Asking for it

Is the Brampton saga of Paradise Lost, related here yesterday, an outlier? Or a harbinger?

Unknown numbers of people rolled the dice, took on epic debt commitments and bought properties when we had peak house in 2021 and early this year. Then rates exploded. The market croaked. Prices retreated. Debt servicing costs swelled miserably. Some people can’t close their deals. Others can’t pass the higher stress test. Variable-rate borrowers are in a vice. Renewers now and into the new year are scared. Builders are ramping down with demand. And recession talk is everywhere.

We finish 2022 with house sales down by half in our major markets. Prices in the largest city are off 25%. In the burbs, up to 40%. The correction started in the GTA. It’s now spread to Halifax and Victoria. The CB rate went up again two weeks ago. The banker boss says there is more to come before a pause occurs. There’s no suggestion rates will fall.

It’s interesting that with the bank benchmark sitting at 4% Canadian households are spending proportionately the same amount on debt service as when the Bank of Canada rate was almost 13% back in 1990. That’s what crazy, stupid, insane, emotional, unsustainable real estate valuations have done. These days 55% of our net worth is in houses, compared with 30% in the States. As permabear David Rosenberg points out, Americans hit the 39% mark just before the US housing market blew up, and almost took Wall Street down as a result.

So the gang in Brampton who bought $2 million unbuilt houses last year that they can no longer afford – threatening the viability of the builder and the incomes of all its trades – may represent and embody the fatal Canadian flaw. Will this be death by FOMO?

Economists put the odds of a US recession in 2023 at 65% last month. Now it’s 70%. This is not the end of the world, of course, given the fact America has the lowest unemployment rate in half a century, consumer spending has remained robust, financial reforms have strengthened the banks and it’s the biggest economy in the world with the global reserve currency.

Us? Well, not so much.

We have chosen another path from the Americans. For example, Canadians hold 62% of their TFSA money in cash and just 29% in equities. In the States, 145 million people – 56% of the population – own stocks. Their RRSP equivalent – the 401k – is typically stuffed with them. In Canada, as a society, we spend twice as much on residential real estate as we do on business investment.

The result?

We’ve got a debt-to-income ratio among the highest in the world, and far about that of Americans. And unlike the Yanks – who can lock into a mortgage rate for 30 years – we’re more exposed to rate fluctuations, having to renew our debt every 60 months or less at prevailing levels. Worse, over-extended buyers last year (during Peak House) were choosing cheap, variable-rate loans more than 50% of the time. Those have now exploded higher in cost, to the extent that hundreds of thousands of families have payments that don’t even cover accumulating interest. They’re paying down nothing and, in many cases, increasing their borrowing. Household debt has tripled in the last 25 years. Incomes haven’t. Not even close.

See what I mean about harbinger?

Mortgage costs went from under 3% to about 5%, and a crisis was born. This is how close many Canadians are cutting it. Almost inconceivable to those of us who, decades ago, experienced loan rates that were 9%, then 14%, then 12%, then seven. The difference is simple. Today most little beavs put most of their wealth in a single asset, at staggering prices, with indelicate gobs of leverage.

As The Atlantic magazine concludes in a recent article on why owning houses is a bad idea:

“The core benefit that homeownership is meant to offer is financial security. Yet in numerous ways it actually exposes homeowners to more risk. By concentrating wealth in one asset, middle-class homeowners are particularly exposed to regional economic and environmental shocks, like if a large employer decides to relocate or a hurricane devastates downtown. Events outside your control can completely wipe you out. It’s no surprise then that the wealthiest Americans are the least likely to store their wealth in their homes. Certainly, they benefit from owning their homes, but the wealthier the American, the more likely they are to hold their assets in equities and mutual funds. (During the pandemic, this difference made the rich even richer, as the stock market outperformed the housing market.)”

In fact, rich Americans have chosen most often to house their wealth in financial or business assets, rather than residential real estate for exactly these reasons. Here is a representation of that from the Federal Reserve Bank of San Francisco.

Wealthy people would rather have stocks than houses

For the past 15 years this pathetic blog has warned of losing balance, having a one-horse investment strategy, loading up on debt and blindly shovelling all your dreams into one address on one street in one city. Especially the young, who must cut a Faustian deal costing them mobility, freedom, choice and cash flow. Now with prices off the chart, a return to normal interest rates has turned lethal.

Will recession – if it comes – be worse in Canada as a result? What can you do?

Stay tuned.

About the picture: “Hi Garth, love your sage advice and rational outlook,” writes Brad in North Vancouver. “Meet Buddy our five year old Havanese decked out in his Christmas jingle collar. He is a bundle of joy and happiness everyday. Wishing you a wonderful holiday season and fantastic 2023!”