TD Bank Predicting House Prices to Drop

From TD Economics.

Our existing home sales and average price forecast for 2010 is largely unchanged since December 2009. We still expect 475K transactions to take place, with an average annual price
nearing $350K, an increase of 9% over 2009.

However, this hides an underlying shift occurring over the course of this year. While we anticipated sales and prices to be strong in the first half and to cool in the second half, we now expect this contrast between the two halves will be sharper.

A surprisingly robust economic recovery provides some offset in the form of higher employment and income, but a combination of factors suggests a weaker handoff to 2011 than previously expected.

One crucial factor is the supply side response (listings) to higher home prices. While it was slow to appear, it is now stronger than had been expected. Housing starts have also been slightly higher than anticipated at 200K units in Q1/2010.

While we previously expected the average home price to gain a modest 1.6% in 2011 (stagnating in real, or inflation-adjusted terms), we now expect a modest pullback of 2.7% at the national level, with 7 out of 10 provinces experiencing lower prices.

REBGV Sales are the Story

The local real estate market has been goosed this spring by the super low interest rates available to your average home buyer.

Sales in the REBGV jurisdiction were very high at 4259 for the month of June.

Active Listings fell to 13,252 units.


Consequently the Months of Inventory fell to a mere 3.11 for the month of June. A dramatic fall from January's levels.

As sales have risen and inventory has fallen, prices have gone up.

The correlation between Months of Inventory and Price Changes is still very strong.

It will be very interesting to see how future price changes play out. We will see if this spring market is a temporary phenomenon like so many other spring markets around North America.

Unemployment levels, interest rates, and many other factors play a big part in the local market and it will be interesting to see which way things turn.

Hoorah for 2008 and Predictions for 2009

2008 in Review

2008 was the year that the entire world woke up to the fact that houses don't go up in value forever and the entire mess of a year that 2008 was can be summarized in that fact.  Stock, bond, and commodity markets all reacted to the spectre of a long and protracted recession with no quick turnaround in sight.  It is truly amazing to see how consumption and borrowing against the value of a home had an impact at inflating the US and Canadian economies.

Locally, house prices fell dramatically starting in May and benchmark prices are now down nearly 14% in the REBGV area and just over 9% in the FVREB area.  The pundits are still calling for a spring turnaround and many real estate agents will likely be disappointed with their incomes during 2009.  They had better learn how to get sellers to drop the price fast or no paycheques will be forthcoming in 2009.  I fully expect that many real estate agents and mortgage brokers will try to find other work during 2009.

Prediction Time

I was 2 for 3 on my predictions for 2008 but I missed a big one as I didn't see how bad the stock, bond, and commodity markets would turn out.  

Predictions make fools of us all unless we are lucky enough to guess correctly.  Sometimes an educated guess is better than nothing however and it is kind of fun to toss around what we think is coming during the next year.

Here are my thoughts:

1) Real estate prices in the Metro Vancouver area will fall by 20% or more during 2009 from current levels.  The fall in prices will be worst for apartments and will be best for moderately priced suburban detached homes.

2) BC will enter recession sometime in 2009.  Canada and the US will continue in their recessions throughout most, if not all of 2009.

3) The Vancouver construction industry will be decimated during 2009 with many more projects hitting the completion phase and the need for labour dries up.  See historical employement statistics here.  The Metro Vancouver area will probably see a loss of 50,000+ jobs in 2009 from the construction, retail, finance, and real estate professions.

Credit Crisis: The Worst May be Behind Us (for now)

Several indicators, like the TED spread, have now reversed direction this week and are now getting better not worse after hitting ridiculously elevated levels last Friday.

See Calculated Risk for more on the Credit Crisis.

The local media has really glommed onto the idea that house prices have fallen and are falling more.  The facts, which were clear to many of us 2 years ago, become more obvious by the day to the average Vancouverite - house prices got too high and now they need to come back down.  Articles in the Georgia Straight, Vancouver Sun, Province, and Globe and Mail all pointing to further weakness in the local housing market.  It is improbable that there will be any material improvement in this situation for at least 18 months.

Several projects have now hit the skids with the overly ambitious Infinity Project in Surrey making the headlines this week.  More to come on further project cancellations.

I had a nice time off.  What are you seeing out there right now?

Bank Raises Rates on Variable Rate Mortgages

LORI MCLEOD, Globe and Mail Update, October 6, 2008 at 8:46 PM EDT

The latest victims of the growing financial crisis could be the standard discount available to consumers on variable mortgages, and home equity loans at prime.

In a move expected to be followed by other banks, all of which have been stung by higher funding costs, TD Canada Trust is raising rates on both types of loans, effective Oct. 7.

Rates on these products will rise to 5.75 per cent, a percentage point above the prime rate. Only last week, TD eliminated the discount on its variable rate mortgages, offering them at the prime rate of 4.75 per cent. During the housing boom of the past several years, consumers could often get their bank to drop the rate by half or even up to a full percentage point.

“While TD Canada Trust has endeavoured to not pass on the increases in rates to its consumers, this change reflects steadily increasing costs of funds in the current economic environment,” the bank said in a statement.

The percentage point increase raises the term interest cost on a $250,000 variable rate mortgage by $12,247.22 over five years, according to Royal Bank of Canada's online mortgage calculator. The difference is based on a 25-year amortization, a variable rate mortgage with a five-year term and bi-weekly payments. On that basis, the bi-weekly payment amount rises to $725.90 from $657.83.

The credit crisis and economic uncertainty have caused banks to stockpile their cash. That's driving up their short-term cost of borrowing from one another, and means margins on variable rate mortgage products are shrinking.

Rates on fixed-term mortgages went up last week too, as banks have passed on fewer of their savings from falling bond yields to consumers to consumers.

“The deterioration of global credit markets is beginning to squeeze the ability of even the strongest of financial institutions to raise longer-term funds, which could limit the provision of longer-term credit in Canada to businesses and households,” federal Finance Minister Jim Flaherty said in a statement Monday.

“Hopefully this isn't a permanent shift, but a short-term reaction to conditions the likes of which we really haven't seen before,” said Gary Siegle, regional manager at mortgage broker Invis.

With a discount, some customers can still get five-year, fixed-rate mortgages at 5.55 per cent, meaning a bi-weekly payment of $707.66 on a $250,000 mortgage amortized over 25 years. This means those looking for peace of mind in the current market turmoil aren't paying a premium to lock in, Mr. Siegle said.

Canada faces housing bust: Shiller

Jacqueline Thorpe, Financial Post Published: Wednesday, October 01, 2008

The Canadian housing market could face a similar housing bust to the United States, particularly in more bubbly markets as Vancouver and Calgary, said Robert Shiller, the University of Yale professor who predicted both the 1990s stock market boom and bust and the US housing slump.

Mr. Shiller, co-founder of the S&P Case/Shiller Home Price Index, said psychology is the primary driver of bubbles and it appears that Canada has been caught up with home buying fever just as the United States and other countries around the world.

Asked whether that meant Canada could face a similar bust Mr. Shiller said: "Yes, especially in places that went up a lot like Vancouver and Calgary. I don't think Toronto has been quite as extreme."

Mr. Shiller said there was a natural connection between the United States and Canada.

"I would be surprised that the bubble that appeared in the United States and elsewhere didn't appear in Canada," he said in an interview with the Financial Post. "It's psychology, I think that drives it.

Mr. Shiller, whose book Irrational Exuberance came out in March 2000 just as the tech bubble peaked, said it was essential for the U.S. government to pass a financial bailout, though he believes the United States is facing a "severe recession," regardless.

"I'm concerned problems are deeper than can be handled by the bailout but that doesn't mean the bailout doesn't do some good," he said.

He said a bailout might help restore some confidence to the stressed financial system.

"What creates a crisis is a lack of confidence," he said.

He said the housing crisis was primarily a policy failure by U.S. authorities.

The U.S. government was "totally blind" to it, regulators failed to monitor the mortgage industry properly and the U.S. Federal Reserve had very low interest rates at a time of the greatest housing bubble of all time.

While homeowners should take some personal responsibility for the debacle, they were being goaded into the fevour by an establishment that endlessly pushed an ownership society.

"They were doing what was considered right at the time," Mr. Shiller said.

Mr. Shiller said human nature seems to predispose people to spectacular excess, fanned by a voracious news media.

"Until we had newsapers and other media we had no bublbles, he said.

While ups and downs in the market can lead to creative destruction the current housing crisis has morphed into a system problem.

"The problem is that perfectly good firms are in trouble," he told the Financial Post in an interview at the Ontario Economic Summit.

A bailout may not be palatable, government assistance is required when the system fails.

The trick is to reduce conditions that fan bubbles.

In his current book, "The Subprime Solution," Mr. Shiller proposes several measures to reduce bubble conditions in the housing market including better information for prospective buyers and broader markets that trade risk better, such as the housing futures he has developed on the Chicago Mercantile Exchange.

There should also be new retail products such as "continuous workout mortgages," that go up and down with the value of the home equity and mortgage equity insurance.

Mr. Shiller, who would not give a precise forecast on the outlook for U.S. home prices, nevertheless said futures markets are predicting more price declines of 10% or more. His Case/Shiller index earlier this week showed home prices down 16.3% year-over-year this summer.

He expects things to get worse for the U.S. economy in the short-term.

"We're going to have a severe recession, most likely," he said. How quickly the economy recovers depends on policy.

"Unfortunately the bailout has hit a snag," he said. "There is resentment of rich Wall Street people. I am worried that the sense of trust, in confidence of each other is being damaged."

Mr. Shiller said he does not have another bubble in his sights as the U.S. economy will be "damaged for years."

"The housing bubble was of record proportions," he said. "Maybe the next big bubble will be your children's or grandchildrens...The excitement we had in the 1990s and in 2000 in the housing market is a fragile thing and it won't come back for some time."

Housing Problems Brewing in Canada

From the Financial Post. Read the actual report here (pdf).

Most of Bay Street has argued there is little risk Canada could suffer the same kind of housing-led credit crunch that is now hammering the United States and to a lesser degree the U.K. but one economist argues all the ingredients are there.

David Wolf, Canadian economist at Merrill Lynch, said Canadians are just as personally indebted as their other Anglo Saxon cousins.

"We believe that markets remain overly sanguine with respect to the prospects for the Canadian housing market, the financial sector and the overall economy," Mr. Wolf said in a note.

Mr. Wolf said the underlying source of U.S. troubles stemmed from the simple fact banks lent people too much money to go out and buy houses but there were obvious danger signs in the data.

For example, every year from 1952 to 1999, U.S. households were net savers, but by 2005 household net borrowing had swelled to 7% of disposable income, which the credit curnch is now reversing.

In the U.K. net borrowing reached a peak of 6.1% early this year.

But Canadian numbers are easily comparable. Canadian households moved into sustained deficit in 2002. The deficit grew to an average 6.3% in 2007 and in the first quarter of this year it reached 6.4%.

Judging from the massive outperformance of Canadian bank shares through the global crisis the market view is that that Canadian housing and credit markets are not going to crack, that somehow household overextention is somehow more sustainable in Canada, Mr. Wolf said.

"We fear, however, it may simply be a matter of time," he said.

The tipping point in the United States was the emergence of falling house prices in the summer of 2006, kicking off the "vicious" circles that have brought the financial system to the brink.

Canadian house prices are now beginning to fall, yet mortgage debt continues to grow at a double-digit pace.

"From this perspective, the absence of a Canadian credit crunch to date may be cause for concern, not comfort," Mr. Wolf said.

Yes, it is true. Canadians are in hock up to their eyeballs and we are no different from most of our counterparts in the rest of the western world. We have plenty of problems here in Canada so we need not try to pick out the specks in other people's eyes until we remove the log in our own.

don't PANIC

Well folks we are certainly in the middle of it now.

There is no denying that the fancy financial shenanigans of the past few years have now fully culminated in the fecal matter hitting the overhead rotational device.

Bring it on is all I have to say. Let's get this over with. Me and my clients are positioned decently to weather this storm but not without a concern for the broader societal impacts.

Investment banks - done.
Sketchy lending joints - done.
Poorly capitalized banks and insurance companies - done.
Hedge funds - done.

Fortunately, life will go on without these companies and hopefully it will result in less speculative mentality and behavior. Let's focus on doing productive things like designing and building stuff that works well. Providing valuable services with pride and honesty. Supplying the world with items of real utility and value.

Phinance for Physicists #1

Thanks to jesse for putting this together and doing some legwork.

I had a brief email conversation with Dr. Somerville on his recent paper regarding proper valuations of residential houses in different Canadian cities. He and I agreed that the life of an economist involves a bit more than plugging numbers into equations. However economics is a science so, having no significant formal finance/economics training but a bit more physics training, I thought I would bridge the divide with some much touted but rarely practiced cross-disciplinary legwork. Scientist to scientist.

A good friend of mine opined about physics education that the number of lies told during one's schooling slowly decreases. In many ways, in my current view, economics is like this. We use simple formulas, supply-demand curves, etc. in an attempt to understand the world around us.

With my limited understanding of finance, here starteth the lies.

Net Present value

The concept of The Net Present Value (NPV for short) is determining fundamental value for an asset, such a car, a boat, a stock, a pair of droids, a sail barge, or a house. The concept is simple: that the purchasing of this asset ties up one's money that cannot be used for other things, that people generally want to maximize their wealth, and that there is risk in tying up money in an asset.

Rule#1: The Net Present Value (NPV) of an asset is the sum of a series of expected discounted future cash flows.

What it means is that rational investors, given all other available choices with what to do with their money (opportunity cost), the risks involved, the expected revenue, expenses, and a little something for their trouble, will look at an asset and determine what the maximum they would be willing to pay to produce a fair return.

We can derive a rough formula for the net present value of, say, a condominium that is rented out. We assume the condo is rented out forever, which is a reasonable approximation (forever and 30 years produce about the same number). Returns and inflation compound so the series of cash flows increases geometrically but are discounted:

(1)

where i is the expected inflation of rent and expenses (say, 2% per year), and r is the so-called discount rate that is a combination of the long term bond rate (that includes expected inflation), a risk premium, and depreciation. The discount rate is a method of combining risk, inflation, and opportunity cost into one number. Rent is gross annual rent, and Expenses are annual maintenance, tax, and insurance costs (et cetera). Financing costs are not included here as the decision to buy is based upon having cash in hand, though more advanced analysis can explicitly include them. (Financing costs are, to a degree, implicit in the above formula) Note depreciation could be abstracted in Expenses or as part of the discount rate r.

Note that some condos will have more problems with tenants than others. How this is handled in the calculation is typically by having a higher risk premium included in "r" though in essence it could also be handled by using the expected value of rent, not nominal rent. The same principle applies for expenses, like the probability and expense of a condo being leaky for example.

This is in fact the formula mohican used to calculate fundamental value. He chose to use r-i (also known as the "cap rate") as the 5 year mortgage rate as a rough approximation. In his words, "The bond market and the banks are particularly efficient at determining the risk premium and adequately price that in to the 5 year mortgage rate. This is why I use it." Mohican also clarified to me that he assumes land appreciation and structure depreciation are roughly equivalent. It's also worth noting that mohican has chosen to use a relatively simple formula to estimate fundamental price and not spend too much time in details. In general there is nothing wrong with this but in certain situations it helps to know what to do if there are significant deviations.

The working paper Dr. Somerville et al published uses a formula similar to this but in a different form. It can be derived from the same basic principle, resulting in:

(2)

Where k is the long term mortgage rate, t is tax rate, m is maintenance, d is depreciation, (the last 3 are as % of property value) and E(DP/P) is expected capital appreciation.

Without going into the details, both mohican's and Dr. Somerville et al's chosen formulas can be construed to have been derived from Equation 1 above, from a strict financial, not economic, perspective.

Example

Let us use mohican's chosen formula in a simple example. A condo rents for $1000 per month, just sold for $220,000 and has expenses that are 20% of rent. The mortgage rate is 6%. NPV = 1000*12*0.8/0.06 = $160,000. This means that a rational investor who is looking only at future cash flows will be willing to pay $160,000 for this condo, according to mohican's formula.

Now, let us use Dr. Somerville et al's chosen formula for the same condo. We will assume that this condo will "conservatively" appreciate at E(DP/P) = 3% per year, k is 6%, t is $1200/year, or 0.5%, m is 0.5%, and d is about 1%. According to this formula a rational investor will pay 12000/(0.06+0.005+0.005+0.01-0.03) = $240,000

Analysis

Why the difference? There are two reasons. The main reason is contained in E(DP/P). It turns out, according to first principle derivations, that E(DP/P) is equal to the expected appreciation of future cash flows. In other words, a value of E(DP/P) increasing faster than cash flows are increasing from the current asset is expecting to either sell the asset to someone in the future for a price inflated by E(DP/P) (selling an asset is a cash flow), or that cash flows can increase more sometime in the future by using the asset more productively. Assuming 3% annual appreciation is more than what was implicitly assumed by mohican.

The second difference is more subtle. Remember in Equation 2 the expense costs were as a percentage of value. If capital appreciation continually outpaces rent inflation, these percentages perpetually drop; in other words the cost of capital perpetually decreases. This works mathematically but one must realize that the capital appreciation inherently includes productivity increases above what the current structure can support. The potential flaw in this is that the expenses must include construction costs for the productivity enhancements and would boost the percentages higher than what was calculated. Furthermore, and more importantly, one must think hard about what value to use in the denominator of the percentages. For this reason it may (must) be preferable to pull m, t, and d and make them nominal, not as a % of an arbitrary pre-calculated value.

Remember Equation 1 assumes an infinite series of geometrically increasing cash flows. If at some point in the future rents increase faster than expected or the land can be further sub-divided and used to produce more rent (say turning a 5 story condo into a 20 story condo 15 years from now), the NPV could be higher than what current cash flows suggest. One can approximate this by adjusting upwards the exponent on the geometric series. Expenses, too, can be nonlinear if there are major renovations or redevelopments in the future. If, however, the cash flows spike up (or down) too far in the future, their present values are diminished so as not to significantly change the expected capital appreciation rate. For example 1000 years from now a giant space tower with 6000 floors is likely to be built in a detached residential neighbourhood. This will have close to no impact on NPV, even if it were a certainty.

We can of course solve for E(DP/P) to figure out, if the condo just sold for $220,000, what the rational investor expects for capital appreciation.

Another measure thrown around local blogs is the 100X-125X monthly rent multiplier for condos. This would put our example condo at $100,000-$125,000. There is historical precedent for this occurring, though just as prices can be above one's calculated NPV, they can drop below as well. It IS reasonably possible to calculate NPV equal to 100X rent in Vancouver; in fact I think there is a good chance of select condo sale prices equaling this someday soon.

Regardless of which formula, mohican's, Dr. Somerville's, or some other fundamental asset formula, you may choose to use, remember that their roots are the same but their assumptions can be different.

The next (lesser) lie to discuss is looking at E(DP/P) -- capital appreciation -- in more detail; naturally, with housing in mind of course.

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.

The Undercover Economist

The Wisdom of Crowds?

A single economic forecast is usually wrong. But groups of economic forecasts are often just as mistaken. Why?

By Tim Harford
Posted Saturday, Aug. 9, 2008, at 6:44 AM ET

When people discover that I am an economist, they rarely ask me for my views on subjects that economists know a bit about—such as how to respond to climate change or pay less at a supermarket. Instead, they ask me what will happen to the economy.

Why is it that people won't take "I don't really know" for an answer? People often chuckle about the forecasting skills of economists, but after the snickers die down, they keep demanding more forecasts. Is there any reason to believe that economists can deliver?

One answer can be gleaned from previous forecasts. Back in 1995, economist and Financial Times columnist John Kay examined the record of 34 British forecasters from 1987 to 1994, and he concluded that they were birds of a feather. They tended to make similar forecasts, and then the economy disobligingly did something else, with economic growth usually falling outside the range of all 34 forecasters.

Perhaps forecasting technology has moved on since then, or the British economy is unusually unpredictable? To find out, I repeated John's exercise with forecasts for economic growth for the United Kingdom, United States, and Eurozone over the years 2002-08, diligently collected at the end of each previous year by Consensus Economics.

The results are an eerie echo of John Kay's: For 2004, for example, 20 out of 21 nongovernmental forecasts made in December 2003 were too pessimistic about economic growth in the United Kingdom. The Pollyannas of the U.K. treasury were more optimistic than almost any commercial forecaster and closer getting their forecast right. So, one might suspect that systematic pessimism is to blame.

But, no, in 2005, the economy grew more slowly than 19 out of 21 forecasters had expected at the end of the previous year. The Pollyannas of the U.K. treasury were yet again more optimistic than anyone and thus more wrong than anyone. A year later, all but one of the forecasters were too pessimistic again. Yet at the end of 2001, three-quarters of the forecasters were too optimistic about 2002.

2003 is an interesting anomaly: the one year for which the average U.K. forecast turned out to be close to reality but also the year where the spread between highest and lowest forecast was widest. The rare occasion that the forecasters couldn't agree happened to be the occasion on which they were (on average) right.

Recent U.S. forecasters have done a little better: The spread of forecasts is tighter, and the outcome sometimes falls within that spread. Still, five out of six were too pessimistic about 2003, almost everyone was too pessimistic about 2002, three-quarters were too optimistic about 2005, and nearly nine-tenths too optimistic about 2006. Perversely, the best quantitative end-of-year forecasts were made in December 2006, despite the fact that the credit crunch materialized eight months later to the surprise of almost everybody.

In the Eurozone, forecasting over the past few years has been so wayward that it is kindest to say no more.

The new data seem to confirm Kay's original finding that economic forecasters all tend to be wrong in the same way. Their incentives to flock together are obvious enough.

What is less clear is why the flight of the flock is so often thought to augur much—but then, some astrologers are also profitably employed.

The curious thing is that forecasters often have something useful to say, but it is rarely conveyed in the numerical forecast itself on which so much attention is lavished. For instance, in December 2006, forecasters were warning of the risks of an oil price spike, a sharp rise in the cost of credit, and a dollar crash. The quantitative forecasts are usually wrong and not terribly helpful when right, but forecasters do say things worth hearing, if only you can work out when to listen.Tim Harford is a columnist for the Financial Times. He is the author of The Undercover Economist, and his latest book is The Logic of Life.

Article URL: http://www.slate.com/id/2196827/

Vancouver Labour Market - VHB Guest Post

Vancouver's labour market is going through an unprecedented hot streak. Unemployment rates are the lowest since at least 1976. Employment rates (which measure employed age 15+ to population age 15+) are more than 2 points above the previous high.



But what is underlying this boom? Is it broadly based? The answer, as you'll see below is no. Definitely no. It is almost *entirely* a construction boom. All data available here.


Let's start with checking out the number of jobs. I've made an index set to Jan-2001 as 100 for construction, real estate-leasing, and total employment less construction and real-estate leasing.


Construction has boomed from 100 to 240 over the past 7 years. The rest of the economy? only from 100 to 118. The new Realtors out there don't account for a lot--only 36% growth.
But, there are raw employment counts. Maybe our population has grown enough to account for this? No. As VHB regulars know, population growth has been fairly moderate (even anemic) over the past 10 years.

Below is a graph of employment to population ratios for two specific industries, construction and real estate-leasing. Construction has gone from 3% of the population to over 6%. Real estate employment, perhaps surprisingly, hasn't moved much at all.

Ok. Now for the grande finale. Let's put this together. Let's imagine a scenario where the employment to population ratio in construction and real-estate leasing had stayed at its 2001 values instead of growing. In other words, we're looking at what would have happened if there had been no construction boom from 2001-2008. The analysis assumes that the new construction employment took people from being out of work and newly employed them, rather than just moving people from one industry to another. (If everyone employed in construction were previously employed somewhere else, then construction actually had no impact on total employment, right?) On the other hand, we are not accounting for the spillover boom into retail etc. caused by newly employed construction workers splurging on toys and joys.


Well, without the construction boom, employment to population would have stayed bouncing around between 58 and 61%. Instead, we see that it went over 64%. This is quite a difference.
Let's move on to the perhaps more familiar Unemployment rate. Unemployment rates take the number of people not working who are looking for work and divide that by the number of people who are employed or unemployed and looking. Again, the scenario we're imagining here assumes that all of the employment boom came out of the ranks of the unemployed; that if the boom ended tomorrow all of those construction guys would be unemployed and wouldn't find jobs elsewhere. Also, it assumes that there would be no spillover effects onto retail.



The results are pretty stunning. Without the construction boom, unemployment would have stayed bouncing around 8-10% instead of falling to under 4%, as it actually did.
Looking forward, what does this mean? Well, to sustain our employment rate, we need to sustain construction. If there is a drop off in housing starts, the labour market will get worse. If the government doesn't start building new big projects to replace the work finishing up on Olympic projects/canada line/etc. then the labour market will get worse.

-- Vancouver Housing Blog van-housing.blogspot.com

TD Economics - The US Housing Market

HIGHLIGHTS

• U.S. home construction shows signs of life
• Global inflation and growth woes remain

In the 1980s, economist and Nobel laureate Amartya Sen found that famines tend to happen not because of a lack of food, but because of obstacles preventing those in need from acquiring the existing stores of food. This juxtaposition is center stage across the globe right now – an ongoing famine for liquidity in many financial and housing sectors versus the flood of petro-liquidity driving consumer and producer inflation higher worldwide. We have liquidity in spades, just not in the sectors that welcome it or need it most.

Why so serious?
Remember April and May? The leaves were returning. The flowers were blooming. The credit crunch was over. Well, the spring fling is over and markets have come to the realization – which incidentally has been TD Economics base case scenario all along – that the credit crunch will continue to slowly bleed for some time. While the market roller coaster saw increasing optimism early this week, apparently markets forgot that the U.S. housing market remains in shambles. There is some light. For the first time since the spring of 2007, the 3-month trend in new home sales and starts is positive. New home construction is what is captured in GDP measures of residential investment, and this same signal preceded rebounds in U.S. residential investment in each of the last three downturns. Existing home sales, on the other hand, make up the majority of the U.S. housing stock and mortgage market, and sales there dropped another 2.6% M/M in June and are down over 15% over last year. Critically, at this current pace of sales, it would take over 11 months to sell the inventory of unsold homes already on the market. And this doesn’t include other homes dumped on the market in coming months through foreclosure or voluntary sales. In the second quarter, one in every 171 U.S. households was foreclosed on – with Nevada showing a staggering one in 43 households and California one in every 65.

This is the heart of the liquidity famine. As more homes are dumped on the market, home prices fall further, driving further mortgages underwater, leading to further foreclosures, further homes dumped on the market, and further home price declines. Lather. Rinse. Repeat. At some point, lower prices will entice buyers into the market, but not until the expectation for further declines recedes. Why buy today when you can buy next year for 10% less? In the meantime, liquidity in the housing market is nonexistent. This feeds directly into the current dilemma for the financial sector. The smaller and more regional the bank, the more exposed to the mortgage market. Real estate loans account for 1/3 of all assets of U.S. commercial banks – over ½ of all assets for banks with total assets less than $1 billion – and nearly 2/3 of assets of savings and loans. This puts these institutions in a vise, and those like Fannie and Freddie that have bought or underwritten about half of all these mortgages in a bind. As a result, commercial banks’ average daily borrowing of $16 billion from the Fed’s emergency lending programs last week was the highest ever.

So the issue becomes what can be done to get that liquidity flowing again? In a perfect world, we’d let the market work itself out. Prices would fall to the point that buyers would move in, and larger banks would recapitalize by attracting investors. But current regulations limit the ability of buyout firms to move into the banking sector – an issue the Federal Reserve is reportedly trying to address – while large foreign investors that bought into large banks earlier have since lost money on their investments and may be once bitten, twice shy. The bill moving through the U.S. Congress right now hopes to help stop the self-fulfilling prophesies of doom, gloom, and liquidity vacuum. The government would increase its debt ceiling by about $800bn – about half of which could cover the expected 2008 federal deficit and the other half would be there just in case. This “just in case” would help cover, among other things, the federal government insuring approximately $300bn in mortgage debt belonging to 400,000 American households who will refinance their subprime loans into 30-year fixed-rate mortgages, $4bn in federal transfers to the states, and the ability of the U.S. Treasury to buy stock in Fannie and Freddie up to the federal debt ceiling. As banks continue to struggle, these two institutions are key to helping the U.S. mortgage market grind on. While not ideal, a government backstop may be just what is needed to avoid their failure and the vicious cycle in the mortgage market. Earlier this week, the Congressional Budget Office estimated the cost of the Fannie and Freddie rescue plan at $25bn. As with most of the estimates placed on the cost of credit crunch, this seems likely to creep higher, but is still much lower than the cost of doing nothing. In the worst case scenario – or even just the next incremental step because let’s be honest, there isn’t much of a difference between the first step off the cliff and the second – the costs to the Federal government could be ten times higher.

A horse with no name
The current U.S. predicament is core inflation and GDP growth both running at about a 2.5% pace over last year. For those unlucky few who need to buy gas and food on a regular basis, total inflation is running at twice that pace. Still, this is well short of the near 15% pace of core inflation and 1% Y/Y contraction in U.S. GDP in 1980 that saw the invention of the moniker “stagflation.” Nor are there signs inflation will come unhinged in the U.S. to that extent so the “stag” part is much more likely than the “flation.” Similarly in Canada, headline inflation is now running at twice the pace of core inflation (3.1% vs. 1.5%). In fact, on a global scale, the most likely scenario is further stagnation in advanced economies and further inflation for emerging markets, with very few of either seeing both on a sustained basis. The U.S. consumer is quickly running out of stimulus checks to spend. In Canada, retail sales for May showed an ongoing sharp deceleration in everything not being bought at a gas station. In Europe, surveys of the manufacturing and service sectors showed sharper than expected decelerations in Q2. The U.K. economy posted its weakest quarterly GDP growth rate in three years in 2008Q2 and is likely to contract before the year is out. And, the pace of exports from Japan and Hong Kong saw precipitous declines in June. So growth is likely to slow in these regions and exert a downward pressure on domestic inflation.
On the other hand, broad-based emerging market resilience and inflation worries remain. The pace of inflation-adjusted retail sales in China is the highest in 12 years. Korea’s economic expansion stayed constant in Q2 while inflation remains at a 10-year high. And across the EM universe (or at least averaging 57 EMs), inflation has accelerated from a 5% pace in June 2007 to 12% in June 2008. So while Malaysia this week hiked interest rates for the first time since 2006, and Brazil surprised markets with a larger than expected rate hike, the average pace of inflation across EMs is rising faster than the average interest rate. This is pushing down real interest rates and helping to fuel both faster growth and inflation in these markets. The same is not occurring in advanced economies, with average real rates still above zero in the G-7.
So in the immortal words of the modern philosopher Axl Rose, “Where do we go now?” Sluggish economic growth in advanced economies is likely to keep a lid on growth prospects in EMs, but not unbearably so. Inflation in EMs is likely to place upward pressure on advanced economy inflation, but not uncontrollably so. And we are likely to see more mirages in the desert before we finally find paradise and bring balanced liquidity back to the global economy.

Richard Kelly, Senior Economist416-982-2559

US Mortgage Bailout

Fannie Plan a `Disaster' to Rogers; Goldman Says Sell (Update2)
By Carol Massar and Eric Martin

July 14 (Bloomberg) -- The U.S. Treasury Department's plan to shore up Fannie Mae and Freddie Mac is an ``unmitigated disaster'' and the largest U.S. mortgage lenders are ``basically insolvent,'' according to investor Jim Rogers.

Taxpayers will be saddled with debt if Congress approves U.S. Treasury Secretary Henry Paulson's request for the authority to buy unlimited stakes in and lend to Fannie Mae and Freddie Mac, Rogers said in a Bloomberg Television interview. Goldman Sachs Group Inc. analyst Daniel Zimmerman predicted the mortgage finance companies' shares may fall another 35 percent.

``I don't know where these guys get the audacity to take our money, taxpayer money, and buy stock in Fannie Mae,'' Rogers, 65, said in an interview from Singapore. ``So we're going to bail out everybody else in the world. And it ruins the Federal Reserve's balance sheet and it makes the dollar more vulnerable and it increases inflation.''

The chairman of Rogers Holdings, who in April 2006 correctly predicted oil would reach $100 a barrel and gold $1,000 an ounce, also said the commodities bull market has a ``long way to go'' and advised buying agricultural commodities.

Rogers, a former partner of hedge fund manager George Soros, predicted the start of the commodities rally in 1999 and started buying Chinese stocks in the same year. He traveled the world by motorcycle and car in the 1990s researching investment ideas for his books, which include ``Adventure Capitalist'' and ``Hot Commodities.''

Stocks Rise
Fannie Mae and Freddie Mac each surged more than 20 percent in pre-market trading today after Paulson moved to stem a collapse in confidence in the two companies that purchase or finance almost half of the $12 trillion in U.S. home loans.

``These companies were going to go bankrupt if they hadn't stepped in to do something, and they should've gone bankrupt with all of the mistakes they've made,'' Rogers said. ``What's going to happen when you Band-Aid and put some Band-Aids on it for another year or two or three? What's going to happen three years from now when the situation's much, much, much worse?''

Freddie Mac rose 22 cents, or 2.8 percent, to $7.97 at 10:13 a.m. in New York Stock Exchange trading, while Fannie Mae rose 73 cents, or 7.1 percent, to $10.98. Paulson's proposal, which the Treasury anticipates will be incorporated into an existing congressional bill and approved this week, signals a shift toward an explicit guarantee of Fannie Mae and Freddie Mac debt.
The Federal Reserve separately authorized the firms to borrow directly from the central bank.
Last Week's Slump

Washington-based Fannie Mae slid 45 percent last week, while McLean, Virginia-based Freddie Mac sank 47 percent on concern they may require a bailout that would wipe out shareholders.
Former St. Louis Federal Reserve President William Poole last week said in an interview that Freddie Mac is technically insolvent under fair value accounting, which measure a company's net worth if it had to liquidate all its assets to repay liabilities. Poole said Fannie Mae may also become insolvent this quarter.

Goldman's Zimmerman said today the U.S. government's plan to rescue Fannie Mae and Freddie Mac won't benefit shareholders. He lowered his share-price estimate for Fannie Mae to $7 from $18 and for Freddie Mac to $5 from $17.

Rogers said he had not covered his so-called short positions in Fannie Mae and would increase his bet if it were to rally. Short sellers borrow stock and then sell it in an effort to profit by repurchasing the securities later at a lower price and returning them to the holder.

The U.S. economy is in a recession, possibly the worst since World War II, Rogers said.
``They're ruining what has been one of the greatest economies in the world,'' Rogers said. Bernanke and Paulson ``are bailing out their friends on Wall Street but there are 300 million Americans that are going to have to pay for this.''

CANADA’S HOUSING BOOM COMES TO AN END - TD Economics

Under the category of "Well No Sh*t Sherlock." Comment in italics are mine.

CANADA’S HOUSING BOOM COMES TO AN END
June 26, 2008

Over the past couple of years, TD Economics has repeatedly forecast that Canada’s major real estate markets would experience a significant cooling. In fact, housing remained stronger for longer than we had anticipated, largely due to increased affordability through new financing options, such as no money down or extended amortizations. Regional economic strength related to the commodity boom also helped to fuel unsustainably elevated home price growth in the west. Nevertheless, our last Special Report on Canada’s housing market, Canada’s Red Hot Real Estate Markets to Cool (April 10, 2008), stressed that there would be a significant adjustment in real estate activity in 2008-09, with national average home price growth slowing sharply from the 11% posted in 2007 to a low single digit pace. There is now clear evidence that this slowdown has taken hold. The year-over-year price growth for existing homes in Canada’s major markets fell to only 1.1% in May, down from 8.6% just four months earlier. The trend has been broadly based, but it has been particularly sharp in some of the markets that had experienced the most dramatic price growth. Calgary and Edmonton home prices in April and May fell to below year-earlier levels. The combination of significantly higher listings, reflecting the desire of homeowners to take advantage of the past increase in prices, and weaker demand, due to the past erosion in affordability, are leading to declining sales and softer price performance across the country, but particularly in the west.

The key question is how far the recent trends will extend and whether Canada will experience a broad based housing correction. In our opinion, sales are likely to continue to decline in the coming quarters and price growth will slip to 2% on a national average basis in 2008 and rise only to 3.5% in 2009. However, this national average will mask very different regional price trends. Most markets will see low to mid single-digit gains, but Saskatchewan and Manitoba will continue to post double-digit gains in the near term followed by a significant cooling in 2009 – with the risk of a mild price correction in the major cities that have recently experienced extraordinary price growth. Alberta will have further weakness in the near term, as Calgary and Edmonton will likely see prices continue to fall for another 3 or 4 quarters, dropping 8% to 10% from their peak, after which prices should stabilize and start rising at a low single-digit pace. Aren't we already down that far?

Cashing in, not foreclosing

From an economic perspective, the recent behaviour of Canada’s real estate markets and the outlook for 2008/09 can be best explained in terms of the trends in supply and demand – the interaction between which determines prices. Wow, I could be a bank economist too!

On the supply side, past price performance has strongly encouraged additional supply in both the new and existing home markets. Housing starts averaged a strong 234,000 units in the first quarter. While we expect new home construction activity to remain robust, starts should gradually edge down to a lower level of around 200,000 units over the course of the next 18 months.

We had anticipated an increase in new listings as a result of solid price gains in the last couple of years, but the recent surge in new listings has been far greater than anticipated. The jump in supply of homes for sale is assuredly an attempt to take advantage of the past home price appreciation on the part of homeowners and real estate investors.

It should be stressed that the rise in listings does not reflect homeowners of principal dwellings desperate to sell, and this is the dominant difference between the Canadian and U.S. experience. Indeed, the U.S. has been characterized by an abnormal rise in delinquencies and foreclosures or large negative equity positions. In Canada, speculators may be quickly dumping properties on the market to get out while the times are good, but individuals that have a principal dwelling are not under financial duress. This distinction is crucial to evaluating the impact of weaker home price performance on personal wealth and consumption. Canadian consumers are also nowhere nearly as leveraged through their home equity as American consumers are. Except in Vancouver where people are overleveraged to the max.

A few more important distinctions also bear noting as the U.S. housing bust struggles to find a bottom, which naturally arouses fears that a similar unwinding could take place in Canada.
First off, many of the seeds that sowed the current U.S. housing bust were never planted in Canada. Interest rates and mortgage rates were significantly lower for significantly longer in the U.S., especially in the case of adjustable-rate mortgages (ARMs) with low initial teaser rates. The bulk of surging delinquencies on mortgage loans occurs precisely when the rate adjusts to a higher level. ARMs never took hold in Canada. No spike in mortgage payments means no spike in delinquencies. As economic conditions will be weaker over the forecast horizon than they were in 2007 and mortgage rates likely modestly higher, delinquencies in Canada will only rise to reflect domestic economic conditions. A surge to high levels is nowhere on the horizon.
Furthermore, it wasn’t just that borrowing costs were lower in the U.S. than in Canada. Overall lending conditions in the U.S. had eased to the point of becoming much too lax, introducing a systemic default risk, which is now a reality. Subprime mortgages were a significant chunk of originations in 2006-07. Not so in Canada, where they peaked at 5% in 2006 before vanishing. In the U.S., the additional supply of homes for sale as a result of ‘involuntary’ listings and / or foreclosures more often than not reflect desperate households trying to minimize their loss. In Canada, voluntary sellers are trying to maximize their capital gains. The difference is far from trivial.

It is also telling that the run-up in prices in the U.S. was, for many large markets, not supported by economic fundamentals. As per Nevada, Arizona, California, and Florida, it seemed to be driven much more by speculative activity. In Canada, markets whose economies have been booming are those whose housing markets caught fire. Witness the experience of Calgary, then Edmonton, and now Regina and Saskatoon. No mention of Vancouver - but why? Could it be because we have excessive speculative activity? Valuations in these markets also started below national levels and arguably had some catching up to do, contrary to the hottest U.S. markets during the run-up which were already higher than the U.S. average. This is unlike Vancouver where we've seen already high house prices rise to levels that are completely detached from rents, incomes or anything remotely resembling a fundamental level.

Finally, financing and economic conditions are largely more supportive of local demand in Canada. Lending has not tightened nearly as much as it has in the U.S. And, as noted above, lending never became as lax. For example, the vast majority of mortgage applicants in Canada were income-tested on the basis of the 3-year or 5-year posted rates; whereas in the U.S. it was common to either dispense with income testing or test on the basis of the low introductory teaser rate. Furthermore, the credit crunch has hit U.S. lenders’ balance sheets harder. The bulk of mortgage origination in Canada is sourced at well capitalized financial institutions. Homes currently being listed in Canada, if priced reasonably, will find buyers who can finance their purchase. In the U.S., despite much lower prices, financing is often hard to obtain, even for credit-worthy potential buyers. The recent Federal Reserve cuts to the policy rate by a full 3¼ percentage points have had little traction into relief on mortgage rates. Clearing the large inventory overhang is all that more difficult in such circumstances that are simply not present in Canada.

The main conclusion is that there has been an increase in supply (i.e. new listings and new home construction) in Canada . That will act to dampen home price appreciation and create a pullback in prices in selected cities where markets went too far, too fast. However, the increase in supply in Canada will pale in comparison to the dramatic surge experienced in the U.S. that caused the worst American housing correction since the Great Depression.

Decaffeinated sales

On the demand front, the dominant theme is that the past price appreciation in Canada has eroded affordability, reducing demand for new and existing homes. Nowhere is this truer than in Alberta and British Columbia. National sales did remain elevated for longer than expected, but are now pulling back more sharply than even our spring forecast due to reduced affordability and greater supply. The year-to-date (as of May data) percentage drop in sales for Canada’s major markets seems dramatic at -12.5%, but sales are in fact simply returning to the solid levels typically experienced in the three years (2004-06) prior the 2007 sales boom. (See sales charts for some major markets at the end of this report.)

Just as Calgary and Edmonton led the way up in sales growth, they are now leading the way down. Home sales in these two cities were down 34% and 30%, respectively, year-to-date as of May. However, Edmonton resale activity is tracking close to 2005 levels, while sales in Calgary are faring worse and look likely to revert back to 2004 levels, near 26,000 units. Our base-case scenario for Alberta home sales for the remainder of 2008 builds in an even greater decline in sales in the near term before levelling off late in the year for a net annual sales drop of 40%. As a result, after two years of percolating over 70,000 units sold, Alberta is more likely to record sales volumes in the 40,000-50,000 unit range this year and next.

The return to norm in resale activity is not confined to Alberta, and nor did we expect it to be. Our April forecast had sales declines for all provinces, except three (Saskatchewan, Manitoba, and Newfoundland & Labrador) that represent only 5% of the national total sales. Only Manitoba is disappointing our April forecast. Sales in Winnipeg are down by an unexpected 3.5% year-to-date, implying a likely sales decline of about 4% in Manitoba in 2008 – but this is only a shift from marginal sales growth to a marginal sales drop.

Sales are also weaker in other parts of the country, with British Columbia and Ontario sales down by more than 10%. Softer demand is therefore not an Alberta-specific theme. While affordability had not eroded to the same degree in other markets, it also had not improved for most markets, on a quarterly basis, since late 2006. Affordability remains at challenging levels for many potential buyers in Vancouver specifically, but also Toronto. Resale activity in Vancouver is tracking significantly below last year’s levels and we expect sales for 2008 as a whole to end up almost 20% lower than 2007. Toronto is expected to experience 10% lower sales.

Affordability to improve

Based on our assessments of supply and demand, what are the prospects for the next 6-12 months? Over this time span, both sides of the market are unambiguously pointing to softer price growth in most major markets. Just how soft, is a matter of location. For Canada as whole, we expect existing homes to appreciate by only 2% this year, a downward revision from our last forecast of 6%. Slower price growth – or declines in certain cities – but still solid underlying economic fundamentals will lead to an improvement in affordability. However, the relatively high prices in many markets will remain a key factor crimping demand.

Looking beyond the next 12 months, as affordability improves in some markets or stabilizes in others, and demand slowly absorbs homes being listed, we expect demand to start pulling prices forward at a slightly quicker pace in the second half of 2009. However, because the current rebalancing has abruptly shifted conditions from seller’s market territory to balanced market conditions in many cities, the price weakness will probably extend into next year. As a result, while prices will improve in 2009, the annual average resale price growth will still be modest at around 3.5%. I don't see prices going up as an 'improvement' - how does that help my family's financial situation exactly?

Turning to a regional perspective, Saskatchewan’s major markets offer an exception to the cooling trend on an annual basis, but this is mostly a question of timing. The price surge above 30% growth came late last year and much of that momentum is being carried into this year. But if Regina and Saskatoon follow the path just recently threaded by Calgary and later Edmonton – and we think they will – Saskatchewan’s price growth will have come back down to earth by early next year. We are looking for 2-3% price growth in 2009, with a risk of a mild price correction.

On the flip side, every other province, except Newfoundland & Labrador, and most notably the four largest provinces in the country, will experience significantly weaker home appreciation this year compared to last. Alberta will most likely experience a slight depreciation of 1-2% in home values on an annual basis. This correction will be concentrated in its largest urban markets of Calgary and Edmonton, where prices are expected to fall by 2-3%, with the rest of the province faring better. After stunning cumulative price gains of 45-65% in the last two years in those markets, our base-case forecast builds in a peak-to-trough correction of 8-10%. Our expectation is that monthly data will show year-over-year price declines for another 2-3 quarters of data (the typical duration of home price corrections in Canada), out to the first quarter of 2009. Alberta prices should then start growing again, albeit modestly at 1-2%, on a year-over-year basis. So TD Economics is basically forecasting home price declines in inflation adjusted dollars for quite some time.

Affordability has been a key issue in Canada’s most expensive market, Vancouver. Outside Alberta, where sales are down about 30% year-to-date, British Columbia is experiencing the largest percentage drop in sales year-to-date at close to 15%. This is not surprising given how strong sales (over 35,000 units) had been over the last six years. Vancouver has recorded a surge in listings since March, enough to bring the supply/demand relationship into balanced territory. Vancouver had not been balanced, by this measure, since late 2000. We therefore expect price growth to be subdued in the next 12-18 months. As a result of higher-than-expected listings, we now forecast 5% home price growth for the province as a whole this year (down from our spring forecast of 9%) and a similar outing next year – both a far cry from the 15% annual average home appreciation recorded over the last 3 years. We'll see how that works out!

Ontario and Québec homes have appreciated at a steady 6-7% rate over the last three years. Both provinces are expected to record only about half as much (3-4%) home price growth over the forecast horizon. Options have improved for potential homebuyers in Québec due to more listings, making the slowdown mostly a supply story. Meanwhile, the softer price growth in Ontario’s existing home market will be most closely related to a cooling in demand, resulting in weaker sales due to challenging affordability, particularly in the Greater Toronto Area.

Bottom line

Between 2005 and 2007, Alberta was skewing the national existing home market figures to the upside. Late in 2007 and early in 2008, Alberta home price growth came back down to earth, converging with national figures. The latest provincial real estate data show that Alberta is now more than a percentage point below the country’s average in terms of home price growth. In the past, we presented figures excluding Alberta to measure the impact of this particular market. As an example, Alberta boosted the national price figure by as much as 2½ percentage points in 2006. The distinction became irrelevant once Alberta had cooled back down to the national pace.
This exercise is once again relevant, and we are re-introducing these ‘ex. Alberta’ measures. Outside Alberta, we expect existing home to appreciate by about 3% this year. Including Alberta – which we think will record a 1.5% price decline – brings the national forecast down by nearly a full percentage point to 2%. For 2009, Alberta’s expected home price growth of 2% will not differ enough from the rest of the country to pull down significantly our forecast 3.5% for the nation as a whole.

The demand side of the home market is behaving largely as we forecast in the spring. Sales are down from the banner year that was 2007, but they are back to the average levels experience in 2000-05 in Calgary and Edmonton. Toronto sales have cooled, but they are still on pace with with elevated 2004-06 levels. Vancouver sales are one of the few cities where sales have dropped well below the levels experienced earlier this decade, and one cannot help but notice that this is also the market where affordability had become the most problematic. No kidding! I hadn't noticed!

Meanwhile, the supply-side is booming. This is helping to rebalance markets that had been in seller’s territory for an extended period of time, which is favourable to affordability and future demand. Recall that since 2002, Canadian resale home prices grew at an annual average rate of 10.2%, so a softer price performance in 2008-09 should not be too surprising. It is also a positive development that markets are cooling before the Bank of Canada embarks on another cycle of interest rate hikes. In our spring report, we highlighted the risk of a still hot housing market running into a monetary policy tightening cycle. It is currently not financing conditions which are causing demand to cool, but slowing economic conditions overall along with the lagged impact of past erosions in affordability caused by price surges in specific markets. History suggests that when a tightening of monetary policy cuts through a hot market, things can unwind in a disorderly fashion. Canadians will remember the bust of the late 1980s as a prime example. Cooling home markets also help to alleviate inflationary pressures which in turn diminish the need for further interest rate hikes. We do not expect the Bank of Canada to start hiking interest rates before economic growth ratchets back up towards 3% in the second half of 2009. Canadian housing markets should be cruising at a healthier, more sustainable pace by then.

BC Non-Residential Construction

Good morning,

Well, we've had a couple days to let that partial yet massive list of projects sink in so now let us look at some data and charts to illustrate the point further. The point being that BC not only has a housing bubble but a construction bubble fueled by loose lending and speculation in the residential sector and by government largesse in the non-residential sector. Hat tip to van_coffee for the data - thanks.

First chart illustrates the nominal value of building permits issued. Note: this only includes 'buildings' not infrastructure like highways, bridges, skytrain, etc. See definitions via Statscan.


Build those strip malls. I'm not exactly sure how the statisticians classify projects but we can see from the previous couple of posts where the bulk of the non-residential construction spending is going. Many government projects like the trade and convention centre are likely classified as a commercial project although it is in fact a government project.

This chart illustrates the value of building permits issued when adjusted for inflation and population.

Real per capita spending on non-residential construction has risen dramatically after a long decline period during the nineties. We can also see what a slowing economy and a tightening of lending standards does to non-residential construction by looking at the early eighties contraction as an example.

Please not that these numbers DO NOT include the massive infrastructure projects that are happening and worth upwards of $5 Billion in the Vancouver area alone.

Drop in B.C. business optimism cited as omen for economy

Fiona Anderson, Vancouver Sun, Thursday, March 27, 2008

Business optimism in British Columbia is dropping and it could be a sign of a turn in the economy, according to the Canadian Federation of Independent Business.

B.C.'s business barometer, an indicator developed by the CFIB to measure optimism among small and medium sized businesses, works from a base of 100 set in 1988. It is now at 107.7, above the national average of 104.0, but the lowest B.C. has seen since 2003. It's also the second quarterly drop in a row.

And that's a concern, CFIB's vice-president for Western Canada, Laura Jones, said in an interview.

CFIB's barometer readings are often a leading economic indicator, predicting future trends, Jones said. That's because the survey goes to the source, asking business owners on the ground how they see the future.

"When the B.C. economy turned around in 2003, our quarterly business barometer was one of the first indicators out there," Jones said. "And sure enough, that ended up being the beginning of B.C.'s boom."

"If it's like 2003, this is the prediction of the turn," she said.

So this is not the time for the B.C. government to get complacent about the economy, Jones said.
"In B.C. we're so used to the economic good times it's hard to remember back to when there were bigger challenges," she said. "And there are bigger challenges."

Across the country, business owners in Prince Edward Island had the least positive outlook at 96.9. Even Alberta --which along with B.C. has led the country in business optimism over the past five years -- was below the national average at 102.8. Topping the barometer were Newfoundland and Labrador with a reading of 119.6, followed closely by Saskatchewan at 116.1.

Optimism also varied across industries, with a gloomy outlook in manufacturing, agriculture and transportation, while businesses in the finance, health care and education sectors saw a rosier future.

In B.C, more than half of businesses that responded to the survey said they expected their businesses to improve over the next 12 months, a drop from the 58 per cent that felt that way in December.

At the same time, one-third of provincial businesses surveyed expected to increase their number of full-time employees, down from 41 per cent.

Sixty-nine per cent of provincial respondents expected energy costs to continue to rise, up from 55 per cent in December.

That may be a reflection on B.C.'s new carbon tax, coming out in July, Jones said. "Energy prices are a huge concern for business owners and introducing a carbon tax into that mix certainly isn't instilling a whole lot of confidence," she said.

But across Canada, 71 per cent of businesses expected energy costs to worsen, even in the absence of a carbon tax. But Jones said B.C. businesses shouldn't be too pessimistic. "We are still higher than the national average," she said. "But the main message for government would be that this is really not the time to get complacent about the economy."

Correction Scenarios

Some discussion took place on the previous post about how a correction may play out in our local real estate market. Will it be fast? Will it be slow and steady? Will it look like previous busts? How will unemployment or a recession factor in? What about the olympics or other psychological factors?

Here is a pictoral illustration to give some food for thought - click to enlarge.


If we accept the premise that housing in Vancouver is overvalued based on fundamental analysis of the assets and the earnings or imputed earnings that these assets can earn, then we must evaluate how this overvaluation will be corrected.

Will earnings / rents grow to meet current prices? This would require a near doubling of local rents. I think most people would agree that this would devastate the local economy as the labour pool would dry up rapidly and many businesses would shut down due to the expense of operating here.

Will prices undergo a minor correction while rents increase modestly and interest rates are lowered? This is possible although trouble in the internation mortgage and credit markets would indicate that lenders may be unwilling to lend money to purchase real estate.

Will prices correct very quickly thus restoring a fundamental valuation to local real estate assets? This is also possible and perhaps even the most likely outcome given several possible events.

Here is the way I see things:

As the US enters recession it is likely to effect many industries here in Vancouver. This, combined with a wrapping up of several mega projects (Canada Line, Highways Improvements, Convention Centre, Condo Developments) during the next 12 - 18 months will drive unemployment up rapidly.

This unemployment will cause two things:
1) Developers will fast-track current housing projects as labour becomes available and
2) Unemployed or underemployed workers will leave and / or put up their homes for sale as they are unable to make the payments.

A wildcard in all of this is the amount of 'speculator owned' housing inventory out there. It is impossible to quantify at this moment but, if anecdotes are to be proved correct, this accounts for perhaps tens of thousands of underutilized or unutilized housing stock that could be put onto the market very quickly.

What do you think?

Wall Street Owns Federal Reserve

In a move that basically puts central bank interest rates below the rate of inflation, the US Federal Reserve lowered their prime rate 75 basis points to 3.5% before markets opened this morning.

Just a reminder to everyone out there, this is exactly the stupid type of move that got us into the whole mortgage mess, housing bubble, credit crisis. Look for the next bubble to start anytime now with even more interest rate cuts left to come with the inflation beast lurking and about to be let out into the street.

What is your bet on the next bubble?

Here is my short list of candidates:

Infrastructure
Agriculture
Alternative Energy

RBC Economics Report

No time to do a post today so here is a RBC Economics Report that outlines some of the reasons for today's market action. These bad numbers were in addition to the massive asset writedowns at Citigroup and CIBC. Interesting times indeed.

U.S. retail sales growth dropped 0.4% in December
Rishi Sondhi, Economist

U.S. retail sales growth dropped 0.4% in December, a much weaker result than the market’s expectation of flat sales. However, the sales decline was following a very robust, although downwardly revised, 1% gain in November. Ex-autos, sales were down 0.4%, again weaker than expectations.

The drop in retail sales in December was, in part, attributable to nominal sales at gasoline service stations dropping 1.7%. However, this partly reflected a decline in gasoline prices. Excluding this component along with the volatile motor vehicle and building material components, sales were actually up 0.2%, building on November’s downwardly revised 0.8% gain (previously reported at 1.3%).

The portion of retail sales that feeds into quarterly spending — retail sales ex autos, building materials and garden equipment, and supply stores — fell a slight 0.1% after surging 1.6% in November. During the November-December holiday period, sales were up 0.3% on average, compared to 0.7% in 2006 and 0.4% in 2005.

The U.S. retail sales figures are consistent with a drop in real spending in December, which we currently estimate to be -0.1%. Despite the likely decline, November’s real spending surge makes it highly likely that spending will come in above 2.5% in the fourth quarter. Slower spending in December does suggest somewhat softer spending momentum heading into the first quarter of 2008. We expect consumer spending growth to weaken to a 1.5% annualized pace during the first three months of the year.

The softer first-quarter 2008 momentum implied by the weaker-than-expected retail sales data will likely keep the Fed aggressive with their policy actions in order to mitigate the downside risks to growth. We are expecting that the Fed will opt for 50 basis points of cuts at their January 29-30 policy meeting.

Modest decline in U.S. producer prices; core prices rise
Paul Ferley, Assistant Chief Economist

The December producer price index fell 0.1%, a substantial slowing from the 3.2% monthly increase in November. The earlier strong increases are keeping the year-over-year rate high at 6.3%, although this is down from the 7.2% recorded in the previous month. On a core, or ex food and energy, basis, December prices were up 0.2% and 2.0% during the past year. The monthly increase was down from 0.4% in November, although the year-over-year rate was unchanged from the previous month.

The moderation in the overall monthly increase was largely a reflection of the 1.9% fall in energy prices in December after surging 14.1% in November. The moderation was tempered by a 1.3% rise in food prices after recording no change in the previous month. Upward pressure was evident in a number of food components, including fresh vegetables, beef and veal, and processed fruit and vegetables.

The moderation in core prices largely reflected a 0.9% drop in passenger cars after a 0.6% jump in November. Car companies are likely cutting prices to help move out the remnants of the old car lines as the 2008 models are rolled into the showrooms.

Today’s report indicates that earlier energy price increases are keeping the annual increase in producer prices high at 6.3%. The year-over-year increase in core prices is rising a much more moderate 2%, although this is likely at the upper end of what is deemed as acceptable by the Fed. As well, Fed Chairman Bernanke has gone to great lengths to emphasize that the Fed had not taken its eye off the risk of higher energy prices putting even greater upward pressure on the core measure. However, despite these risks, the near-term focus of the central bank is to ensure that the economic expansion continues in the face of the ongoing financial market volatility and attendant credit tightening. Thus, today’s report does not alter our view that Fed funds will be lowered a further 100 basis points during the first half of this year, with the first installment, a 50-basis point cut, coming at the conclusion of the next FOMC meeting in January 29-30.