US Housing Market strong for Softwood

The US housing market has gone from disaster to doldrums.  Although some areas have bounced back quickly (New York and San Francisco most notably), the overall market appears to be stagnant.  But is it?  To know the real story, take a look at the industry that supplies the hungry US market.

 

Major Canadian softwood manufacturers, whose precarious profitability depends upon accurate forecasting, are predicting US housing starts of 835-900,000 in 2013, up from an estimated 746,000 in 2012.  By comparison, housing starts hit a low of 558,000 in 2008.

 

Already, the composite price of Random Lengths framing lumber (the most common wood used in homebuilding) has risen 27% in 2012, both from increased demand and the expectation of more.

 

The US housing recession is not over.  Yet, with immigration and family development continuing faster than housing starts, a full recovery is only a matter of time.

 

Doubting the US housing recovery is a popular pastime at present - but it is not wise to bet against such obvious statistics.

 

____

 

 

"The best thing about the future is that it comes one day at a time."

 

Abraham Lincoln

 

____

Forget Greece and Italy

Greece and Italy have been stealing economic headlines these days.

The media has been so focused on Greece and its pint-sized economy, that they have completely missed what should really be headlining world economic news…the slowdown of the world’s second-largest economy.

China’s government-induced GDP growth and red-hot housing market have both stalled.  Ironically, the government itself caused the slowdown, as it introduced prudent anti-bubble measures throughout the year.  Such measures were an unfortunate necessity: without them, inflation was turning rampant.  But now the slowdown may turn out to be just as devastating.  And, it seems that the largest companies in the world are well aware of what is coming.

Last week, Goldman Sachs sold $1.1 billion worth of its shares in Industrial and Commercial Bank of China (1398.HK).  This week, Bank of America announced it was selling the remainder of its shares in China Construction Bank (0939.HK) – $6.6 billion worth.

Today, the International Monetary Fund announced that Chinese banks could suffer “huge losses” on the very extreme case that credit shock, currency shock, and yield curve shocks were to occur together.  Interestingly, this “slim and rare occurrence” appears to already be starting.

The IMF's Jonathan Fiechter stated rather bluntly stated (as far as economist-speak goes) that "while the existing structure fosters high savings and high levels of liquidity, it also creates the risk of capital misallocation and formation of bubbles, especially in real estate." In other words, the current government’s financial policies force people to invest in real estate (since buying other asset classes in China is considered too risky), and, banks are lending too much to capital projects with no economic future (again based on government direction).

One could say that the Chinese economy is a centrally-controlled “our government knows better” economic marvel mess.

It is my advice - stated on several occasions previously - that you follow the lead of Morgan Stanley, Goldman Sachs, and Bank of America; that is, sell all but your very best Chinese holdings.

 ____

See also:

China faces grim foreign trade outlook

China's property cost curbs to remain despite home price drop

China’s CCB Plays Down BofA Share Sale Impact

____

Conversation with a Chinese Property Developer

A week ago, the Chinese government instituted a new set of anti-corruption rules, specifically aimed at local government officials.

Of course, giving bribes and other forms of corruption were always illegal, but about as enforced as copying DVDs. Under the new law, officials will annually vote on each other's trustworthiness: how does one say "backstabbing" in Chinese?

Today's article is a short excerpt from a conversation with a property developer from Nanning, and a few of the problems (or opportunities, depending on your point of view) with regard to bribery and business in China. For obvious reasons, the name of the developer is not revealed. The conversation took place on July 17th, 2011.

____


Frost Report: "First off, how does one go about doing business - that is, securing a contract - in China? I've heard that it's all about 'who you know,' rather than about a good reputation or good pricing."

Property Developer: "It's tough. You have to bribe officials 1-2 years in advance of a (major) project, when you put in your bid. A year later, all the officials may have changed, and you have to start all over again."

Frost Report: "So, when you give a bribe, do you just hand someone a red envelope?"

Property Developer: "That's too obvious. But, you can't just give a gift, either. It's not enough. You have to hide money inside a gift."

Frost Report: "So basically, whoever gives the biggest bribe gets the contract, is that right?"

Property Developer: "Yes. Sometimes you sign everything - all the papers are signed. Then, a few weeks later, you find out that the contract went to someone else."

Frost Report: "So after you signed the paperwork, someone came along with a bigger bribe?"

Property Developer: "Right. This business is like (American) football. You get one big play and it changes everything. It's not like basketball, when you keep getting points one at a time."

Frost Report: "What if the official won't take a bribe from you? These days, I guess they are careful. How do you win the contract then?"

Property Developer: "There are always ways. If you can't get in touch with the officials directly, sometimes you can give money to their kids. For example, at New Year, you can give a kid an envelope with 2000 yuan (equivalent to a month's salary in rural China). Holidays you have to give away a lot of money."

Frost Report: "Do you think that things will change as a result of the new laws?"

Property Developer: "No."

____

See also:

China issues anti-corruption regulation targeted at village officials

More Chinese cities see property prices fall as result of cooling policies

____


“Few men have virtue to withstand the highest bidder.”

George Washington

____

China's Housing Bomb

keeps burning, though the fuse is getting shorter.



In an recent article (Year of the Hot Rabbit) I related the news that property purchase restrictions have been introduced in more than 40 of China’s major cities, in an effort to deflate their massive property bubbles.

In Beijing, for example, a property purchaser must prove residency status to purchase in that city, and is restricted to owning one primary residence and one additional property. The days where a non-resident investor could buy 20 or 30 properties is - at least according to the rules - over. For the moment, these rules seem to be working. In fact, they are working too well, and could potentially obliterate the bubble rather than deflate it slowly.

According to China Real Estate Index System (CREIS) statistics, home prices sank in most of China’s largest cities in March. For instance, prices in Shanghai dropped 7.6% in that month alone: an annualized rate of 91.2%! Most of this titanic drop occurred in the final week of March, where prices sank 5% (260% annualized). These large nationwide drops occurred despite very high volumes in “home trading” (their words, not mine).

Following the lead of real estate spokespersons throughout history, Zhu Zhongyi, Vice Secretary-General of the China Real Estate Association, said he predicts a “modest decline” in prices, adding that a large decline in real estate prices is “not quite possible.” He said this quite seriously, as if saying it seriously makes it true.

Nonetheless, not everyone has given up hope on one of the greatest booms in real estate history. Lin Lei, in charge of marketing for 21 Century Real Estate (not to be confused with Century 21, despite the libelously similar name), said that the market would drop only “if restriction policies were carried out strictly.” In other words, he hopes that if real estate prices continue to drop, government officials will simply ignore the new rules. Red "gift" envelopes are likely to fly off store shelves.

And the bubble continues...

____

“Having a third party sign a mortgage loan contract on behalf of another person is a serious offense, and banks and financial institutions have to examine their own operations and investigate to find out who is responsible for such offenses.”

The China Banking Regulatory Commission, March 2011
(Showing that already, Chinese citizens are trying to get around new regulations that home buyers in a city must be residents of that city).
____

For further information, see:
China's housing prices expected to drop, but not sharply, in second quarter

World Housing Bubble - All Aboard!

For months, I was clearly the minority in saying that real estate prices in places like China, Australia, Canada, Hong Kong etc are experiencing a bubble. I was also the minority in saying that US home prices are, in fact, undervalued. In recent weeks though, such ideas have become accepted, even mainstream.

By now, I have to admit that I am actually sick of writing about housing bubbles. However, I know from emails I have received that as a result of these articles, at least some people have been dissuaded from purchasing high-priced condos at the edge of personal affordability, and for this I feel that repeating the same message ad nauseum is worth it.

Paradoxically, money tends to flow to assets and areas that are considered "safest," without regard to whether or not they are "reasonably priced." For investors, immediate safety of capital (or immediate gain) is paramount, and everything else is secondary. It is precisely this desire for immediate reward that results in horrible long-term investment choices.

In some countries, such as China, investment dollars are still incoming. In the US, real estate is stagnant water, despite low prices and excellent investment opportunities. In Canada, the flow is now a trickle, and ready to backflow.

The educated media is coming on board. For the masses, the onset of reality will still take several months.

____

Video: Bubble Trouble - MSN Money
___


See also the previous Frost Report articles:

The World Housing Bubble – Part II

The World Housing Bubble

____

Canada’s Banking Albatross

And How to Benefit from it.



Deathly afraid to enter the stock market, Canadian retail investors are keeping their money in low-yielding GICs and bond funds - if they are investing at all. Mortgage and refinance business has collapsed. The self-employed have entrenched. Business is slow.

With mortgages newly dead and rigor mortis setting in on investing, there is nothing to sustain the currently high stock prices of Canadian banks. As an investor, what can you do to protect yourself, and perhaps make some money in the process? The Frost Report states the case in black and white.

First off, sell your Canadian bank stocks, as well as your Canadian dividend mutual funds (which usually contain 50% bank stocks). In order for stocks to drop, banks don’t need to have a disastrous quarter; they just need to have a quarter that is less spectacular than the last one.

Secondly, sell your Canadian REITs (Real Estate Investment/Income Trusts). There is no point holding on to REITs to generate income when you know that income from real estate will soon drop, and the price of REITs along with it.

Thirdly, buy distant at-the-money put options on Canadian banks, so that you can make a profit on the coming stock price decline. If you don’t know what an at-the-money put option is or how it works, completely ignore this piece of advice, for now is not the time to be learning.

Alternatively, you can buy Inverse financial ETFs, such as the Horizons BetaPro S&P/TSX Capped Financials Bear Plus ETF 2X, (symbol HFD). Again, if you just read this description and have no idea what any of it means, don’t even consider buying HFD. For those who understand, read the full prospectus.

Lastly, Canadians should start paying down debts and building cash reserves. While everyone else is experiencing a crisis, you can be comfortable. Cash gives you a sense of control & security, and, when things start to pick up again (which they always do), you can take advantage of the bargains that will be everywhere.

The Bank of Canada shot the albatross with its low interest rates months ago, and for a while the results looked good. Now, however, the storm is approaching. As with any other impending disaster, preparation is crucial.
____


Bank of Montreal reports Tuesday Aug 24th. Analysts expect third-quarter share profit of $1.21, up from $1.05.

Canadian Imperial Bank of Commerce reports Wednesday Aug 25th. Analysts expect third-quarter share profit of $1.53, up from $1.36.

Royal Bank of Canada reports Thursday Aug 26th. Analysts expect third-quarter share profit of $1.02, down from $1.21.
National Bank of Canada also reports Thursday Aug 26th. A third-quarter share profit of $1.52 is expected, down from $1.79.

____

Disclosure
Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.
____

“Instead of the cross, the albatross / About my neck was hung”

The Rime of the Ancyent Marinere, Samuel Taylor Coleridge.
____

Canadian Real Estate: Stick a Fork in It

IT'S DONE.



The Canadian housing boom is officially over.

In addition to the myriad of anecdotal stories from real estate agents and mortgage specialists who tell me that the market “has shifted in favor of buyers,” banks are finally experiencing the inevitable decline.

Back in July, I mentioned that the mortgage pipeline was drying up, and that the results should soon hit the banks. Well, they have. According to my contacts at three of Canada’s major banks, new mortgage and refinance business has fallen off a cliff. Pre-approved mortgage applications – an indication of sales beyond 30 days - are virtually non-existent. Any of this may be confirmed by a casual visit to a local bank or credit union, which reveals empty reception areas and bored lenders.

In an effort to kick some life back into the markets, major Canadian banks reduced their mortgage rates twice in the past two weeks, but it had no impact whatsoever. In light of these circumstances, I suspect the Bank of Canada will rethink its intention to slowly raise interest rates.

At the same time as the Canadian media was announcing that home prices have dropped, sales have slipped, and housing starts fallen, the Canadian Real Estate Association was busy announcing that home prices will continue to rise. I love the CREA. When sales and demand increase, they announce that real estate prices will rise. When sales and demand drop, they announce that real estate prices will rise. You can say a lot about the CREA, but you can’t fault them for inconsistency.

I suspect that several months will pass before the severity of the downturn becomes fully apparent. By then, it should be so obvious that not even the CREA will be able to ignore it.
____

Further reading:

The CREA's Use of Spin (The Frost Report)
The Canadian Real Estate Market - Trouble in the Pipeline (The Frost Report)
Housing Starts Slip in July
Shaky Days in the Housing Market
Homeowners Sell, Start Renting Instead
CREA's Resale Housing Forecast

____

The Golden Age of Appraisals

“What are you looking for?” the man on the phone would ask me. At the time, I was a retail lender for a major bank.

“Uh, they need 680 thousand,” I would answer. A few days later, the appraisal would arrive on my desk. The home’s appraised value: exactly $680,000.

I miss the golden age of appraisals; the days when an appraiser would ask their banker what value they needed to complete the deal, and the result would neatly correspond. Of course, it didn’t always happen that way. Occasionally, when a client was buying a property that was obscenely overvalued, the appraiser just wouldn’t do it. “The most I can give you is “X,” they would tell me, apologetically.

The Golden Age of Appraisals (and the housing bubble itself) resulted from general human psychology, and a lack of regulation to counteract it. The government wanted a robust market so that voters would be happy. Bank executives wanted stunning results so they could exercise their stock options. Lenders wanted to underwrite mortgages to exceed their targets and get good bonuses. Appraisers wanted to keep lenders happy and get bank business. Clients wanted to be approved so they could buy homes to flip and get rich. And so, everyone worked together to create a royal mess.

At the time, I didn’t even realize that by answering the appraiser’s question, “What are you looking for?” I was contributing to a bubble. I recognized that the question was suspect, but thought I was simply helping them cheat at their jobs by giving them an anchor figure to work from.

Housing appraisals go by either “replacement value” or “the comparison approach,” the latter of which is the most common. In this approach, a home is compared to the recent sales of similar homes in the area, adding or subtracting value for any differences. In the bubble years, the values given to differences were often generous. After all, who’s to say that the $500 of gardening supplies and weekend of sweaty work didn’t add $20,000 to the value of the home? It’s a judgment call.

These days, most appraisers no longer ask their banker what he is “looking for.” They rarely assign a value of $20,000 to a small garden plot, or $30,000 to a new paint job. And, they often anchor their appraisal based on the price of the nearest foreclosure, knowing that foreclosures drag down prices for everyone. The old days are gone. Appraisals are becoming – dare I say it – accurate.

That is, until the next hot economy…
____

“Until you play it, St. Andrews looks like the sort of real estate you couldn't give away.”

Sam Snead
____

Chinese Real Estate - Trip Report

Back from China…

First off, my impressions of the housing market in China - one of my primary reasons for visiting Shanghai.

Virtually everyone I spoke with admitted that the Chinese housing market is “expensive.” Yet, when asked if prices would drop, almost everyone answered with a blunt, “No.” When I inquired further (ex. “Why not?”) I received any one of a number of points exhibiting national or local pride. For example, that Shanghai is “a great place to live. Everyone wants to live here.” Or, that “the Chinese people have an entrepreneurial spirit, and so prices will keep going up.” And of course the real estate bubble classic: “There is a limited amount of space.”

Then I asked the follow-up question: “Are you planning on buying a home?” Only two out of dozens said “Yes.” A few said they already own one. Many added that they would buy “if they had enough money.” Therein lies the problem.

An inexpensive one-bedroom condo in Shanghai costs around $140,000 USD. An inexpensive two-bedroom condo costs around $205,000 USD. At the surface, this does not seem overly expensive; that is, not until one remembers the reality of Chinese prices.

For reference, I had a three-course meal and two beer at a local restaurant for $6 USD. A 30-minute subway ride costs 22 cents. Despite recent prosperity, the average salary in China is 1/7th that of the United States.

So, that one-bedroom condo is equivalent to $980,000 USD, while the two-bedroom is equivalent to $1.44 million. The average Chinese citizen has no hope of buying even a basic home (unless several generations come together to make a purchase), while wealthy Chinese continue to buy multiple homes on speculation. This cannot last.

When I first started writing about the Chinese housing bubble in January, the media was speaking about it as an “if.” Since then, reality has started to set in. The Chinese government is – to their credit – well aware of the situation, and continues to take steps to lessen the coming catastrophe.

Beginning Aug. 31st 2010, insurance companies will no longer be allowed to hold more than 10% of their assets in property development. The government is also instructing banks to tighten (again) the lending requirements for 3rd+ homebuyers in Beijing, Shanghai and Hangzhou. I would list all the bubble-busting measures the government has implemented previously, but it would be a long list.

As the Chinese and related Asian markets unravel, worldwide construction-related commodity prices (iron, coal, copper etc) should decline. In addition, one should obviously avoid Asian banks, development companies, and in fact any company with non-essential products or services that relies on China for a substantial part of its business.

Despite government measures and media warnings, the Chinese housing bubble remains steadfast: greed, pride, and cognitive dissonance are hard to break. But, as soon as the cracks appear, reality will set in with a vengeance. This bubble is BIG.
____

See also: Sell the Chinese Market SHORT!
____

"China's economy, in general, is in line with the government's macro-economic regulation and control."

Chinese Premier Wen Jiabao, July 18th 2010
____

The Canadian Real Estate Market: Trouble in the Pipeline

The Canadian Housing market is going well, with big volume and qualified customers. At least, that’s the current perspective at the end of the line. The further one goes up the pipeline, however, the worse the big picture looks.

A mortgage department employee from a major bank recently told me that application volumes are down 25% or more since June 15th. Though employees are not being laid off, those who leave or retire are not being replaced. At the same time, the quality of mortgage applications is deteriorating rapidly (“scraping the bottom of the barrel” was the exact expression).

Further up the pipeline, Real Estate agents tell me they are worried. Sales have dropped noticeably since May. In an attempt to make up the difference, agents are cold-calling and self-marketing like they have not done for a very long time.

Of course, all this is anecdotal evidence. At the bank level, sales numbers still look great. Yet, I suspect that the drying mortgage pipeline will reach Canadian banks soon. When it does, you will read about it here.

For further information, see:

Spin City
Canadian Debt II
World Housing Bubble II
____

"Phew. With yesterday's report that home resales are cooling and price increases shrinking, we can finally put behind us the horror of Canada's great imaginary housing bubble. ...What Canada had was modest overvaluation with very little sign of speculation."

Jay Bryan, The Montreal Gazette, June 17 2010.

The World Housing Bubble - Part II

Just in case you thought it was over...

Back in March, The Frost Report noted that during the economic crisis of 2006 and beyond, countries around the world drastically lowered interest rates to spur economic growth. Like the Frankenstein monster, the good intentions of these low interest rates have morphed into a hideous mess: a multinational, worldwide housing bubble.

Some economies have already moved from the "we don't have a bubble" stage to the "bubble is beginning to burst" stage, while others are still recovering from the first one. In case you missed the original article or it has faded from memory (see: World Housing Bubble), here is another selection of this year’s headlines to remind you that the problem is far from over.

__


THE UK

House price rises ‘unsustainable’ as lending falls
The Times, June 2nd 2010

"Vicky Redwood, Capital Economics’ senior UK economist, said that the data 'continues to suggest that the recent rise in house prices is unsustainable'."

http://business.timesonline.co.uk/tol/business/industry_sectors/construction_and_property/article7142355


CHINA

May property sales plunge in Beijing, Shanghai, Shenzhen
Xinhua, June 2nd 2010

"Beijing, property signings slumped nearly 70 percent to 3,357 in May from April, the Shanghai Securities News reported, citing data from the city’s housing regulator. In Shanghai, transactions may have dropped about 70 percent to 2,550 signings, the paper reported, and in Shenzhen, sales fell 62 percent."

http://news.xinhuanet.com/english2010/business/2010-06/02/c_13328894.htm


AUSTRALIA

Interest rate rises subdue housing bubble
The Australian, June 1st 2010

"The Reserve Bank of Australia's rate rises have pricked the boom in housing prices and have also sent lending to businesses skidding into reverse."

http://www.theaustralian.com.au/business/property/interest-rate-rises-subdue-housing-bubble/story-e6frg9gx-1225873746105


KAZAKHSTAN

National Bank Chairman: Kazakhstan Focuses on Economic Recovery
Ministry of Foreign Affairs, May 4rth 2010

"Kazakhstan was one of the first countries to experience the global economic meltdown of credit. As a result, it was one of the first to respond with a comprehensive program to deal with problem sectors, such as banking, financial services and property development — the industries that created an economic ‘‘bubble’’ whose collapse the country is still recovering from."

http://portal.mfa.kz/portal/page/portal/mfa/en/content/news/ASTANA%20CALLING/2010-05-04


KENYA

As Nairobi Property Prices Rise, Home Buyers Suffer Low Returns
AllAfrica, Feb 22nd 2010

"Many people who have taken mortgages to buy rental properties are finding it increasingly difficult to service the loans since rents accrued are not sufficient to cover the monthly mortgage repayments.
At the heart of the problem is the fact that rents in many parts of Nairobi suburbs are facing a property price bubble."

http://allafrica.com/stories/201002221638.html


ISRAEL

Legal Ground: The end of easy mortgages?
The Jerusalem Post, May 28th 2010

"It was predictable that the Bank of Israel would move to cool the residential mortgage market. We have seen what anarchy of easy mortgages could do to a massive established economy like that of the US. Even more so, the collapse of a bank in a small economy such as Israel could be a disaster."

http://www.jpost.com/Business/Commentary/Article.aspx?id=176747


CANADA

House prices to drop: TD
The Globe and Mail, May 5th 2010

"House prices will fall in 2011, TD Bank said Wednesday as it revised its outlook for the Canadian real estate sector."

http://www.theglobeandmail.com/report-on-business/house-prices-to-drop-td/article1557540


TAIWAN

Taipei Real Estate Risks Grow After Record Rally
Bloomberg, May 20th 2010

"Investors should sell Taipei property now, taking advantage of a 21-month rally in prices before the government acts to make real estate more affordable, according to the Taiwan Real Estate Research Center and the island’s largest real-estate brokerage."

http://www.bloomberg.com/apps/news?pid=20601206&sid=a0cIUQ74Wfy0
__

After today’s “hot economies” become tomorrow’s “busted economies” and real estate prices return to normal, the world map of economic health will need to be redrawn. Those with developed infrastructure and the ability to raise taxes will fare better, while emerging markets will likely be hardest hit.

If you have a margin account and/or trade international stocks, it would be wise to raise some cash (if you haven't already), to take advantage of bargains as they come available in the next 18 months.

Despite ongoing domestic problems, it is my belief that in a few years the United States - whose massive deleveraging has preceded and superseded all others - will look enviously safe and stable.

____

"...in an environment in which the financial sector is prone to excess and the supervisory structure does not respond sufficiently, the interaction of low interest rates and financial vulnerabilities can clearly be dangerous."

Donald Kohn, Federal Reserve Board, 2010

How to Speak Fed

The Federal Reserve: seen by some as an economic savior, and by others as an evil force.

Through its direct manipulation of interest rates and other mechanisms, the Federal Reserve determines the overall pace of U.S. economic growth (or decline).



Since investors trend toward euphoria when times are good & panic when times are bad, the Fed’s mandate is to control the economy; for example, to stimulate a weak economy by lowering interest rates, or to slow down an overheated one by raising interest rates. Yes, that's right – the Fed sometimes purposely initiates recessions. This is not conspiracy, but rather a method of controlling human stupidity (or at least cleaning up after it).

In good times wages tend to increase, which in turn increases spending, which increases prices of goods, which increases stock and real estate prices, which induces inflation, which causes wages to increase and so on. When times are good and voters are happy, the government wants it all to continue. If an independent Fed did not exist, human greed and optimism would allow bubbles to grow to stratospheric levels, then come crashing horribly down. The recent crash and burn of the U.S. housing bubble is an example of the Fed's failure to do its job – it let the bubble grow for too long.

Importantly, while the Fed always hints at what it wants to accomplish in the future, it does so in a cryptic manner. So, while the Fed’s intentions may be crystal clear to professionals, they pass by virtually unnoticed to non-professionals – exactly as intended.

Buying reasonably priced stocks of good companies is always a good idea, but it’s an even better idea to buy them when the tide of the economy is moving with you. The purpose of this article is therefore to teach the rules of “Fed speak,” the cryptic voice that shapes the nation’s economy.


Rule #1 - The Fed Understates Everything

The Fed is aware of its huge influence in the market, and takes care not to overstep its boundaries. If the Fed simply said, for example, “we intend to raise interest rates because we think there is a bubble in technology stocks,” the market would likely dive and the Fed would be blamed. For this reason, the Fed avoids stating anything of importance directly. Thus, “this market has a bit of froth,” really means, “this is a bubble of massive proportions.” Asking, “Is there a reason to think that homes are overvalued?” means that homes are terribly overvalued. Whenever the Fed states or suggests an opinion, you can safely magnify it tenfold.


Rule #2 –Recognize Moral Suasion

Moral suasion, also known as “jawboning,” is the name for scolding market participants in order to change behavior. By sending a warning to the market, the Fed hopes that it can delay or even avoid taking a negative course of action.

For example, in 2009 the Bank of Canada (Canada’s equivalent to the Fed) stated, “the recent sharp increase in the value of the Canadian dollar, if it proves persistent, could fully offset recent positive developments in financial conditions, commodity prices, and confidence.” This stern warning (see Rule #1) told market participants that if they keep buying the Canadian dollar, the Bank will take measures to devalue it (to improve exports).

In the long run moral suasion rarely works, but in the short run it can have the desired consequences. Moral suasion also indicates the course of action the Fed will take if moral suasion fails.


Rule #3 – Read the Speeches Verbatim

The introductions and conclusions of Fed speeches are made for public consumption (the media) and generally reflect useless broad opinions (such as, "the economy is improving.")

The subtle nuances with true predictive value are in the carefully chosen text. For this reason, any online news article about a Fed speech will include a link to the Fed’s word-for-word text. This verbatim text is meant for market professionals.

Examples of Fed Speak in Action:

“But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?"
Alan Greenspan, Chairman of the Federal Reserve Board, 1996 Speech

Translation: Stocks appear to be grossly overvalued (the Internet bubble).
_

"It's pretty clear that it's an unsustainable underlying pattern. People are reaching to be able to pay the prices to be able to move into a home."
Alan Greenspan, Chairman of the Federal Reserve Board, 2005 Speech

Translation: There is a housing bubble in the U.S., and it will crash.
_

“With recent improvements in the economic outlook, the need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus.”
Bank of Canada, Press Release, Apr 2010

Translation: We will be raising interest rates soon.
_

The importance of understanding the Federal Reserve cannot be underestimated. To a large extent, the Fed determines the near-term growth or contraction of business, and therefore the direction of the stock market. In addition, the Fed is a reliable asset bubble "early warning system." Learning to speak Fed can save you a lot of anguish.

____

“Augmenting concerns about the Federal Reserve is the perception that we are a secretive organization, operating behind closed doors, not always in the interests of the nation as a whole. This is regrettable, and we continuously strive to alter this misperception.”

Alan Greenspan, Federal Reserve Board Chairman, 1996

The Canadian Housing Bubble: CREA to the Rescue

In response to a series of headlines suggesting that real estate is overpriced, visibly annoyed members of the Canadian Real Estate Association issued a statement today denying any possibility of a housing bubble, with scores of statistics and beautiful charts to support their claim.

In this article, The Frost Report reviews the CREA's rebuttal (and why they should be ashamed of themselves).

__

CREA: “Canada’s solid mortgage market trends, conservative lending practices, and prudent borrowing by home buyers means that Canada will avoid a U.S.-style housing price correction.”

The Frost Report: Canada's conservative lending practices are a myth. In the heat of 2006 Canadian banks were, just like their American counterparts, doing loans without even confirming the borrower’s income. As long as the client’s credit bureau reported the name of the company they claimed to work for, this was considered enough evidence. In addition, although the Canadian Mortgage and Housing Corporation has strict guidelines regarding credit scores and income levels required for approval, a CMHC representative recently told me that they had been making exceptions to the rules "left right and center."
__

CREA: The “vast majority” of Canadians have mortgages they can afford.

The Frost Report: Canadians can afford them today because of record low interest rates, which is exactly what caused the bubble to re-expand. For several months now the Bank of Canada has been warning consumers that interest rates will be increasing, and expressing concern about their personal debt levels. From June until Nov 2009, many if not most new mortgages were variable rate; this worried the Bank of Canada as well as the Big 5 banks. As a result, laws were passed stating that all buyers must qualify for a fixed rate even if they intend to take a lower (for the moment) variable rate mortgage.
__

CREA: “Over the past 12 months, most new mortgages (64 per cent) have amortization periods of 25 years or less. This is an increase compared to 54 per cent one year ago.”

The Frost Report: The insinuation here is that since people are choosing 25-year mortgages (with higher payments) instead of longer-amortization mortgages, they must have money to spare. In fact, the opposite is true. In the past year home prices have become so high that the majority of home purchases have been from existing homeowners - either selling and repurchasing, or doing equity take-outs to purchase second properties. First time homebuyers are seldom able to afford 25-year amortizations. The decline in longer mortgages means that first time homebuyers are abandoning the market.
__

CREA: Twenty five per cent of mortgage holders recently increased their home equity via lump sum payments against the principal and/or by increasing their mortgage payments above their scheduled payment.

The Frost Report: It is not these homeowners, but the 75% of homeowners that do not or cannot make extra payments that is concerning. The CREA's comment ignores that fact that if even a small percentage of homeowners fall behind on their payments it will bring down the entire market. In the United States in Q3 2007, subprime adjustable rate mortgages made up only 6.8% of the market, yet accounted for 43% of foreclosures.
__

CREA: Most mortgage holders (77 per cent) have a home equity position of at least 25 per cent.

The Frost Report: This is because until 2006, 25% was the minimum requirement to purchase a home in Canada. At that point, the minimum down payment was changed to 0% in order to boost the housing market. Presumably because of the risks, CHMC pulled the plug on zero down payment mortgages in 2008. The minimum is now 5%.
__

CREA: Housing prices will not drop. Instead, personal incomes will rise to match home prices.

The Frost Report: I feel vomit in my mouth right now.
__

It's hard to imagine a more biased source of information about real estate than an organization whose purpose is to represent “more than 96,000 real estate Brokers/agents and salespeople working through more than 100 real estate Boards and Associations.” Still, the CREA could do the morally upright thing and at least present the potential downside risks. Due to the CREA's press release, hundreds of dreamy-eyed homebuyers will once again enter the market, oblivious of the dangers.

For more examples of CREA spin-doctoring, see Spin City.

For the full text of the CREA statement from which this article was based, see: Relax: It's Just Another Housing Market Cycle.

____

“There is no evidence of a housing ‘bubble’ in the United States and housing demand should stay strong for years to come.”

James F. Smith, Society of Industrial and Office Realtors, 2005
____

Canadian Debt II

Nothing confirms things like a good old-fashioned survey.

When I wrote about the perils of Canadian debt (Spending 'til it Hurts) I had no idea that CMHC would soon be confirming those ideas; but they did, with the spin cycle set on high.

Today, CMHC released the results of a survey showing that Canadian consumers are not - in the least - concerned about their high debt levels. In fact, 68% of new homeowners feel that they will be able to pay off their mortgages early, which means that they expect free cash flow and good times ahead.

The report also confirms that Canadian consumers feel they are savvy real estate investors, due to the extensive "self-education" they undertake before making purchases. This self-education includes consulting mortgage brokers, lenders, and real estate agents (all of whom have a vested interest in selling homes).

As a side note, the CMHC report frequently reads like an advertisement for mortgage brokers, including this gem: "According to mortgage consumers, the benefits that mortgage brokers offer are that they are able to get the best deal or rate for their clients, they are convenient, and they offer time-savings when obtaining a mortgage." On the same page is a photo of a smiling, embracing couple: presumably homeowners.

Hubris and propaganda continue to feel the love in Canada.
____

CMHC survey

CNBC article (regarding CMHC survey)
____

"(It's) actual mandate today, which is different from what it was back 20 or 30 years ago, is really just to get people into houses...and that's always been something that bothers me, because it really doesn't have a stability mandate."
David Dodge, former Governor of the Bank of Canada, describing the role of the Canadian Mortgage and Housing Corporation (CMHC), February 2010.

The World Housing Bubble

The title of this article is a bold statement…world housing bubble.

The near-failure of the U.S. economy in 2007 brought with it the ultimate Keynesian response: extremely low interest rates, all across the globe. Shockingly, although countries lowered their rates in response to a real estate collapse in America, the result has been bubble-like housing growth all over the world.

Consider this selection of recent articles…

___


CHINA

Overseas realty proves safer bet
“More wealthy Chinese are buying overseas properties for better investment returns as skyrocketing property prices in the country makes domestic home purchases more risky.”

www.cs.com.cn/english/ei/201003/t20100322_2373066.htm


AUSTRALIA

House surge leads to mortgage stress
“VICTORIA'S resurgent housing market is putting borrowers under severe financial strain, even if they are employed or earn more than $80,000 a year.”

www.news.com.au/money/property/house-surge-leads-to-mortgage-stress/story-e6frfmd0-1225843130252


CANADA

House prices to hit record: Scotiabank
"Canada's housing boom will continue this spring as exceptionally low mortgage rates and the expectation that borrowing costs will soon be headed higher – add a sense of urgency to consumer buying."

www.theglobeandmail.com/report-on-business/economy/house-prices-to-hit-record-scotiabank/article1509303/


ISRAEL

This bubble won’t bust, if we build over the Green Line
"The great crisis in the financial market drove people out of financial assets while historical low interest rates made mortgages much cheaper. The feeling that the only safe assets are the old-fashioned ones, first and foremost solid buildings, combined with a wave of foreign Jewish investors rushing to buy homes in the land of the Jews as a kind of an insurance policy drove the prices of homes in Israel to the top."

www.jpost.com/Business/BusinessFeatures/Article.aspx?id=171505


SOUTH KOREA

Housing Market Bubble possibility not high nationwide
"A KCCI representative commented that 'although there are many ongoing debates about the possibility of housing bubble...the possibility of house bubbling is quite low,' and further added that 'we must rather focus and prepare ourselves for the possibility of sudden drops in house prices due to unstable economic situations.'"

english.korcham.net/bbs/viewnotice.asp?code=reports&page=1&id=460&number=460


U.K.

Fears grow that new mortgage drought could hit house prices
"House prices fell 1.5 per cent in February after seven months of uninterrupted growth, according to the Halifax, the UK’s biggest mortgage lender. It says that buyers were deterred from visiting estate agents by the severe cold weather and changes to stamp duty."

www.timesonline.co.uk/tol/money/property_and_mortgages/article7060101.ece


LEBANON

Salameh rules out any real estate bubble
"Central bank Governor Riad Salameh said on Thursday that he does not expect a real-estate bubble to take place in Lebanon, and that the surge in property prices in the country is due to a real increase in demand."

www.beirut-online.net/portal/article.php?id=6669


SWEDEN

Economists reject 'housing bubble' report
"Economists from state-owned mortgage lender SBAB have rejected as unfounded warnings from the National Housing Credit Guarantee Board (BKN) that Sweden stands on the precipice of a house price crash."

www.thelocal.se/25236/20100226/

___


The worldwide economic recovery, which is only now taking shape, is threatened by the very thing that started the crisis in the first place: real estate. Only this time it doesn’t just involve a single country.

The world's economies are in a dangerous position. On one hand, increasing rates could slow down or even derail the recovery. On the other hand, the longer interest rates stay low, the more unsustainable long-term real estate prices will become.

Somewhat perversely, the U.S. economy seems to be the real winner here. After two years of suffering, U.S. banks have recapitalized and are sitting on cash; home prices are affordable; consumers have been paying down debt. Although the U.S. economy looks ragged at the moment, it is in the best position to move forward.

One can only hope that the world real estate reversal will be more anticipated, more orderly and more methodical than the earlier U.S. meltdown: yet somehow, I doubt it.

Investors can do some simple things to prepare for the inevitable. First, take some profits and build cash. That does not mean selling all your stocks, for heated markets can rise for much longer than you may think. It does, however, mean selling parts of your portfolio related to housing and construction. It also means making sure that if you have a margin trading account, you are using margin sparingly, if at all.

Most importantly, be vigilant -- which includes checking this website from time to time. When the “things have slowed down but are still fine” headlines start making regular appearances on the news, it’s time to start considering making money on the downside.

As manias subside, the result is never pretty.
____

"When money is free [interest rates are lower than inflation], the rational lender will keep on lending until there is no one else to lend to." George Soros

Chinese-Style Bao Ba

A quick and dirty definition of a bubble is when, a) everyone thinks that an asset is overpriced, but b) they want to buy it anyway.

This is precisely the situation in China, where, according to state news agency Xinhua, 86% of investors believe that a housing bubble has begun; yet 92% expect prices to remain steady or rise. On average, investors expect a gain of 4.4% per quarter, or 17.6% per year! Recent adjectives used to describe the Chinese housing market include “rocketing,” “sizzling,” “surging” and “searing.” In capital city Beijing, a 950 sq ft apartment costs the equivalent of $2.8 million dollars to an American (roughly 0.65 month’s salary per square foot). And if all that were not enough, the General Office of the State Council (Jan 16th) issued a report noting that “excessively rising house prices have recently emerged in some cities,” and recommended “restraining purchases for speculators and investors.” Ouch!

When something is this obvious, it’s painful to watch.

____

“One clear indication of a bubble is the rapidity of the price rise. Although there are occasions when sharp increases in the price of individual stocks are justified, this has never been true of market sectors.” Jeremy Siegel