Are the big banks really concerned about the consumer or are there ulterior motives?

Hat tip to John for this insightful comment in regards to Ottawa’s discussions about changing mortgage requirements.  I have added a few graphs to support John’s position, which I fully agree with.

It doesn’t make much sense to close the barn door after the horse is gone.

The government, minority or majority, cannot kick the legs out from under the lower end of the housing market. Housing markets collapse from below.

The banks are being a bit disingenuous in their call for tighter mortgage rules. Over the past three years credit card debt on bank balance sheets has grown by 15% and line of credit debt has grown by 20%. In the past six quarters credit card debt has flat lined while line of credit debt has grown by 10%. This suggests that credit cards are maxed out and being serviced with the line of credit. There is also no way for us to know how many households are currently servicing some portion of their mortgage with their line of credit. The banks know.

In the past six months, household debt is growing at half the rate of the past several years. Delinquencies are substantially above pre-crisis levels.

The level of debt growth is unsustainable and is no longer being sustained. This is what Carney and the banks are telling us, after the horse has left the barn.

So, the banks are finding themselves in a bit of a box. Tighten up on lines of credit and credit card delinquencies take off. Continue with loose line of credit terms and uninsured liability takes off. Banks have about $500B of (mainly insured) mortgage loans on their books, but they have over $350B consumer loan exposure. That’s a significant portion of their net $2T assets and is where the real risk lies.

Note by Ben:  John is absolutely right on this point.  The banks understand that as people are forced to borrow higher and higher sums to purchase their homes, the percentage of their income being consumed by mortgage payments rises accordingly, and that is assuming static interest rates, which are unlikely over the longer term.  When consumers become financially strapped, they default on unsecured debt first, namely credit cards and lines of credit.  Hence the nervousness by the big banks.

What can the government do or what can we expect the government will do? I suggest the government will further tighten the rules for second (third and so forth) homes. This will take the froth from speculation off the top of the housing market. For the most part, amateur speculators (middle income consumers buying for the rental market) are in the best position to unwind their holdings in a reasonably ordered fashion over the next two or three years, the so-called soft landing. Wholesale tightening of rules for first homes at this point in the credit cycle will simply force the lower end of the housing market into default (over the next two or three years from failure to qualify for re-amortization) which will precipitate a market collapse from below.

Americans are guaranteed “life, liberty, and the pursuit of happiness.” We see where that got them. We are guaranteed “peace, order, and good government.” Let’s hope we get some.

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14 Responses to Are the big banks really concerned about the consumer or are there ulterior motives?

  1. Sam says:

    Again this is nothing new, your comment
    “When consumers become financially strapped, they default on unsecured debt first, namely credit cards and lines of credit. Hence the nervousness by the big banks.”

    Explain how the consumer is going to get “financially strapped”? unemployment has been decreasing and job creation is very strong. How is that changing? Why do you continue to only focus on the expense side of the balance sheet – while the revenue side is growing and stable?

    • John in Ottawa says:

      In business, if you have rising and stable revenues growing at half the rate of your rising and stable expenses, you will go out of business. It is the same for consumers. Something has to give.

    • Lumpen says:

      In aggregate, the revenue side is growing much more slowly than the liability side (yes – mixing BS/IS concepts here – but you’ll see why). Mortgage/LoC/etc. payments (expenses) are direct results of the liability balance and the financing rate. But your assets (RE) – what drives their performance? Revenue/profit – i.e., wages and rents. They’re not keeping up with the liability growth rate. If wage growth or rent growth was equal to credit growth, we’d be ok, and in a sustainable position.

      The problem that we all face is that BoC and Statcan don’t provide the level of granularity that is needed to understand what’s happening properly. Reporting mean debt/income, asset growth and liability growth is not very useful without understanding the distribution. If the top 5% of wealth-holders (not income-earners) own the vast majority of the appreciating assets, and are levering up to increase their proportionate ownership, that’s a very different scenario than the same top 5% getting the asset gains, but the bottom 95% drawing down on credit lines and credit cards to meet expenses. However, both can result in the same reported averages.

      Something has to give is not a framework. Nor is 7% appreciation forever. As John says, there are lots of unknowns. No one knows the outcome in advance. There are examples of much more stretched price/income ratios than Vancouver, and have lasted for decades – e.g., Mumbai. Not sure that the bottom 95% of wealth-holders and income-earners would care for the implications of such an event. But can it happen? Sure.

  2. Sam says:

    Why does something have to give? You have a job and pay your bills, your bills get larger, your savings assets grow along with them. What you continue to fail to understand that a house has NO margin call. Those assets can very volatile and calm. have you look at real estate graph in Canada John – where do you see that up trend has moved the other way, prices go and up down, over time they are higher.?

    Something has to give is not a framework.

    • John in Ottawa says:

      You are pulling my leg, right? A house has NO margin call? You are in NYC if I recall correctly. With a US 30 year mortgage no bank is going to call the loan, underwater or not, as long as the payments are on time.

      In Canada, we have a margin call every five years on the mortgage and the HELOC. That’s when we walk into the bank, cap in hand, and ask for a new mortgage at the going rate. IF the house is under water, too bad. Sell it. Of course, if it isn’t they’ll offer a new mortgage and a line of credit.

      You say unemployment is improving. I don’t see it. Since April, unemployment has basically flat lined, printing between 8.1 and 7.9%. Wages are up about 4% over the past six quarters, but interest expenses, which are a leveraged expense are up too. There must be some reason that debt is rising at twice the pace of wages. Share.

      A house isn’t savings. It is a balance sheet asset that must, once every five years, be marked-t0-market. If it was “savings” the savings rate in the US would not have been negative at the peak of the housing bubble. You can pledge a house against debt, and then “save” by paying down the debt, but it is the mark-to-market that will get you. If you keep taking on debt because all ships are rising, you are not saving. You have no equity and no savings.

      I think I read recently that the savings rate in Canada is 2%. That’s the sum of “savings,” earned money safely tucked under the mattress, and debt repayment. Doesn’t sound like much to me.

      Don’t take these blogs too seriously, Sam. We aren’t saying there is going to a collapse, living in caves, foraging for food. Heck, we don’t even have guns. We’re postulating, looking at scenarios, what might happen in the confluence of certain events. We like to look at housing, peak oil, health care, pension obligations, inter-generational frictions, and charts galore; lots of fun stuff. That said, some of the possible realities we look at aren’t all that far fetched in light of the global situation. Unless, of course, we really are different (and don’t cite Vancouver, they’ve always been a bit “different”). Got any hard data to share? Something Carney hasn’t thought of? I’m sure Ben would love a post.

      Speaking of Carney and hard data, start with the Bank of Canada — Banking and Financial Statistics report. Biggest spreadsheet you’ll ever see.

      • Sam says:

        I believe you hit it at the end of your email. These markets can stay overheated, stretched for long periods of time. I have never said real estate will raise forever. But I believe the same stories are recycled over and over. At this point we don’t even know how much that five year top up will work?

        I enjoy pushing people to the limit to get them to present a very clear framework on thoughts on how this market will break. U might have have guessed I am a guardian of capital who has traders come all day looking to put on trades with no

        You guys have good concepts, I want to connect them to a trading instrument.

    • jesse says:

      “IF the house is under water, too bad. Sell it. ”

      I don’t think that’s the typical response. There will be higher rates and MI premiums for those renewing with negative/reduced equity but the bank has an incentive to renew underwater mortgages: they are paid through interest not through liquidation. It’s worth thinking about what banks actually do in these situations; it’s not as simple as the nefarious or teary-eyed borrower handing over the keys.

      The problem is how this looks on the balance sheet. Banks need to resolve making what is effectively an unsecured loan. That’s either done by cramming down the initial balance, marking to model, or just writing it off. The implications are severe: balance sheet weakness means capital must be retained and that’s deflationary.

      • John in Ottawa says:

        I agree Jesse. A little hyperbole there. As you say, it is in the bank’s interest to do everything it can to work something out with the borrower. However, that won’t include an increased line of credit for life style maintenance.

  3. SuperPL says:

    I seem to recall no real full time job creation through the stimulus. Thats what newspapers reported. Also, income has been flat for years when inflation is factored in while HST, hydro, insurance, gas, food, just about everything else has been on a steady rise. Hydro and insurance alone is up another 25%. Hydro is also projected to be up 100% in the next 5 years.

    • Sam says:

      Carry costs on assets are something I watch carefully because they are added on the borrow costs on the asset and they only go up. That is why it looks great to grab a whistler condo for 200k but the costs 11k a year in fees. I would not spend that over six years in hotels in prime time.

  4. Pathrik74 says:

    I am conflicted as to whether the credit boom was caused by ‘short termism’ by the banks (and no I don’t work for a bank or defend them). But I can recall back in 2006, when the CMHC policies were changing and ‘home ownership’ was being promoted in Ottawa – David Dodge was reprimanding the CMHC in public (and getting his knuckles rapped for it in private). There were stories in the mainstream press (the G&M specifically) that indicated that the CEOs of the major banks (the CEO of TD was cited specifically) were aggressively telling the central bank that Ottawa needed to put an end to its relaxing of lending standard regulations. These meetings were supposedly quite heated as they (Bank CEOs) were concerned about the banking sector facing the same kind of reputation damage that the banking sector in the US and Europe eventually experienced. The point being the banks were aware of the long term problem way back then and as long as Ottawa was regulating the loan standards diligently for all of them they were more or less resigned to go along making billions by charging fees on simple transactions. In other words, they were content to be saved from themselves as long as their competitors were not getting an upper hand.

    Ultimately when the regulators loosen the rules, banks which do the right thing lose market share and those that reduce lending standards make short term profit for shareholders. Hence banks are compelled to compete for lower lending standards when it is the law of the jungle. Steve Keen has an interesting take on ‘competition’ in the banking sector which nicely demonstrates the dilemma (see link : )

    If Canadian banks have been cynically pushing behind the scenes for lower lending standards I wonder if the reasons would be more international than domestic. Our big banks crave being ‘big players’ internationally. Look at all of their purchases in recent months. Thus the credit expansion domestically bloated their cash reserves to better enable ambitious forays into international markets.

    However here again it may not be all the banks leading the charge. The Harper governments policy views on Canada’s banking system has been somewhat opaque in recent years. Going back pre-crisis they were quite critical about the regulatory system that was in place on foreign ownership and regulations. Since being elected, and since the economic crisis, the fiercely critical talk of bank regulation literally disappeared and has been replaced by happy talk about what wonderful regulators they are. However in substance not much has really changed.

    The government now seems to believe that the current economic crisis is a wonderful opportunity for Canadian banks to become more international in scope. The government did not really want more ambitious Basel 3 requirements, for example, which enabled our banks to expand their size internationally.

    One worries about the interconnectedness problem in the long term. Our banks were relatively inoculated by the last crisis due to the insular rules on them at the time ( e.g. prohibition on foreign ownership and others). Now that Harper and Flaherty are promoting the internationalization of Canadian banks this is something that could change in the future – as they are growing in size.

    While the outcome remains unknown we should remember one jurisdiction that went down this road as well. In that country the politicians were bragging about how the economy was growing in financial services areas. The politicians also seemed to think that ‘competition’ in finance was always wonderful. The politicians severely criticized national regulations, implemented by previous governments, as outdated socialist plots and they claimed that their country needed to obtain the benefits of scale provided by these banks to enter the new age.

    Of course, that country was Iceland.

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