Thursday, July 30, 2015

This is a recession in the 21st century

The past few weeks we’ve seen the dollar sink, the Bank of Canada’s rate drop to .50%, and not-so-great economic reports over the last two quarters have been released.  And with all this comes discussion that Canada is going through a…(whisper) recession.

According to the definition of a recession -- a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters – that’s what we’re experiencing. However, this seems to be a very different downturn than previous recessions.  And because the definition puts us squarely in one, it doesn’t mean that the country is slipping into serious economic trouble.

David Madini of Capital Economic said, “The recession may not last much beyond the middle of this year (2015).

Here’s some of the key data.  According to Stats Canada figures, the Canadian monthly trade data are now back to pre-2008 levels. However trade data and deficits are simply movements in capital and may not be the best indicators of the economic health of a nation. The U.S has been in a trade deficit for four decades without much harm – in fact, they seem to have prospered well through it all.

While economists fret about trade data and GDP numbers, consumers just keep buying, despite the struggling loonie.  They’re buying cars.  The housing market is still humming along in most parts of the county. Canada’s imports are higher this year, which is benefitting consumers.  Employment is strong in most parts of the country. And consumer confidence is high.

This may be the best recession ever. Or perhaps this is what a recession looks and feels like in the 21st century. Some economists are now suggesting that, although by definition, Canada is in a recession, the two-quarters rule may not be the best test.

During the recession in the early 1980s Canada experienced higher inflation, higher interest rates and high unemployment.  The Bank of Canada rate hit 21% in August 1981, and the inflation rate averaged more than 12%.

Canadian companies no longer focused on innovation and productivity improvements – they were in survival mode.  Also, high inflation was partly responsible for larger government spending. In the early 1980s, Canada’s unemployment rate peaked at 12%. It took almost four years for the number of full-time jobs to be restored.  Real GDP declined by 5% between June 1981 and December 1982. By 1979, the Canadian dollar was worth 85 cents U.S., which made U.S. imports more expensive. On the other hand, Canada’s major exports declined in price. Combined with high inflation, and interest rates, these high commodity prices reduced the standard of living.

Pretty grim picture. Now fast forward to today’s recession. The inflation rate remains in check at 1%. Canada’s unemployment rate is approx 6.8%, which is considered normal. The Bank of Canada rate is .50%. There is an entire generation of Canadian who have never experienced high interest rates -- today’s low rates are the norm for them. 

After the June employment figures were released, Scotiabank released a report suggesting the country was not in a recession “in any meaningful or broadly defined way.”

Some have billed it the Great Canadian Non-Recession.

Technically, we may in a recession and those in areas impacted by the downturn in the oil industry may be feeling it the most, however, consumers are purchasing big ticket items and home sales were up 3.1% from April to May.

So what’s going on?  Is this a true recession? Or, is this what we can expect future recessions to look like going forward? Perhaps the definition of a recession needs to be updated. The world has certainly changed in the past three decades. Some of the credit has to go to government policies. Policymakers have lived though previous recessions and have put safeguards in place to ensure old scenarios are not repeated.

But more so it might be that just two quarters data numbers is not enough anymore. Douglas Porter, chief economist for BMO Financial Group, says it’s too early to declare a recession – that there are some other indicators such as the three “Ds” – depth, duration and dispersion -- which have not been met yet.

Whatever Canada is going through at this time, it has not had a negative impact on most households… and really, that’s all that matters.

Wednesday, July 22, 2015

How will the recent rate cuts impact mortgage regulations

By Mark Kerzner, President, TMG The Mortgage Group

With the latest Bank of Canada (BoC) rate cut to 0.50% comes a reminder that many would like us to believe our housing market is tenuous.  Once again there is a lot of discussion about just how overheated our market is and the dire circumstances many current homebuyers are likely to find themselves at renewal time.

First, let’s think about why the Bank of Canada decided to cut interest rates once again last week. In January the BoC surprised many of us and cut the overnight rate in response to a rapid decline in oil prices.  This time around it did so because the Canadian economy has not rebounded the way the Bank had hoped.

In an effort to stimulate spending, the Bank used one of its levers to lower the cost of borrowing. In doing so the value of the loonie further decreased thereby making imports more expensive and exports cheaper. The hope is that foreigners will both invest in and buy Canadian goods.  The caveat to that appears to be Canadian real estate where many economists and policy makers would prefer that no additional investment takes place. The problem is, it’s hard to have it both ways.

The Canadian housing market is resilient – no doubt about that. But when we speak of the Canadian real estate market we really have to speak in terms of what is happening in Toronto and Vancouver and then the rest of Canada … the latter is nowhere near as hot as the former.

For the past seven-(ish) years the Bank of Canada, the Government of Canada, our mortgage Insurers and our lenders have introduced numerous lending restrictions designed to strengthen the underlying housing market, soften a blow at the time of renewal  --in the event of increased mortgage rates -- and reduce the rate of home price appreciation.  In the wake of these last two rate cuts, discussions are heating up again.

Now we are hearing rumours of increased down payment requirements as well as possibly reducing the maximum amortization. Both of these changes could have a significant impact on the market – and I do not believe the policy makers are looking for ‘significant’ market changes immediately preceeding an election. They could, however, prove to be precursors to a discussion to take place later this Fall.

In late 2008 the Bank of Canada reduced the overnight rate and the banks passed along only 3/4 of the reduction. So far in 2015 the banks have passed along only 30 of the 50 basis points.

While the banks do incur costs with each change to the overnight rate they are also ‘banking’ additional spread on both new and on their existing books of business. With arrears remaining at very low historical rates, and the high quality of borrowers, the banks are already protecting themselves from a potential overheating of the housing market. As such, to potentially trigger a downturn in the Canadian housing market by pushing regulations too far, such as increasing the down payment requirement to 10%, would not be prudent.

In the event the down payment requirements were to increase to 10% approximately 20% of first-time homebuyers could be affected. Some will find the means to borrow additional down payments and others may seek out secondary financing. At the margin, for the homebuyers that remain in the market, their cost of borrowing will increase.

Another “buy”-product of lower interest rates are lower bond yields. People look for better returns on their investments and some will move funds into equities.  Perhaps this will prove to be a good long-term investment strategy, though in the long run, real estate investing may turn out to be a sounder investment approach.

The reality is, in the wake of a massive global recession (2008-2009), followed by major geo-political uncertainty and a perilous Eurozone, our economy, and especially our housing market, have done phenomenally well. The steps taken over the past 6-plus years have proven prudent.

Once again we find ourselves in a sort of conundrum – borrowing costs are getting cheaper, the economy is stagnating yet our housing market, at least in two major cities, continues to push forward.  My concern is that we overshoot and impact one of the main engines -- first-time homebuyers -- that drives the marketplace.

I think it’s important to ensure that families who invest in real estate have the strength and ability to do so. I do not believe that policy makers should be trying to massage the actual market itself. As such, here are a few recommendations they may wish to consider.

  • Register all first-time homebuyer mortgages at 30 or 35-year amortizations but set qualifications as well as payments at 25 years.  In the event of a future default, payments could then be set at 35 year amortizations to allow for some flexibility and preservation of cash flow.
  • Keep the down payment minimum at 5%, though in certain geographic locations require liquid assets equal to 7.5% (plus closing costs).
  • Index the cut off where mortgage insurance can be obtained. For instance a number of years ago a policy was created that restricts mortgage insurance on properties that were greater than $1M. That number should be indexed to allow for natural price appreciation (or depreciation) and geographic factors in the market.
 The housing and mortgage markets in Canada have proven to be resilient. Now more than at any point in our young history, it is vital for Canadians to seek the expert advice of mortgage brokers to navigate their options.