Thursday, May 03, 2007

breakdowns



I've written before about the madness of man, wondered at the disconnection from "reality", and mumbled about a depression coming. Some might say that I am bedecked in a shiny metal haberdashery, but there is a real strangeness going on.

Why did the US stop reporting M3? Why would CMHC fuel this madness by dropping to 20% the down payment required to avoid mortgage insurance? Why do "they" jig the way that inflation is reported - leaving it understated?

I was at my bank the other day and was discussing mortgage qualification with the manager. I mentioned to him that his bank had qualified me for $600k, and that I would just not be able to afford those kinds of payments. He told me that "everything changed, and disconnected from sound lending practices a couple of years ago. He agreed with me that those practices are dangerous, and plain crazy. We discussed the RE market, economy, education, etc. for a while, and he didn't know much. He almost offered me a job, saying that I should work for the bank. Me? I know things are bad now.

Where I'm going with all this is that I think we are in for some serious economic meltdowns in the very near future. I read that Cameron Muir said that things are cooling, and a more modest increase in housing prices is expected for this year, and into 2008. I believe he said 8% for this year. How could that possibly be? The Chipman Report indicates that prices are declining very marginally (1%-2%) - as I read it. I am really beyond caring anymore. It just doesn't merit reporting on.

I can't for the life of me figure why the BoC did not raise rates. The prices of energy and housing have become so daunting that something needs to give. I've always had a good feeling about David Dodge, and am wondering what comes next. Being that our dollar is closing in on the US$, it can't but indicate that the US is in very rough shape. Those who don't make the connection to our own economy are in for a rude surprise.

We are heading for a major breakdown. As freako so eloquently described it - 'humming down the Autobahn, and all the warning lights on the dash are blinking furiously, and nobody notices (or something like that). Just wait until the costs of whatever the guvmint comes up with to "battle" greenhouse gases start to crush us. There is already talk of upping the GVRD gas levy, hydro rates going up, property taxes up, food costs, pay per use this and that. Something's gonna give. There is just not that kind of money around. Not real money, anyhow.

Those who "steer" the economy (and us with it), should have put the brakes on a long time ago, but they didn't. In the US, it was purportedly to avoid recession, but the situation is so exacerbated that a recession would be the kindest of fates. The whole thing is like swerving to miss running over a chipmunk, and going head-on into an oncoming truck. It's crazy.

Below I have pasted a few quotes from an article that I read, that spurred me to drag this rant out again. I read the article as broadly contextual, and recommend the reading - with the economy, and RE (and so much more) in mind.

Conflagration coming link
System breakdowns are normal, but complete collapses can be permanent
By Michael Nenonen
By now it’s clear that our world faces a series of unprecedented ecological, economic, and geopolitical challenges. Too often, we look at these challenges in isolation from one another, perhaps because we don’t have a theoretical foundation to help us understand how they interact. Thomas Homer-Dixon’s The Upside of Down: Catastrophe, Creativity, and the Renewal of Civilization (Knopft Canada, 2006) provides just this sort of foundation. His work allows us to see past the sizzling trees to assess the direction and scale of the fire that’s consuming the forest.

It’s dangerous to prevent breakdowns. The longer we delay a breakdown, the more likely it is that it will occur at the same time as breakdowns in sub-systems and macro-systems.

Our woods will soon be ablaze. Our actions will determine which seeds, if any, will survive the fire.

What me worry? I have a tin foil hat!

18 comments:

jesse said...

"everything changed, and disconnected from sound lending practices a couple of years ago."

I assume your conversation was at an American bank. The MSM only cites sources that claim lending practices in Canada are on solid footing.

solipsist said...

Thanks for commenting jesse.

It was a Canadian bank (one of the Big 5 - the biggest actually), in Vancouver.

aetakeo said...

I'm going nuts, over here. What the hell is going on? Whatever drug or mania everyone else is on, I wish I could partake, because at least I wouldn't be pointing at danger no one sees.

I started reading these blogs as a head-scratching lark. Now I'm embedding my fingernails in the dashboard.

The thing that I don't get: how folks bullish (or semi-bullish) don't see that high housing costs take money out of the rest of the economy, (eventually, when credit tightens, because YOU HAVE TO PAY SOMETIME). When people can't make ends meet, something has got to give, and one certain failure will be in consumer goods.

The highlight, for me, was Rob's "let them eat Ramen noodles" suggestion: that really, anyone COULD buy real estate, if they just prioritized differently. Holy shit, yes. And they could sell their kidneys or children on the black market if they were REALLY motivated to get into things.

But I'm getting pissed, now, because this is affecting rental stock AND business opportunity.
Businesses are leaving due to high cost of office space, and all the rentals are being converted and munched and condos are sitting empty; and now some f*ckt@rds on craiglist want $3000/month for yaletown boxes that are no better than brand new social housing suites. For the love of Pete.

I have some very, very indebted friends. (Bad advice + personal tragedy = very bad decisions.) They have pride, but they really ought to be declaring bankrupcy: they're paying credit with credit at this point.

And their parents tried to convince them to *buy, reno, and flip* in BC. Nelson, dontcha know. (They chose to ignore the advice.) They are in NO place to be taking investment risks, and they're not home renovators. They're handy: but they're not licensed professionals. Would they buy one blooming STOCK and sit on that at this point? Would they buy biotech stock and then offer to do the company's assays?

Peter said...

aetakeo,

Great point, I have been trying to get this message out through posting comments in a couple of real estate blog. The economic meltdown is exactly what's happening in Hong Kong. A housing "boom" literally wiped out an entire generation of middle class. The retail businesses are all death and will be until the mortgage madness has been paid off. With 35 yrs mortgage coming into the picture, we are looking at 25-35 yrs of economic darkness. Japan is another great example.

solipsist said...

I read this comment posted from The Guardian by ulsterman over at vancouver condo info.

I find it interesting that I am not the only one foreseeing doom and gloom, and even more interesting, I have been talking about this for years. It's popping up all over the place lately. Perhaps I ought to be less negatively solipsistic.

Sunshine and lollipops for everyone. Kool-Aid too.

What worries more than economic melt-down, is the societal one that will follow.

The comment.
MarkinChina

May 6, 2007 4:58 AM

A very good article. I first became concerned about overheating in the housing market as long ago as 2000/2001.

The reason for my concern was that I was buying a house after returning from overseas. I saw one house which I missed due to the sale of my own house falling through at £115,000. 3 months later I saw a house in the same road, same type, slightly better condition but further away from the centre, and it was selling for £139,000, and achieved this price. This was the state of inflation at that time generally.

Whilst this example was in 'Silicon Fen', as it became known, it was still an unjustifiable rise from any rational economic point of view. I have been waiting for a crash ever since.

Fast forward to now.. Why did the crash not happen. In part there have been several factors that have been in play.

World Macroeconomics

- the introduction of China (& India to a lesser extent)into the world market has introduced a huge reserve of labour, which has helped to restrain wage inflation.
- As above - but the introduction of Chinese manufacturing has helped to push down prices of many goods, holding down inflation.
- The massive foreign reserves held by China and Japan have provided a supply of cheap money, helping to keep interest rates down. I describe this as a conveyor, where US (the most important consumers but also the UK et al)purchases goods from China, this creates foreign reserves in China, and this is then fed back on the return conveyor into 'cheap' money which is then lent so that households can continue to buy things.
- In normal circumstance the exchange rate would rebalance this trading system, with the RMB appreciating , but the RMB is not a free currency.

UK Macro

- The UK has had a massive expansion in the population due to immigration. This is a sensitive subject with many people politicking about the numbers. As such to keep the focus on the economics here lets all just agree that it is 'a lot' by which I mean enough to influence supply and demand of housing - pushing prices up.

- In addition there has been the speculative buy to let market, changes in the lending criteria for mortgages etc. pushing house prices up.

- The immigrants are here, in part, in response to the 'success' of the UK economy which provides plentiful jobs. The UK economy is, in part, successful due to the massive expansion in the money supply created through the record growth in consumer credit, and also through increased mortgage borrowing that is the result of record levels of equity withdrawal, which is the result of house price increases. This in turn allows people to spend on home improvements, goods, services etc. thereby holding up employment, thereby encouraging immigration, and pushing house prices up.

- In addition to this the government is also spending more money - resulting in borrowing increasing. Of particular note is that PFIs do not appear on the 'balance sheet' and are therefore a massive form of hidden borrowing. This is a big injection of money into the economy.

If you take out the low inflation and interest rates that would not have occurred if China had not entered the world economy, the current boom would have disappeared long ago, as a rise in inflation and interest rate rises would have occurred. As it is we have now created a monstrous bubble, that will have to burst. I do not think people have yet to grasp how bad it will be.

In particular if there is a downturn in the housing market/the economy (this is the classic chicken/egg story) - there will effectively be a loss of confidence. In each case house prices will fall/have fallen. Once they fall - they will collapse, as the equity withdrawal and 'feelgood' factor will disappear, and with it spending on goods, services etc. Banks will tighten credit in response, further pushing spending down. This will hit employment, further ratcheting the economy down. As unemployment increases some (or many) of the immigrants will start to go home, ratcheting down the house prices by reducing demand (One curious feature I discussed with an economist at Oxford University was that the immigrants will take their accumulated savings with them, which will be the equivalent of importing goods - you may wish to think about this point and realise that it makes sense - a further negative effect on the economy during a period when it will already be in trouble, and where typically the outflow of money will reduce with the tightening of spending).

Sorry, a gloomy picture. However, in the UK the belief for a while is that borrowing is the same as earnings. This is not so and the lesson will be hard. We have had a 'strong' economy due to record borrowing. As we all know, pay back time must come with all borrowing. This develops a new question, aside from the City of London - have we any new earnings to show for the last ten years?? Is the growth of the City enough to support the UK on its own? I'll leave these questions open.

Real estute said...

I also totally, totally agree with the opinion that something has got to give. There is no way this party is sustainable - economically.
I think I have the answer to when the local housing crazyness will end; when the BC Economy goes into recession. I know it sounds overly simple, but our hot local economy is the only factor I can point to that sustains all of the debt. There is always going to be rich foreigners coming to town, but it is the average employed lower mainland resident that is responsible for the lion's share of the hot demand for RE around this area. When people start losing jobs and cannot find new employment, that is when the confidence to borrow and over-borrow and the ability to make the monthly payment is going to disappear. High energy prices, high CDN dollar, US housing problems are all going to ensure the recession comes.

Anonymous said...

comment

Karen said...
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mk-kids said...

A re cheerleading show! this is sick. "take baby steps, get in as soon as you can, at this time next year prices will be higher and you might not be able to buy at all" - holy crap! no consideration that prices might not go up. CMHC's new senior analyst was on forecasting "market moderation & increased activity"... wow.

I give.

casual observer said...

I was interested in the long term price history for RE, and for its propensity to track the inflation rate.

Over the last five years, all of the usual inflation indicators (real estate, precious metals, oil, energy, commodities, etc.) have all increased in price by double digits or more.

Growth in money supply has also been in the double digits. In 2006, the U.S. actually stopped reporting the figures for their broad money supply measure, M3. They just said that they were no longer relevant.

Anybody who actually spends money in this economy, has the feeling that prices are rising for most of the things that they buy (with the exception of electronics), yet the government reported CPI is quite benign (around 2%).

What if all of these traditional inflation indicators are correct and the posted inflation rate is not? Most government wages, benefits, entitlements, and interest rates are based on the posted CPI rate. It would be in their best interest for this rate to be low.

The CPI used to be based on a fixed basket of goods. Now it is computed using substitutions and hedonic adjustments.

For example, under the old way of reporting inflation, if the price of steak went up, it would be reflected in the CPI. Now, the government assumes that if steak goes up in price, people will substitute hamburger for steak.

This will mute the increase in steak prices, and keep it from being reflected in the CPI. The cost of living stays the same, but its for a lower standard of living.

There are other examples of manipulation in the way CPI is reported. There is a good article on this website that talks about some of the changes in CPI reporting.

http://www.shadowstats.com/cgi-bin/sgs/article/id=343 Check it out.

If their assessment is correct, then perhaps the run up in RE prices is just a reflection of the higher inflation rate.

It seems unlikely to me that all of these inflation hedges can experience huge price increases, and yet the inflation rate remains at 2%. It just doesn't pass the smell test.

solipsist said...

I'm sorry to have misrepresented you Karen. My brain function is a tad low in the AM. It was such a convenient progression of thought. Or not.

My moniker is not solipsist for nothing...

M- said...

On the side of "stealth inflation", one thing that I've noticed, and I'd feel wrong not mentioning it, is that new cars haven't really changed much in price over the years.

For at least the last few years, the base Honda Accord has cost (MSRP) about CAD$25,000 (plus freight&PDI).

In the US, the price has gone up, but hasn't done anything insane. In 2000, a base Accord's MSRP was US$15,350. The 2007 US MSRP is US$18,625. That's about a 3% a year price increase. Nothing particularly hefty.

solipsist said...

mk - I didn't hear much of the show but for about 3 minutes of the CHMC automaton.

The regular host may have been more discerning and inquisitive.

real estute - I think the BC economy is on the edge of a precipice, and is already in contraction. One of the hoo-haws at West Fraser Timber said a couple of weeks ago that the forestry sector is already in recession. That's pretty big.

Also, a lot of the Olympic construction is nearing completion, so there will be lay-offs soon.

Thanks for that link casual.

Not much passes the smell test in any realm anymore.

Lambs to the slaughter.

solipsist said...

m - I've noticed the same thing. The pick-up that i paid 20k for 15 years ago will cost about 25k plus PDI, etc. today.

Hey! 0% financing is available too.

Karen said...
This comment has been removed by the author.
casual observer said...

...new cars haven't really changed much in price over the years.

We just recently bought a new car and we saw the price for the 2006 identical model. There was about a thousand dollars difference. It was a moderate priced car (26k).

Not all new cars have stagnant prices.

M- said...

My dad just retired (and my mom's about to), and so for a gift to themselves, they just bought a new car. The 2007 model was $700 cheaper than the 2006 model. There was a touch of decontentment to the car-- the 2007 model didn't have painted bumpers, but painted bumpers don't account for that much of a price drop.

WoodenHorse said...

I can't believe the market is still chugging away, but your banker's comments echo what I've read in the sub-prime meltdown in the US (that standards went out the window.)

That better not be my tinfoil hat you're wearing.