Dear Prudence


Canada’s Real Estate, a new China Syndrome and a System Getting Played?

“Dear Prudence is me. Written in India. A song about Mia Farrow’s sister, who seemed to go slightly barmy, meditating too long, and couldn’t come out of the little hut that we were livin’ in. They selected me and George to try and bring her out because she would trust us. If she’d been in the West, they would have put her away.”   – John Lennon

Prudence has seemed to go a bit barmy here in Canada as well, although I refer to the very real Canadian debt levels and Toronto/Vancouver real estate markets rather than someone on meditative leave.  During the great credit crisis, Canada’s conservative banking system was revered around world for its conservatism and relative stability. But fast forward to today, the takeaway from these pictures speak plainly.

Canadian real estate is running hot on global measures.

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There is no precedent for this level of consumer leverage, leaving Canada highly sensitive to interest rate and or income shocks.  Tired economic cycle and job markets, please don’t fail now.

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The hot markets are predominantly a Vancouver and Toronto regional issue, especially with energy markets taking Alberta’s economy down.   Although it isn’t as though slumping energy and mining markets haven’t reached BC.

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Naturally its right to focus on central bank policy and their solutions to everything – easy money.  Today’s bubble economics, manipulating markets and forcing all asset prices and debt levels higher and higher, is proving simply to be an experiment of hope to somehow turn improbable math into economic favour.  Easy money has lifted house prices around the world.  Still, taking this monetary background as a universal given, there must be something more to the story that distinguishes Canada’s housing and debt journey from the rest of the world.

A new China Syndrome ?

‘China Syndrome’ was originally coined to describe the sequence of events following the meltdown of a nuclear reactor, in which the core melts through its containment structure and deep into the earth.  Are we in an era maybe aiming to apply new meaning to the phrase, this time to China’s possible inability to contain its own massive economic bubble?

Even in their world of crazy large numbers, never has the world seen the kind of borrowing and building as China has produced just since the credit crisis. Desperate to keep growth going,  since 2007 debt/gdp soared from 80% to over 300%, debt growing  fourfold or some $18Trn.  In a span of a few short years they’ve used more concrete than the US has in its entire history, more steel than the UK has in its history.   We’ve all heard about their empty cities but…they reportedly sit on some 11 Bln sq ft or 63mm vacant homes.  Debt to be repaid and empty spaces to fill, this is tremendous future growth that they’ve pulled forward and must now digest.  It’s easy to conclude it all unsustainable and vulnerable, but it is a planned and manipulated economy of unprecedented size, so it’s so difficult to game and time.  It’s no surprise they’ve put controls on capital wanting to leave the country.  The world would be right to be afraid of currency devaluation and some larger looming economic danger.

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But capital does get out, an estimated $1Trn over the last year.   There are plenty of stories of strong Chinese buying heating real estate markets elsewhere – Vancouver and Toronto included.  The motivations of one side, individuals de facto exporting bubbles, are very different then the other, countries understandably not wanting to import them.

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Dear Prudence, won’t you come out to play?

Remember the systemic complicity of the US housing bubble, the failure at so many levels?  A Federal Reserve asleep at the easy money and oversight switch, even denying there was a problem when it had become obvious.  Wall St couldn’t leverage up and repackage garbage mortgage product and the banks couldn’t underwrite the feed fast enough.  The rating agencies minted money by bolstering securitization with blind endorsement.  Regulators were nowhere to be found.  Banking became all about quantity not quality.  Wall St bonuses boomed, suddenly mortgage brokers drove nicer cars than realtors and the appraiser owned a few homes ready for flip.   Everything to do with building, renovating, furnishing, financing, buying, selling was red-hot.  Joe Public had no chance, a system literally throwing money at him, demanding he borrow to buy and ignore the fine print.  The media swarmed with mortgage ads and stories of getting rich.  Politically, a home for everyone was fulfilling the American dream.

And within this ‘no-brainer’ confidence  came the nefarious –  liar loans, predatory terms and outright fraud.

Brought to its economic knees, eight years later the world still wears the shrapnel.  So, live and learn and never again, right?

Central banks are surely repeating their mistakes.  And China is reinventing the mistakes to scale.  In Canada it feels like some of the same mistakes of systemic complicity are playing out in Vancouver and maybe Toronto too.  Outside the real estate related economy, it’s not like the country is booming nor immune from debt headwinds and the global growth slump, especially to those exposed to commodities.

A reminder that Ontario has the world’s largest sub-sovereign debt at $307B, over twice that of California but with just a third of the population.  To the west,  ag, mining and energy markets have experienced downturns ranging  from severe to disastrous.  A consequential 25-30% drop in the $C over the last few years has helped stem some of the blow and helped manufacturing remain competitive and helped make real estate that much more attractive to foreigners. But still, these aren’t the economic roots of a healthy income-driven housing boom.

While unlike China, Canada doesn’t sit on millions of empty homes, like China, the levels of consumer debt dictate that the economy now needs to hope home prices remain relatively stable to avoid triggering real problems.  Given crisis history is so recent it is a wonder that the Bank of Canada and reputable banking system engendered such unstable consumer credit levels.

Look Around round round

Nonetheless the recent news stream suggests there are oversight cracks that can be addressed, even if it is a bit like closing the barn doors after the horses are gone.  While a passionate proponent of free markets, as a Canadian I see no reason why we should willfully and silently watch, if in fact foreign buying is resetting the domestic economics for Canadian tax paying homebuyers.  Maybe there should be a separate set of rules for non-citizens?

It’s 2016 and a time of heightened border concern everywhere, and elevated info-tech and data management abilities –  there should be no excuse for lack of oversight of any foreigner transacting in real estate;  from realtors and their local Board’s oversight, to FinTrac, legal contracting and titles, contract assignments, bank lending,  immigration, tracking numbered companies, Canada Revenue Agency (CRA) and differing Provincial standards.

Remember, nefarious dealings are symptomatic of bubble environments.  As once famously said, banks get robbed  “because that’s where the money is.”  The stories in the press of foreign money laundering or lack of CRA oversight on capital gain loopholes or banks offering different lending standards to foreigners with no income verification or foreign investment clubs funding flips;  these all scream out that Canada is a system getting played…because that’s where the money is.  When I read a foreign student in BC purchased a $7mm property and flipped it for $8mm , I have to wonder about the bubbly systemic complicity enabling it to happen.

It’s a struggle to make a list of solutions.  We are that far deep into the problem.

Vancouver’s new tax on foreign buyers is showing early impact.  But what if this just hurts Vancouver and means the business moves elsewhere, to Toronto or Calgary?  There are already reports of buying tours even redirecting to Seattle.  These buyers seem committed.

New Zealand, also dealing with hot markets, imposed a 40% down-payment requirement on investment properties.  Maybe Canada could similarly entertain a heightened downpayment requirement on foreigners?

Maybe the CRA should make the capital gains exemption for primary residence eligible for Canadian citizens only?

Hawaii has a significantly elevated property tax for out-of-state non-resident owners.  Something Canada could consider for foreign buyers?

Its great that Canada is such an attractive country that foreigners want to invest here and move here.  But it would be wise for Canada to get its immigration/real estate/banking/taxation paper trail act together.  We’d rather be sure Canada is attractive for its beauty and people and civility and prudence, not because it was easy to play.

With Canadian debt having run so high, there is growing vulnerability to macro developments.   Very recent global history should serve as reminder.  The Bank of Canada can’t run national policy to what is clearly extreme regional noise.  But they and the banks and the regulators need to identify the increasingly obvious cracks in the system and fill them.   Or risk remaining complicit.

 

Dear Prudence

Dear Prudence, won’t you come out to play?  Dear Prudence, greet the brand new day
The sun is up, the sky is blue  It’s beautiful and so are you
Dear Prudence, won’t you come out to play?

Dear Prudence, open up your eyes  Dear Prudence, see the sunny skies
The wind is low, the birds will sing  That you are part of everything
Dear Prudence, won’t you open up your eyes?

Look around round  Look around round round  Look around

Dear Prudence, let me see you smile  Dear Prudence, like a little child
The clouds will be a daisy chain  So let me see you smile again
Dear Prudence, won’t you let me see you smile?

Dear Prudence, won’t you come out to play?  Dear Prudence, greet the brand new day
The sun is up, the sky is blue  It’s beautiful and so are you
Dear Prudence, won’t you come out to play?