CAAMP puts the cart before the horse

New CAAMP report

The Canadian Association of Accredited Mortgage Professionals was already in damage control mode prior to Flaherty’s mortgage rule change announcement.  Earlier in the week, CAAMP chief economist Will Dunning released a report titled, ‘Good Lord please don’t change the mortgage rules!’…..more or less.

I will likely devote future posts to other data contained in the report, but this post will deal entirely with one statement made by Mr. Dunning.

As is the case with most mainstream economists, Mr. Dunning has an exceptionally difficult time determining where the horse ends and the cart begins.  To wit:

“The rapid growth in Canadian mortgage debt is related to a very strong economy. The employment rate – the percentage of adults who have jobs – rose rapidly in the second half of the past decade, and reached all-time record levels during 2007 and 2008. This resulted in a need and demand to rapidly expand the housing stock.”

I would word that differently.  Certainly the rapid expansion in debt has been associated with a strong economy…..but in the sense that it CAUSED the appearance of economic growth.  Debt has a funny way of doing that.  By way of a simple example, consider a family that borrows 100K to live large.  They certainly have the appearance of economic prosperity while they’re spending the money.  It’s not until the tide goes out and the money must be repaid do you find out that they’ve been swimming naked all along.

When an entire society embraces the notion that saving is no longer necessary, renting is for chumps, granite countertops, stainless steel, and annual cruises are basic human rights, and 30 year olds should be living in larger and more luxurious homes than their parents live in after a lifetime of work……well….a credit bubble is born.  And as that credit permeates the economy, it makes its way to the parts of the economy that would not otherwise thrive were people not willing to spend all their income and then some on stuff they can mostly live without.  So sure, the economy looks great in that circumstance.  Jobs are abundant.  But does the abundance create the debt or the other way around?

Does a rise in employment create housing/credit demand or does housing/credit demand create a rise in employment?

This is an exceptionally important question.  Depending on the answer, it gives a vastly different picture of the short to mid term economic prospects in Canada.  If stable employment has been the driver of the housing boom and unparalleled expansion in debt, then the entire economy should be alright.  In this case, the expansion in debt would be sustainable over the longer term as job creation has not been dependent on rising debt levels, meaning that they should not be affected when consumers inevitably move to repay their mounting debts.

But if the economy and employment have been buoyed by a sizzling housing market and an unprecedented expansion of credit, the future looks markedly different.  In this scenario, once the inevitable repayment of consumer debt begins, you would expect it to significantly affect employment, leading to a potential feedback mechanism of rising unemployment, lower consumer spending, and more rising unemployment. 

How might we determine which dynamic is presently at play?  Well we could start by noting that our economy is currently 65% dependent on consumer spending for growth.  This is a far cry from the 55% that was the norm for most of the previous 50 years. 

So what has this consumption done to the unemployment rate?  The following graph provides some insight.  It shows the annualized change in US consumption and the annualized change in US unemployment.  You’ll note that consumption leads unemployment…..the blue leads the red.  True it’s not Canada data, but both economies rely overwhelmingly on consumer spending to generate growth, so it applies equally on either side of the border.

In Canada we have had an expansion in our reliance on consumption to fuel growth and employment over the past decade.  And yet at the same time we have seen an unprecedented rise in consumer debt to its all-time high of about 150% of personal disposable income here in Canada.  Note the particularly acute expansion in debt since 2000.

I find it interesting that Mr. Dunning quite clearly indicates that the greatest growth in employment occurred in the second half of the last decade……right about the time that CMHC began loosening its mortgage insurance standards.  It’s no surprise that this led to an employment boom.  When mortgage insurance requirements are loosened, it pulls demand forward.  The rising demand creates a parallel rise in home sales, both new and resale.  Rising new home sales in particular have a way of boosting employment…

The loosening of mortgage insurance requirements and the associated real estate boom has resulted in home ownership rates that have risen to their highest level on record.  Despite what some demographers might suggest, this is not solely attributable to an aging population as home ownership rates have risen across all age groups.

All of this, plus rapidly falling interest rates, have buoyed house prices well above their measures of fundamental value.

As prices have risen, people have eagerly tapped their home equity to provide additional capital to fuel the rise in consumption….hence consumer spending has become an increasingly large segment of total growth.

To connect this back to employment, this extra consumer spending has made its way throughout our economy buoying sectors of the economy that would not otherwise flourish.

Got it?  Rising credit in Canada made possible by loosening lending standards has flown primarily into real estate…..the rising value of homes has caused a subsequent and parabolic rise in HELOCS and other personal lines of credit as people have felt richer and were therefore more willing to spend their new-found wealth on stuff they could live without (vacations, extra cars, boats, other toys, other homes, etc.)……this has caused our consumption as a percentage of GDP to rise…….the extra consumption has buoyed parts of the economy that would not otherwise have flourished to the same degree……unemployment has remained low while growth has remained high.

This is my take on the economic boom of the past decade….particularly the past 5 years.  It was primarily the unparalleled expansion in debt that caused the low unemployment and appearance of economic prosperity, not the other way around.  So to those commenters who would suggest that ‘credit bubble watchers’ like me do not consider the income side of the equation……now you have your rebuttal. 

Implications

As I have noted before, several things can be expected following the bursting of a credit bubble.  Once consumers move to restore their tattered balance sheets, expect significant deflationary forces to be felt in any credit-reliant asset priced in local currency…….namely real estate. 

Expect unemployment to remain stubbornly high and economic growth to remain stubbornly low.  I wouldn’t be shocked to see Canada wrestle with 10% unemployment for several years once the realignment begins.

Expect the feedback mechanism that buoyed the economy on the way up to cut just as deeply on the way back down.  Rather than having rampant credit demand buoying all aspects of the economy, the lack of demand for credit will cause falling home prices, falling consumer confidence, and rising unemployment.  While our credit bubble was not on par with that in the US, they are an excellent model of just how difficult it can be to stimulate credit demand in a post-credit bubble economy.

Those who have actively paid off their debts and have diligently saved will be best positioned to take advantage of the fantastic opportunities that lie ahead.

I’m not a doom and gloomer…..but this is how I see things.  It won’t be economic carnage, but I see much more pain on the horizon than most others do.  There will be organic growth on the other side of the mountain, but it will be a rough few years as the economy delevers.   

If this post has rained on your parade and you need a picker-upper, check out this great quote from the CAAMP report:

“In fact, some might argue that with the (mortgage) changes implemented in April 2010, Canadian (lending) criteria are currently too tight.”

Come on.  That’s got to make you chuckle.  Nice try, Mr. Dunning.  The only people who would advance such a notion are those whose livelihood depends on the continued loosening of mortgage terms to entice new buyers to step up to the plate.  Pretty brazen of you, good sir.

Cheers,

Ben

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14 Responses to CAAMP puts the cart before the horse

  1. TS says:

    It was a fine attempt by Dunning to sway Flaherty. Glad Flaherty did not bite but the change does not help with the consequences of the last 10 years of rule changes. I love where the Dunning minimizes the following fact and I quote below
    “The most recent data (as of October 2010) shows an arrears rate of 0.43%. While the
    increased rate is indicative of increased financial difficulties, it is lower than was seen
    during most of the 1990s (when the average arrears rate was 0.50%).”
    The arrears number shows we are at presently is not far off from the 1990’s which was a horrible time for many and values have not even began the downward spiral that is inevitable. The 90’s prices dropped up to 50% in some cases. This just shows how stretched some are in homeownership. I find many in Real Estate are spinning and twisting facts and data to keep up a front that life is grand and everything is fine in LALA land. It was a nice run people like let of the greed and let the market get back to some healthy fundamentals please.
    If CAAMP feels so sure that the loans are solid than I recommend that they have their brokers put their money where there mouth is and pay back the upfront brokerage fees they receive on these so called solid CMHC insured loans if the property returns to CMHC and is sold with a shortfall. That is only fair and it would be the best way to show their confidence in our so called solid banking system. What a most honourable endorsement of their members qualification process and brokerage practices that would be! I would believe them when they have something to lose and not just gain. In fact I would include Real Estate agents in that commitment. Put your own money up and take some risk and leave the taxpayer alone. Keep things honest….

  2. BBC says:

    I have been reading your blog daily for about a month and it is excellent! Your observations are keen and you always have FACTS to back them up….very refreshing.

    Do you feel that the US economy will follow that of Japan? Could this be a possibility for Canada?

    Thanks again for your time.

  3. pascal says:

    Mr. Dunning say:“In fact, some might argue that with the (mortgage) changes implemented in April 2010, Canadian (lending) criteria are currently too tight.” WHAT! Mr. Dunning, Please, tell me Where did you get your diploma in economic so my kids will never go there!

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  5. Yosh says:

    Excellent post, Ben! A move towards thoughtful analysis is certainly welcome.

  6. debunking says:

    Ben,
    I am too drunk tonight to debunk most of what you say on your article, but you are still looking at things with your bear glasses and a self interest bias.
    Debt has been rising since the second world war, debt is money and supply of money/debt has expanded in response to economic growth and inflation.
    Who are you to say that we Canadians have too much debt? Who are you to tell Canadians if they should borrow or not?
    The only thing limiting debt growth is the ability of borrowers to pay it back. So far, our default rates are below historical average which supports the theory that we are no way near our borrowing capacity. I fully agree with CAAMP on this point.

    There is nothing factual about your schadenfreude rant regarding savings, spending, luxury etc. People in this country are free to make their own financial decision and nobody has to tell them how they borrow or spend their money.

    Regarding employment, as I have discussed in previous posts, comparing Canada to US is comparing apples to oranges. I see hiring picking up substantially, at least in my business. I also monitor craigslist job adds for the last 4 years and can tell that their intensity is very similar to 4 years ago. The job picture is sound and improving in Canada.

    What is wrong with higher ownership rate? I find it laudable that more Canadians own their home. We have the same ownership rate than Australia, same economic fundamentals, yet Australia has 8 to 10% mortgage rates and we have 3%. The prices have not come down in Australia. Why do you think they will come down here and compare us with US which are totally different from us?

    Your take on our past boom that it was expansion of debt that enabled it is right. But it has been that way for the last 50 years. Why do you think it will stop, people are paying their bills and their debts here.

    Claiming that lack of credit will crash RE here is preposterous. Credit has never been cheaper and more available and there is no reason for it not to stay cheap for the foreseeable future. Overcapacity / surplus in China and other developing countries will insure low interest rates for longer than many people think. And if ever credit conditions worsens, our government and CB have tremendous leverage to alleviate the situation. People discarding this possibility are in denial.

    On your last statement : “The only people who would advance such a notion are those whose livelihood depends on the continued loosening of mortgage terms to entice new buyers to step up to the plate.” I would like to ask you : how is your objective / dream of a RE crash to get a house on the cheap different /less selfish from Mr. Dunning’s statement looking after his own self interest?
    If you are a saver, your money has value only because other people spend, otherwise money will be worthless if there were only savers. Think about it!

    • “Debt has been rising since the second world war, debt is money and supply of money/debt has expanded in response to economic growth and inflation.”

      Two points: 1) Debt had been expanding at roughly the same pace as income growth until the 80s. No concern there. Since the 80s, debt has outpaced income growth with a particular acceleration in the past 10 years. It’s not the total debt that is the concern but the debt relative to income…..it’s never been higher.
      2) The expansion of credit is by far the largest determinent of inflation, so when you say that debt has risen in response to inflation, you’ve just made the same mistake as your buddy Will Dunning. Know where the horse ends and the cart begins.

      “The job picture is sound and improving in Canada.”

      If you take the headlines at face value and never ask questions, I could see how you could come to that conclusion. Certainly it has improved, but it has done so on the back of construction and a rise in public sector employment. Check ot the graphs in this post: http://bit.ly/ga42NV

      “We have the same ownership rate than Australia, same economic fundamentals, yet Australia has 8 to 10% mortgage rates and we have 3%. The prices have not come down in Australia.”

      Give that some time. Sales are tanking down under. Australia is in a bigger bubble than we are. It won’t end well for them either.

      “Your take on our past boom that it was expansion of debt that enabled it is right. But it has been that way for the last 50 years. Why do you think it will stop, people are paying their bills and their debts here.”

      Maybe you’re right. Maybe we’ll see our debt to PDI hit 1000% when other countries have peaked between 140 adn 160%. That’s reasonable.

      “Claiming that lack of credit will crash RE here is preposterous. Credit has never been cheaper and more available and there is no reason for it not to stay cheap for the foreseeable future. ”

      Have you not opened a paper this week? The government is moving to limit credit. 70% of new credit is generated by mortgages. The new mortgage rules will ensure less credit entering the system all else being equal. I’ve written about this several times.

      “how is your objective / dream of a RE crash to get a house on the cheap different /less selfish from Mr. Dunning’s statement looking after his own self interest?”

      My income is in no way derived from the direction of the real estate market. The same cannot be said for the mortgage professionals Mr. Dunning represents. Nice try

      The economic pain associated with a real estate crash would be acute. I don’t wish it on anyone. I rent my home because I can do so for a fraction of the cost of ownership. It’s the more rational use of capital. I could care less if house prices move up, down, or sideways. I’m happy building wealth in any way. All that being said, I think the FACTS suggest that real estate is significantly over valued in Canada, and it is in the best long-term interest of the Canadian economy to it normalize.

  7. Nicolas says:

    Outstanding post Ben! A post backed up with data and indisputable facts. It makes a lot of good common sense that those credit/RE bubbles will be deflating sooner than later.

  8. mac says:

    Here are the newest January sales to come into my inbox from an automated realtor system:

    First figure is ask : Second figure is sold
    SOLD* $ 459,000 $ 475,000 Jan 17 Kitsilano
    SOLD* $ 759,900 $ 775,544 Jan 17 Kitsilano
    SOLD* $1,088,000 $1,350,000 Jan 17 Cambie
    SOLD* $1,299,000 $1,350,017 Jan 17 Cambie
    SOLD* $ 788,000 $ 850,000 Jan 16 Kitsilano
    SOLD* $ 225,000 $ 185,000 Jan 14 Fairview VW

    And there’s no huge surge of listings yet.

  9. mac says:

    Ask Sold Vancouver Westside, this week:
    459K 475K
    759K 775K
    1,088M 1.350M
    1.299M 1.350M
    788K 850K
    225K 185K

    • jesse says:

      You do know there are well over 17000 listings in the greater Vancouver area, with listings outpacing sales by a factor of 2, right? Stick to your wonderful westside bubble; I’ll look at the 10,000 foot level when making calls about market direction.

      Thanks for the insider information though.

  10. mac says:

    It takes two weeks for a place to be sold, finalized and end up in one of these realtor updates. So it’s normal for sales to be well behind listings in the 3rd week of January. The few sales that I do see are coming in over ask, which is bad news. And a lot more over-ask than I thought they would.

    It’s a marked difference from the Fall market and shows continued strength in the upper end of the market, which is what I both feared and expected, with the “rumours” of foreign money doing a lot of the purchasing still going strong. If sellers continue their “strike” this Spring, I fear it will only force prices up in Vancouver Westside (SFH) again! Whereas in other parts of the universe, a seller’s strike would simply flatten out and slow the market down. This, I think, has a trickle down effect on our housing market as you can well imagine some older Dunbar types getting 4M for their place… the first thing they do is give the kids a cut so the can afford to stay in Vancouver.

    No need to shoot the messenger.

  11. Pingback: More thoughts on CAAMP report; RRSP use among younger generation at record lows; | Financial Insights

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