Abouuuuut….Face!

The CREA Gets Real




Just seven days ago, I wrote an article stating that the Canadian Real Estate Association should be ashamed of themselves for their cheery and completely unrealistic assessment of the Canadian housing market (see: CREA to the Rescue).

Today, in a stunning about-face, the CREA "updated" its forecast, admitting that by 2011 a "demand-driven downturn" will push Canadian home prices lower. They even added that the threat of rising interest rates and new taxes caused buyers to jump into the market sooner than they may have otherwise (something I wrote about in April, in Spending 'til it Hurts).

It’s unclear what prompted the CREA to come clean. I’d like to think it was my blog, but more likely they simply realized that a small dose of reality now prevents egg-on-your-face later.

Of course, the CREA is still being idealistic (read "deceptive"). Amongst other nonsense, they insist that Canada’s "conservative lending practices" and mythical "prudent borrowing" will prevent a large price correction; that the two most overpriced markets (Ontario and B.C.) will inexplicably plateau next year after a small drop; and, of course that the current market shows a good balance between supply and demand. But, at least they aren’t encouraging a new wave of oblivious buyers. The CREA has, with its latest press release, gained back a shred of dignity.

I have to give credit where credit is due: the CREA did the right thing. More of the same would be nice.

For the CREA's full press release, see Housing Forecast Revised.
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"Home sales are coming down from the mountain peak, but they will level out at a high plateau -- a plateau that is higher than previous peaks in the housing cycle.”

David Lereah, Chief Economist, National Association of Realtors, USA 2006

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).
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"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.
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“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.
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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.

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“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).

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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."
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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.
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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.
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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.
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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%.
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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.
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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.

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“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
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