Saturday, May 5, 2012

Sometimes we have to look past RE in our town

and look at the bigger picture. The 'and then some', in the title of this blog.

We know that the CMHC is finally going to be roped in, the question is, is it too late?

It may well be. The CMHC has accounted up to 60% of all mortgages in recent years according to it's $600 Billion Cap and the $1.1 trillion Mortgage industry.

That is an astounding number for one institution. Then when you learn that the institution is Government backed, you wonder if we live in North Korea or a few of the last bastions of Government run economies. Except this semi-socialist animal has in fact made a few (brokers, speculators, developers) very wealthy and spread the risk to many.

To many of us bloggers, it was obvious what a scam this was which was benefitting a very few people. here's how it goes:

1) Bank of Canada keeps rates at zero.

2) Savers get zero on deposits + banks sell bonds at near zero as  they have implicit Gov of Canada backing = accumulate a lot of cash which has to be put to work.

3) Banks offer mortgages to everyone with a back, high leverage, speculative, stated income, mortgage holiday etc etc

4) They get CMHC insurance - hence the bulk of the risk is transferred to you and I.

5) The banks sit back and clip coupons - getting 3-4% gross on each dollar lent, but since they are leveraged up, multiple times this amount.

6) banks look sound. Speculators, developers, mortgage brokers, bank CEOs and some realtors make great huge chunks of money.

The profit comes from the hide of savers (zero rates) + first-time buyers (higher prices) + the tax-payer (future liability)

No wonder they didn't want the golden goose to be killed. Several years ago David LePoidevin a money manager at National Bank pointed at the CMHC as the creator of the housing bubble. 

The CEO of National Bank jumped in to defend the CMHC and said that he did not share his manager's views. Who could blame him, the wagon kept on rolling and the bonuses kept on coming. A cool $5-6 Million a year, which is a lot for a small bank.

Since then the problem has been made a lot worse. About $300 Billion worse. 

When Flaherty doubled the CMHC lending cap, and dished out money to the banks, yes he saved Canada from the worst of the financial down-fall -But he knew what he was doing long-term.

- He was adding air to the housing bubble. A LOT more air. $300 Billion more in a $1 Trillion market! Now the bubble will deflate from a much higher level and cause a lot more collateral damage.
- He transferred risk into the future.
- He cynically backed a semi-socialist organ (which was set up after the war to help the poor get mortgages) and turned it into a financial megalith, a bonus generator for Bay Street.
- He bought Stephen Harper his majority.

In case any of you still think that it is wise to have a debt-burdened economy (and remember we are now at the same level of consumer debt that the US was before their collapse) then I would suggest you read this excellent summary from the most astute money managers in the US.

Economies which are debt laden from RE booms (think Japan, Spain, the UK and the US)  go through very painful adjustments. There is no reason why we should be any different.

The sad part is, it could have all been prevented. It is hard to imagine how we could all have been so foolish.


  1. Good post Fishy,

    I share your frustration. But you hit the nail on the head--- its all about getting re-elected. Nothing will ever change that.

    1. Thanks. Our political system favours short term panaceas rather than long term fixes.

    2. With due respect Anon, having a back door is the big picture when re-election is lost. If one's next job is to steer the Royal SG Bank, it makes sense to score as much brownie points now doing nothing, but once in the new job to sit tight-do nothing and enjoy the huge rewards.
      All that is needed is a thick hide, as no decent folks would go on tv repeating same old, same old BS.

  2. The CMHC's original mission was to alleviate the housing shortage faced by returning WW2 veterans. They made sure that houses got built! The mandate to help the poor came later, and they built a bunch of rental housing in the '70's. Arguably they should have been scaled back. Instead they are the market, in this socialist wonderland that is Canada.

    1. Well it has become anything but socialist. It has helped cause rampant speculation, the hall-mark of an unregulated free-market economy. It has become a tool for the most right-wing Government we have had in some time. How ironic!

      They killed the Wheat Board for being a Soviet-collective and turned the burners on full for the CMHC.

  3. Thanks for the post. Though I generally agree that CMHC is at the root of the problem, I'm not sure I'd agree with everything you've written.

    > 5) The banks sit back and clip coupons - getting 3-4% gross on each dollar lent, but since they are leveraged up, multiple times this amount.

    How do you figure the banks are getting 3-4%? The spreads on the posted rates may be that large, but on the discounted mortgage rate that it seems most everyone really gets, the spreads seem to be a lot smaller. What am I missing? (Though with leverage, as you say, it's still a significant profit.)

    > 2) Savers get zero on deposits + banks sell bonds at near zero as they have implicit Gov of Canada backing = accumulate a lot of cash which has to be put to work.

    I wasn't entirely clear about the point you're making here with regard to the real estate ecosystem, but I'm assuming you're suggesting that because returns in other asset classes are so poor (or appear too risky) this is pushing people with excess cash into real estate?

    > this excellent summery form the most astute money managers in the US.

    You might want to correct that to "summary from".

    I think another significant point that needs to be made in this discussion is the benefit to various levels of government from increased tax revenues. Higher property values means more property tax revenues. Higher property values plus high sales volumes means more property transfer taxes and, where applicable, GST/HST.

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  5. Hi Rick.

    Thanks for picking up the typo- fixed.

    Here's how the banks make 3-4% base - how much are you getting on your savings account (not GIC) ? The Royal Bank is paying between about 0.25% depending on the balance. As low as 0.05 up to 0.5%. The posted five year mortgage rate for the Royal is 5.4%.

    Assuming some wiggle room with both, we get 3-4%.

    As for their bonds. They are paying 1-2% up to for four years out. net 3-4% again. Why do they pay so little? because the investors know they have handed off the risk to Mother Canada, and the Government has said many times they are too big to fail.

    HOWEVER they are in fact making more than that thanks to the wonders of fractitional banking.

    here's one summary.

    There are many others.

    As to taxes, I'll save that for a separate post. Local taxes are a zero sum game. The Province and the Federal Government have been getting huge revenues form the Property Transfer Tax and GST as I have posted before.

    That's why they have been so reluctant to burst the bubble. However what they have done is magnify the effect of any crash. Imagine being on the hook for the CMHC at the same as revenues take a big plunge and the low skilled hammer-and-nail jobs vanish. It would not be too dramatic to say it would be a fiscal catastrophe- one that could have been avoided.

    However it is higher than that thanks to fractitional

  6. A high school classmate is still trying to sell their extended family's side-by-side duplexes at 15% above city assessment. Recent sales in the last 12 months showed all sold below or up to 3% max above assessment in their neck of woods. It is kind of late to ask for that much, but they might strike it rich with some HAM developers and stand to make triple what they paid for less than 10 years ago. I certainly wish them well as they will never save up that kind of windfall in their lifetime with their low skilled occupations.
    They have had so many holidays abroad that it is unlikely they have any savings for kids' education and retirement funds. It is weird that I actually know people who live large and beyond their incomes.

  7. > how much are you getting on your savings account (not GIC) ?

    The bulk of my tax-unsheltered cash is in a HISA at 2% and I've got GICs up to 3.55%, but I take your point. My tax-sheltered cash is getting squat, and my chequing account is getting close enough to squat to make no difference. 0.25%, I think.

    Thanks for the Youtube link. I was familiar with most of the bits and pieces, but I hadn't seen it put together like that before or followed the chain of logic that deeply. I'm interested to see how the pro-banking side attempts to rebut this sort of argument. I suppose that'll be a research project for a future day.

    Until now I was under the impression that mortgages were funded, at least in part, by issuing bonds; and that a mortgage rate was a kind of direct markup applied to a bond rate. Seems that I was quite wrong. So by my math, I'd expect a typical current mortgage rate of ~3.8% and a savings interest of ~0.25%, leaving about a 3.5% difference - 3 to 4 percent, as you say. That got me wondering what the reserve requirement was in Canada, and I was a bit shocked to find that the reserve requirement was repealed from the banking act in 1999. Banks are apparently trusted to set their own internal reserve requirements, and these are supervised by OSFI which has some authority to enforce a higher reserve if they see fit. I found this post and the followup comments quite illuminating:

    So I poked around some more. According to Royal Bank's 2011 annual report, their Tier 1 Capital Ratio was up 0.3% over 2010 to 13.3%. According to their 2012Q1 report, it's now down to 12.2%. Poking around some more:

    CIBC: 2010 - 13.9%; 2011 - 14.7%; 2012Q1 - 14.3%
    Scotia: 2010 - 11.8%; 2011- 12.2%; 2012Q1 - 11.4%
    BMO: 2010 - 13.5%; 2011 - 12%; 2012Q1 - 12.7%

    I find it interesting that all the banks seem to have started accumulating a capital reserve war chest starting in 2008, and I wonder if it's cause for concern that all four banks I checked show a significant decline in that reserve in 2012Q1. Is this a side effect of the 2.99% mortgage wars?

    So let's see if I've got this right using Scotia's numbers, and assuming that I deposit $100,000.

    I'd make %0.25 (probably more with a deposit that size, but let's ignore that) so about $250/yr.

    Meanwhile my $100,000 can get levered up 8.77 times (1 / 11.4%) to $877,000, which they make 3.5% on, or about $30700 per year. (I think that's a bit oversimplified and it's not pure profit, of course. Still, that's one hell of a revenue engine.)

    Thanks for the enjoyable conversation. Sorry if it's dragging your post off-topic.

  8. Thanks for adding all the extra info. The internet has made us all better informed and hopefully eventually will empower those who do not want to get their news fed to them like pablum from the multinational corporations that own the media.

    It is a sobering equation, which is why so many people open banks in the US, there are 5000 with assets over $100 Million.

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