BC Budget assumptions: nice try

Three weeks ago the BC Budget was released. The basis for the revenue and cost projections for the budget was an average 6.2% unemployment rate in 2009, falling to 6.0% in 2010.

I previously posted on this topic here. For the assumptions in the budget, see this pdf page 87.

How are we doing so far? Well, three weeks after their projection, unemployment has now hit 6.7%--up 0.6% from January. I'll put up the graphs later, but it appears to be going hyperbolic. [UPDATE: here it is! I think my 10% by 2010 prediction is looking likely.]
In short, the $495 million dollar deficit projection has now been blown out of the water.

I'm not clairvoyant here. I just observed that housing starts were going to plummet leading to construction employment to go back to pre-bubble levels. If you do the math, you can see what will hapen to employment. But, I'm sure all we'll hear from the usual economic commentators and our government leaders is another chorus of 'hoocoodanode'.

Enough with the koolaid and the rose coloured glasses! Can we please all open up a can of reality soda and get on with what has to be done?

BC Budget: Junky assumption

I didn't look at the BC Budget in too much detail, but something on the radio caught my ear. Sure enough, I confirmed it on this pdf on page 87.

The BC Budget hinges on the projected unemployment rate averaging 6.2% in 2009. Have a look at the January 2009 numbers here. The January number is 6.1%. Does anyone really think that we won't see that go higher in February and then farther up from there?

I think the budget projection is pie-in-the-sky. I would say a more realistic projection, given the construction sector dry-up, is 8.7% by the end of 2009, with an average of 7.5% for the year.

The 2010 projection is 6.0%. By then, most condos under construction will have completed. Construction employment will be back below historical averages. The Olympics will be over as well. Unless every other sector suddenly pulls up the slack, there is a serious risk of double digit unemployment rates. 6.0% is a total joke.

US Financials Falling Like Dominoes

Sept. 14 (Bloomberg) -- Lehman Brothers Holdings Inc. prepared to file for bankruptcy after Barclays Plc and Bank of America Corp. abandoned talks to buy the U.S. securities firm and Wall Street prepared for its possible liquidation.

Lehman and its lawyers are getting ready to file the documents for bankruptcy protection tonight, said a person with direct knowledge of the firm's plans. A final decision hasn't been made, though none of the other options being considered appeared likely, the person said, declining to be identified because the discussions haven't been made public.

Sept. 14 (Bloomberg) -- Bank of America Corp. agreed to buy Merrill Lynch & Co. for about $44 billion, a person with knowledge of the deal said, after shares of the third-biggest U.S. securities firm fell by more than 35 percent last week and smaller rival Lehman Brothers Holdings Inc. neared bankruptcy.

Bank of America and Merrill reached a deal in principle, according to the person, who declined to be identified because the deliberations were private. A final merger agreement hasn't been signed yet, the person said. The boards of Merrill and Bank of America approved the transaction this evening, the Wall Street Journal reported, citing unidentified people familiar with the matter.

Sept. 14 (Bloomberg) -- American International Group Inc., the insurer struggling to avoid credit downgrades, is seeking a $40 billion bridge loan from the Federal Reserve as it tries to sell assets, the New York Times reported.

The insurer has turned down a private-equity investment because it would have meant handing over control of the company, the Wall Street Journal said on its Web site, citing unnamed people. AIG may get access to the Fed's borrowing window in an ``extreme liquidity scare,'' Citigroup Inc. analyst Joshua Shanker said in a Sept. 12 research note.

Economics 101: Opportunity Cost

I have had many discussions with people about how to evaluate the potential purchase of a home and it never fails that the discussion comes around to something like this:

Person: "I'd like to buy a rental property."

Mohican: "Make sure you are buying something that costs less than the rent you will generate."

Person: "I have done the math and if I put 20% down ($100,000) I can buy a house with a basement suite and the rent ($2200/mo) will carry the mortgage ($2200/mo)."

Mohican: "Really, that sounds interesting. Have you factored in taxes, insurance, maintenance, and any unexpected loss of income ($500 / month+)? Additionally, have you factored in the loss of income from your downpayment ($400 / month+)?"

Person: "Hmmmm . . . . I guess I'd have to pay the property taxes and stuff but the house will always go up in value so if I get stuck and can't make those payments I can just sell it."

Mohican: "What about the downpayment? How much could you earn on that every month if you invested it?"

Person: "The money is in a savings account right now and I don't know how much it earns, I think it is 4%."

Mohican: "My suggestion is that you have a look at your math again and assume that you don't have a downpayment. Would this potential purchase look as attractive with 100% financing? Additionally, I suggest that you find a property where the rent will cover ALL of the expenses, including taxes, insurance, maintenance and a buffer for lost income."

Person: "But that is impossible. No property is that cheap."

Mohican: "No property in Vancouver currently has those characteristics but that hasn't always been true nor will it always be true and Vancouver isn't the only place to invest. You are considering purchasing a $500,000 property which yields approximately 4%. This is the same yield as your savings account but with much more risk than a savings account. If I were looking at the same property I would only be willing to pay $330,000 for it, which would give it a yield of about 6%. This increased yield would compensate me for the risks I am taking on by owning the property and for an adequate return on my downpayment."

Person: "But real estate is so powerful because of the leverage component. You are ignoring that."

Mohican: "Yes, I am ignoring it because I can use leverage with all sorts of investments including dividend paying stocks and income trusts where the cash flow would cover my borrowing costs. So to be fair we should evaluate all investments without leverage first so we have a fair comparison and so the investments stand on their own merit."

Person: "I don't understand."

Mohican: "Let's assume we can find a property that yields 4%, which you have done. The price to earnings ratio of that property is 25. We can find a stock with a lower price to earnings ratio that also pays a large enough dividend to pay for our borrowing costs. An initial screen produces dozens of companies that meet these characteristics so based on that we should not purchase the property but the stocks instead."

Person: "But my brother lost his shirt in the stock market and he's made tons of money flipping houses. He owns 5 properties right now and he is buying more all the time."

Mohican: "It sounds like your brother is a speculator/gambler and he'll probably lose his shirt in real estate too. He may have made some money recently but that is no garauntee that the profits will continue. If you are buying for cash flow you should consider the metrics I have put forward but if you are buying for capital gains I can't help you evaluate the investment merits because there are none."

Person: "But real estate always goes up."

Mohican: "No it doesn't. If you are naive enough to believe that you deserve to lose money. Go do some more homework and investigation if you want to be a professional investor. Ameteurs jump in without doing their homework, professionals know all of the knowable facts before jumping in."

Person: "That sounds like work, I think I'll just buy the property."

Mohican: "See you later."

From Wikipedia:

Opportunity cost is the loss of potential gain from the best alternative to any choice. Thus, opportunity cost is the cost of pursuing one choice instead of another. Every action has an opportunity cost. For example, someone who invests $10,000 in a stock denies oneself the interest that one can easily earn by leaving the $10,000 dollars in a bank account instead. Opportunity cost is not restricted to monetary or financial costs: lost time, pleasure or any other benefit that provides utility should also be considered.

Opportunity cost is a key concept in economics because it implies the choice between desirable, yet mutually-exclusive results.

Example

If a city decides to build a hospital on vacant land it owns, the opportunity cost is the value of the benefits forgone of some other thing which might have been done with the land and construction funds instead. In building the hospital, the city has forgone the opportunity to build a sports center on that land, or a parking lot, or the ability to sell the land to reduce the city's debt, since those uses tend to be mutually exclusive. Also included in the opportunity cost would be what investments or purchases the private sector would have voluntarily made if it were not taxed to build the hospital. The total opportunity costs of such an action can never be known with certainty (and are sometimes called "hidden costs" or "hidden losses", what has been prevented from being produced cannot be seen or known). Even the possibility of inaction is a lost opportunity (in this example, to preserve the scenery as-is for neighboring areas, perhaps including areas that it itself owns).

It can also apply to time; one might use a limited vacation time to travel to a place of cultural enrichment or to do household improvements. Thus the two-week road trip might preclude repairing or painting one's house that year. To the vast majority of people, time has value.

Evaluating opportunity cost

Opportunity cost needs not be assessed in monetary terms, but rather can be assessed in terms of anything which is of value to the person or persons doing the assessing (or those affected by the outcome). For example, a person who chooses to watch, or to record, a television program cannot watch (or record) any other at the same time. (The rule still applies if the recording device can simultaneously record multiple programs; there is going to be a limit, and if the number of desired programs exceeds the capacity of the recorder, some of them will not be saved, and thus cannot be seen.) In any case, at the time the person chooses to watch a program, either live or on a recording, they cannot watch something else, and if they are not able to record another program showing at the same time, the opportunity to view it is lost (presuming the particular program is not repeated). Or as another example, someone having a video game can choose to watch a program or play the video game on the TV; they can't do both simultaneously. Whichever one they choose is a lost opportunity to experience the other. Or for that matter, a lost opportunity to engage in some other activity entirely (exercising outdoors, or visiting with family or friends, as merely two examples).

The consideration of opportunity costs is one of the key differences between the concepts of economic cost and accounting cost. Assessing opportunity costs is fundamental to assessing the true cost of any course of action. In the case where there is no explicit accounting or monetary cost (price) attached to a course of action, ignoring opportunity costs may produce the illusion that its benefits cost nothing at all. The unseen opportunity costs then become the implicit hidden costs of that course of action.

Note that opportunity cost is not the sum of the available alternatives, but rather of benefit of the best alternative of them. The opportunity cost of the city's decision to build the hospital on its vacant land is the loss of the land for a sporting center, or the inability to use the land for a parking lot, or the money which could have been made from selling the land, or the loss of any of the various other possible uses—but not all of these in aggregate, because the land cannot be used for more than one of these purposes.

However, most opportunities are difficult to compare. Opportunity cost has been seen as the foundation of the marginal theory of value as well as the theory of time and money.
In some cases it may be possible to have more of everything by making different choices; for instance, when an economy is within its production possibility frontier. In microeconomic models this is unusual, because individuals are assumed to maximise utility, but it is a feature of Keynesian macroeconomics. In these circumstances opportunity cost is a less useful concept.

Subprime Primer

Bob Rennie is a (very well) Paid Shill

I heard a panel of financial market analysts on CKNW this morning comprised of Michael Campbell, Michael Levy, Helmut Pastrick and Bob Rennie. I am amazed every time I hear the silver tongued Bob Rennie open up his mouth. I believe that Bob actually believes the crap he says about Vancouver being able to weather the financial storms that are hurtling around the world right now and that our economy is an invincible fortress built upon ever increasing real estate wealth.

At times, during the few minutes I could tolerate, it seemed as if the 3 actual financial industry players were about to say - "What is this guy doing here?" After all Bob Rennie is a marketer, not an economist. He wouldn't know a price/rent ratio if it hit his Rolls Royce on the hood.

Bob, after being lobbed softball questions by host Bill Good, spouted the usual nonsense about the Vancouver Olympics, world class city, blah, blah, blah. Are you nucking futs? Blind? Deaf?

Rant off.

Canadians in Hock

Tip of the hat to reader '/dev/null' for forwarding this news story. Credit card debt is obviously a major problem for many Canadians. It is hard for me to comprehend how much revolving debt many people have and they don't even realize that they are enslaving themselves to the cheap crap they bought on the card.

Growing credit debt is crushing Canadians: study
Updated Tue. Nov. 13 2007 8:46 AM ET CTV.ca News Staff

A new study of Canadians' credit debt finds that a whopping 25 per cent owe between $10,000 and $40,000, and 28 per cent don't even know the interest rate they pay on their main credit card.

The report by Credit Canada and Capitol One was timed for release during their Credit Education Week, and is designed to raise awareness of good financial management.

Laurie Campbell, of Credit Canada, said the numbers -- which don't factor in mortgage debt -- were surprisingly high.

"The numbers are quite startling, even I was quite surprised, but nevertheless, this is truly what we're seeing," Campbell told CTV's Canada AM.

"Savings rates at an all-time low and debt rates at an all-time high so this financial literacy week in my opinion is long overdue."

The study, which questioned 4,000 respondents about their personal credit debt practices, found a disconnect between Canadians' debt levels and retirement plans.

When asked about their total outstanding debt from credit sources and loans, respondents said the following (figures don't include mortgage debt):

$0 -- 16 per cent
$10,001 to $20,000 -- 13 per cent
$20,001 to $40,000 -- 12 per cent
$100,001 to $200,000 -- 9 per cent
$300,001 to $500,000 -- 1 per cent

Two per cent of Canadians said they had six credit cards; while six per cent had five credit cards; 12 per cent had four cards; while the majority, 25 per cent, had two credit cards.

Twenty-two per cent of Canadians said they had only one credit card.

When it came to the average balances people said they carried on their credit cards, 36 per cent said their monthly balance was $0 because they paid off their credit card each month.

Eleven per cent said their monthly balance was between $1,001 and $2,500, 9 per cent had a balance of between $2,501 and $5,000 while 1 per cent had the highest monthly balance of between $20,001 and $30,000.

When asked how their credit card habits could be best described:

50 per cent said they pay their credit card off in full every month.
37 per cent said they pay the minimum requirement each month
10 per cent said they do not have a credit card.
3 per cent said they sometimes/often miss the minimum required payment.

"Certainly what happens with a lot of people is they look at their statement, they see a minimum payment, and say that's what I have to pay and unfortunately they don't look further to find out what the implications of only paying the minimum payment are," Campbell said.

When it came to budgeting, 53 per cent said they have no budget. Another 31 per cent said they have a budget and stick to it, and 16 per cent said they have a budget but rarely stick to it.

When asked when they thought they would be able to retire, respondents said the following:

13 per cent -- never
3 per cent -- between 71 and 76
24 per cent -- between 56 and 60
29 per cent -- between 61 and 65
14 per cent -- between 66 and 70

"The majority of people expect to be able to retire at 60 or 65," Campbell said.

"I don't know how they expect to retire if they're not saving, so there's a real dichotomy between the way people see their future and the way they're handling their money."

When asked what their top concern was regarding credit and debt management, 26 per cent said they worried about not being able to deal with unexpected emergencies.

Campbell said the goal of Credit Education Week is to raise awareness among Canadians about credit debt and how to deal with it, through providing free advice and online resources.

While a strong Canadian dollar has lulled many Canadians into a sense of financial security, people must be cautious, she said.

"People are very optimistic which is a very wonderful thing but you also have to plan for your future and think about where you're spending your money and put your goals in place, that's the most important thing."