Shocking report by CAAMP….part 1

So this morning I stumbled across a little tidbit from a report published by the Canadian Association of Accredited Mortgage Professionals (CAAMP).  I haven’t been able to get it out of my head.  The report itself contains a wealth of interesting data, but there was one sentence that just tripped me up:

“The survey data indicates that 18% of mortgage holders took out equity from their homes or increased the amount of the mortgage principal within the past twelve months. The average amount of equity take-out is estimated at $46,000.

The report then goes on to calculate that the total equity withdrawal is in the ball park of $46 billion.  The report outlines a number of things that the money was used for:  renovation, debt consolidation, investing, miscellaneous consumption, etc.

I can’t believe that people can gloss over that number!

Let me reiterate some basic math:  If 18% of all households with mortgages (~60% of total) have withdrawn equity in the past 12 months, and the average amount was $46K, that means that when averaged across all households, it would be equal to over $5,400 in additional household spending per household in the past 12 months.  Given that the median after tax income of Canadian households was most recently calculated at $63,900, this equity extraction has ‘boosted’ income and spending by an additional 8.5%.

While equity extraction in the US peaked at a higher rate than we are currently experiencing, it is worth noting how that worked out for them.  Today, equity extraction in the US is negative, meaning people are actually paying that debt off.  More than anything else, this has hampered the US’s ability to get out of the nasty recession/anemic growth they are in.  People don’t want to spend.  Too much consumption has been pulled forward.  People have too much debt.

Where that money goes is irrelevant.  It would not be money in circulation had people not borrowed it.  More to the point, consider that this has the sole effect of pulling demand forward and creating an artificially strong level of consumer spending.  The reality is that when house prices normalize (read: fall), not only will equity withdrawals cease very rapidly, they will actually go negative, as seen in the US.

The Dallas Fed published a paper (authored by none other than Alan Greenspan) in which they examined the wealth effect and Mortgage Equity Withdrawal (MEW) as a root cause of the difficulty the Fed faced in trying to resuscitate the economy:

“One estimates (of the impact of rising home prices on consumer spending) that a $100 rise in housing wealth leads to a $9 increase in spending. Another finds that increases in housing wealth generate three times the spending from stock-price gains.

Together, higher home values and financial innovations have enabled homeowners to more easily tap housing wealth. Mortgage equity withdrawals have risen sharply recently relative to income.

By this measure (home equity withdrawals) have become more sensitive to swings in home-price appreciation, aided by the lower cost and greater ease of cashout mortgage refinancings”

In other words, this whole equity withdrawal business is driven primarily by rising home prices, which are now at extreme valuation levels all over the country.  This practice has the effect of borrowing from tomorrow’s consumption.  What would have been bought tomorrow has instead been bought today on cheap credit.  As a result, when this unsustainable withdrawal of equity ceases, it will have the effect of not only choking off consumer spending, but also of eating into the consumer spending that would naturally have existed as people will then be paying off the debt they accumulated on their spending binge.

None of this bodes well for our economy…none of it.  This is a structural issue with how the Canadian economy has generated growth since at least 2005.  To correct this will involve a recession, likely by Q3 2011, or as soon as people realize that their homes aren’t worth what they thought they were, home equity withdrawals dry up, and consumer spending abruptly dives.

When that happens, you just remember where you read it first!

-Ben

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11 Responses to Shocking report by CAAMP….part 1

  1. cloudy1123 says:

    Agree with your thesis, but nitpicking on the numbers. The 18% refer to mortgage holders, and 60% of all homes have mortgages attached to them. Therefore you need to multiply your ratio by 0.6. Nevertheless it’s still a pretty bad number.

  2. breezer1 says:

    i believe canadians are even more delusional than our cousins to the south. ‘it can’t happen here’ and ‘social safety net’ are the mantras that cause and perpetrate this dangerous mental condition.
    the organizers of this race to enhance gdp#s are the same dickwads that urged us to buy buy buy while they spend spend spend. when you are living in a cardboard box remember that their names were carney and harper and their economic scientists .

  3. Chris says:

    I don’t believe that on its own, that figure tells the whole story. I think it matters a lot where the money actually went: not all of it went to “bring forward” consumer spending. Maybe some people used the money to buy assets (investments); not only did they *not* bring forward consumer spending, but they also (at least for now) did not decrease their net worth. People who used the money to consolidate debt also did *not* decrease their net worth (or bring forward consumer spending). Finally, although seniors with reverse mortgages are in fact decreasing their net worth, they are not really “bringing forward consumer spending” … Or at least, they hope they are not.

    The fact that the money would not be in circulation if it had not been borrowed ignores the fact that most of the money “in circulation” is borrowed anyhow, so it’s not clear to me why that matters, except that the point you make about how it is harder now for central banks to move the money supply is a good one. This is why, I guess, the US Fed now resorts to “Quantitative Easing” … In this debt economy that we have, sustained deflation would be such a disaster that it seems unlikely it could ever happen in a country where we still hold our politicians accountable at least to some extent … 🙂

    • “Maybe some people used the money to buy assets (investments)”

      Possibly but highly unlikely. We have generational lows in savings rate. Only 30% of eligible Canadians contribute to RRSPs. Let’s be honest…..saving and investing has not been on the mind of the average Canadian. Anecdotally, how many people do you know who tapped their home equity to invest. I can’t think of one, but I can tell you of a number of people who have taken vacations, bought ‘toys’ like boats, ATVs, etc using their home equity. I doubt that argument carries much weight.

      “People who used the money to consolidate debt also did *not* …(bring forward consumer spending)”

      Of course they did! Think about it more.

      “The fact that the money would not be in circulation if it had not been borrowed ignores the fact that most of the money “in circulation” is borrowed anyhow”

      That is my point. Money in our system = debt. When you have a credit bubble you also have large quantities of money sloshing around the system looking for somewhere to settle. Read the primers on inflation and the great connection to get why this is a huge problem going forward.

      “In this debt economy that we have, sustained deflation would be such a disaster that it seems unlikely it could ever happen”

      Just so I understand….the point you are making is that because it would be extremely painful, it is unlikely to happen. Not sure of the logic there. Do you not think that the central bank in Japan did everything they could to stop deflation? Yet it has ravaged that land for almost two decades. You have too much faith in the central bankers.

      • Chris says:

        Most of the people I know who have taken equity out of their homes in the last decade (including me) have done so for investment purposes … But this is just anecdotal knowledge: my point remains — what happens to the money is important.

        Just to be clear, I don’t doubt the possibility of negative real growth (as in Japan), but a true deflationary spiral as happened in the ’30s seems increasingly unlikely. The bond market seems to have responded to Ben’s QE efforts with a vote for inflation (albeit mild … for now)

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