Entries from October 2008 ↓

What to fear


Abandoned condo tower site in Vancouver.


Listen to Garth’s interview on the financial turmoil, here.

Funny days, these. The dollar falls three cents one day and climbs four the next. The TSX is down 700 points, only to climb nine hundred two days later. The government gets elected saying no deficit and two weeks later there is one. There’s a credit crisis and yet interest rates look like they’re headed for zero.

RRSPs, pensions, nesteggs – they’ve all been violated. Corporations are whining for federal bailouts and saying they can’t afford pensions for retired workers. Unemployment’s rising and consumer confidence is plunging.

Strange times. Deflation is the big story now – falling retail prices, crumbling house prices, cheap cars and Christmas sales in October. But in times to come, it will be inflation – since governments are spending billions they don’t have but will be looking for down the road. Higher taxes, increased money supply, less purchasing power.

The Fed threw another log on the fires of distant inflation Wednesday, cutting interest rates yet again, and taking its key rate down to just 1%. This is scary. You might remember Japan did exactly the same over a decade ago when its real estate market went to hell, forcing interest rates to hit 0% as the government tried to prime the pump. Didn’t work, though. Japanese house prices stayed in the shark fin soup for 15 years, recovered a little and have recently crashed again. An apartment in Tokyo that was $1 million US in 1985 is today worth less than $480,000.

But in Canada, we’ve been told by the prime minister and other less notables, it’s all different. We’re an island of stability. A rock. Northern star. Canadian Shield (not, that’s not a condom).

Maybe not so much.

Close to two years ago I said our real estate market was poised to fall. Said it again in a book six months ago. Now it’s here. This is vitally important because – as in the United States – this is the thing you should most fear. Not the stock market. Not the currency. Not energy costs. Houses.

Residential real estate accounts for almost 85% of all family net worth. Meanwhile the Canadian savings rate – as in the US – is now zero. Once home values start to slide, nothing has more of an impact on consumer confidence and concern about financial well-being. Since house prices rose by more than 73% in the past decade (about the same as the US in the years following Nine Eleven), mortgage debt has exploded. After all, household incomes have barely budged, so pricier houses simply mean more borrowing.

So, never before have we (a) saved nothing, (b) had so much of our wealth in one asset, (c) owed so damn much or (d) shown such appalling financial planning, with a total lack of diversification, as now. It was obvious when the average price of a home exceeded the ability of the average family to buy it, the market was over-valued. It would have corrected harmlessly, had it not been for the geniuses who invented subprimes in the US and 0/40 mortgages here. The boom became a bubble, and now a bust.

It was real estate, after all – not Wall Street, hedge funds or the greedy twits who ran Lehmans or Bear Stearns – that created the mess in America. The middle class there is being dealt a body blow and it seems we’re destined to be smacked in the same fashion.

Officially, home prices have fallen just over 6% nationally in the past year. But that number’s misleading. In Toronto, they’re down 15% from the peak, and an equal amount in Edmonton and Vancouver. Condo projects are being cancelled all over everywhere while home sellers now wait months for an offer and realtors play with their Berries during clientless open houses.

Listings have hit a high point, and sales are off 50% in BC, 43% in Muskoka, 70% in Leaside and by half in Kelowna. Spooked by the times, and rightly so, buyers are staying home in drives, knowing prices will be lower in January than they are now.

There is no option but for the Canadian government to push for lower interest rates, bring in an income tax cut and throw more billions we apparently don’t have at the Bay Street lenders. If that were to happen immediately, in an economic statement, it might help some to keep the real estate melt from becoming a meltdown.

But don’t hold your breath. It’s different here. You’ll see.

What we sowed.

Some time around 1990, with gas prices low and the economy growing, GM made a fateful decision: scale back on compact and fuel-efficient vehicles and go full-out with SUVs.

The gamble started to pay off by the mid-Ninties and lasted for a decade. Behemoths like the Suburban, Escalade, Tahoe and Yukon earned the company up to $15,000 a unit, and production peaked at 680,000 a year. At the same time, pickup truck sales boomed, with Silverados streaming off the Canadian production line. Never before had so many vehicles consuming so much fuel been sold to so many consumers.

The parts industry flourished, typified by Magna and a host of other companies who ringed assembly plant sites with satellite operations feeding just-in-time inventory to the voracious factories.

About the same time on both sides of the border, starting especially after 2001, North Americans launched onto a real estate boom. Home prices were bid far beyond the ability of average families to afford them, rising on average more than 70% in both countries. Mortgage debt exploded, and then lenders lowered the bar for buyers, ushering in subprime mortgages in the US and zero-down payments and 40-year amortizations in Canada.

As a result, North Americans became history’s ultimate consumers, driving the most consumptive vehicles ever mass marketed and living in homes millions of people technically could not afford or had purchased without money.

This, of course, could not last.

I’m reminded of it all with news today that the Canadian auto parts industry is asking Ottawa for $1 billion in assistance to keep factories open and workers on the job. This joins a $25 billion request made to the Canadian and American governments by the auto industry, where GM is believed close to bankruptcy and where a merger is brewing with Chrysler. It also joins a pleas for government assistance by the forestry sector, and warnings by several provincial governments that they will need charity.

Of course, this is all layered against the news of a $700 billion bailout of Wall Street banks which gambled on the securitization of toxic mortgages on houses people could not afford, along with the nationalization of the American mortgage business (Fannie and Freddie) and a new $300 billion package to rescue people living in homes they cannot make the payments on.

I understand clearly the argument that without government assistance in this time of financial stress the economy will crater sooner and deeper. Millions of people may lose their jobs, many in the auto sector, and real estate values will plunge as supply swamps demand. At the same time, banks are wobbling, recession is undermining commodity prices and our dollar is fading fast.

Not a happy picture. But what should be done?

Here’s a radical thought. Government should not intervene further, lest we poison the future trying to mitigate what we have coming to us.

Houses became overinflated because greedy sellers asked too much and capricious buyers paid it. Profit-hungry lenders provided the money. Self-dealing real estate companies promoted the market. Myopic politicians legislated no-money deals and mortgages that increased indebtedness. People bought and sold homes for more than they were worth, speculators and homeowners made bundles, builders overbuilt, realtors earned big commissions and banks constructed massive asset portfolios.

Concurrently, car companies built millions of trucks and SUVs, earning billions, while eschewing gas-sipping models largely because they were far less profitable.

And nobody thought of sharing any of this wealth with the taxpayers.

Today we are in a post-excess, post-credit world. Governments, and the citizens who stand behind them, are being asked to pave over the past. In the US, this will mean unheard-of deficits and a federal debt that could hobble America for the next four decades. In Canada, it now appears the government will need $10 billion or so more than it has – even without considering industry rescues.

Debts and deficits do not encourage economic growth. Bailouts don’t, either. They reward bad corporate decisions and human greed. The stock market knows that, even if the politicians do not.

Long before granite countertops and SUVs, we once had this figured out. You reap what you sow.

Painfully obvious.

Update:
TSX plunges 700 points in panic sell-off
Oil at $63 helped stocks to a 4-year low

Some visitors here have accused me of being a merchant of doom. You are accentuating the negative aspects of the economy, they cry! This is a global phenom, and not Ottawa’s fault, they admonish! Lighten up, they beseech!

Well, a few sober words of response.

First, the economy is going to crap and we’d all better get used to the idea. Stock markets continue to look for a bottom, and the depth of the global recession is yet to be known. There will be no quick fix, and not even President Obama will have one. In fact, his election may well make things worse for a while (if Washington tries spending its way out of this).

It’s expected that 200,000 people lost their jobs in the US this month (we’ll know in a week or so). We also expect Ottawa will have a deficit next year of at least $10 billion – which will mark an historic erosion in national finances of almost $24 billion since Mr. Harper assumed office in early 2006.

We should anticipate the US stays in recession for two to five more years. Stocks will not stop losing value until there is some glimmer of a recovery on the horizon. Commodity prices, including oil, will stay weak for the same reason, since global demand will continue to fall. Some industries – travel, consumer electronics, home furnishings, car sales and, of course, real estate – will be very poor indeed.

The consequences are painfully obvious. The oil sands, for example, will be in considerable trouble as expansion plans are cancelled, the cost of production exceeds world oil prices and Alberta goes from boom to quasi-bust (but with billions in the bank). Homeowners in every city will see their net worth take a hit and selling will be a painful, protracted experience. Unemployment will rise sharply as key industries (building and selling cars, new home construction) fizzle. But the collapse of the Canadian dollar – to as little as 70 cents US – will suddenly make some slagging exporters competitive again.

Public finances will deteriorate quickly as corporate taxes fall and the number of working people erodes. A deficit in Ontario has already been announced, and BC and Quebec will follow – accounting for 70% of provincial finances. As mentioned, the feds will be in the same boat with monthly deficits by January, at latest.

These are just routine assumptions, based on events which have already transpired. There is no doom involved in making them, and anyone who refutes these realities is delusional. We should all be preparing. The only real regret I have is that the election just passed was fought more on puffin poop, mangled English, sweaters and a far-off carbon tax than on a collapsing economy, plunging real estate, lost jobs and an immediate recession.

Now, if you want to get quite depressed, we could talk about how the destruction of our credit-gorged economy is coinciding with the inevitable effects of climate change, the arrival of peak oil and the advent of the greatest age wave in history. But that would beg a painful question: Why are our leaders not talking about this? Is there a plan? What is it?

Economy. Energy. Environment. Demographics. If you think things suck right now, wait a decade.

So, if leaders aren’t ready, are you?

Much more to come on this, whether you deniers like it or not.