Here are some of the must read articles from today:
I want to start with a theme that should get increasing media attention in the months and years ahead: The fact that the Canadian taxpayers are on the hook for potentially significant losses in the real estate portfolios of major banks. It’s been well over two years now that I have been warning of an eventual taxpayer bailout of CMHC (Canada Mortgage and Housing Corporation), or ‘Canada Moral Hazard Corporation’ as they should be known as.
I’ll delve more deeply into this in a later post, but suffice to say that the vast majority of new mortgages in the past few years have been backed by the federal government via CMHC. What that means is that the banks have an insurance policy on which to draw from in the event that people default on their mortgage and the repossessed house cannot be sold to cover the full value of the loan. That insurance policy is you! That insurance policy also extends to Canada Mortgage Bonds, which are essentially a collateralized bundle of Canadian mortgages sold off to investors in the form of a bond. You back that too!
We’ll spend lots of time looking at the ridiculous entity that is CMHC. Suffice to say that it guarantees nearly a half trillion dollars worth of residential mortgages in Canada. So what happens when a rising proportion of those mortgages begin to default? Nothing good! In fact, it will probably be down right ugly!
As an aside, every time the government steps in to guarantee anything in the world of finance, they inevitably create a moral hazard and encourage stupid and reckless behaviour. The two most glaring examples of this are CMHC in Canada (Fannie Mae, Freddie Mac in the States) and CDIC in Canada (FDIC in the states). CDIC and FDIC guarantee deposits at banking institutions, which pay a token fee for this insurance. The idea is that if the banks ever screw up and make bad decisions with their investments and consequently don’t have the reserves to actually pay you back for you deposit, the government will step in to pay you. The practice of government meddling in the banking sector is exactly what allowed the meltdown in 2008. Government guarantees encourage excessive risk taking and imprudent lending standards.
Traditionally depositors would fiercely punish imprudent business standards at banks by withdrawing their funds on mass. Since the risky bets are being made using depositor’s money, they would keep a close eye on things to ensure that nothing stupid was going on. Similarly, they would scrutinize the lending practices of an institution. If defaults began to soar, both depositors and shareholders would punish the banks. Since deposits are insured in both Canada and the US, depositors could care less what sort of stupid bets the banks make, as the government will cover their deposits should things go awry (as we saw in the US and to some extent here in Canada too).
This removes the intrinsic accountability that has existed in the banking sector since the time banks were first created. Runs on banks are a healthy and natural part of a banking system. They punishes the stupid and rewards the prudent. Since Canada insures not only deposits, but also virtually all new first time mortgages, it creates an apathy on the part of the banks, shareholders, and depositors that allow imprudent lending and risky trading to take place. Governments don’t need to guarantee anything. No one should ever be guaranteed a profit. People should be accountable for their own decisions about where to store their money. Depositors have always been the ultimate regulators and impose far stricter regulations than governments ever could. Banks survive on deposits and therefore must maintain the trust of the depositors or face a bank run. As it stands now, when the crap hits the fan, taxpayers are the ones holding the bag. It’s not the CEOs, depositors, or shareholders as it ought to be. I’m not sure where your moral compass points, but none of
this sits well with me.
On to other news:
I’ve been wondering lately if perhaps the Bank of Canada is going to try to orchestrate another ‘shock and awe’ emergency rate cut in order to spur credit demand. I just cannot fathom why Mark Carney would raise interest rates in the face of what is so obviously a smoke and mirror recovery. An article out today in the Grope and Flail suggests that Carney’s rate decision tomorrow is a tough one. I disagree. From a Keynesian monetary perspective (which Carney adheres to and I despise) it’s a clear-cut decision: Hold the line. However, I’m starting to grow suspicious that perhaps the idea here is that they will let interest rates rise incrementally for a period of time and let it garner a lot of media attention. Then when the inevitable recession hits later in 2011, they can slam rates back down to emergency levels. Seeing as how successful that was at stimulating demand in the great reflation of 2008-2009, I can’t help but wonder if they aren’t trying to set us up for a similar rush to capitalize on ‘record low interest rates’. We’ll see.
Finally, I was quite excited to have a blog entry featured on one of my favourite blogs, ZeroHedge. Seeing as how they have a daily readership in excess of 200,000 I was pretty stoked! One of the comments to the blog made me chuckle. I think the poster did a good job of capturing the mentality of Canadians. It is an interesting anecdote. Note: I edited this post slightly for language.
“Living in Canada is a chore on the best of days. Between the unending lust for tax reform which typically gets downloaded to service fees, then the infamous GST @5% (which was put in place to pay off the national debt, Canada still has lots of it) now HST @13%. To give a picture of what the rental market looks like I’ll use some of my own examples.
I came out of dot.bomb with a pile of money, moved back to Canada from NYC (a sad trade, but there was work here). I bought two s**t pile condo’s (800-950 sq ft each, a parking space for each right downtown Ottawa) for 105k and 117k respectively in 2000, condo fees/mgt fees weight in for around 820 a piece. I owe no money on these condo’s btw at time of purchase, I took the pile of money I made during dot.com and rolled it into property. Now the rental on these places is around 1400-1650, not a bad haul really, although in the last three years the challenge has been to keep the space occupied regardless of the property management company I pay good money to do so (yes they are useless f***s).
Now flash forward today. I’m putting these s**tpiles up for sale for around 370k and 410k, out of the buyers I’ve talked to about buying these I honestly think are on crack. Half are talking about renting the property in a building where the property management company makes the prices on the rental units as not to f**k the other investors. Then the other bunch of morons are planning on living there with 575 a month condo fees to essentially live in a hut downtown Ottawa. Just off the top of my head, even with 4% interest it’ll take around 42 years for the condos to pay themselves off. For the dumba***s buying them to move into the condo’s, with condo fees it’ll take basically a lifetime. I’m selling them for the sake I want the cash out of them and be in a better position.
Alternatively the 300 acres I bought at the same time has paid itself off around four times in the last 10 years.
Yes, the Canadian housing market is saturate with people bad at math and just follow dogmatic drivel spewed endlessly by our very small, costly and incredibly dull public media sources. There’s a reason multi-level marketing schemes work here, people sincerely believe that the government will protect them in it’s typically incompetent fashion. Usually by adding another tax.”
Well said my annonamous friend.