Get over it

Sean and his squeeze have six university degrees between them. Investible assets total $900,000 and household income is three hundred grand. Plus two government DB pensions. And they’re so unhappy. Bitter. “We cannot find a house to raise our two children in that is commensurate with what we think we have earned,” he says.

From Victoria he wrote a 1,600-word email (six degrees, remember?). The blame for their massive misfortune is heaped somewhat upon politicians, a bit on non-citizen investors and mostly on people like me. Boomers. Wrinklies. Selfish oldsters standing between young people (who have six degrees plus needs) and what they deserve.

First, there’s fiscal irresponsibility. Boomer fault.

Young families like mine are going to be left holding the bag.  Who, exactly, is going to pay for the heart surgeries, joint replacements, chemotherapy, and expensive drugs when healthcare, the biggest expenditure amongst governments, is financed by current tax dollars?  Hint: it isn’t the person paying little tax in retirement!

Second, undeserving old people won the housing lottery. Otherwise they’d be total losers.

Canada has become a Potemkin economy where selling real estate to one another isn’t just the real national sport, it’s the basis for our economy, and where working people, whether in the trades or professional classes, are getting shafted to keep the old, who had a lifetime to prepare for retirement, living in a style they otherwise would never have access to.  The notion that your house is a retirement plan basically says you’re going to make your kids pay for your own inability to plan and make good decisions.

Finally, Sean is being screwed because his elders are selfishly sucking off his gen’s future.

I have worked hard, created value, and been successful.  If that’s not enough to warrant being able to afford a decent home, then what is?  It seems the only troubled future for real estate in this country affects those who don’t own any.  Everyone else takes on massive risk trying to get a place to live to raise their family and gets to finance the idiotic decisions of oldsters who get to live in a style they can only enjoy due to the next generation taking on massive debt.  How is this not a massive natural Ponzi scheme scheme?

Now, let’s check the latest numbers. As mentioned here a few days ago Canadians took on $17 billion in extra mortgage debt in one month, April. We owe $1.69 trillion on real estate (a trillion is a thousand times a billion). New mortgages surged 41% in the first 90 days of this year. The average amount borrowed has swelled to a record high. Sean’s right. It’s “massive risk.”

Even the lending guys agree. “Too many people are panic-buying and getting in over their heads,” says high-profile mortgage broker Rob McLister. All it would take, he says, is a 10% price correction for a lot of recent 5%-down buyers to be wiped out. “In fact, they’d owe roughly 6.3% more than their home is worth in that scenario. If they tried to sell and got their asking price (doubtful in a falling market), they’d be left with almost 11% less than they owe on their mortgage. If they didn’t have other resources to pay that difference, they couldn’t sell. It’s that simple. They’d be stuck in a home they don’t want.”

Could this occur? Of course. Any increase in interest rates would hasten it, or an economy slowdown, or a fourth Covid wave. Then, “a meaningful percentage of underwater borrowers is within the realm of possibility.”

New buyers have blindly swallowed this mounting and historic level of risk by telling themselves, ‘the government won’t let real estate fall’ with artificially low rates, 40-year mortgages or maybe even a debt jubilee. All false. We’re in a classic asset bubble which will, like every other one in history, end. In tears. Prices can certainly inflate more, but without massive gains in household income (not happening), a tumble in borrowing costs (impossible from here) or big tax cuts (ha!) the outcome is obvious. When over 90% of people cannot afford real estate at current values, it is completely irrational to expect sustained gains.

As this pathetic blog detailed last week, more and more wise owners are selling, as the myopic kids keep buying. It’s classic mania behaviour. In time the decline will arrive. Then, as in the US in 2006, housing values will fall precipitously and few will have the guts to jump in. We want what goes up and eschew what goes down. Understand human nature and you will invest with brilliance. Succumb to it, and become Sean.

Only in Canada, a rich and privileged land, would a young couple with high incomes, almost a million in savings and fat, life-long, government-sponsored pensions whine and moan about being denied and victimized. If you ever doubt we have lost our way, or poisoned our children, behold this.

About the picture: “This is Ollie, our $2,500 Covid Canine,” write Bryan and Karen. “He’s our only deviant from the plan since the madness began. Love your blog, been reading from your days in newsprint.”

Do deficits matter?

RYAN   By Guest Blogger Ryan Lewenza

I recently had a heated discussion with one of my ‘left-leaning’ good mates over whether deficits really matter. His view is that with interest rates so low we would be stupid not to take advantage of this and load up on cheap debt to support new government programs like early childcare, investments in renewables and money for those hurt by this terrible pandemic.

While I agree that our government should be helping those impacted from this downturn, I completely disagree that we should rollout new billion dollar programs and leverage our future by racking up hundreds of billions in new debt. Essentially, government can’t be all things to all people and we need to pick and choose which government programs are most needed, all the while, focusing on our out-of-control deficits, which one day could come back and bite us in the butt.

Let me explain why I believe my good friend is wrong.

First an update on where things stand with the Federal government deficit. Get your Tylenol and warm blanket out. The last estimate from the Federal government (April budget) is for last year’s deficit (fiscal 2020/21) to be an eye-popping $354 billion, give or take a few billion.

This would be $315 billion higher than the previous year when the deficit was still a very high $39 billion. Even crazier, last year’s deficit was 6x the previous record high deficit of $56 billion during the financial crisis. These are numbers no one even dreamed about before the pandemic.

The deficit is being largely driving by a massive increase in new spending as the government rolled out emergency programs to help individuals and businesses. For example, the Federal wage subsidy is estimated to cost $110 billion by the end of this year. As a result of these new programs, government spending surged by $272 billion last year to a record $634 billion. That’s how you get a record $354 billion deficit!

Last Year’s Deficit to Hit a Record-High of $354 Billion

Source: Bloomberg, Turner Investments

My issues with the government programs to deal with the fallout from Covid-19 are: 1) they were too large and generous; and 2) they were poorly structured. On the second point, it’s coming out that many large and profitable companies received the wage subsidy when they really didn’t need it. According to G&M analysis, 388 publically traded companies received more than $3.6 billion from the wage subsidy including companies like Air Canada, BCE Inc., Canadian National Railway and Suncor. These companies did nothing illegal but probably some should not have been eligible for this government handout in the first place.

The chart below speaks to my concerns over Trudeau and the Federal government’s largesse. It shows the increase in deficit from last year over 2019 as a result of all the spending from different G20 nations. You can see that Canada experienced the largest deficit increase (as a percent of GDP) over all other G20 nations as a result of our very generous support programs.

Anecdotally I’ve heard numerous stories of people turning down jobs or simply stopped looking for work since they are receiving government support. These are all examples of how these programs we’re poorly constructed and need to be changed or wound down in the coming months.

Estimated Change in Deficits Between 2019 and 2020 – Canada Tops the List!

Source: NBF Economics

As a consequence of all this spending and deficits, our total Federal government debt has doubled over the last few years to record high of $1.1 trillion. And we’re not done yet! In the April budget, the Federal Libs announced new spending of $100 billion over the next three years, including, for example, a new national daycare program to the tune of $30 billion. This new spending is over above the $272 billion already spent related to Covid-19.

Our Federal Government Debt has doubled to $1.1 Trillion

Source: Bloomberg, Turner Investments

In reviewing the April budget the government is forecasting additional deficits of $333 billion over the next five years. So let’s have some fun with numbers.

If we add the forecasted deficits of $333 billion to the current $1.1 trillion in debt outstanding, we’re looking at total Federal government debt outstanding of roughly $1.5 trillion by 2026. Here’s where it gets interesting.

Where will interest rates be in five years from now? Currently they are at record low levels around 1%, which is why my good friend is saying it’s a good time to load up on debt. The problem with this is that the debt doesn’t just magically go away. It gets ‘rolled over’ as the bonds mature at current market rates. What happens if interest rates rise from the historically low levels of 1% to 4 or 5% over the next five years? Then the interest expense on the debt will surge to $60-$75 billion per year. Last year the Canadian government incurred $20 billion of interest expenses so if rates rise materially the interest expense could easily double or triple over the next decade. The point is that the current government is gambling our future on interest rates staying low, using this to justify their out-of-control spending. If they are wrong and interest rates rise materially, then as Garth likes to say ‘we’re pooched’!

Today I tried to show what could happen if our government keeps spending money (our money by the way!) as recklessly as they are. In my opinion, we could be up ‘shits creek’ if interest rates ever normalize from the current record low levels. This is a huge gamble that Trudeau and the current government is taking and I worry deeply that this could come back and hurt us, either through significantly higher taxes or dramatically lower future government spending. Which one do you think is most likely? But hey, as Trudeau keeps parroting, he’s making ‘investments’ in Canada and our future, the problem is, they may end up being crappy ‘investments’ leaving us holding the bag in the years ahead.

The Future Cost of our Government Debt

Source: Bloomberg, Turner Investments
Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.

About the picture: Police service dog Jago was born in 2016 and served with the RCMP for four years. His handler, Cpl. Scott MacLeod, has about 10 years of experience as an RCMP police dog handler. Jago was killed in the line of duty Thursday during exchange of fire in the arrest of a fugitive in High Prairie, Alberta. He was a hero, the police service said. Jago gave his life in the protection of his partner. – Garth