Edmonton Housing Bust

So, apparently this is my 200th post… okay, actually it’s 201. I was going to write this last week but inspiration never struck, and the sales data came out, so it didn’t happen… but who’s counting anyway?! Its interesting looking back, it’s been almost two years since this blog started and in a lot of ways the market is almost right back to where it was when we began.

Alright, so at the time I was figuring by now we’d be down 20% by now, and obviously we’re not there (yet?!). I’ll be the first to admit my understanding of the market and all its factors has grown by quantum leaps since then… but I actually still think it was a good guesstimate given the information available at the time. Reminds me of the old economist’s adage, if you give a number, don’t give a date… if you give a date, don’t give a number.

If I had known we were just months away from governments the world over collapsing interest rates, I probably would have had a different take. But in a roundabout way it has kind of proven my suspicion of weak market fundamentals to be true. Interest rates are still at all-time lows, yet after the novelty wore off, the housing market just as quickly ceded its gains, inventory surged again, and sales have plummeted.

So, like I said, we’re kind of back where we started. Except now interest rates have absolutely nowhere to go but up. That’s not to say there are not other measures the government could (and might) take to attempt to prop up the market should they so choose… but given the current climate and resistance to further deficits that kind of ties their hands. Beyond that, they need look no further than South of the border to see that when the housing market get overvalued you can throw the kitchen sink at it policy wise and it will do nothing for the market long-term. Regression to the mean is a powerful force.

Truth is I suspect we’re on the cusp of a new paradigm. The age of the house, some GIC’s and a mutual fund isn’t going to cut it anymore. This last 30 years has kind of been the golden age of real estate. Prices have been rising faster than inflation… but I think we may have reached out limit and the clock is ticking.

The conditions that gave us 30 years of gains are about the reverse. Interest rates have been going down virtually the entire time, but they have now hit their absolute bottom. That’s not to say I expect them to start going up soon, but they will eventually. Nothing like what we saw in the early 80′s, but back to 6-7% is a given… and if people aren’t willing to pony up rates are 2-3% below that, it doesn’t paint a pretty picture.

Beyond that, demographics are about to shift radically. The last 30 years have seen the Boomers come of age en masse, all the while fuelling massive economic growth, earning a ton of money and spending it almost as fast. That’s about to change… in the next 30 years this colossal age bracket is going to go from an unprecedented tax contributor, to an unprecedented drain. No more buying bigger and better, they’ll be selling out. Not good news when supply is already outstripping demand.

Buying a house and passive investing isn’t going to cut it the next 30 years when it comes to building wealth. In a few years we may begin to question if it even worked the last 30. Going forward, wealth will only be built through living within ones means, active investing, and eschewing debt if one can’t use it wisely. Fiscal excess will no longer be en vogue… instead fiscal restraint will.

We’re in the dying days of the era of credit, and on the cusp of the era of cash.

The 2nd quarter National Balance Sheet Accounts numbers were released today, and it appears households may finally be starting to rein in their debt levels just a little bit, at least relative to disposable income. We’ve been following the debt-to-disposable-income ratio for awhile now, and in the second quarter we saw a rather dramatic reversal as it dropped 3%, from an all-time high of 148.58%, to 145.57%.

One month obviously doesn’t make a trend (and we can see it often just resumes rising after a down month), but this is the first major downward movement in this measure in years. Beyond that we’ve been wondering why despite the recession we hadn’t seen a hint of levels slowing down as they typically do in such economic circumstances (as as was seen in the numbers in 2000).

Fortunately, or unfortunately, depending on how you want to view it, this drop is not rooted in an actual decrease in debt levels, but rather an increase in disposable income. The Household-debt-per-capita measure jumped by another $800, and now sits at $43,400, and is up over $3,000 from 1Q 2009 when the recession really took hold.

Knowing that, it’s not a surprise the the debt-to-GDP ratio continued to climb… up almost half a point in the quarter to rest at an all-time high of 94.17. Though at least this ratio has more-or-less leveled out in the last year.

So, long story short, we had some good income gains in the second quarter of this year, unfortunately we continue to pile on the debt.

Came across an article a few days ago, that made a very interesting observation… that being, that historically bond yields (which are effectively, interest rates) going back to the 1700′s have fairly reliably followed 60-year cycles.

Within that, the 30 year period of generally declining interest rates we’ve been experiencing is not just not unusual, but actually appears to be rather predictable, and right on schedule. So, I figured this is worth exploring a bit, and without further ado…

Here is the graph displaying (for information on their data compilation/methodology read the article linked to in the first paragraph). We can see that with the exception of a war or two over the centuries, that the pattern is remarkable consistent (obviously give or take a year or two on just when the absolute peaks and troughs are experienced). And we’re looking for a general trend, as there is no such thing as absolutes when it comes to things like these (or it you really want to get philosophical, one could argue there are no absolutes, period… but lets not go there)

Looking at the graph, obviously what stands out, and sets the last 60-year cycle apart is the extremes reached, on both ends. We have never seen this kind of volatility before. Going back to 1950, obviously we’re in the immediate aftermath of World War II… which itself was coming off of The Great Depression… so, the double whammy of stunted economics and political unrest conspired to give us the lowest interest rates in history.

Then we flash forward thirty years, and the runaway inflation of the 70′s and early 80′s. That was eventually slayed by the policies of Paul Volcker to choke off inflation by jacking up interest rates, and we end up reaching heights thought unimaginable before. Even the highs reached during the Mexican War is dwarfed by what happened from ’79 through ’82 (and the time it took to unwind and return to Earth).

From there, obviously there was no where to go but down, but regardless it seems these 30-year periods of interest rates heading one direction is pretty much business as usual as far as these things go… and within that we’re right on schedule to be bottoming out right now.

I suppose this trend my be a bit troubling to those who recently bought into the market, and have 25-35 years of payments ahead of them, as if things go according to Hoyle, they can expect to be paying a bit more every time they come up for renewal… a concept that would seem very foreign to anyone who has bought in the last 25 years.

Of course there is no telling just how much things could increase over that period. Up until the last 60 years, the highs and lows have been much less volatile, and unless one was so unfortunate as to hit the extremes, the swings would typically be within reason.

I wouldn’t expect a return of anything resembling what happened in the late 70′s-early 80′s, but historically speaking we’re very low at the moment, and even what we experienced though much of the last decade have been at the low end, so even just going back to historical norms could eventually put 5-yr fixed rate mortgages back into the 7-8% range… which is a point or two higher than we’ve become accustom to, and three-or-four above what they are currently.