Entries from December 2015 ↓

Coming to an end

SOLAR modified

For reasons as yet unclear, an unruly pack of moist Millennials was spotted attacking this pathetically defenseless blog yesterday. When they were finally chased off by Bandit and several aroused Amazons, we found this spray-painted on an inside wall:

Interest rates will remain low for a generation. Boomers will be made to pay for all the unfair advantages, and so will their estates. They have sucked way more than their fair share out of society through transfers, health care and preferential tax treatment. The last thirty years of excess privilege for this boomer generation is coming to an end. The gold will all be pulled out of your teeth before you are laid to rest, be assured. Finally. And if the boomers don’t like it? LOL!!

Hooligans. But is there any validity to it? Seems every single person born since 1985 believes the cost of money will never increase. That mortgages will stay below 3%, and ‘the government’ won’t allow more since everybody’d be screwed. Besides, the pre-pubes add, we now have a new-gen PM who’s so technologically advanced he can selfie on any device, will soon give the masses weed, understands the rich must be eaten and that rates shall never rise.

No doubt about it. The kids are brash since T2 ascended. The laws of economics no longer apply to Canada. They can borrow and spend with impunity. It’s the wrinklies who will end up mashed.

If rates stay low ‘for a generation’ and the moist ones keep buying condos and slanty semis, they figure real estate will endlessly rise, building equity while you text. Thus, they’ll inevitably get wealthy by borrowing and not by saving. Equity will increase and debt diminish, all on its own. Don’t believe it? The leader of our nation does. “The deficit will take care of itself,” he famously said. So there. Suck it up, geezers.

But what if it turns out the Hot One’s wrong? After all, the pressure for higher rates is bound to come from the south, not from Ottawa. As the US increases the cost of money, bond markets follow and higher mortgages are not far behind. The federal government doesn’t control bond yields, and it might not matter that much what the Bank of Canada does.

But let’s say mortgages climbed moderately over the next 13 months, rising 1.2% by January of 2017. What might we expect as a result?

“Over the weekend we plugged those numbers into our model for Canada’s current housing sales chain,” says analyst Ross Kay, “to see what consequence these mortgage rates will have on Canada’s housing market. Of course while first time buyers will have no choice other than simply choosing to pay less for that first time home, the fallout further up the sales chain is massive.”

Kay looked at homeowners in the ‘mature’ stage who, after years and years of mortgage payments, have at least 75% equity. The rise in overall interest costs by a little over one per cent, he estimates, would rob most people of 12% of the value of their home – about $100,000 in a city like Toronto.

“That 12% will be removed from the 75% equity position many of them currently sit at.  This means their net worth would drop around 16% as a result of only a 1.25% increase in bond rates, as each trade in the sales chain has a cumulative negative impact as rates rise versus the cumulative positive impact as rates fell. When interest rates drop those homes higher up on the (mistakenly called) “property ladder”, lose the most money.  That is money they are relying upon for retirement.”

Well, is Kay delusional with this crazy talk about more than a 1% jump? Here are some expert opinions:

First, the most optimistic view, which comes from the BC Real Estate Association. Here’s what it said about rates as the US Fed jacked higher for the first time in a decade this month:

“While the benchmark qualifying rate for Canadian mortgages has not changed in eight months, offered or discounted mortgage rates at banks and other lenders have recently moved higher. The average 5-year rate offered by lenders has increased about 20 basis points in recent weeks to 2.79% and the discount from prime lending rates on variable rate mortgages has narrowed from 60 to 40 basis points. Rather than reflecting changes in underlying economic factors, these increases are largely due to regulatory and other market structure changes that are pushing banks’ cost of capital higher.”

The realtors say by the end of 2016 a five-year mortgage will be 5.11%, based on US rates rising all this year by only half of one per cent.

Forbes disagrees. The US publication says the Fed will increase rates steadily, but prudently, for two years – “about one and one-half percentage points per year” in both 2016 and 2017. “The Fed has pushed rates up or down at the rate of three percentage points per year in the past, so expect a milder rate of change this cycle.”

That means, says Forbes, that in two years (the end of 2017) the Fed rate will be 3.25%. Today it’s 0.5%. So you do that math.

Trading Economics, an online US resource, is banking on a further .75% increase to happen in 2016, and for the Fed to keep on trucking for the next four years. “The United States Fed Funds Rate is projected to trend around 4.5% in 2020, according to our econometric models,” it says. That, kids, would see you renewing a five-year mortgage taken today at a rate you only hallucinated about (while toking).

And what does the Fed itself say? Here’s the Bloomberg report from just after the central bank announced the end of its zero-rate policy:

“The Federal Open Market Committee unanimously voted to set the new target range for the federal funds rate at 0.25% to 0.5%, up from zero to 0.25%. Policy makers separately forecast an appropriate rate of 1.375% at the end of 2016, the same as September, implying four quarter-point increases in the target range next year, based on the median number from 17 officials.”

Four quarter-point hikes is actually about what Ross Kay plugged into his gee-whiz forecasting machine to come up with that 12% decline in housing prices. So, if you’re a Millennial with 7% equity in your sexy, expensive condo, maybe you should write your hip Lib MP.

Good luck with that. (LOL.)

All they want

MILK modified

She had a little trouble fitting under the edge of the table. So, when are you due, I asked? And Tracy said, “early March.” Beside her Alvin looked proud, but there was a soupcon of terror when she added this would be the second of “at least three.”

Then I learn they bought a townhouse seven months ago, paying a little less than six – cheap, but expected for a ‘developing’ part of town. It’s small, though, no yard, tough hood. Now they want a detached on a better street for a growing family, and have no illusions what that’ll cost. A mill. Alvin makes one-ten, Tracy makes babies. They have $125,000 equity in their current home. And, I probe, what else do you have?

That turns out to be five thousand dollars, in a savings account. So, in their mid-thirties, I judge them to be financial illiterates. You must realize, I say, you’re going over a cliff?

They don’t. The reason they’re talking to a financial guy the day before Christmas is so I can make it all work for them. Like Jesus. Loaves and fishes. Besides, [email protected] told them that with Alvin’s salary they can borrow at least $600,000. Add in the existing equity, and maybe a loan from the Bank of Mom, and how hard can it be to get what they really want? In fact, that’s all they want. Three babies who will need college degrees and no pension plans between them, be damned. That house, it’s an obsession.

As you might imagine, T&A left disappointed. They probably hate me. And all I did was call them myopic, irresponsible fools who need to get real, budget and live within their means. Imagine.

But these two aren’t unusual. It looks like 2016 has the potential to make everyone understand how many couples around us are on the verge of blowing up. The overwhelming reason is cheap money. As reported days ago, the number of households with debt levels equal to 500% of what they earn has increased from just 3% in 1999 to 11% in 2012, and likely 15% today. That means between 500,000 and almost a million more people are on the edge.

A study by CD Howe tells us more about who they are: they generally earn less that the average; they’re younger; and they live in Vancouver or Toronto. Oh yeah, and never forget that in Canada 20% of all folks with mortgages have less than $5,000 in financial assets to deal with any curves life might throw at them. One in ten, unbelievably, have only about a thousand bucks – even though they may “own” a house worth hundreds of thousands, and a fat mortgage.

Here’s the problem.

First, our resource-based economy is in piteous shape, as evidenced by the price of oil, the performance of the Toronto stock market, the dollar and household finances. Second, we’ve developed a culture of house lust and a one-asset investment strategy, layered over a deep financial illiteracy. In other words, hundreds of thousands of happy people (like Alvin and Tracy) have no idea how screwed they are. Third, the Bank of Canada should be taking away the punch bowl, but can’t. Our floundering economy makes it all but impossible (at least immediately) to follow the Fed lead and end emergency interest rates. Fourth, the T2 government just got elected telling people without money they’ll see lower taxes financed by the rich, and everything will be cool. Plus they get weed.

The feds know this. It’s why down payments were increased on a graduated basis, starting in seven weeks. That move to 10% down over the half-million mark was intended to shield weakening markets (like Winnipeg or Saskatoon) along with most first-time buyers, while putting some brakes on epic debt-snorfling. Likely it won’t be enough. Especially if the Bank of Canada does what many expect, and cuts rates once in 2016 to stave off an oil-induced recession.

A reasonable conclusion is that the year will bring at least one more round of credit tightening by Ottawa, which will coincide with rising fixed-term mortgage rates, despite the central bank holding the line or even reducing its own rate a quarter point. Expect the first T2 budget to be a mother of a deficit-creator as the Hot One’s cabinet tries to spend its way out of a deepening economic morass. This will also mean new taxes – including a war on personal incorporations and more HST.

Meanwhile, understand there are legions of Alvins-and-Tracys working with you, living beside you, in your employ or part of your town. The share of households under age 35 with 300% debt ratios has swollen by a third. The average family with a mortgage in BC has 375% more debt than income. Retired people have never before had this much debt, and half of mortgaged Canadians say they’d struggle to make higher payments.

And yet the house-humpers in YVR and the GTA say 2016 will be another year of heroic gains. Borrow and be free.

No wonder the kids dis me.