Budget Day In Canada

Today is budget day in Ottawa, and by now the government has announced the largest deficit budget in Canadian history. Strangely, for those of us who have been paying attention, there is little criticism of this planned deficit, even by those who have previously railed against any deficit by the Feds.

So what's going on?

The truth is, both the country and the world economies are at a place unseen by anyone alive. The major financial institutions all around the world are in deep trouble, due to collapsing confidence in financial instruments, mostly brought about by the US subprime collapse, but certainly exacerbated by a serious of other financial failures, the likes of which haven't been seen since the Crash of 1929.

What governments all of the world are trying to do is to replace private spending, which is almost at a dead standstill, with government spending, to trigger a rebirth of economic confidence in consumers, (and probably more importantly, in bankers).

Seldom before during my lifetime have I seen such evidence of the transient nature of what we know of as "the real world" or how vulnerable that world is to a collapse of belief. Students of economics will always tell you that the "real" value of anything is what a willing seller and a willing buyer agree it is. The logical extension of this is that there is no "objective" value to anything, all economic values are relative, and depend upon the confidence of buyers and sellers in the marketplace. Once confidence is seriously damaged, or even destroyed, it is extremely tough to restore it to its proper place.

But this is precisely what governments are trying to do with massive deficit spending and building programs. The whole economy of the world is somewhat based on a house of cards supported ultimately only by our belief in it. If that belief is fundamentally flawed, then we really are in for a serious collapse. If the system merely needs to be "tweaked" by better regulations and public policy, then it may perhaps come back sooner rather than later.

What does this mean for investors?

It means a rough ride is getting rougher all the time. There's little point in trying to say that the stock market will be volatile... that would be more than a little redundant after the past couple of years. Real estate values will continue to slide... but nobody can tell you with any confidence how much they will slide.

I still believe that your best investment bet is in mortgages against residential property.... because no matter what happens in the world economy real people still need to live in real property, and will pay to keep their homes. Even if there is double digit unemployment the vast majority of people will continue to be employed, and will continue to pay their mortgages to stay in their homes.

We are recommending lenders be more cautious than ever in their second mortgage investments, with the result that the absolute maximum loan to value in private mortgages these days is 85% for people with otherwise excellent credit, and 65-75% for so called equity loans. This isn't a reflection of paranoia, but rather of useful prudence given the uncertainty surrounding property values in the near future.

In other words, if we have to foreclose we need to be aware of the potential for loss created by the current market conditions, and therefore lend more cautiously than in a strongly expanding marketplace, such as existing in the past five years or so.

The balance to this is that we receive far more applications these days from people with better credit scores than ever before... because if private lenders are being more cautious, institutional lenders are as well. The range of risk represented by private lending is much less exposed today than it was previously, simply because there is less competition for the loan opportunities.

So if you want to maintain a good return on investment, then invest in debt... residential mortgages.

And returning to the budget... let's hope that the Finance Ministers from around the world are able to right the ship and get the world economy back on track.

Bank Lending Policy Initiative by MOF

Loosen your purse strings, Canada tells banks

OTTAWA (Reuters) - Canadian Finance Minister Jim Flaherty delivered a blunt message on Wednesday to the country's banks, telling them to loosen their purse strings and summoning them to a meeting to press the point.

"There is evidence now of a constriction in credit in Canada, not only for smaller businesses and for families, but for larger businesses. So this is something that we are going to continue to address with our financial institutions. In fact a meeting is being set up now," he told CTV television.

"We expect our banks to make lending available, to have credit available and affordable in Canada. We're acquiring a lot of their mortgages ... up to C$75 billion worth. We've given a guarantee with respect to some of their obligations. So this is a two-way street. We expect credit to be available through our financial institutions."

I have had many borrowers ask me why it seems so difficult now to obtain mortgage financing, despite the fact that the official policies regarding loans haven't really changed very much over the past few months - yet loans seem virtually unavailable no matter what the applicant presents in terms of qualifications.

Anecdotally I have been told by a loan manager for a local community credit union that the credit union hasn't made a new mortgage loan since May of 2008, six months in total. The real estate market in that community is completely dead,and last month there were only two sales in the entire community.

So do you think that these items are related? You bet they are. Banks and Credit Unions claim that their lending policies haven't changed... but they aren't lending money.

What the Minister of Finance isn't saying, is that the banks are actually directly creating the current economic crisis in Canada, even though there was no crisis until they made one! The real crisis in confidence is NOT the consumer but rather tha corporate elite at the banks, who no longer trust each other or their institutions. Bank Paper is not considered worth the paper it is written on, or the electrons used to count it. The feds have done their share all around the world. It is time for the banks, worldwide, to get over it... and do what they need to do to begin lending money again.

If they don't this recession will go from a serious recesssion to a full blown world wide depression, the end of which will be uncertain at best.

And it will have been created almost entirely by bankers, because they don't trust each other. At some point these people need to be held accountable for their completely irresponsible behavior. It may be bad banking to make loans in an environment of uncertainty, but it is bad citizenship to withhold credit from the entire world because of corporate cowardice.

Mixed Messages

It's been a whole month since my last blog entry on mortgage investing. The reasons for this are many but the biggest reason is that the fall is traditionally one of my biggest seasons of the year for private mortgage investments. As a result I find myself extremely busy dealing with new investments in mortgages and MICs by investors, and have found it difficult to find the time to contribute to this column.

In addition, of course, I also had to serve Jury duty in a trial in BC Supreme Court, which was interesting, if you consider "interesting" to be a pejorative. Twelve ordinary people come together to decide the fate of one of our fellow citizens, whether or not he is guilty of the crime of which he is accused. Human nature being what it is, I was amazed that we all managed to agree on a verdict, despite much discussion about the merits of the case during deliberations. I hate the jury system, but I still think it is better than allowing the experts to decide our fate as citizens.

Now, back to mortgage investing.

2009 will go down as the year of the great world-wide financial crisis, the likes of which few of us have experienced in our lives. According to all the economists there really has been nothing like it since the great depression.

This crisis was triggered by the US sub-prime mortgage collapse, and, quite frankly, incredibly incompetant lending practices south of the border. Unfortunately it didn't end there, as the underpinings of whole international financial system have ended up coming under assault as a direct result of a profound lack of trust in the system itself by the very people in the heart of the system.

When banks won't or can't lend money to other banks, financial liquidity dries up in a hurry. Much of the efforts of the various national governments and central banks around the world are doing everything they can to restore faith in the system, not so much in the minds of ordinary investors but rather in the hearts and minds of the major players in the industry.

There has been a lot made lately of the failure of the US regulatory agencies to control the conduct of US Banks, and there is probably a significant amount of truth to the criticism. However, the challenge is not merely about regulation and control, but rather more fundamentally - if nobody understands the investment products they are buying or selling, how can faith and trust ultimately be earned and maintained. A significant part of the failure of the international financial system has been the undermining of sophisticated financial products like derivatives.

This should not be taken to suggest that more sophisticated products shouldn't be bought or sold, but rather there needs to be more transparency and a better job done of disclosure of these complicated financial products. The banks who rely on these instruments to provide fundamental security for their loans need to be able to rely on the ratings assigned and on the disclosure filings as to the nature of the risks being undertaken when they invest in those instruments.

High risk investments are not necessarily bad investments, they are simply investments that require a risk premium appropriate to the amount of risk and type of risk. They should also represent only a portion of a balanced portfolio rather than a primary portion.

I've never criticised my relative who goes to the horse races ever Thursday and "invests" fifty bucks in his favorites of the day. Some days he wins, although mostly he doesn't. So this investment is extremely high risk, but once in a while he wins enough to make the whole exercise worth every dime. Those nights are great.... we all go out to dinner to celebrate his success as a gambler. However, if he started to gamble his nest egg, set aside for his retirement, I would be most concerned.

Of course, I found it equally perterbing when I realized that his investments in blue chip mutual funds were almost as risky as the race track.

Years ago I began to move out of stock market based investments into secured investments or real property. Yes, real property does go up and down. Just like stocks in the public markets. But there is a fundamental difference - real estate will always retain real value over the long run, as opposed to the stock of any given company, which has at least as good a likelihood of disappearing completely in 15 to 25 years as it does of thriving.

You want proof? Check out the names and positions of the top 1000 US listed companies in 1990 and see how many of them have completely disappeared in 2009. There are no properties that have fallen into the sea since 1990, and most have increased in value at a pace at least equal to the rate of inflation in the intervening period.

Real property and security based on real property, if managed with a degree of caution, will protect an investor for the long run. In the short run you can easily lose your shirt if you make a bad investment, or leverage your capital at the wrong time and in the wrong market. However, in the real estate world, time is generally your friend.

Just remember this - subprime mortgages in Canada have a default rate of less than one half of one percent. A portfolio made up of Canadian mortgages, even subprime mortgages, will have made money during the past twelve months during this market meltdown. There is few other investments that can make the same claim.

There are few guarantees in the world, especially in the investment world. But there are reasonable ways to mitigate risk, including lending in strong real estate markets in a stable country with good prospects.

And being persistent and patient enough to see the investment through.

Final Mortgage Insurance Guarantee Parameters

Those of you who are following this blog may remember my tirade a few weeks ago about the changes to CMHC insurance rules, particularly in regards to fixing a minimum credit score at 620 and removing all discretion from lending institutions in working with people on the "bubble" as it were.

The following is extracted from an email delivered to me by the Canadian Association of Mortgage Professionals in regards to this issue which answers a number of these issues.

On Friday, September 19, 2008 the Department of Finance issued its final
mortgage insurance guarantee parameters and accompanying explanatory notes.

The final guidelines follow the initial announcement on the
financial
guarantee for mortgage insurance providers issued July 9, 2008 by
the Department
of Finance.

There are two noteworthy changes from the draft parameters:

1. Elimination of reference to a Total Debt Servicing (TDS) number, replaced
by a
principles based approach;

2. Reduction in minimum credit score to 600 from 620. Three percent "basket"
for flexibility remains;

These modifications follow discussions with stakeholders, including CAAMP.
CAAMP through its submission focused its comments on the minimum credit score
and welcomes the decision by the Department of Finance to adjust the credit
score. For more information on the mortgage insurance guarantee parameters click
here for Schedule A and click
here for Schedule B. All of these changes come into effect October 15,
2008.

If you have any questions please contact jmurphy@caamp.org; 416-385-2333 ext. 31Jim Murphy, AMPPresident & CEOCAAMP/ACCHA

This is an example of how concerted effort on behalf of an industry can help to protect the public from a poor legislative or regulatory change.

More importantly, it leaves the job of evaluating credit risk in the hands of the industry as a whole, justifiably in my opinion, given the record of the Canadian credit granting industry in maintaining stability while the rest of North America goes to hell.

Stormy Weather - Any shelter in a storm?

Those of us who grew up on the west coast know all too well that when the weather gets really nasty, when you're out on a boat on the ocean, that it's a good time to head for a safe harbour. Preferably one where you can get out of the wind and waves, behind a solid breakwater if possible.

Well, the world economy is certainly going through a major storm these days, with the storm centred in the US Financial services meltdown as a result of the mortgage crisis.

Some investors are choosing to move to cash investments, others to precious metals, like gold. Both of these strategies are a little like adding ballast to the boat, stabilizing it but not really helping you get where you want to go. Holding cash or near cash investment is a sure fired way to go backwards against inflation and shrink your capital base. Holding gold is probably as high a risk as holding stocks right now... after all stocks are at historically low values and gold is at the top of its cycle of prices...

Actually the ballast in the case of gold might actually sink your ship... to carry the metaphor further.

Anyone who follows this blog knows that I am a big believer in mortgages and Mortgage Investment Corporation investments, because of their inherant stability and underlying security. Like all investments mortgages do require diligent review and careful allocation of funds, in addition to common sense lending (something not practiced in US backed subprime mortgage market previously).

But mortgages do represent a relatively safe harbour in an economic storm, with security based on something that every investor can understand... a home where the borrower has something real to lose in the way of equity.

AIG Bailout - Will they sell AIG Canada?

AIG Canada is one of the most secure investments in the AIG universe with strong Canadian government guarantees behind it. If the US government managed its mortgage industry the way that the Canadian government has, the US wouldn't be in the total mess that it is...
Both McCain and Obama are promising to increase regulation of the financial services industry after this mess.... sounds all too familiar... the leaders promised the same after the Savings and Loan screw up... leading to this???

I think it is unlikely that the US government will make sensible changes in the rules... in an environment with such strong state rights... including the right for any state to make stupid.

Price and Volume Changes in Canada

Headlines in the local papers in Vancouver this week were screaming about a decline in prices on sale of homes in Greater Vancouver of approximately 4% since the spring, and an increase in new listings of an alarming amount.

Excuse me. One of the things that drives markets, of course, is media speculation about the current trends in the market. Sometimes it seems to me that there are those in the media determined to create a real estate crisis even in the absence of one. New statistics from the Canadian Real Estate Association indicate a decline in the volume of sales from last year to this year, along with a significant increase in new listings. But the numbers hardly indicate a crash in the market across Canada, or even in British Columbia, with an increase in average sale price to the end of July of about 8% over the past twelve months.

I caution anyone thinking of buyer or selling to be careful and think for themselves.

Anyone who thought that the real estate boom of the past few years would continue indefinitely, without pause, hasn’t been around very long. It has already been a very long positive market, and it is time for a market pause or even correction. The question at the end of a long boom is how severe the correction might be.

I leave you with this thought. Residential vacancies in Greater Vancouver are less than 1%. Unemployment is at just over 4%, and is stable, despite rapidly increasing populations. Does this sound like a bubble? So when prognosticators tell you that the market here is going to hell, take their opinions with a grain of salt.