still 20% below their peak, despite a big bounce-back in major cities. Collectively, the American middle class lost $6 trillion in housing equity, and government was unable to staunch it.

This forms the foundation of what the doomers were moaning about here yesterday. They decry the structural unemployment, the widening gulf between the 1% and the rest, the food stamp numbers, the 77 million citizens with debts in collection and the fact middle-class incomes have declined by a third since the GFC. This is overwhelmingly attributable to real estate.

The Yanks made a big mistake when they let building, selling and fluffing houses account for such a big chunk of the economy. Just like we’re doing now. The recovery period’s been long and uneven. That much is obvious.

Only now are jobs coming back to the US (another 209,000 were announced this morning), with the economy kicking out robust GDP numbers and corporate profits. Consumer confidence is up and the federal deficit in decline. This is why the Fed can finally throttle back on its stimulus spending, turning off the tap that flowed $85 billion a month, seriously enhancing the wealth of those smart enough to load up on financial assets.

The fact this spigot is closing was one reason investors punted stocks and headed for the exits on Thursday. The Dow cratered more than 300 points since it’s clear the economy is ramping up, with inflation and higher interest rates to follow. Of course a default in Argentina, pesky Ruskies and dead civilians in Gaza just made things more acute. But crises flare and fade. Economies move like glaciers.

The bottom line is that real estate destroyed a good portion of the biggest middle class in the world. The US economy is clawing its way back, but for millions of families the future will never approximate the past. They’re done like dinner. The average 50-year-old American has saved only $43,000, while almost 40% of everyone has saved nothing. Eighty per cent of people over the age of 30 believe they don’t have enough to get by in the future. And they’re probably correct.

Now interest rates will go up as the government bond-buying stops because the economy as a whole is growing again. Stock investors will take money off the table and put it into fixed income, where prices are dropping and yields rising. When equities look cheap again, they’ll pile in and make another bundle, as corporations with global sales keep stacking profits.

This is the new reality for Americans. The gulf between rich and poor will spread, but it’s the gap between the wealthy and the middle that’s really opening up. Millions of families gambled their whole wad on housing going up forever, and lost. Thus, an ownership rate of almost 70% has plunged to levels unseen for two decades. Rich people, meanwhile, watch from afar. They’ve always understood diversification is salvation.

Is real estate in Canada too big to fail?

You really want to wait and find out?

The change

401-KEELE modified

Location: Keele Street & 401, Toronto

Jennie asked me how she should borrow, now that her mortgage has come up for renewal. “They’re offering 2.4% for a variable-rate,” she said, “over three years. Or I can get a fixed one for 2.96%, for five years? Whaddya think I should do?”

That was easy. Lock in, Jen, I said. In 2019 you’ll look like a flipping genius.

How defeated all those people must feel who drag their sorry, doomer bottoms here day after day to tell us Canada is just like Japan, that rates can’t go up or the country will collapse, that the US economy’s in tatters or real estate in 416 or YVR will go up forever. Nothing’s been going their way lately, and things fell apart completely on Wednesday.

For months this pathetic blog’s been telling you the American economy’s in renaissance, that rates have but one direction in which to travel, and the peak for housing prices is already in the rear view mirror. The evidence is everywhere, so you might as well get ready.

Jobs are sprouting at the rate of more than 50,000 per week in the US – a pace in place now for six months. Over a million new positions have been created in that time (while Canada added a few new drywallers and condo marketers), dropping the unemployment seriously below ours. No wonder consumer confidence has jumped. This week it hit the highest level in seven years.

House prices are still rising – 9.3% annually across the States right now – down from the torrid 13% rate of a few months ago, thanks to higher mortgage rates. But that’s a good thing, as the recovery was so rapid bidding wars have erupted in most major cities, raising bubble fears.

Corporate profits are vastly exceeding projections. They’re up about 11% so far in 2014, and to date 77% of all big S&P companies reporting quarterly earnings have trumped analysts’ expectations. More importantly, sales are also up and, as you know, it’s all kept stock market values in record territory for the entire year. The market has not had a 10% correction since 2011.

And this week came word the American economy grew by 4% in the second quarter. That’s elephantine. It blew past the most optimist economists. It proved the 2.1% decline in the first three months of the year was directly attributable to the Winter from Hell. And it made idiots of those who looked at an aberrant number and concluded the US was sliding into a depression rivaling theirs.

Of course, economic growth, rising profits, more jobs and surging consumer confidence pretty much guarantee inflation. And that means higher rates.

But don’t stop there. Let’s bring in Janet. As the most powerful woman in the world, Mrs. Yellen just about guarantees that Jennie’s decision to lock in her mortgage (she listened to me) is brilliant. Janet Yellen is the boss of the Fed, the US central bank, which has just decided for the sixth time to reduce its stimulus spending, which we affectionately know as QE.

Your will recall the doomers coming here last year to say that America could never reduce its government bond-buying program because it was hooked on printing money and would crater without it. Pshaw. Too much bullion-licking. The Fed has relentlessly and predictably trashed the stimulus program by tapering back since last December. Where they bought $85 billion a month in bonds a year ago (to lubricate the economy and keep rates low) it will now be $25 billion. By Thanksgiving it will be zero.

What does that mean? Well, this, for starters:

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Bond yields rose on the news, and will likely continue. The five-year Canada bond popped its weasely little head back above the 1.5% level, and I’d say will be about a full percentage point higher by this time next year. On the Fed news, US Treasuries reacted, with the price falling and yields rising. That makes sense. After all, demand for bonds in the US has now fallen by $65 billion a month, so why wouldn’t prices fade? And there’s more slack to come.

So here’s the deal. The US economy has been powering ahead even as government support is scaled back. Jobs are erupting, as are profits and attitudes. The Fed knows this will lead to inflationary pressures, which means there’s a 100% chance its stimulus spending will soon end entirely. The bond market smells it, and is already reacting.

Higher rates will likely throw some water on equity markets, while higher yields will knock back the prices of fixed income assets like bonds, preferreds and (by association) REITs. Finally. For a few months now, almost all financial assets have been looking expensive, so any dip would be a welcome reprieve for those with cash.

Then, in 2015, the Fed will raise its own key rate. I’ll leave you to imagine what that will bring.

Just be happy you didn’t buy a pre-construction condo.