Helmut Pastrick and the Twilight Zone
JUNE 11, 2011
I had to make a short post to highlight a monumentally bad article over at the MoneyVille (Toronto Star) website. You can't make this stuff up. Reading this article is like passing through a portal to a parallel world...
I'm not sure what surprises me more...that a chief economist at a Canadian financial institution could make such questionable statements, or that one of Canada's largest media outlets could pass it on to its readers without so much as a critical analysis of the contents. Check that last point. When it comes to splendidly bad reporting on real estate, Moneyville seems to have carved out a niche. Please see these two gems for some additional comic relief.
Meet the author: Helmut Pastrick, chief economist for Central 1 Credit Union. The name should ring a bell. He's the guy who looked at a chart like this...
...and concluded that we have no consumer debt problem in Canada. Pastrick used impressive mental gymnastics logic in outlining his case that consumer debt is benign, most notably in the assertion that it doesn't matter since it is being used to buy real estate, which "holds its value".
That mental prowess is once again on display in this Moneyville editorial (thanks to Data Junkie for the link)...
This housing expert waited too long to buy
"Here are three reasons why buying a house is a good idea:
1. You build equity
The amount you owe declines with each mortgage payment. The difference between what you paid and what you owe is your equity and it is one of the most valuable assets most family’s have. The sooner you start, the faster your equity grows."
This point is true, though misleading in what it omits. Yes, one can build equity through home ownership over the long term. However, as I have often pointed out on this blog, renting can also be a great way to build equity provided the renter has the discipline to save and invest the significant cost advantages that renting currently provides over ownership, particularly in Canada's larger markets. It nonetheless highlights the prevailing notion that home ownership is a superior way of building equity, despite the fact that the costs of ownership compared to rents are at all time highs in all major cities in Canada. This is misleading information and one would expect that a chief economist would know better.....unless perhaps they work for a lending institution whose client base is centred in the bubbliest part of Canada (BC) and is at significant risk from a price correction.....or unless they live in an alternate reality connected and similar to our own, but where debt doesn't matter, trends never revert to their long term and stable means, and where the price of some assets can outpace the growth in their fundamentals in perpetuity.
2. It is an appreciating asset
Home prices decline when the economy turns down, but the long-term trend has been and will continue to be rising prices. The reason is supply and demand. As someone once remarked – “Buy land. They ain’t making any more of the stuff.” Land supply constraints for residential development exist in most markets.
Where to begin with this crap? First, let me suggest that while housing is hit hard during periods of economic contraction, the flip is also true. At the tail end of large, credit-induced housing bubbles, wealth effect spending and the economic benefits of the housing boom become more significant drivers of economic and employment growth, meaning that the economy can turn sour on the back of a housing correction. For more on this, check out these posts:
The role of housing in boosting GDP
Housing and employment in Canada: Why a housing correction would really suck
How important is construction to employment and economic growth in Canada (part 1 and part 2)
CAAMP puts the cart before the horse
The author also notes that the reason for rising house prices is supply and demand. This is largely an erroneous statement and it highlights just how few people actually understand what moves house prices. As shown before, rising population causes real house price growth only when supply cannot be brought to market quickly enough to satiate demand. Our construction industry in Canada is generally highly responsive to increasing demand. Let's face it, where there is a buck to be made, someone will make it. So while demand increases with rising population, so too does supply. That is, unless you live in an area that has restrictive land use policies, such as parts of Toronto or Vancouver. In this case, rising population can cause house price increases beyong inflation and other underlying fundamentals. But here is the rub.
Demographia, the same research group that publishes the annual affordability rankings, has extensively studied the impact of restrictive land use regulations on house prices. Their conclusion: Cities with restrictive land use regulations are far more prone to boom-bust cycles. For a great read on that, check out this fantastic post by Australian economist Leith Van Onselen. The reality is that house prices are far more influenced by credit conditions. When the mortgage credit spigots are held wide open while CMHC lending requirements are loosened, THAT is what primarily moves real (inflation adjusted) house prices. As the great Australian economist, Steve Keen notes, "people don't buy houses.....people with mortgages buy houses".
Finally, the notion that houses are an appreciating asset is true over long enough periods of time. However, that assumes that prices are at levels consistent with underlying fundamentals like rents, per capita GDP, incomes, and inflation (which they most certainly are not at present). When house prices have outpaced such fundamentals, it suggests that future returns will be sub par while prices and fundamentals realign. At present, it would seem that a best-case scenario would be a decade or more of stagnant nominal real estate prices (meaning negative real return) while fundamentals catch up. Yet with overvaluation at unprecedented levels, it implies a very significant chance of a more rapid realignment of prices and fundamentals.....in other words, a housing correction.
Where this advice becomes dangerous is when it influences people to purchase real estate with little down (the majority of first time buyers). In the event of a price correction, negative equity means that a home becomes a prison, making it impossible for the owner to sell without coming up with additional money at closing to cover the outstanding mortgage. And since a housing downturn would be a major headwind on employment, it would serve to inhibit worker mobility and prevent new home owners from relocating to pursue other opportunities in the event that they did lose their job. This is a bad scene and one of the reasons why I advocate having at least a 10% down payment, and preferably 20%.
3. Demographics trends are favourable.
Meanwhile, there is population growth it producing demand. Canada has 34 million people now. In 1961 it was about 18 million.
BULL!... and DOUBLE BULL! Even if it were true that demographic influences represent primary factor in influencing real house prices (which they do not....as previously discussed), the reality is that demographics are set to be a headwind, not a tailwind on real estate prices. Please read the hyperlinks for more on that. Enough said!
And finally a few more choice tidbits from this ridiculous piece:
Yes, it will become increasingly difficult for first-time buyers to achieve homeownership since affordability will decline in the long term. Fundamental housing supply-demand forces will drive higher prices while incomes lag.
But this should not discourage potential buyers from their goal, but they need to adapt to those circumstances and be smarter with their money than I was.
I feel fortunate to have become a homeowner many years ago when the price-to-income ratio was considerably lower. The adage it is better late than never always applies to home buying.
Frankly this is some of the worst economic commentary you'll read anywhere. The notion that house prices will outpace income growth for the foreseeable future is utterly ridiculous, as is the subtle suggestion that the relatively stable price-to-income ratios of the past will never again be revisited. What we are currently experiencing is a deviation from long term trends driven not by demographics, but more predominantly by unparalleled loosening of credit conditions during a period of falling interest rates, coupled with a new and widespread mentality regarding the investment worthiness of residential housing as an asset class. Neither of these conditions can be sustained, and the reversion to long-term trends will not be pleasant regardless of whether that reversion happens rapidly or not. Unlike what Mr. Pastrick suggests, it is not different this time.
Cheers,
Ben
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25 Comments
I also don't appreciate the blanket prescription that it is always better now than later. Really? So there's never a point where it makes sense to wait? So house prices always go up? Be sure to pass that juicy news on to the rest of the Western world.
You gotta be in the game to play..... It is amazing that once you buy a property you become a cheerleader for the market, it only serves your best interest. It is like getting a stock tip from the guy that already bought, he needs more buyers to profit from his purchase.
@Dave I concur. The average citizen was duped into believing that a home was a safe asset and would appreciate until "Flip This House" becomes an episode of "Home Squatters".
Yep, keep renting people.
Good advice!
That's what I plan to do...
It's quite possible that Pastrick believes interest rates will not return to normal for at least a decade, perhaps longer. Bill Gross was pushing that idea again (in the US context) in the Barrons cover story this weekend. And it's not impossible, given the 15+ history of exceptionally low interest rates in Japan. I'm slowly coming around to the idea that the bond guys feel this is the more likely scenario, even with the inflation consequences that would be almost inevitable (though not guaranteed, again, viz. Japan).
You do realize why interest rates stayed so low in Japan?
Because the economy never got going on its own two feet? I'm not convinced our own economy could handle more than a moderate (1%, perhaps) increase without plunging back into recession. Certainly the U.S. economy cannot at this stage, which Bernanke has essentially conceded.
Their economy was crushed in a deflationary spiral where real estate and stocks shed the better part of 80% over a decade. In cases where the money supply and velocity of money collapse, causing deflationary pressure, sure, interest rates can stay low for very long periods of time. But what does that do to leveraged assets like real estate? A 'Japanese' experience would crush real estate far worse than a round of rate tightening at the BoC.
Trust me....if there is any real concern about inflation, the bond market will put the boots to the 5 year Canadian bond. Whether Carney budges or not, housing would be hit hard.
http://theeconomicanalyst.com/content/why-housing-market-now-almost-enti...
I think the situation and possible outcomes are more complex than your assessment. Carmen Reinhart, Stiglitz, and Gross are all starting to use the phrase "financial repression" to describe the likelihood of a prolonged period of intentionally low rates and moderate to high inflation. It's effectively a stealth tax, but if the US is doing it, we're not going to be able to run a dramatically different fiscal policy. The Canadian dollar is already too high as is. And low rates+high inflation is a possible "out" for the government to get out of the mortgage and consumer debt mess, as the real value of debt is eroded away.
(Plus, never underestimate the government's willingness to transfer money from savers to debtors if it's the politically easiest solution.)
Carmen Reinhart also stated that in order for Financial Repression to work, Gold ownership must be prohibited.
How would bond holders react in such a situation? Rising inflation and low/falling rates on bond yields, to my knowledge, has never before occured over a long time horizon as you describe. Unless we're dealing with a global, coordinated bout of QE by all major central banks artificially suppressing bond yields by acting as the buyer, what could possibly motivate bond holders to hang in there?
My point is that the rate that now matters most for housing is the qualifying rate, based on the posted 5 year fixed rate....itself based on the 5 year GoC bond.
I love it when you called this a "short" post :)
When you read the post plus the outside links, it's far from a short post IMO
Yeah......I guess I should have said, "I intend for this to be a short post". Which I did. Tendency to ramble does me in every time.
Demand comes from employment. Most immigrants take 5 years to buy a place. Of course with the five percent down that changed substantially over the years. Just another economist with underlying motives. People of course will drink the kool aid if they do not investigate facts. Most buyers of condo's take more time to buy a car....
The banks need more home buyers please
http://www.businessweek.com/news/2011-06-13/rbc-prices-home-equity-loans...
You have to remember where poor Helmut is sitting -- in Vancouver -- and some of his previous calls in 2009 -- he forecast a 10-15% fall in prices that year, when the exact opposite happened. The guy was singed by a woefully incorrect prediction of the direction of prices. I don't know the guy but all's I can state is that buying a condo in Vancouver is a piss-poor yield investment these days and fraught with systematic risk.
On a completely different subject, credit unions in BC are aggressively pressing mortgage loans, offering terms that most big banks simply won't compete on. And credit unions fund these loans almost entirely off their deposits. Just saying, check out the deposit insurance limit at CUs if you have holdings at these institutions.
"On a completely different subject, credit unions in BC are aggressively pressing mortgage loans"
Yes. My credit union asked me if I wasn't "tired of renting" when I recently called up about a GIC. Yeesh. Like I wouldn't get "tired of paying a mortgage" that would cost me double what I'm paying in rent for the same place!
A client of mine also has a mortgage from a credit union-$900,000 owing and he's never made more than $50k per year in his life!
Time to cash out those GICs I think...
Wow....scary stuff!
@ Ben - yes, rates are going up. Guys like me would dump real estate, take out the cap gain and sit in bonds. Carney is not that nice. My money in a 5 yr 7% GIC ain't doing nothing for Canada, but my leveraged bets on real estate are keeping things humming...
NOT*** going up
Freudian slip?
If you look at Canadian reserves this month, you will notice there was a huge deposit from the BIS. I can only guess that the Canadian government is preparing to bailout a few major Too Big To Fail institutions. CMHC would be first in line.
I wouldn't be surprised if the BoC lowers rates when the market plunges anytime soon.
Ben, this post should be required reading by every Canadian. Your logic is undeniable.
I agree that this should be required reading! A couple of years ago, my husband and I were like most Canadians thinking we would enter the market at our soonest convenience. When we were close to being ready, the prices had gone up so much that we became nervous about taking on such a high mortgage....and also a funny thing happenned along the way.....we became really comfortable in our rental situation. Yes...we live a great life renting and we are able to put away a lot of savings. I started reading financial papers and some of the blogs....all this information available on why buying RE here in BC makes no sense. It is so clear to me now that renting is the best scenario for us in this over valued market.