Friday Mortgage Round Up – September 14th, 2012

Friday Mortgage RoundupHeadlines have been littered with updates on the Vancouver and Toronto real estate markets for the last couple of months, putting them front and centre as they make up Canada’s largest metropolitan areas.  Vancouver’s once healthy market has really taken a turn for the worst while Toronto’s condo market continues to be put under the microscope.  But move over!  There’s a new player in town…

Stepping into the Spotlight: Montreal

Montreal’s numbers aren’t looking too pretty either. Sales are down year-over-year and have fallen to the lowest level since 2004.  The number of listings in Montreal is at an all-time high for August and their months of inventory sits at a hefty 11!  Generally speaking, any reading that is greater than 10 months signals a fall in prices is in the forecast.

Canada’s three largest urban centres saw a significant decrease in home sales, increase in inventory as well as an increase in unsold units from this time in 2011.  A decrease in prices is the fuel to the real estate market at this point in time.  The purchasing power of Canadians has weakened while household debt remains at an all-time high.  Is the credit road so many Canadians travel down becoming a bumpy terrain – and how big of a threat is the heavy consumer debt load to the overall health of the Canadian economy?

Consumer Debt Levels and the Health of the Canadian Economy

The Globe and Mail featured a face off debate on current debt levels as a major threat to the Canadian economy, featuring analyst and M. Hanson Advisors Strategist Ben Rabidoux, as well as Eric Lascelles, chief economist at RBC Global Asset Management defending Canada’s resilience.

Round One: Opening Statements

Rabidoux points out that for the last 10 years, Canada’s household debt to disposable income level has risen a whopping 135 per cent (residing at 154 per cent) which is unsustainable as the Central Bank has even warned debt levels are the greatest risk to the economy.  He argues that we’ve simulated a growth spurt across Canadian industries as the credit boom has pushed demand past its equilibrium.  Consumers have made purchases today on credit, which they will pay back with savings tomorrow while forgoing a purchase and thus creating a demand gap.  Eventually the headway we’ve gained in the purchase race will catch up to us and therefore mute future purchases.

Lascelles agrees that debt levels and prices are too high; however the recent efforts to cool the housing market will result in another year or two of curbed growth and does not see a recession or financial crisis in Canada’s future.  Lascelles claims that the low interest rate environment has made household debt more affordable and therefore an increase was a natural progression.  The demographics of the consumer with higher than average debt level are young couples, netting a combined $80K with a $300K mortgage (actual debt:income ratio of 375 per cent), yet somehow they are managing!  Although a future increase in interest rates would reduce borrowing, lower home prices and dampen consumer spending; the aftermath would be a weaker economy and not a recession.  Major threat?  He thinks not!

Round Two: Rebuttal

Rabidoux cites his recession recipe: one part elevated home prices with a risk of hard landing, one part high consumer debt and equal parts of booming housing and credit markets; this batch is in the oven and nearly ready!  He argues that the demand gap that this is also cooking up can only be maintained as long as interest rates stay low enough for consumption to carry on, noting the echo from changes in regulations are heard in the price of homes, consumer spending, the labour market and overall economy.  Although the interest rate environment that we are currently in is said to be in line with affordability, Rabidoux points out that RBC’s quarterly report was far from comforting.  The report indicated that Canada is stretched when compared to long term averages drawing attention to the fact that this report even assumes a 25 per cent down payment.  Rabidoux sticks to his guns and says that there is an elevated risk of a recession and none of these figures should be taken lightly.

Lascelles agrees with Rabidoux on the point that Canadian household debt is a risk; in fact it’s likely the largest domestic risk to the Canadian economy.  But by no means is this more problematic than the trials and tribulations that come along with the global markets – namely those of Europe, China and the US.  Yes, there is a muted economic forecast but it poses no recessionary risk alone.  Lascelles argues that the only way for this so called demand-gap to rear its ugly head is if borrowing costs increase dramatically.  Fortunately, the global environment will not support this so as long as rates remain low, we can manage.

Round Three: Closing Statement

Rabidoux begins with a quote that captures his stance on the topic: “[It’s] Not the fall that kills you.  It’s the sudden stop at the end”; and the end in Rabidoux’s mind is a hard landing in the housing market which would ultimately cause a recession.  Just look at the numbers!  The level of household debt in Canada sits at $1.65 trillion, 85 per cent of this is made up of housing debt … 70 per cent in mortgages and the other 15 per cent in HELOCs.  This figure has increased by 700 per cent since 2000 and he believes that this is what temporarily boosted the economy.  He highlights that the economic growth Canada has experienced has been fueled by purchases and these purchases are financed through HELOC drawdowns.

Lascelles stresses the teeter-totter debt:income scenario… debt is larger in young families since income peaks later in life and it is this understanding that allows a credit vehicle to pull future income forward.  It is only natural for household assets to increase over time and there will be a proportionate amount of debt held against that asset balance.  The reason he feels that the Canadian economy is not heading for a recession is that the fate of the economy is in the hands of an interest rate hike.  This is the real threat, but is not happening anytime soon.  Seeing as 85 per cent of debt is held in the form of a mortgage/HELOC there is a shield against interest rate hikes in itself!  Those in a fixed mortgage rate are protected against hikes, while variable rate mortgage holders have been qualified based on an inflated rate.

So, Who Won?

Many factors contribute to the overall health and direction that the economy is headed in but it’s a messy storm out there – and the economic forecast can change daily.  What’s more (not to sound morbid here) but we will begin to see a shift in wealth as the aging demographic transfers their savings in the form of inheritance over to their kin.  Although a subjective question as to who wins, I side with the Chief’s economic brain here and agree that Canada is not set up for a recession.  You can’t disregard the numbers and statistics that Rabidoux presented but you can argue the end result on the economy.  I hear what Rabidoux is saying but do not agree with the depth and breadth of the problematic picture he paints. Week in Review

To the consumer’s delight, rates have dropped over the last week and not by 1 basis point either!  The 2 year fixed and 5 year fixed rates both dropped 10 basis points and sit at 2.39 and 2.89 per cent respectively.  While the 3 year variable rate is level with the 5 year variable rate and is priced at 35 bps under prime.

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