Deflation, austerity, and housing blues in the US; Risks to Canada’s growth from the IMF

Deflation in the US

The January 2011 edition of the Bank Credit Analyst has been released (hat tip to DR for the head’s up).  For copyright reasons I can’t link to it, but I will post a few interesting quotes.  For more info on BCA Research, check them out here.   They are a well-respected economic research firm.  This latest issue provides an outlook to 2011.  Some key quotes:

“Policy settings look very inflationary, but economic conditions are more deflationary with large amounts of slack in labour and goods markets.”

“…Inflation risks will increase over the medium term”

As I have been saying all along now, the inflation fears are a ways out.  It’s not until debt deleveraging runs its course, credit demand picks up, and velocity of money increases will we see significant inflation.  That does not mean that commodity prices cannot rise in the interim.  If that concept still confuses you, read this.  When true monetary inflation will rear its ugly head is anyone’s guess, but my guess is at least 2 years out, barring a kamikaze approach by the Fed and Congress.

“Fears that China is an accident waiting to happen are misplaced”

We’ll see about that one.  Camps are certainly divided.  China is a potential economic powerhouse, but they have structural issues to deal with first:  Primarily the fact that 60% of GDP is construction and the fact that their per-capita income is still below $4000 USD annually.  The Chinese middle class is not yet set to replace the US consumer as the global consumption engine, but that time is coming.  I have my concerns about the near-term.

Austerity in the US….Coming to a province near you!

Meredith Whitney was on 60 minutes last week discussing, among other things, the “day of reckoning” for many American states.  She predicts that 50 municipalities will be facing severe cuts or outright default over the next few years.  Here’s a part of the interview.  It also features one of the last true fiscal conservatives on the planet, Mr. Chris Christie.  On a related note, the Business Insider looked at 16 cities in particular that would be under the austerity knife over the next few years.  Scary stuff.  The days of the government providing a plush safety net for its citizens may well be drawing to a close.  Time to make your own parachute!

Lest you think this is an American-only problem….

Rein in deficits or face EU style crisis, Flaherty warns provinces

With Flaherty set to lower the spending boom and with a populace that is arguably ready to embrace fiscal prudence from their elected officials, the provinces and provincial and federal public sectors had better get a clue and position themselves accordingly.


US housing market set to rebound?

Not so says the Dallas Fed in the US.  In a report titled, “The Fallacy of a Pain-Free Path to a Healthy Housing Market“, the Fed, of all people, notes the following:

“Prices, in fact, have begun to slide again in recent weeks. In short, pulling demand forward has not produced a sustainable stabilization in home prices…”

No kidding!  Wow I see parallels with Canada in 2008-2009 when our housing market was stabilized by cratering interest rates and getting every 20 year old with a pulse to jump in to the market in order to take advantage of historically low interest rates and zero down mortgages (don’t kid yourself…they’re still around) as they were enticed, and continue to be enticed by offers like this:

Where will the next jump in demand come from when sales remain weak through 2011 yet inventory begins to build?  Homeownership rates are at all-time highs.  Immigration?  PLEEEASE!   Total household formation has been running at 175K steady for several years, yet housing starts have been well above that since the recessionary lows until just earlier this year.  Back to the Fed article…

“With nearly half of total bank assets backed by residential real estate, both homeowners on the cusp of negative equity and the banking system as a whole remain concerned amid the resumption of home price declines…”

And with the renewed price pressure on US real estate, expect consumer demand to remain tepid.  As the US consumers go, so go our exports.


Risk to Canada’s economy

After posting my own gloomy(ish) Canadian economic forecast last week, the IMF has issued their own warning for Canada:

IMF warns of risks to Canada’s muted growth

“(The IMF) gave the country high marks for its comparatively solid fiscal standing…(and) resilient banks”

Let me translate:  The IMF gave the country high marks for removing mortgage lending risk from the banks and placing it on taxpayer shoulders.  It also applauded their ability to get their consumers to bury themselves even further in debt, thereby stocking the ‘recovery’.

I guess that passes as good news today.

“…The central bank should keep interest rates low and could even cut rates if needed…. “We think it’s important to remain vigilant to any risks that could emerge. After our discussions in Ottawa and Toronto we are confident that the authorities are very much on the same page with respect to that”

“Monetary policy should be the first line of defense if the outlook deteriorates, given the room to ease quickly, although fiscal policy has room to respond as well in a downside scenario.”

Let me reiterate my controversial and contrarian stance that we will not see any rate hike for the foreseeable future and I would be willing to bet that we will even see emergency level interest rates once again before a serious round of rate tightening.

“The report said growth would be muted in the second half of 2010 and in 2011 as household debt has run up to high levels, housing markets are cooling and fiscal stimulus is waning.”

Yup.  Of course you already knew that.

“Ottawa could curb borrowing by making it tougher to take out a mortgage, the IMF said.  “At this point, probably the appropriate thing to do is to wait and see how the credit cycle matures but one option would be to take more steps on the mortgage market”

I’d love to see it.  You all know my position on whether or not amortization rates should be tightened.  I’d love to hear the screaming by the mortgage brokers and real estate industry who would quickly decry the hand of the government in meddling with “free markets”.  What a sweet sound it would be.  I will say that I’d be surprised to see much by way of mortgage tightening without a majority government in Ottawa.  But we can hold out breath and wish.



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28 Responses to Deflation, austerity, and housing blues in the US; Risks to Canada’s growth from the IMF

  1. Ray says:

    They will tighten mortgages, they will raise interest rates before emergency rates appear again (did you say you’d bet?), and public internet hyperlinks aren’t protected by copyright regardless of the content behind them. You are losing it! 🙂

  2. jesse says:

    A reasonable analysis. If Carney is one thing it’s taking a medium term view. The longer household credit remains available without incomes to sustain payments the greater the pain in a few years’ time. Moving back to 25 year am and perhaps further restrictions on investor mortages is only a matter of time.

    • Sam says:

      Why not take away the duration risk? Why doesn’t Canada simply offer 10,15,20,25,30 y mortgage products? If they can issue governement back Canada Housing bonds with duration, Pensions would gooble them up to match liabilities and banks could sell them to hedge mortgages – same as the GIC at 1% and mortgage 3%- Canadains already seem to accept negative carry.

    • jesse says:

      “Why doesn’t Canada simply offer 10,15,20,25,30 y mortgage products?”

      I don’t know the reason why Canada doesn’t want to match durations. If I’m a power company looking to build a coal plant, I would issue bonds with the same duration as the life of the power plant. But with housing with a multi-decade useful life, I can only get 5 year. (Yes I can get more but it’s not underwritten and of a significantly higher interest rate.)

      It’s a good question. Maybe an astute interviewer can ask someone like Mark Carney about this one day.

  3. Sam says:

    If ben is right, Canadians are screwed and lift with the bill

    Canada Mortgage and Housing Corporation’s Guarantee of Canada Mortgage Bonds
    Canada Mortgage Bonds issued by Canada Housing TrustTM No. 1 (the “Issuer”) are fully guaranteed as to timely payment of principal and interest by Canada Mortgage and Housing Corporation (“CMHC” or the “Guarantor”) as agent of Her Majesty in right of Canada (the “CMHC Guarantee”).

    CMHC’s Guarantee of Canada Mortgage Bonds constitutes a direct unconditional obligation of CMHC, as agent of Her Majesty in right of Canada, and as such carries the full faith and credit of Canada and constitutes a direct unconditional obligation of Canada. Amounts payable under the CMHC Guarantee of the principal of and interest on Canada Mortgage Bonds constitute a charge on and are payable out of the Consolidated Revenue Fund of Canada.

    The following is the text of the CMHC Guarantee as set out on the Canada Mortgage Bonds and, if issued, on each bond in definitive form:

    “Canada Mortgage and Housing Corporation as agent for Her Majesty in right of Canada hereby guarantees the timely payment of the principal and interest set forth in this instrument in accordance with the terms and conditions of this instrument, pursuant to the powers given to it in Sections 4 and 14 of the National Housing Act, R.S.C. 1985, as amended, which expressly provide that ‘Every right or obligation acquired or incurred by the Corporation under this Act, whether in its name or in the name of Her Majesty, is a right or obligation of Her Majesty’ (Section 4), and ‘The Corporation may guarantee payment of any or all principal or interest, or both, in respect of securities issued on the basis of housing loans’ (Section 14). It is certified that no provision of any law or contract adversely affects the rights of the holder to the benefit of this guarantee.”
    The CMHC Guarantee ranks equally with all of the Guarantor’s other unsecured and unsubordinated indebtedness and obligations from time to time outstanding.

  4. Sam says:

    sorry, never finished my post Ben, you already know about the guarantee – but if the government takes all the product on to it’s balance sheet, as we have seen in the US, everything else is still booming – commodity, stock prices, etc. So I am not sure how you can have a doomsday, you end up moving mortgages on the balance sheet with has infinite duration??? Society moves forward and you toss in mortgages with the Canada space arm budget and they rot…This is actually a very anti-doomsday credit burst situation. no private banks or institution suffers, nothing is implicity such as Freddie mac…the market has full clarity. you are going to be very wrong even if your outcome occurs.

  5. Sam says:

    and ben rates are lower in the US post crises. and you calling for defaltion doesn’t help your case either.

  6. Fish10 says:

    I think we are on the same page Ben.

    My play book every whiff of which there will be some BS QE in the US and panic in Ottawa which will be lower rates or lax spending and then when the velocity of money picks up…the mother of all inflationary cycles leading to higher bond rates.

    The question is will we have to wait for the inflationary and higher rates to get a good housing correction in Canada or will it come with the earlier deflationary episodes.

  7. reality check says:

    Four years ago, a happy man with no knowledge of economics or markets, while getting ready to purchase a house in Vancouver, I stumbled on one of those real estate blogs that have become so well known to us who follow real estate in this city.

    As doubts permeated my life, I began reading and reading more every day, so blogs like Mish’s, ZH, Garth’s etc etc became my daily information fix. They seemed to make sense with their “imminent collapse” predictions and also caressed my dream of getting a house on the cheap.
    I lived for 4 year anxiously anticipating change that never arrived and my emotional being was severely depressed in the process.

    Today, 100 000 CAD thrown away in rent since, I realise that renting really sucks when you have a family and kids and the affordability has deteriorated even more since 4 years ago. I can’t afford a house in this city anymore.

    I also realise that daily reading of blogs that predict “imminent Armageddon” is a pointless exercise and a complete waste of time. They are in the business of getting some more ad money while trying to generate more readership. What better way to do that than fear mongering!

    So this year, I am taking my New Year’s resolution early: Stop reading all the internet crap about “end of the world” and get back to living life as before. Nobody can predict the future. Buy a house whenever you can afford it, if you need one, the crash might not ever come.
    Happy holidays and adieu!

    • Sam says:

      Best comment I have read on this blog. Well said

    • jesse says:

      “Nobody can predict the future. Buy a house whenever you can afford it, if you need one, the crash might not ever come.”

      I predict prices will be lower. How’s that for a prediction?

      Good luck with your advice. Your doppelganger who stated the same thing in Phoenix 5 years ago is eating crow.

  8. “I also realise that daily reading of blogs that predict “imminent Armageddon” is a pointless exercise and a complete waste of time. They are in the business of getting some more ad money while trying to generate more readership. What better way to do that than fear mongering!”

    Good luck finding either an ‘imminent armageddon’ reference or a single ad on this site. And good luck buying that house in Vancouver. You’re going to need it.

    • Sam says:

      Why would he need luck? According to your thesis he should have it in no time!

      • What exactly is my thesis, Sam? I’d love to hear it in your words. Your comments often misrepresent my position.

      • Sam says:

        You are basically trying to build a framework by selecting negative pundits, comments to support your predication of a house price crash and consumer spending slowdown from the large debt burden society has built upon itself.

        Unfortunately, you continue to be wrong as prices climb higher and debt levels increase. This is not because you don’t know how to read stats but your lack of understanding of modern finance, demographics, immigration patterns and ignorance of the revenue side of balance sheets. I have asked you many times what you would do if you were in Carney’s shoes, you never answer. Not everyone looks it at the same way, most people who are in leadership roles don’t jump into the abyss – they suggest solutions – ie. longer dated mortgage markets, etc. job creation to get people working, etc.

        Debating is healthly Ben, don’t take it personal, but staying narrow minded and not presenting both sides can cause you to miss the rally! Keep it balanced and fair, being bullish is not a sin.

  9. John in Ottawa says:

    I suspect Nicole Foss tipped him over the edge.

  10. @ Sam

    Not a bad synopsis. When you said in your previous comment that “he should have it in no time”, you suggest that I think the real estate price decline will be sudden and violent. I think we’ll see year-over-year declines for several years. It won’t be armageddon (sorry to disappoint you ‘Reality Check), but it will leave a huge financial hangover for many new home buyers.

    Vancouver prices will fall. I’m quite happy to miss that ‘rally’. The rest of Canada will see house price declines as well.

    If I were Carney I never would have cratered rates. I’m well aware of the pain that would have caused in the short term, but look where we are today as a result. They’re now trying to close the credit taps after they’ve realized that consumers are setting themselves up for a shock.

    As far as the revenue side is concerned, my position is that that very revenue has been largely made up of new bank-generated credit in the system which has given the false appearance of economic strength while riding the wave of greater and greater consumer debt levels. That revenue position is set to deteriorate.

    I don’t take any of your comments personally. I just want to make sure you’re presenting your own opinions rather than posting your own potentially misguided interpretations of mine.

  11. reality check says:

    There is no doubt in my mind that following the advice of those blogs (I am not saying this one in particular) has been a huge mistake, a waste of time, emotional strain and money.

    When I started to post some challenging comments on the Garth blog regarding his real estate arguments he would systematically censure them. Even the message above that I tried to post it there was censored. Then you look closely at all the comments there and you find a monolith view of things, like you are the greatest, you saved my life etc, you know the guy is in the business of selling fear.

    I am not saying they all are, but if you take VCI is the same thing, if you have some argument contrary to the mainstream, you are voted down fervently by hardcore bears, without chance of having a debate. I would guess , if they started spinning a more balanced view their readership will go down big time.

    When I hear people saying with full confidence: I predict that blah blah… all I have to say is : they are arrogant charlatans playing God. Your ability to predict human future events other than blind luck is ZERO. No disrespect meant to jesse.

    I have been following this for the last 4 years, but I see that those people have been saying the same garbage for the last 10 years. That is a very very long time to be wrong.

    I can’t predict anything, but I see that Canada has a very similar economy as Australia and I see that RE affordability is similar in both countries.
    However, mortgage rates here are 3.5% and in Australia have been high for the last 2 years, north of 7%.
    Why hasn’t real estate crashed in Australia with 7% mortgage rates the last two years?
    If Australia can afford 7% and not crash, why can’t Canada do the same? How long before we get to 7% rates in Canada? 2, 3 or 5 years? And yet, who can say that prices will come down at 7% mortgage rate, after all, look at Australia, they haven’t.

    Merry Christmas

    • “When I hear people saying with full confidence: I predict that blah blah… all I have to say is : they are arrogant charlatans playing God. Your ability to predict human future events other than blind luck is ZERO.”

      You’re right. The reality is that predicting the exact timing of economic events is impossible simply because of mass psychology and emotions. But that should not take away from the fact that certain trends are predictable. For example, is the current rate of debt accumulation by Canadian households sustainable? Clearly not. That’s not prediction. So what does that look like when the trend reverses? I’ve laid out what I believe things will look like as well as what I believe will cause the mean reversion. But it’s still dependent on the masses, so timing it perfectly is impossible. Does that mean there’s no merit in forecasting?

      “If Australia can afford 7% and not crash, why can’t Canada do the same?”

      A fair question. I would point you to the latest CAAMP data.

      “16% of respondents also indicate that they could not manage an extra $300 increase in mortgage payments. Yet every one percent increase in interest rates equals a jump of 9 to 11% on mortgage payments, meaning that 16% of respondents are basically banking on historically low interest rates to remain for an indefinite period of time.

      The report confirms this, noting that 11% of households would run into financial trouble if mortgage rates rose only 1.5%.”

      Given the precarious position of many Canadian households, I have a hard time believing that our real estate market would simply shrug off a rise in interest rates of such magnitude.


  12. mac says:

    Amen to Sam. A good blog needs balance.

    I wonder when VREAA will pick up Reality Check’s comments and post it on his ridiculously biased blog.

    • “A good blog needs balance.”

      No it doesn’t. You have the mainstream media for ‘balance’. You come here for pure, unadulterated truth via my witty, insightful commentary. This site IS the balance. You’re welcome.

  13. mac says:

    Oh, and don’t forget the mainstream media is keeping us down… them and the real estate boards. Anyone connected to real estate in any way is suspect and anyone who sells stocks, bonds and investments is beyond suspicion when they advise you to sell your house and invest it in equities, bonds and preferreds instead.

    Have you recently read Garth sideswiping mortgage investment corporations? One of his new elderly clients earned 9% per annum for the last decade. He advised them to run. Why run? A well-run MIC will not suffer from small real estate declines, only Armageddon and total collapse would cause investors to completely lose their money. MICs don’t even own real estate, they just make short-term loans often with LTV ratios decidedly in their favour. Sheesh.

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