CIBC on the housing and the Canadian Consumer; Bank of Canada speech; Other noteworthy news stories

CIBC on housing and the Canadian consumer

Just a week after Scotia Economics released a report suggesting that Canadian consumers are “tapped out”, CIBC economics has released an interesting report that contains some similar themes.

Some highlights:

This suggests that something more fundamental (than demographics -ed.) has impacted all Canadians uniformly, and is responsible for the drop in the savings rate. Such factors probably include lower inflation expectations, an extended period of low interest rates, the cohort effect (for example, the changing financial attitudes and behaviours of a 40-year old person today compared to a 40-year-old person 10-20 years ago), and innovation and deregulation in financial markets.

The recent surge in savings in the US suggests that changing macro economic conditions can dramatically impact the savings rate. In fact, at near 6%, the American savings rate is 1.6 percentage points higher than in Canada2—the largest gap on record.


These are indeed some of the frequent topics on this blog:  Canada’s low savings rate and the propensity for people to change perception en masse in response to economic conditions.  I’ve long maintained that the primary driver of the low savings rate is shifting consumer perceptions towards consumption and materialism, with falling interest rates as a close secondary factor.  One need only look at the arguable rise in housing as a form of conspicuous consumption to see this reality.

Note what caused the savings rate in the US to spike, even amid the lowest inflation and interest rate environment in half a century:  Falling house prices, collapsing net worth, and a retrenching consumer.

CIBC notes that Canadians have largely ignored savings due to the perceived wealth increase in their homes.

“The reality is that the (Canadian -ed.) real estate boom has rested on low interest
rates that are clearly behind us. And one should not underestimate the importance of the housing market in impacting the Canadian savings rate. After all, with the average house price in Canada more than doubling since 1997, many households have been saving indirectly or passively via the increase in their home equity, and thus felt less pressured to save from their current income.

That housing “wealth effect” stimulated consumption and reduced savings. Not only has real estate wealth risen much faster than wealth linked to financial assets during
the past decade (Chart 2), but also the housing wealth effect is significantly more powerful than the wealth effect associated with rising stock prices.


Here’s the thing:  You can’t eat your house.  It can’t sustain an expected lifestyle in retirement absent significant associated financial assets.  You can, however, use the interest and dividend payments from financial savings to sustain a lifestyle during retirement.  Therein lies a huge unanswered question for me:  All evidence seems to suggest that the wave of boomers set to retire over the next decade are exceptionally house rich, yet not nearly as financially healthy when financial assets are considered.

This is a topic I explored in an earlier primer on demographics.  It remains to be seen just how many people are planning on accessing home equity via downsizing to partially fund their retirement, though all evidence seems to suggest that it is not an insignificant number.  The next obvious question is how will this happen without exerting downwards price pressure compressing given that home ownership rates and debt levels are already at all-time highs.

Bank of Canada toots its own horn

Jean Boivin, Deputy Governor of the Bank of Canada, recently gave an interesting speech in Montreal:

The “Great” Recession in Canada: Perception vs. Reality

Boivin offers his insights into how Canada managed to experience such a strong rebound from the depths of the “Great Recession”.  It’s an interesting read, though I certainly don’t agree with all Boivin’s conclusions.

Some snippets:

“If the recovery was speedier, despite weaker contributions from investment and exports, support for the recovery must have come from household and government spending. This was indeed the case. Household spending declined by only 2 per cent between 2009 and 2010, compared with 6 per cent during the previous two recessions. The contribution of government spending to growth was more than one percentage point in each year.

The greater strength of household and government spending reflects Canada’s favourable position at the outset of the recession. Major adjustments had been made to the structure of the Canadian economy. Business and household balance sheets were relatively sound, and the banking system was robust, managed prudently, and sufficiently capitalized.”

Certainly it was household and government spending that served as the catalyst to the rapid rebound in economic growth, but I certainly don’t believe that this in any way reflected a “strong” consumer balance sheet.  Boivin notes that household balance sheets were “relatively strong”.  Compared to what?  If compared to our own Canadian history, this is categorically false as we had been making historic highs in debt/income ratios for some time before the onset of the recession.

If compared to the US, sure we may have looked okay then, but we’ve now passed the US consumer in terms of our relative indebtedness.   And may I suggest that perhaps it’s unwise to look at the greatest example of wealth destruction in human history currently ongoing in the US and suggest that since we didn’t experience their levels of excess, that somehow that makes us prudent.

Other noteworthy news stories:

1)  Rosenberg’s 180 on Canadian housing: Canadian housing is okay– Globe and Mail

I’ve got a lot of respect for David Rosenberg, but I believe he is flat out wrong on this one.  Rosenberg argues that there is no looming supply/demand imbalance as home builders have pared back new single unit construction.  This is a valid point, although it does not address the overall level of housing starts which continues to significantly outpace net household formation once condos and other multi family dwellings are taken into account.  Perhaps the more important question involves the ability and willingness of Canadians to continue to take on mounting debt loads to support house prices.  Interest rates have only one direction to rise while credit conditions are tightening and job growth remains tepid.

Rosenberg also argues that increased immigration may help to support house prices:

“Note that in 2009, net international immigration to Canada surged 13 per cent. So not only is the country acting as a magnet for international capital inflow, but Canada is also being increasingly viewed as a stable place to do business and a desirable area to live.”

This is highly suspect.  Read yesterday’s post for insight into how immigration affects real estate prices.  Rosenberg’s about-face on Canadian housing leaves me scratching my head as the underlying fundamentals which he so often referenced while discussing the Canadian bubble (or “giant sud” as he would say) have only deteriorated in recent months.

2)  Consumer confidence slides in March– Globe and Mail

The Conference of Canada released their March consumer confidence numbers which showed widespread declines across all key measures.

“Responses to the current and future finances questions were particularly pessimistic, the board said. Sentiment toward current finances were “worrisome,” the board said, and although it has improved since the recession, the balance has remained negative for 30 straight months.”

“The balance of opinion also worsened on future employment and responses to the question on major purchases trended negatively.”

Cheers,

Ben

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25 Responses to CIBC on the housing and the Canadian Consumer; Bank of Canada speech; Other noteworthy news stories

  1. Sams Mango says:

    Ben said
    “ere’s the thing: You can’t eat your house. It can’t sustain an expected lifestyle in retirement absent significant associated financial assets. You can, however, use the interest and dividend payments from financial savings to sustain a lifestyle during retirement. Therein lies a huge unanswered question for me:”

    @Ben
    Ben the answer is HELOC. You can borrow against your house mark to market value just as you can with any other financial assets. In fact, the reg Joe get better access to leverage and credit via a house and not the stock market.

    In retirement, say you are house rich and have equity in the house (i hope you do by retirement) – you simply borrow against the house and sell it down the road and pay the bank. Happens everyday. Hope that clears up your confusion

  2. jesse says:

    See Carney’s speech from a few days ago:
    http://www.bank-banque-canada.ca/en/speeches/2011/sp260311.html

    The comments recently by the BoC governor and his apostles are interesting. What I picked up on in their speeches are:
    1) Commodity prices are “demand-driven” and look to be undergoing a long secular run. They see little to indicate this will change in the medium term. I didn’t see much in the way WRT prices, only demand.
    2) Imbalances in the global economy are still a significant problem.
    3) There should be sustained capital flows from the developed world to the developing world, but capital flow restrictions due to rigid exchange rate policies are causing unhealthy distortions.
    4) Commodity prices are arguably in a bubble in part due to these capital flow restrictions.
    5) Emerging economies may soon start exporting their inflation through higher prices.

    I always listen with both ears to these speeches.

  3. jesse says:

    See Carney’s speech from a few days ago:
    bank-banque-canada.ca/en/speeches/2011/sp260311.html

    The comments recently by the BoC governor and his apostles are interesting. What I picked up on in their speeches are:
    1) Commodity prices are “demand-driven” and look to be undergoing a long secular run. They see little to indicate this will change in the medium term. I didn’t see much in the way WRT prices, only demand.
    2) Imbalances in the global economy are still a significant problem.
    3) There should be sustained capital flows from the developed world to the developing world, but capital flow restrictions due to rigid exchange rate policies are causing unhealthy distortions.
    4) Commodity prices are arguably in a bubble in part due to these capital flow restrictions.
    5) Emerging economies may soon start exporting their inflation through higher prices.

    I always listen with both ears to these speeches.

    • John in Ottawa says:

      China’s Dagong (their rating agency) contends that the US’ policy of Quantitative Easing is a repudiation of US debt and amounts to economic warfare. These are strong words from an agency that is speaking indirectly, but specifically for, the Chinese government.

      Dagong believes, as I do, that the US will continue to engage in QE regardless of what they may say publicly in the meantime.

      As long as the US continues to devalue its dollar, the Chinese dollar remains relatively pegged, and the Canadian dollar floats, we are unlikely to see substantial inflation from within this country. US policies make our exports more expensive around the world, particularly to China, and our imports less expensive.

      The appreciation of the Loonie alone is enough to make foreign investors interested in buying Toronto condo’s regardless of the rent they can garner. Over the past eight years or so, the Canadian Loonie has been one of the best investments available. Anyone with US funds who invested in our housing market eight years ago has benefited, not only from the capital gain of the real estate, but the gain of the Loonie. Compare that with an almost flat Dow in US dollar terms. Any Canadian who invested in the Dow eight years ago is deeply in the red today in terms of Loonies.

      A strong reversal in the US dollar would be the big game changer for Canadians, and especially the Toronto condo market. I don’t see that happening. Even Warren Buffet is warning investors to avoid US long bonds. The US intends to default through devaluation.

      • Sams Mango says:

        Agree, long loonie is one my biggest positions this year.

      • jesse says:

        It’s not the US’s job to tell China how to run its monetary policy. They are taking care of their own economy and QE is how they’re doing it. Considering the alternatives I can’t say I blame their policy. China’s pissed off because it has significant inflation and its one-sided capital flow restrictions are causing significant inflation.

      • Financial Newbie says:

        “Even Warren Buffet is warning investors to avoid US long bonds”

        … because Buffet never, ever sells his book…

        Here’s a slightly different take:
        http://www.oftwominds.com/blogmar11/funny-feeling-market3-11.html

      • John in Ottawa says:

        I’ve always liked Charles Hugh Smith.

        I’m not sure technical analysis is working properly during QE. The game is too rigged.

        Charles’ view that it doesn’t matter which way the US dollar goes is a uniquely American view. It matters a lot to us!

  4. John in Ottawa says:

    WRT to US savings rates, it is important to remember that “saving” includes paying down debt and defaulting. US consumers have been defaulting at an unprecedented rate. Recently, however, the savings rate in the US is beginning to go down again. Perhaps this simply means that there is less defaulting.

    Ben, I’m curious that you chose to use Gluskin’s debt/income ratio instead of the Bank’s ratio from their own speech. I’m referring to Chart 7 in the Deputy Governor’s presentation. It doesn’t match with Gluskin’s (which is unsourced). The Bank’s chart suggests that Canadian’s debt/income ratio is only now as bad as the US and UK’s ratios have improved to. They seem to be in agreement on Canada’s ratio, but disagree on the US ratio.

    If the Bank’s chart is correct and I strongly expect it is, then the Governor’s assertion that we started the recession with a stronger household balance sheet is correct. Our situation is utterly hopeless if the Bank can’t even get simple facts straight.

    Let’s be careful not to ignore data that can inform us.

    • Hi John

      Good point about the differences between the two graphs. I’ve inserted the BoC graph for comparison. You’ll note that the discrepancy is in the calculation of US debt/income. My understanding is that a straight comparison of consumer debt levels and income levels between the two countries glosses over significant tax differences as well as other factors such as mortgage deductability making it an apples-to-oranges comparison. Some analysts have adjusted the US measure to account for some of these factors in an attempt to align the readings and make them more comparable.

      It’s not just Gluskin Sheff who has calculated it in this manner. I’ve seen it in several other sources.

      Regardless, the point that I was making is that if we are comparing ourselves to the US, we shouldn’t take too much comfort from the fact that we are more prudent than them, considering it was bad debt that sank their economy and is still a millstone around their neck. If the BoC is holding up our consumers against the consumers of a country that has just experienced a near depression because of bad consumer debt, I’d be leery of taking comfort from the fact that we are marginally better than them.

      I’d say a far more relevant question is have we embraced our own level of dangerous excess that, while uniquely Canadian, is nonetheless potentially problematic.

    • jesse says:

      Do savings rates include defaults?

  5. Sams Mango says:

    I am sure the “net, net” is somewhere on the web. The new mtg rules in the US

    http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20110329a1.pdf

    • John in Ottawa says:

      The new “skin in the game” rules more closely align the rules in the US with long standing Canadian rules.

      There is a key paragraph roughly describing a “qualifying residential mortgage” or QRM.

      As discussed in greater detail in Part V of this Supplementary Information, the proposed rules would generally prohibit QRMs from having product features that contributed significantly to the high levels of delinquencies and foreclosures since 2007—such as terms permitting negative amortization, interest-only payments, or significant interest rate increases—and also would establish underwriting standards designed to ensure that QRMs are of very high credit quality consistent with their exemption from risk retention requirements. These underwriting standards include, among other things, maximum front-end and back-end debt-to-income ratios of 28 percent and 36 percent, respectively; a maximum loan-to-value (LTV) ratio of 80 percent in the case of a purchase transaction (with a lesser combined LTV permitted for refinance transactions); a 20 percent down payment requirement in the case of a purchase transaction; and credit history restrictions.

      The section I marked in bold describes subprime, and option-ARM loans of a type that have never existed in Canada. Yes, I know we like to call any loan that isn’t a conventional 80% LTV loan subprime, but as you can see from the paragraph above, there are subtle but extremely important differences between our low LTV loans and, lets call them exotic, US loans.

      There is no such thing as a Canadian mortgage where the borrower has the “option” to not pay the interest, or where the interest is set very low (teaser rate) with the explicit understanding that it will become higher than market normal at the reset date unless the mortgage is refinanced. Of course, the borrower was assured the mortgage could be refinanced into another exotic loan with a further deferral of the interest payments. As a result of the financial crisis, refinancing into another exotic loan is now impossible. Just look at Table A on page 11 of the report. ABS financing has dried up in the US.

      2011 is the year a tsunami of these exotic loans comes due for refinancing. Thus, the second leg down in the US housing market, as a significant percentage of those loans will be forced into default.

      With the average time from default to eviction now running 527 days (and growing), and 30% of those defaulters not paying a dime towards their mortgages (a sweet deal), you can see that it is going to take a very long time for this pig to run through the python with continued massive losses in the US credit markets.

      • jesse says:

        The US proposal would require privately held MI on LTV 90% loans or require 5% reserve, or require <80% LTV.

        Sounds close to Canada's system but notice the subtle differences. Just saying…

  6. Sams Mango says:

    Like website change. Just noticed ony iPad. How are you as on twitter?

  7. mac says:

    Carney talks about huge amounts of foreign capital looking for a home. Ben, does that help you believe in the “mythical” Chinese?

    On a personal note… I sat in a meeting yesterday and was told by a developer of their plans to fly in a group of 30-40 Shanghai buyers to one of their stalled developments in a vacation area outside Vancouver. It’s happening next month. I will let you know how it turns out.

    Here’s the quote from the CBC article:

    Carney also warned about the particular risk of inflation in emerging economies. The continuing global commodity price increases he predicts — along with the enormous amount of foreign capital looking for a home in booming emerging economies — risks driving up inflation in those regions.

    http://www.cbc.ca/news/business/story/2011/03/28/dollar-rises-carney-comments.html

    I think, Ben, us locally-reconpensed Canadians have great difficulty in understanding the scope of wealth coming from Asia. It’s beyond our ken.

  8. mac says:

    Let’s say it’s not sustainable. But what does that mean? It’s unsustainable over a period of 20 months or 20 years? Low yield or no yield it’s money out of the country. Maybe they too are concerned of a collapse in their homeland. Just means more money will pour out. Unfortunately, I’m not sure Ben’s stat on 60% of the economy being housing-building-driven is correct (sorry if I have misstated that Ben). I thought this article from the Wall Street Journal gave an interesting alternative to Ben’s interesting alternative of a shock coming to Canadians once China’s housing melts down:

    http://online.wsj.com/article/SB10001424052748704517404576222853779046560.html?KEYWORDS=china+subprime

  9. Alexcanuck says:

    John in Ottawa says “There is no such thing as a Canadian mortgage where the borrower has the “option” to not pay the interest, or where the interest is set very low (teaser rate) with the explicit understanding that it will become higher than market normal at the reset date unless the mortgage is refinanced. ”
    I beg to differ. When a VRM is taken out at the lowest rates in history, or a three year term fixed is, or when the developer offers a special interest rate for 2-3 years, or when you can skip-a-payment, or when the strata fees are paid by the developer for two years hence lowering your monthly cost, or another clever way is found to lower monthly payments for a 2-3 year period, what is the real difference?
    We basically don’t have the 30 year fixed mortgages that are the norm in the US, and even 10 year fixed are as rare as hen’s teeth.

  10. Pingback: So much for the ‘conservative’ Canadian consumer: Another look at Canada’s credit bubble | Financial Insights

  11. mac says:

    http://www.businessspectator.com.au/bs.nsf/Article/China-property-Australian-economy-pd20110325-FA9SR?opendocument&src=rss

    Sounds familiar…

    “For example, in the first half of 2010, a Chinese report revealed that 64.6 million urban electricity meters registered no electricity usage. This amounts to unused housing that could accommodate 200 million people. Andy Xie, the former chief economist for Asia at Morgan Stanley, crunched his own numbers and estimated that residential vacancies for commercial housing is around 30 per cent. Speak to Chinese middle class property investors and they will tell you that they buy property not to rent but to hoard as assets – in the same way one buys gold. In other words, the rise in property prices has little to do with demand and therefore yield.”

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