Canada - Edmonton Housing Bust

Category: Canada

Thursday, November 12, 2009

Fixed vs. Variable

This has been a much requested topic, and one I would have touched on sooner but I made the mistake of over-thinking the question initially. It wasn’t until BMO came out with a report last month, that I realized it was far simpler an analysis… in fact, incredibly simple.

Now, obviously all the variables cannot be accounted for as we know banks generally lend variable at rates of prime-plus-, or prime-minus-, thus leaves an infinite number of possible combinations… but with a little intuition we know that whatever the rate is relative to prime would merely result in a shift in data. So, you can use your imagination, we’ll be doing all the calculations using the average five year rate straight against the prime rate.

Here is a look at how the two have moved over time. Obviously track very similarly, though prime is generally lower (but not always). These are spot rates though, and to get an idea of how the two stack up in practice over time we much take into account how they perform relative to each other over their 5 year terms, and even over the entire life of the mortgage.

This is a more useful presentation of the data, comparing the 5-year fixed rate at any given moment against the moving-average of prime over the next five years. You’ll notice it is remarkably similar to the graph from the BMO report, that’s cause it’s the exact same data, except their’s only goes back to 1975.

As we can see, in general variable has provided the more beneficial choice the vast majority of the time, as BMO noted, 82% of the time since ’75, even higher at 89% going back to ’51… and it has exclusively been the better choice since 1987. That is not surprising though, as rates have going down generally since 1981.

The times fixed has been the better option has been during periods immediately proceeding large spikes in interest rates. Beyond that, during periods of generally rising rates (the period up to 1981) even when fixed is the less preferable option, it tracks much closer to how variable performs.

So, as rates have for all intents and purposes hit absolute bottom, such info is worth considering going forward as rates are sure to rise above current levels in the years to come. That goes for whether you’re buying, or if your mortgage is coming up for renewal. This may be an ideal time to hedge your bets and go fixed, at least while rates are still near record lows.

Here is a bit of a different perspective of the previous data. Any time the line goes into the red area, fixed was the cheaper option… conversely, when it’s in the yellow, variable was the cheaper option.

We kind of already discussed this, but this just gives you an idea of the proportional difference in these cases. It went as high as 4.4% into fixeds favour, and as low as 8.8% into variables. Over the presented period, the average was -1.33%, and median of -1.14%, both in favour of variable.

So, on average there is certainly something to be gained by going variable, but it’s usually only a 1-1.5% advantage. So in times of uncertainty, such as now, you need to carefully weigh the potential positives and negatives of either route when you make a call like this.

This is another take, assuming if a person went fixed or variable at the start, they stayed with it through the remaining renewals for the full life of the mortgage. Here we can see how payment advantages from prior periods can compound over time. This is because at different rates, you also pay off different amounts of principle during any given term (except the final term of course)… basically, the lower the rate, the more principle you will pay off.

So if you make the right choice in one period, it will pay off for the remaining life of the mortgage… conversely if you got the other way, you’ll be paying for it for the rest of the mortgages life. This measure is a measure of how much is saved relative to the more costly option.

We can see that over 25 years (five terms) the scale of the advantage is much larger. Going as far as 28% in favour of variable. But again, remember this is over periods when the majority of the life of the mortgage would be while rates on going down.

We’re not in that situation today, in all likelihood rates are heading up at least a point or two in coming years, thus, pay particular attention to the data in the 50′s and early 60′s when in a similar situation. During that period, the results were much more mixed.

The dotted area is of mortgages and/or terms have not year completed, and the further right you go, the younger the mortgage, and thus the more the data will respond to future data. Those plots/figures have not been included in any figures I’ve discussed, they’re just there in case you were interested in such things.

Finally I just threw this one in for shits and giggles, this is what they’d look like if we had 30-year fixed rates like they do in the US, rather then our preference for the 5-year terms. This is using the Canadian data as I’m too lazy to look up the US numbers, and from experience their 30-year rates are close, if not often lower then our 5-year rates (no wonder our banks are so profitable huh?!) and prime would be very similar.

We can see here the results are more muted then the prior graph. During periods of increasing rates, fixed performs better, and during ones of lowering rates, variable does. No surprise, that’s what intuition would suggest.

I know real estate is still ugly in the states, but you gotta figure in a lot markets prices have returned to their long term trendlines, if not dipped below. That combined with this current interest rate environment, there may never be a better time to buy if you’re a potential first-time buyer south of the border. Even if prices slide a bit further, you’ve locked in at a sweetheart rate, and thus probably still better off.

We north of the border on the other hand, are at the opposite end of the curve, still near the top (or in some cities, right at it) of the bubble. We still have a world of hurt to come before we return to market conditions that are ripe for those looking to enter the market, buying in now is more a debt trap then anything.

Anyway, hope this answered some of your questions about the historical performances of fixed vs. variable rates. But, if you have any more, fire away!

7 comments

Thursday, November 5, 2009

A hill to die on?

Filed Under: Canada

Pay no attention to the man behind the curtain

Had another post planned for today, but in light of this emerging story that will no doubt be on the forefront for the next while, I figured lets run with this. So, the shit has kind of hit the fan this past week in MLS land, as the Competition Bureau concluded that the CREA has rules deemed anti-competitive.

While the specific details of the Competition Bureau’s findings have not been officially released, there was news of a leaked CREA letter more or less detailing said findings. I’ve obtained a copy of the original, and you can view it in all it’s glory via this link if you’re so inclined.

Nothing particularly earth shattering about it, just kind of outlines the Competition Bureau’s findings, which the CREA states they disagree with (duh!), the some possible ramifications of the requested changes.

Seems the CREA is leaning towards pursuing a settlement agreement, rather then face a Competition Tribunal… which basically translates to their not liking their odds if they had their day in court, and would rather try to plead it down rather then risk really having their asses handed to them at the tribunal.

But that is just the higher-up’s position, the actual decision will be made in December when they’re holding something of an emergency meeting where the members will decide on their ultimate strategy… I would think if they thought they had a hope in hell they’d probably fight this one to the death. If their is any hill this cabal would be willing to die on, these issues would be it as this would really draw the curtain back. So, it will be interesting to see what comes out of the meeting next month.

These are the items the Competition Bureau wants changed/removed from CREA policy:

Section 17.1.1.1: Agency
A listing REALTOR® must act as agent for the seller to sell the property and to assist the seller through the entire time of the listing contract.

Section 17.2.1: The listing REALTOR® shall receive and present all offers and counter offers to the seller.

Section 17.2.3: The mere posting of property information in an MLS® system is contrary to CREA’s Rules. A “mere posting” occurs when the listing agreement relieves the listing member of any obligations under the Rules, including the obligation that the listing REALTOR® must remain the agent of the seller throughout the term of the listing contract.

Section 17.2.6: Only the listing REALTOR® name(s) and contact information may appear on REALTOR.ca. The seller’s name or contact information shall not appear on REALTOR.ca or in the public remarks section of the MLS® system.

Basically it boils down to wrestling much of the control over dealings with the seller, and allowing the seller more options when it comes to what services they want (sort of like going from a table d’hôte system, to an à la carte one).

While none of that seems like particularly egregious requests, agents are resistant because this would effectively shine a light on a region of their dealings that they benefit greatly from a tacit agreement from their ranks to toe the party line and keeping the public in the dark.

Even with the recent emergence of reduced commission brokers, while they may get on MLS, they are still often shunned by regular agents, or potential buyers are scared off those properties by the prospect of paying their agents commission directly out-of-pocket (though, it’s effectively coming out of there anyway). The entire process is kind of ambiguous to the general public, whose real estate transactions are few and far between… which is advantageous to agents, as knowledge is power, and the less the public has the better it is for you.

In my opinion, I think the Competition Bureau’s requests would actually be beneficial for both the public and agents. As it stands now when taking on clients, agents bear all the risk. The listing agent goes out of pocket for all the listing and marketing, and only gets paid if the property sells. Same goes for the buyers agents, they do all the leg work, and again only gets paid if there is a sale.

If there is no transactions, the agents end up eating all those costs, fiscal and their time/effort. The commissions currently being earned are excessive (IMO), but they are in no way guaranteed… commission sales can be highly compensated, but remains a tough and risky gig.

So, assuming the Competition Bureau gets its way, I think we’ll see some very distinct changes to the operations of these outlets. We’ll probably see a lot of specialization, some outfits will just get you listed and a lockbox and charge a flat fee (sort of like ComFree does now)… others will offering marketing services, again for a fee upfront. Which for the sellers will transfer all risk and reward onto them.

On the buyers side, we may see commissions stay, or a move toward charging an hourly rate, and/or some hybrid(s) of the two… but I think the payments will eventually be coming directly from the buyers, rather then the current situation. Probably also see even more focus on certain areas/segments of the market.

Ultimately I think these changes will be good, for the consumer and the industry. Services should improve, transparency definitely will, and highly competent agents would probably make just as much and have the added bonus of dealing with others of their ilk, as hopefully the increased competition would weed the bad ones out.

What effect will all this have on prices? Probably not much. Sellers may be a bit more willing to negotiate from their asking price, but in general they’ll still be looking to get every penny they can. Just look at ComFree, those listings don’t tend to be any cheaper then those on MLS. The benefits would be felt in the processes, not in the prices.

13 comments

Sunday, November 1, 2009

Bank of Canada Rate

Filed Under: Canada, Macroeconomics, United States

Greeting all, hope you all survived Halloween and are saving up for the next trip to the dentist. During our discussion about exchange rates last week, it was requested I take a look at the Bank of Canada Rate and it’s influences, so today we’re going to do just that.

Here is a look at the historical Bank of Canada rate, going right back to 1935. Seems to chart a pattern much like the mortgage rates we’re familiar with, but that’s no surprise and we’ll touch on that again toward the end.

Of note, we can see that currently it sits at it’s lowest point in history. The prior low had been 1.22%, hit for one month, July of 1958. Before that it had an extended run at 1.50% in the mid-to-late 40′s, toward the end of WWII and immediately following. The high was August of 1981, when it hit 21.03%, which was the only time it eclipsed 20%.

Now we’ll take a quick look at how the bank rate effected the exchange rate (with the US). There doesn’t appear to be much rhyme or reason to the movements, though after the big recession in the early 80′s through the turn of the century there does appear like there could be some relationship, but not so much since.

To get a better picture I think we need to include the American equivalent, the Fed Funds Rate, as just looking at the Canadian rate in a vacuum against another currency could be misleading.

So, here is how those two chart out. As I’ve said here before, we tend to move lockstep with the US, so no big surprise that we share very similar patterns. Over the above period, the Bank of Canada rate averaged to be 0.93% higher, for what that’s worth.

Bank of Canada Rate / Fed Funds Rate / Exchange Rate

Now we’ll take a look at how the spread between the Bank of Canada Rate and Fed Funds Rate relate to movements in exchange rate… and I really can’t say I see much of anything on that front. This shouldn’t really be a surprise, as our policy tends to follow theirs very closely and can adjust very quickly in that regard.

So, for the most part it appears that exchange rate movements are more dependant on stimuli other then central bank rates. That’s not to say they couldn’t be, but because we’re tied to the hip to the US, and our economy dependant on exporting to them, maintaining consistent policy (and thus exchange rate) is often viewed as desirable.

Finally, we’ll tie this back in to housing by comparing the Bank of Canada Rate to the average five-year-fixed mortgage rate and prime lending rate (what variable mortgages are tied to).

They seem to be fairly consistent in their behaviours, tracking together with the bank rate the lowest, the prime rate shifted above that, and the five-year-fixed rate another shift above that, with the odd deviation here or there. Noticably, in the mid-50′s there appeared to be a larger spread then since, and there was a lot of turmoil during the runaway inflation of the 70′s and resulting recession in the 80′s, but the pattern largely persists.

Since 1951, the prime rate has averaged to be 1.42% higher than the bank rate… and the five-year-fixed rate 1.34% higher than prime (or 2.76% higher than the bank rate). It’s remained in that ballpark over the last 20 year, and 10 year periods as well in case you were curious.

So, hopefully that answered any questions you may have had about the Bank of Canada rate! On tap for later this week will be the October resale stats release, and a long-term look at fixed vs. variable mortgages, and which performed better. Enjoy what’s left of your weekend!

4 comments

Wednesday, October 28, 2009

Leading the nation… at falling behind

Filed Under: Alberta, Canada, Foreclosures

The latest mortgage arrears numbers were released today, and once again they are up. Through August the rate sits at 0.65%… getting ever closer to the modern day high of 0.69% from February 1997. As these numbers are two months old now, in all likelihood we’re already at or past that mark now, but we won’t know for sure until the numbers are officially out… so for now:

Month-over-month the number was up from 0.62% in July, and year-over-year from 0.30% last August. Alberta continues to widen it’s lead in regards to highest rate in the nation, as the month-over-month increases too have been the largest in the country.

As we can see, we’re also well above the long-term average and showing no sign of slowing… and with the interest rate shock no doubt awaiting those that bought into the market at the recent all-time low rates, we haven’t seen anything yet.

Haven’t graphed out the national numbers in awhile, so figured it’d be a good time to do that again. Here are the western provinces. They’ve all been tracking up this year, no surprise given the recession, but none nearly to the degree Alberta has… though I have a hunch B.C. soon will be charting a very similar path as their bubble deflates, and ultimately will could even dwarf us.

Saskatchewan and Manitoba enjoy the opposite end of the spectrum with by far the lowest rates in the country, 0.25% and 0.27% respectively. Saskatchewan could later has issues as they had a bit of a bubble form there last year, so time will tell for them, but Manitoba appears relatively safe as their market has remained very stable.

Now the east, and national average for good measure. They have actually all been fairly stable the last six months, creeping up just slightly. Quebec has held their 0.35% rate for the fifth consecutive month, while Ontario held at 0.43 for the fourth straight month. The Atlantic region also held from July at 0.48%.

Nationally, the rate continues it’s slow steady climb, now at 0.43%… up from 0.42% in July, 0.38% six months ago, and 0.28% a year ago. Largely due to increases in Alberta and BC, though Ontario was also accelerating last year.

4 comments

Monday, October 26, 2009

Exchange Rate

Filed Under: Canada, Japan, Macroeconomics, United States

Was hoping to do an update on the latest arrears figures, but it doesn’t look like they’ll be released today… so, instead I’ll do a post on something I kind of touched on in the last post, and is more a general interest/macroeconomic issue, exchange rates.

Obviously for we Canucks, the big’uns is the United States, and here is a look at how much one Canadian dollar is worth in US dollars going back to 1950. These are the monthly averages of the noon spot-prices for those wondering.

Up until it’s collapse in 1971, the Bretton Woods system controlled international currencies, but unlike most, Canada’s dollar was allowed to “float” until 1962. At that point you can see a very distinctive flattening as it then had a “fixed” value.

In 1970 the dollar was again allowed to float, this in an effort to tide inflation, at which point it’s value relative to the US dollar started to climb (probably at least in part due to Nixon Shock). Soon thereafter Bretton Woods collapsed, and the value of the Canadian dollar has been floating ever since.

For much of the time the value floated up until 1976, the value of the dollar was usually above par with the US dollar, but after November 1976 the Canadian dollar weakened significantly and would not again reach par for over thirty years (September of 2007).

So, it’s been a volatile last thirty years for the Canadian dollar relative to it’s US counterpart, no time more then the last six. Obviously this kind of movement, particularly upwards, will play havoc with much of our economy, especially export and tourism sectors.

I also took a look at the daily stats, so for those trivia buffs out there the all-time record high for the Canadian dollar is trading at $1.1030, reached November 7th, 2007… the all-time low appears to have been $0.6179, reached on January 21, 2002. So, both relatively recent, particularly the high.

For curiosities sake, I also graphed out a few other international currencies. Mainly for my interest, but some others may find this stuff interesting, if for no other reason then to gain a historical context for what the dollar has been worth around the world. Starting with the Euro and UK Pound.

Here we have the Yen, it’s obviously increased in value significantly over the last sixty years, but it’s been relatively stable for the last twenty or so years… even before the onset of the “Lost Decade.”

Finally we’ll do the peso, just so our other NAFTA partner doesn’t feel left out, and with increased globalization Mexico is becoming increasingly relevant. The dollars value has been rising relative to the peso, or conversely, the peso has been losing value, on a whole for the last fifteen years. This would obviously be advantageous to Mexico as they have become an attractive option for manufacturing goods for the rest of North America.

7 comments

Saturday, October 17, 2009

Interest rates and defaults

Filed Under: Alberta, Canada, Foreclosures, Personal Finances

Continuing our consumer debt series, and today we’ll take a look at how interest rates play into things. So lets jump right in and start with interest rates and bankruptcies.

Here I’ve overlayed interest rate and the national and provincial bankruptcy rates. What we can take from this graph is that the gradually decreasing interest rates haven’t had any noticeable impact on bankruptcy rates. The one thing that does stand out is the dramatic spike in interest rates in 1994/1995, which coincided with the start of a more gradual spike in bankruptcy rates which eventually topped out in 1997.

It’s hard to say if, or how much, of a causal relationship may exist between these happenings, but as we discussed in my last post, people are increasingly likely to default on loans early in their terms, particularly when the rates charged are high. So the rise in bankruptcy rate could be a remnant of people taking on debt during the interest rate spike… or it could be nothing. Worth noting anyway.

Moving on, now we’ll hit on interest rates and mortgage arrears. This data goes back one more year, and here we can see there was an additional spike in interest rates in 1991… and like the bankruptcy rate, we can again see an arrears spike lagging, and topping out about two years after the interest rates did.

Again this could be a coincidence, but such a relationship would seem rather intuitive and seems to show abrupt interest rate spikes may contribute to later spikes in loan defaults. The slow decline of interest rates don’t appear to have a major effect, but rapid increases do seem to be a noticeable driver.

So, obviously in our current low rate environment this could spell trouble ahead as rates are almost assuredly to rise at least back to more historical norms. That graph is also another reminder of just how historical norms have been and how fortunate borrowers have had it for the last decade. 7.5% appears quite moderate over the last 20 years (and if we went back 30 it would look even better), but if we suddenly found ourselves in that situation tomorrow, havoc would be wreaked, and not just on the real estate market.

Finally, cause I have the data and went to the trouble of making the graph, we’ll take a look at interest rates and average bankruptcy deficiency We hit on this last week, but for a quick and dirty explanation, deficiency is the surplus of liabilities over assets upon filing for bankruptcy.

This data goes back much further, all the way to 1976 and the series was annual. Obviously what catches everyone’s eye is the big spike there in the early 80′s. Seems there were a whole lot of bankruptcies that included foreclosures during that spike, especially in Alberta.

Beyond that period there doesn’t appear to be as much a relationship between the measures as the ones we’ve discussed earlier. But as I discussed last week, most of the time the majority of bankruptcies do not include foreclosures, so that isn’t surprising. While we don’t have foreclosure numbers going back to the early 80′s, the deficiency measure would seem to indicate there were a whole lot of them.

Anyway, hope you guys found this interesting, a little macroeconomic food-for-though to chew on this weekend. Take it for what it’s worth.

9 comments

Friday, October 9, 2009

Consumer debt

Filed Under: Canada, Macroeconomics, Personal Finances

I got my Wild Cherry Diet Pepsi, and I got my Black Jack gum here, and I got that feeling… mmm that familiar feeling that something rank is going down up there. Yeah, I can smell it. I can almost taste it.

Summer is gone and it’s fucking snowing again!

Alright, so you can’t really smell snow. Give me a break, I’m working on a theme here!

Anyway, as you may have deduced by that I’d done as many posts in the five days as I had in the prior month, my little month from hell has ended and I now have more time to dedicate to the all important business of blogging.

Today I think we have a really interesting one, not so much directly related to housing, but moreso to the greater socio-economic front… that being, consumer/household debt.

Statcan has some good data sets on such things, here is a link to the one I used. Actually that one is slightly more up-to-date then the set I used, it’s up to October where as the data I used was only up to May… but one was free (thanks in no small part to the university never deactivating my database access even years after convocation), whereas the other costs $43, which would effectively increase this blogs budget infinitely, and would provide essentially no perceptible difference. I digress.

Actually that data only gives you the total debt, I then divided that by the population at any given time (available here), to come to a per capita level of credit which would be more relatable. Could have also done it on a per household basis, but I could only find one data set for that and it only went back to 1997. It would just be a function of per capita anyway though, so it’s all the same.

As I’m sure you noticed, there are three lines. The green one in the middle is mortgage debt, relating to the purchase of residential housing. The yellow line, is consumer debt, things like credit cards, lines of credit, automobile loads, etc. Finally there is the blue line which they call “Household Credit,” which is the sum of mortgage and consumer debt.

The above graph is of nominal values. As those of you who follow the blog knows, nominal values are not terribly useful when talking about long term comparisons, so lets adjust it for inflation.

There, that’s better… and a little bit scary. As we’ve discussed before incomes have been fairly flat for the last 30 years when adjusting for inflation, so to see household debt has increased 3x in the last 25 years since the last big boom/bust cycle.

This isn’t all together surprising, as we have also discussed how real estate prices have increased faster then the rate of inflation throughout recent history anyway, and residential mortgage debt makes up the majority of total household debt.

What is more alarming is how consumer debt has taken off, particularly in the last 15 years, where it appears to be growing exponentially. Like mortgage debt, this is no doubt linked to the decline of interest rates over the last 25 years.

The current recession has done nothing to quell Canadians thirst for debt, as they continue to rack it up at a record pace thanks to the rock bottom rates we’ve seen the last six months, even while Americans have pulled back at the same time.

The question now is that rates have for all intents and purposes reached their absolute bottom, they must now go up. The degree to which that will happen is yet to be seen, but once it happens it will contract the levels people are capable of carrying… which would have a devastating effect on not just real estate values, but the economy as a whole.

Here is a look at a bit of a different angle of the numbers, this the year-over-year change. Much more volatile, but we can also see, the forms of debt tend to track together. When consumer debt spikes or dives, so does mortgage debt, to different degrees but strikingly similar patterns.

We also know the last big decline in real estate values came in the early 80′s, and we can see the mother of all troughs. Such a decline in not only mortgage debt, but also consumer debt would obviously have a major impact on the economy, and this would seem to be consistent with has been happening in the United States the last couple years after their housing bubble popped.

So, one would expect that if the same were to happen here in Canada, we would see a big contraction in not just mortgage debt, but also consumer debt, which currently stands at record levels and an extended period of relatively high year-over-year growth.

Exactly what is to come is difficult to say, but there is no doubt that if interest rates were to return to historical norms it could spell big trouble considering the level of debt carried by Canadians.

So, until next time, just look inside yourself and you’ll see me waving up at you… naked… wearing only a cock ring.

6 comments

Friday, August 7, 2009

Gazing into my crystal ball

Filed Under: Canada

So, in an e-mail I was asked why I haven’t referenced the bond market in awhile since they’re so important to interest rates.

Well, the reason is simple, because I haven’t felt they’ve moved enough to warrant a change in interest rates, so their fluctuations are not really of much concern at this point. Interest rates tend to only adjust when they have too, so unless yields go up over 3% or drop below 2%, I don’t see them interest rates changing.

The Bank of Canada rate isn’t likely to change either. Even with the markets rallying, they want to keep the dollar down as much as possible, and raising their short term lending rates would cause the dollar to jump, and that would be disastrous for manufacturing, tourism, et al. So, their pledge to keep the rate at 0.25% into 2010 is still good at this point.

Now, if the market rallies continue, that would likely draw up bond yields, as investors become less risk adverse it takes a bigger payout to get them to put their money in bonds… and with governments around the world racking up massive deficits, there is a ton on the market so as time goes on yields will have to continue rising to absorb the increased supply.

Though, peaking in my crystal ball, I’m still wary of the current market rallies… these gains haven’t been based on much, and the fundamentals of the economy still don’t appear to have turned the corner even if stock prices indicate otherwise… so at this point, I still think we could have another mini-crash or two left before stability truly returns.

Thus, six months from now I don’t expect interest rates to be much above where they are today, though there could be a hike and cut or two between then and now as the markets fluctuate. When interest rates do start climbing for real it will be hard and steep, but for the next few months at least I think they will remain around current levels.

But that’s just my two cents on what’s happening and where we’re heading in the short term. Of course as we’ve seen, the markets are anything but rational, so your guess is as good as mine and a lot can change in six months… and you need look no farther then the last six to see that.

Late addition: The July employment numbers were released today, and again they weren’t good. Another 11,900 full-time jobs were lost in Alberta, putting the tally since last fall at 82,000 lost, which has erased some gains made in the spring and is now at a new low. The unemployment rate was also up, now standing at 7.2%.

2 comments

Wednesday, July 1, 2009

Beaver Style

Filed Under: Alberta, Canada

After another night burning the midnight oil, I decided that today I was going to take today off… my first day off in over a month. Yes, I know, you don’t care, but this is my sandbox, so that just sucks for you now don’t it! But before I’m off to engage in at least eight different kinds of debauchery, I figured I’d do a entry since I had the chance.

The realtors are out there all whipped into a tizzy screaming we’ve hit bottom and the current surge is just confirmation that real estate only goes up, the market has corrected! Hallelujah! Holy Shit! Where’s the Tylenol?

But has it? Just what has changed from six months ago? Inventory is still poor, prices are about the same if not a bit higher, vacancy rates are way up, foreclosures are up, arrears are up, and more people are out of work thus so earnings have to be down. So, if anything that would suggest the market has softened.

And most of that recipe is true right across the country on this fine Canada Day… so what has changed? What would cause real estate not just in this city, but right across the country to rally?

Pretty simple really… interest rates. They’ve went from low, to ridiculously low… and not surprisingly, the lower they got, the stronger sales got. The market didn’t correct, interest rates plunged and suddenly the combination of that, seasonality and emotion has manifested itself into a suckers rally. That it’s happening across the country, just supports that.

The fundamentals are still poor, even with the interest rate plunge creating something of a temporary illusion of affordability. But people who felt burnt in the last boom, suddenly they could qualify for a ton of money and having been seemingly left behind in 2006, are jumping in with both feet.

Problem is, as soon as the economy starts showing signs of life, interest rates are going to go back up. Even 6% would leave affordability in tatters, and while for many recency clouds their judgement, 6% is still very low historically. So just imagine if they went back up to 8%.

The market hasn’t corrected, all the problems that were there six months ago, are still there today, and in many cases have actually gotten worse… interest rates going down have just delayed the inevitable. This whole thing was fueled by credit, piling on some more isn’t solving any problems, it’s just buying time all the while making it worse. It’s like paying off one credit card with another.

This correction isn’t going to be quick. It started two years ago, and will quite likely still be ongoing two years from now. This is not an efficient market, it’s an emotional one, so there will be many rallies, dives and plateaus along the way.

Those focused on the short term will continue to call bottom in thinly veiled attempts to convince themselves… but my focus on this blog is the long term, and until the fundamentals are corrected, there will be no bottom to be had. Even when it is, it cannot be recognized until well after the point.

So, now I’m off to enjoy an ring in our nations birthday by going out with some fellow Canadians, drink some Canadian beer, and maybe even watch some Canadian football… and later on, might even throw on some Anne Murray and see if the girlfriend is up for doing it beaver style (which I believe involved doing it in a mud hut).

Happy Canada Day everyone!

5 comments

Monday, June 8, 2009

Of bonds, banks and mortgages

Filed Under: Canada, Mortgages

TUESDAY UPDATE: Reports are circulating TD is about to raise their 5-year fixed rates another 0.4%

We’ve been hearing lots about central bank rates being at historic lows, and it’s influence over mortgage rates… but anyone following my Twitter feed the last while has no doubt noticed my little obsession with the bond market.

While on the surface there doesn’t seem to be much reason for a site like mine to concern itself with such things, but in fact the bond market is very influential on mortgage rates, and thus has a very big effect on the real estate market.

Mortgages themselves are essentially bonds, in exchange for the banks money, the buyer agrees to pay it back over a specific time at a specific interest rate. The bond and mortgage back securities markets are closely tied, and thus so are mortgage rates (which are usually slightly higher then bond rates).

So today I’m going to take a look at the relationships between bond yields, bank rates and mortgage rates. Here is a look at these rates since 1981.

As we can see, all three tend to track quite similarly. Also of note, mortgage rates are usually the highest of the three. For the sake of this post we’re going to be using Government of Canada 5 Year Bond Yields, and the average lending rate for 5-year fixed mortgages (as they are the most popular here in Canada).

We will start by looking at the relationship between the central bank rate and mortgage rates. As we can see here, there is a significant relationship between the bank rate and mortgage rates (these are through December of 2008), with an R² value of 0.9064, the pattern is also obvious from the chart.

We’ve been hearing lots of late about how Mark Carney has been pledging to keep the Bank of Canada’s key policy rate at 0.25% until next June. Which from the trendline equation would suggest a mortgage rate of about 3.25%, which was never quite realized as 5-year fixed rates never got much lower then 3.95%, but that is certainly within the expected range.

The issue though is that even despite the assurance that the bank rate will not change, mortgage rates have started to creep up, advertised rates went up to 4.15% last week with suspicion it could be headed higher shortly… why is this? Well, the simple answer is we’ve been seeing a lot of upward movement in the bond market (and a huge jump in US T-Notes).

As we can see from this graph, there is an even stronger relationship between mortgage rates and bond yields then there was between mortgage rates and bank rates. This is evident in how the plots more tightly hug the trendline, and the R² value of 0.9647, which is extremely high (1.0 would be a perfect relationship).

So while the bank rate may not change, if the bond yields rise it would appear that we should expect mortgage rates to rise as well. Especially since at this point the bank rate is being intentionally depressed, thus a short term decoupling would not be unexpected as the other two are still largely at the will of market forces.

Finally, we’ll do a scatter plot for bank rates and bond yields. The relationship of these two appear to be very similar to that the bank rate and mortgage yields, complete with a similar R² value of 0.9046. Which is again a very strong relationship in its own right, but not as significant as bonds and mortgage rates share.

So, while the bank rate is expected to stay low for the foreseeable future (though we are hearing increasing reports that it will be heading up by year end, well before next June as initially promised), that is no promise that mortgage rates will stay down. For a better idea of where mortgages are headed, keep a close eye on the U.S. Treasury Note market, and Bank of Canada bonds (though they largely follow T-Notes).

If bond yields continue to rise, mortgages will follow. Which in turn will force the governments hands when it comes to quantitative easing (which is aimed at keeping bonds and financing rates down, but is intensely disliked by most debt holders).

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