It's Just A Matter Of Time

Canada could be headed for a housing and mortgage meltdown similar to the one that has devasted the U.S. economy, Merrill Lynch warned Wednesday.

Canadian households are more financially overextended than their counterparts in the United States or Britain, a report issued by Merrill Lynch Canada economists David Wolf and Carolyn Kwan says.

So it's revealed that Canadian home owners have more debt than their US or British peers. How comforting.

“What worries us is that Canadian households have been running a larger financial deficit than households in either the U.S. or the U.K.,” the Merrill report says. “... After 40 years of net saving, Canadian households moved into sustained deficit in 2002. In 2007, household net borrowing amounted to 6.3 per cent of disposable income, a wider deficit than in the U.K. and not far off the peak U.S. shortfall seen in 2005.”

But yet many still believe we are different.

To read David Wolf's full report, "The Tipping Point," click here.

Update:
Perhaps the Merrill Lynch report has ruffled a few feathers among other economists (are they speculators themselves?).

The nature of the decline in Canada is much different than that of the
U.S., said Benjamin Tal, senior economist at CIBC World Markets Inc.

"You need a trigger for a crash in the housing market. In 1989 to
1990, the trigger was double-digit interest rates that killed affordability in
Canada. In the U.S., the trigger was subprime, and a huge increase in default
rates when people who were not supposed to be in the business of owning a house
did, and that created artificial demand," he said. "Unless Canada goes into a
major economic recession ... I'm missing that trigger."

Let me do your job for you.

Falling house prices. That is the trigger. It's simple.

40 year mortgages, 0 downpayment, etc...all these new mortgage products introduced by the CHMC over the last two years force-fed false affordability on unsuspecting home buyers. These are the same home buyers that would not even qualify for a traditional 25 yr amortization period. People who have no business buying houses bought during the last two years. Just talk to my single hairdresser who owns 3 properties. A significant majority of homes bought in the last two years were bought with 40 year mortgages. Once can argue that affordability is now worse in 2008 than it was back in the 1990s as now the principle amounts of mortgages are astronomical.

In the US, the trigger was not subprime. Subprime would have never been an issue if house prices continued to rise or remained static. Those who were overextended once the teaser rates adjusted to higher rates could easily escape by either selling their property or refinancing their mortgage. When house prices fell in the US, those home buyers with subprime mortgages were trapped. They couldn't sell because there were no buyers. And they could no longer refinance their mortgages because their property was losing significant value. The only option was to default.

The same scenario is occurring in Calgary and other cities across Canada. Houses aren't selling under similar principles. I fear that sellers are unwilling to lower their prices because they will take a big loss. Intelligent buyers, are exercising their patience on the sidelines. Meanwhile, home prices which have risen exponentially over the last two years are starting to come crashing back down. Soon many Canadians will be in the same trap. Severely upside down on their mortgage they will be forced to either sell or refinance their mortgage. Both of which cannot be accomplished when asset values are decreasing. Skyrocketing inventory is a symptom and precursor of what is to come.

Reality check, as house prices slide in every major Canadian city - real estate is still unaffordable to the average wage earner. These include important people such as teachers, firefighters, nurses etc.

Even if our own meltdown is a fraction of what happened in the US, it will still have a significant impact on our own economy. Perhaps an in-house grown recession (pun intended).

To simply ignore all the warning signs and to discount what is happening in the US is complete ignorance.

Alberta Retail Sales Fall

Alberta was the only province in the country in July to see year-over-year retail sales
drop into negative territory, according to data released Monday by Statistics Canada.

The federal agency said retail sales in this province declined by 0.9 per cent from July 2007 to July 2008 while at the national level retail sales have increased by 4.9 per cent.

[Insert record scratching sound here]

Alberta leads the nation in real estate price declines and now in retail activity. In consideration to the economic decline of the manufacturing sector in Eastern Canada, this simply shows that the "solid economic fundamentals" may not be solid afterall.

"Using the year-over-year level of sales alone, it would be tempting to
conclude that Alberta has the weakest economy in the country," said Hirsch. "It
was the only province where sales in July were lower than last year.

"But that impression would be incorrect. Sales per person in Alberta are
still by far the highest in the country."

He said that at $1,455 per person, retail spending in the province is 34 per cent higher than the national average of $1,083. But Hirsch said even that figure has come down over the past year. In 2006, retail spending in Alberta, he said, was more than 40 per cent above the national average.

Spending more than the average Canadian should not be used to as a metric of economic health. Albertans may make more money than an average Canada. This then equates to greater spending statistics. But Alberta is an inflationary (and CPI) leader in the nation so it is all relative. Consumer confidence is vital in triggering spending in an economy. In Alberta, we are constantly reminded that we live in the most financially insulated place on Earth. With that instilled confidence, retail activity should not be faltering. Perhaps the reassuring fundamentals were exaggerated? With the current global financial crisis, consumer confidence will not return to the utopia levels of the boom years. This will hurt demand for real estate. As seen in the recent pending sales statistics, there isn't a significant push in demand. Despite the new mortgage rules coming into affect on October 15, 2008, this shift in consumer spending will further downward pressure on home prices.

One simple explanation why retail activity may be down is that Albertans no longer have disposable income after bills and other necessary expenditures. The opportunity cost of carrying a large mortgage, discretionary income becomes a scarcity.

I believe the term is being "house poor."

As house prices continue to slide, it will be interesting to see what many upside down Albertans will do when they reevaluate their financial well-being.

Uncharted Waters

Alot has happened in the world since I last blogged. Concerning the financial sector, we're witnessing a historic market meltdown on Wall Street. Many of the prominent investment banks are falling one after the other. Over the weekend, Henry Paulson (US Treasury Secretary) and Ben Bernanke (Chairman of the Board of Governors of the Federal Reserve) are putting the final touches on a $700,000,000,000+ (yes, that's what billions looks like) bailout plan to rescue Wall Street. The problem with this bailout is systemic on many levels. The bottom line is that the already cash strapped US taxpayer will be on the hook for this bailout. Where is everyone going to get the money? It will be like pouring gasoline on a huge burning fire. We are also witnessing the nationalization of the banking system and disintegration of the free market. A postponement of the inevitable which is now amplified exponentially. Keep in mind the Federal Reserve is composed of a group of private bankers! To pump money back into the system, money printing machines will run 24/7. This will only lead to one thing: hyperinflation. This will translate to a future of higher interest rates which will wipe everyone out. I just hope that the shields on the USS Alberta are at maximum capacity and will hold.

Back on the home front, Stephen Harper has called a federal election approximately one year earlier than expected. Remember that Harper is the same person who introduced Bill C-16 back in 2006. This bill was aimed to structure a 4 year time period between federal elections. Now, there is only one perception of this bold move. It is the only way he will win a majority government. But why call an election so early? Timing is crucial. Amidst a straight face, Harper knows the truth of Canada's impending economic condition. In 2009, the economic landscape of Canada will further deteriorate as we follow in the wake of the US. Despite all the current hot air pumping that Canada's fundamentals are strong, we just cannot ignore what is happening to our neighbours down south. There is no doubt we will be affected to some degree.

In Calgary, we are seeing a loosening of the social fabric. Murders, shootings and crime dominate headlines each day. Road rage is the worst I have seen in my lifetime here. Many attribute these factors to a growing city but I believe that you have recognise the increased levels of stress by living in the most expensive inflationary province in the country. The city just feels different now. Calgary continues to lead the nation in real estate price declines amidst having the oil sands in our backyard. Office vacancies in the city are also set to rise. Another condominium project has stopped construction bringing the total now to three (Gateway Midtown, Manchester Station, and Skytower). The diplomatic answer to the construction stoppage is high construction costs. But in reality, you'll find many of the buyers have walked away from their deposits not willing to gamble anymore in a dwindling housing market. There are more tough times ahead for the real estate industry. Surely, all these elements portray the sound "economic fundamentals" that have been eternally preached. I think not.

For those of the bulls remaining who believe that house prices will just plateau and not decrease sharply, don't be foolish or overly confident. Looking at past historical trends with a statistical fine tooth comb will not prepare you for what will happen in the next couple of years as the world enters into a position of financial chaos and eroding economies.

In times like these, the most favourable position is to be debt free.