Differing Opinions

I've gotten way more than my $2 worth out of the National Post this weekend. Two commentary pieces caught my eye, or rather, contradictions within themselves and each other caught my eye.

The first, entitled What subprime crisis? reminded me that I'm pretty much sub-primed out. It's almost as if the sub-prime debts have become the big bad wolf that economists and people who write about the markets can just refer to and expect us all to just get it--though apparently few do--without question. It's as if they can't explain their point using rational, reasoned, time-tested economic theory, so they just cry "wolf."

In a completely different section, and an obscure location as if editors either expected no one to read, or wanted no one to read, Our housing bubble may be the next to pop seems to have a more credible author (economics professor) and an easier sell in hhv-land.

Here are the highlights:

What subprime crisis?

Subprime does not mean the interest rate is below the prime lending rate. It means the borrower is below what is considered a prime candidate for a mortgage.

Canadians are not facing a subprime mortgage crisis.

After [subprime lenders] got the borrower to sign on the dotted line, the lending institutions packaged up the loans and sold them to hedge funds, mutual funds and private equity groups looking for quick returns.

The shares of these companies were then bought by pension funds and insurance companies looking for high returns, even though they would never have bought the risky mortgages outright.

Over the past five years, thousands of new mortgage brokers have entered the market in Canada and the U.S.

...it is true that some Canadian lenders dramatically lowered their lending criteria...

...the Canadian housing market has not been artificially driven by bad lending practices.

So, what's the lesson in all of this? Chasing short-term returns leads to an inevitable correction in any market.

Look carefully at those last three lines: lowered lending criteria, not been artificially driven, chasing short term returns = correction. Anyone else see the contradictions there? Nope, no one in Victoria has been chasing short term returns in the RE market. Not my dad with his two houses, nor my friend's parents with their two houses, nor my other friends' parents with their three houses (only one of this group happens to be rented by the way). Nope 5 people, 7 properties, 3 principle residences, 1 rental, and 3 vacant "flips." Nothing to see here kids.

Our housing bubble may be the next to pop

After a decade of low interest rates, it is no surprise that investors poured their money into real estate and the stock market.

Not raising interest rates in the foreseeable future may stave off pain for a little while longer, but the end of cheap credit is near.

...Canadian housing prices over the last decade have risen to the extent that we may also need to be concerned, given interest rate trends.

In Canada, the average MLS residential price rose from $150,720 in 1995 to reach $249,311 in 2005 -- a 65% increase.

In many cities, the price increases are so steep that homeowners are experiencing massive wealth effects as their homes appreciate, while first-time buyers are increasingly unable to afford a home.

The lowest interest rates in 40 years fueled this boom, and as prices and mortgage sizes have risen, financial institutions have "helpfully" come up with new affordability strategies, such as putting only 5% or even a zero down payment and extending amortization periods beyond 25 years.

A price-earnings ratio is the ratio of the price of an asset to its earnings flow.

...a crude P/E ratio can be constructed by taking the average MLS residential price and dividing it by the average annual rent for a two-bedroom apartment.

Declining P/E ratios can represent undervaluation, while rising P/E ratios can represent overvaluation.

...in Toronto, the residential housing P/E ratio remained at about 20 from 1995 to 2001 and then jumped to 27 by 2005.

...Vancouver, which already had P/E ratio of 31 in 1995. This actually declined to a range of 26 to 28, but then soared after 2003 and reached 35 by 2005.

Does this mean anything? Maybe no.

...in stock markets, whenever the P/E ratio for the market has risen substantially above 25 there has often been a correction, meaning a sharp drop in the prices of shares.

The P/E ratio for Canada as a whole is about 28, suggesting that the real estate market may be overvalued.

In light of the turmoil in the U.S. economy and the tightening of credit markets, which foretell a rise in interest rates, the question is not if but when the housing boom here will end.

Reading this one seems kind of familiar to anything else being espoused lately by economists: inflation concerns, rising interest rates, over-valued markets, looming correction. History has a funny way of repeating itself, non?

As an aside, with my new schedule it would appear I will have all kinds of blogging going on over the weekends. I know many of the regular readers of HHV are Monday-Friday types, so I'll make a habit of indexing the weekend posts on Sunday afternoons so you can catch up Monday mornings if you'd like. Did you like the polls?

A life sentence to the poorhouse
Weekend Poll

Maybe this time it really is different?

I have to admit that four straight days of TSX increases has got me in a bit of an ignorant stupor. Beginning last Friday, when the US Fed dropped its short term interest rate by 5o points (0.5%), the markets have undergone a bit of stabilizing and a subsequent rally that has the TSX recovering 50% of its recent drop.

A recent Decima poll produced some rather unexpected (on my part) results:

The Canadian Press-Decima survey found that 55 per cent of respondents didn't think the market troubles herald a recession, compared with 22 per cent who were pessimistic. It also found that 66 per cent of respondents reported being unaffected by the financial tumult.

Another four per cent said they'd lost a lot of money, 17 per cent reported losing some money, and five per cent said they'd made money.

Almost half of the people surveyed said they felt the worst was over and the market will rise again soon, while 28 per cent said markets will continue to fall in the next few months.

I don't wish financial hardship on anyone. I think that savvy investors, both RE and equities, can avoid losing money in most market cycles by paying attention, getting good advice, and trusting their instincts. That said, from watching the markets with more care and attention, mostly due to this blog, for the past 8 months I'm surprised that more people aren't concerned about both over-inflated markets.

I consider myself fairly risk friendly. I like to play poker and I don't mind losing. I've found that by learning and paying better attention, I lose far less often. I have a similar outlook on the equities market: I'll take a chance with a percentage of my portfolio, rarely exceeding 20% speculation. The rest of my investments I consider value. That means I look for good deals. My favourite ratio is price to sales. I like to think that for every dollar of my own, I should get at least a dollar of the consumer's.

During recessions the pickings are slim for this philosophy, mostly because the peeps aren't a buying. During periods of high inflation (like now, and yes I know that's unsupported) the pickings are also slim because stock prices are hyper-inflated. Long story short, I have some cash in my trading account that I can't find a suitable place to park. Usually in transitional markets the choices are plentiful. I don't believe that this market is in a transitional phase. And I do believe that is a direct result of Central Banks' irresponsible actions over the past few weeks... even years.

Take this headline for example: Central banks are stealing from the average citizen.

What happens when fiscal irresponsibility gets rewarded with bailouts? You get more fiscal irresponsibility.

But as our credit bubble undergoes an ugly unwinding, it's dawning on folks that central banks lie at the epicentre of the problem.

Andy Xie (Financial Times) writes: "The global credit bubble is bursting. This bubble is primarily leverage financing for owning risky assets. The people who were responsible for what happened played with other people's money, marketed arcane financial products with false promises of fat profits, but stuffed their own pockets with big bonuses. Neither these masters of the universe nor their greedy but naive investors deserve to be bailed out. They deserve what is coming to them.

"The central banks should focus on price stability, not financial market stability, and should provide liquidity only to contain the multiplier effect of the bubble bursting on the economy. Nor should central banks stimulate to avoid recession at any cost. Business cycles are not bad. Excesses must be followed with cleansing...

"Markets have been taking more risk than they should because they believe that central banks will come to their aid during times of crisis, like now. The penchant of Alan Greenspan, former U.S. Federal Reserve chairman, to flood the market with liquidity during financial instability is the genesis of this 'central bank put.' As long as this expectation remains, financial bubbles will occur again and again. Now is the time to act. Let the crooks go bankrupt. Central banks should bury the Greenspan 'put' for good."

Now to paraphrase Mr. Wheaton (sorry couldn't resist one last poke): one person's opinion does not an expert analysis make. So I'll give you this one too, also from the same article:

U.S. Comptroller General David Walker was quoted Tuesday (also in the Financial Times), as follows: "Drawing parallels with the end of the Roman empire, Mr. Walker warned there were 'striking similarities' between America's current situation and the factors that brought down Rome, including 'declining moral values and political civility at home, an overconfident and overextended military in foreign lands, and fiscal irresponsibility by the central government.'"

I'm not suggesting that the doomsday scenario is imminent, but is it not telling of a considerable problem when federal financial leaders split on economic policy so diversely? What is it going to take for the markets to start paying attention? Given how interconnected the RE and stock markets have become since the dawn of the ABCP debt-funded retirement mutual fund mess, something drastic needs to take place in the stock market for the drastic correction I'm looking for in the local real estate market.