Friday, September 18, 2009

Money makes the world go around...

A good comment from Markoz..

MarKoz here: I had really thought that the stagnation in sales and surge in listings last year was the beginning of the end. I was wrong. I had always considered government intervention in the RE market to be somewhat random, and that ultimately market forces would bring prices down. I now believe that no provincial or federal government will let prices down as long as their members have a pulse ...... I know that nearly 70% of Canadians are homeowners. Virtually all politicians are certain to be homeowners....

He is absolutely right. The politicians will do everything they possibly can to prop up real estate. It is the big kahuna. The result of it's collapse can be seen in the US. Wide spread bankruptcies, unemployment and bank bail-outs.

It's too bad they weren't a bit more concerned on the way up, allowing banks, speculators and regulators to behave completely irresponsibly. If you allow a huge unstable tower to be built in front of your eyes, don't you think it could come crashing down one day??

What more can they do in Canada if/when the down-trend resumes?

Not a lot.

Interest rates are already rock bottom and tax-relief on mortgages or other mechanisms to support prices will just exacerbate the huge deficit. (BTW the UK just posted it's largest ever deficit). So their options are becoming very limited.

Firstly we have to get one thing straight- who are these much maligned politicians? Are they aliens bread in captivity sent to rule and ultimately destroy our planet. No. On the whole they are just like us. Apart from the odd Billionaire like Paul Martin the rest of our pols are fairly regular Joes..who like to feel important (and popular). Some have a vision, others are guided by polls.

They will tell us what we want to hear, not what we (deep down) know has to happen. This is the same the world over. The response to the financial crisis, which by the way was completely avoidable, was to loosen money even more...punish savers yet again...and reward irresponsible activities, especially by highly paid bankers.

Was there an alternative. You bet, but I am not sure anyone would like it very much. Let real estate drop.
1) Let all assets drop and find their natural support.
2) Let the big banks fail if need be.
3) Pay up on insured accounts.
4) Seize the bonuses of the bankers responsible and let the chips fall where they may

The result would have been a catharsis of default and even possibly a rapid depression. Awful, yes. But the excesses of the last twenty years of bubbling assets, deregulation, greed and materialistic orgy would have been dealt with in one fell swoop.

Governments would be there to pick up the pieces afterwards and stop people from starving -at a much lower cost. Then we would have had to rebuild a system that was not based on fractional lending or which did not allow the privatization of profits and the socialization of losses.

Were we ready for this around the world?

Not at all.

So our politicians did their damnedest to plug the hole, for now. As one economist said..."they just kicked the can down the road". The degree of debt that they are accumulating will require a huge expansion in the economy to service, if that doesn't happen there will be a de facto default which is monetization (you print the money to pay your debts).

Future generations won't be burdened by it, because it will probably come to a head in the next few years and will have to be dealt with: by slashing and cutting, or defaulting and printing money.


  1. Our debt to GDP ratio is the best it has been since Trudeau despite our current deficit.

    Canada debt service ratios are still quite low and only a small percent of our GDP is actually devoted to debt servicing.

    I am not suggesting debt are not big issues to think about. They are. But, I don't see these as insurmountable issues.

  2. Dave- agreed that the Debt/GDP ratio is down from a high of over 60% to the 30% range.

    However I expect to move up briskly from the deficits and slower GDP growth.

    Also Provincial debt has expanding rapidly due to deficits, even Alberta has reported it's first deficit in 15 years.

    Here is the debt to GDP for the Provinces alone (2007 numbers)

    Here is the Canadian debt clock:

    Many other countries do not have Provinces which have large borrowing abilities, so one has to account for that too.

    Add in the all our debt to GDP and I would guesstimate from the numbers I found on the net that we are at over 50%. However I am ready to be corrected on that one.

    But we are in better shape than many other countries. Japan is over 150%! (However it is mostly held by Japanese savers.)

  3. Sorry West Van-last up-date.

    6 listings 4 price reductions. 1 sale. (and two shootings! In ambleside-by-the-sea! no less)

  4. Fish, love your blog as always. I've been enjoying your West Van numbers. Is it just me, or are they starting to tell a story? If you have time, it would be great to see them listed together to allow for easy comparison.

  5. Deficit in canada as % of GDP is currentlty 3.7%
    However what this does not account for is all CMHC obligations. Were this to be taken into account as it should, Canadas deficit to GDP would be -21.4%
    Here are the figures that nobody want to see in billions:
    Budgetary revenues : 216.6
    Program expenditures : 241.9
    Public debt charges : 30.7
    Budgetary Balance (sub-total) : (55.9)
    CMHC Housing subsidies:
    - Indirect loans to homebuyers through purchase of securitizations 100.6
    - Increase in high loan-to-value mortgage guarantees : 30.1
    - Increase in guarantees of bank loans sold to capital markets: 139.7

    Total Budgetary Balance : (326.4)
    Estimated GDP : 1,526
    Deficit as % of GDP : -21.4%
    It seems that there is a silent understanding between the media and the goverment to keep the truth hidden from till the truth becomes too heavy to handle. For how long? Time will tell.

  6. Markoz again. I have no training in economics. Can someone explain how interest rates can be kept low when so many western countries are running huge defecits. If these countries all need to borrow money, doesn't it create competition to sell debt instruments rsulting in higher interest rates? I guess I'm missing something (or maybe several things). Any help would be appreciated.

  7. This comment has been removed by the author.

  8. Thanks GM. My time and technical skills (lack of) preclude graphs, charts etc. Clip art is about my limit :)

    Anon thanks for that comment. As you have pointed out, we have hidden debt here, CHMC, Provincial, Crown Corps and worst of all the health/ retirement and pension liabilities of the baby-boomers.

    I think the hands of government will be tied by these fiscal realities in the future.

  9. Well that is very interesting Markoz, and three economists will probably have three different. Here's my shot at it.

    Short term interest rates are (generally) determind by the BOC and Fed etc. As they lower the over-night rate, Fed funds etc, so the banks tend to lower lending rates. (and the amount the pay depositors)

    This relationship held until late last year when we had the bank melt-downs. A that time, the fear of bank defaults - even in Canada - was so high that bank borrowing went up and the banks were not matching the drops in Fed/BOC rates.

    So the banks were bailed out in the US, and here in Canada the Government bought some loans and made funds available to banks to bring rates down and keep lending.

    So that in a nutshell is short rates.

    Longer rates...5/10 and 20 years out, are determined by the market. The bond market works like an auction and buyers and sellers determine what price they will buy and sell at.

    The rates are determined by :

    1) Inflation - or more importantly inflation expectations. You wouldn't want to be holding a 20 year paying 3.5% if inflation goes to 6%.

    2) Supply - as you have mentioned supply is going up from the huge debt and deficits.

    3) Alternate areas of investments.

    These three play against each other. Inflation is low, a huge amount of debt is being turned onto the market, but conservative investors are still leery of RE and stocks -despite the run-up- so demand is high.

    Therefore we sit at low long and short rates.

    What could change this?

    1) A sudden spike in inflation
    2) A consensus that the recession is over and a flood back into other assets with better returns.
    3) A de facto default. Where the governments cannot meet the capital and interest payments on tax revenues alone. So they monetize debt. They just print money and cancel debt like Zimbabwe.

    The ultimate ponzi scheme run on a worldwide scale.

    I cannot see any of these on the immediate horizon, but gold's spike is something to watch. I don't think Gold is going up because of inflation, since we are at generational lows, but because of the fear of eventual monetization.

  10. Markoz says: Thanks Fish. Great to have someone like you to explain things.

  11. "Can someone explain how interest rates can be kept low when so many western countries are running huge defecits."

    I don't think it's accurate to connote that the government is actually setting rates in some grand conspiracy. They are, of course, setting rates but it's not like they have many options available to them other than what they're doing.

    The problem is that there is not a lot of private investment which means too much capital chasing too few investment opportunities, government bonds included, which is driving rates down. This has the possibility of being deflationary so... the government steps in, borrows money cheap-cheap on the open market then turns around and invests it in lieu of private investment. Voila -- large deficits even though rates are low.

    Interestingly because there is a general lack of investment options, mortgage rates are low and as long as other investments opportunities are lacking will remain low for a while.

    Dave makes a good point about the nation's debt-to-GDP ratio and I'll add that most conventional mortgages are seen as low risk, which is why they are still making loans through the recession and spreads are razor thin.

  12. Jesse- the returns for banks are pretty good. They are paying almost nothing on deposits and lending it out at 4% or more. Leverage that up a few times and it adds up to good chunk of dough.

  13. frank, how exactly does a bank leverage deposits? I don't know how much of the mortgage market is securitized but I don't think the spread is 4% on prime stuff.

  14. jesse- look up fractitional lending, and it will explain how banks leverage up their deposits in lending.

  15. Jsee and others interested in the money is debt videos 9there are 5 in total and are very eye-opening)

    here is the first:

    In the arcane world of banks, your deposit is counted as a liability. However the mortgage they give, is counted as an asset. Though it the mortgage that brings with it the risk of default!

  16. fish10 and frank, that's explaining fractional reserve banking but that's not my point. Banks at any one time have $X deposits on the books and with FRB can lend out around $0.9X. The spread is only on the $X deposits, not some multiple of it.

  17. Jesse- watch all the video series I posted above and it will all be made clear.

    We do allow banks to 'create money', far above their deposits/or reserves.

    It is bizarre but true.

  18. fish10, I've seen the video before. Is it not true that the bank is only allowed to lend out around 90% of its deposits? From the entire economy's perspective yes the "seed" money is loaned out to produce 10X the amount but, at any one time, the bank cannot lend out more than it has: it cannot leverage your deposits because your deposit is at any given time part of the 10X amount already in circulation.

    If we throw in the securities market then the leverage can increase vis a vis the deposits but that's different.

  19. Here's another article that leads me to believe the government will do everything in its power to keep the housing bubble going:

    Link is a re-post from VCI.

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