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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Increased Risk that Something May Happen in World Markets

World markets fell again today, increasing the likelihood that adverse consequences could result if the drop in equity values continues.

Nervous investors are worried about Greek debt, the Euro, and other things that change regularly, keeping the U.S. economic recovery in jeopardy but increasing news turnover and ratings significantly.

If credit markets continue to tighten, it could result in conditions that may negatively affect the U.S. market, leading to a double-dip recession. Despite this, moderate economic growth is predicted unless something else occurs.

In a statement released today, T.V. personality and part-time economist “Dr. Sinister” said that the S&P 500 could fall to as low as 700 to 500, or could go “even lower.” He did not elaborate on how these numbers were chosen, but his expression appeared very serious so it must be true.
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“…if there were to be a significant tightening of financial conditions and credit availability gets tighter in a big way, there is risk the economy could fall back into recession...”
CNBC, 24 May 2010, http://www.cnbc.com/id/37324540
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"Nearly everyone interested in common stocks wants to be told by someone else what he thinks the market is going to do. The demand being there, it must be supplied."
Benjamin Graham, The Intelligent Investor

Cognitive Dissonance

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Improve your investing by improving your way of thinking.





"Cognitive dissonance" is the name for anxiety caused by disconcerting thought processes. That is, when people are faced with facts that make them uncomfortable, they tend to ignore these facts, literally to the point of self-denial.

Cognitive dissonance is the reason why a mother won’t accept that her son is dead, even when the police are standing in the doorway telling her. Cognitive dissonance is the reason why a husband with an unfaithful wife will always be the last to know. It is why those in debt do not open their mail. It is why Al Capone thought he was a good person because he donated to charity. And, it is why Americans who wished to buy a home in 2006 (or already had one) insisted that there was no housing bubble, despite all evidence to the contrary.

It is a natural thing for people to seek confirmation of their existing beliefs. Finding facts to prove you are right is both satisfying and comfortable. This is why conservative Republicans watch Fox News, anti-globalization protesters read Noam Chomsky, and why environmental activists seldom read the Oil and Gas Journal. But in order to be a truly effective thinker, one must embrace cognitive dissonance by intentionally seeking disconfirming evidence. For many great thinkers, including investors Charlie Munger and George Soros, the best technique for embracing cognitive dissonance is a simple one known as “Inversion.”

Inversion states that in order to prove that something is true, you should try to prove it false; that is, for any strong belief that you have, regularly search for evidence you might be wrong. If you wish to buy a stock, for example, you would include a search for reasons not to buy it. You would read not just the glowing press releases about the company, but also seek out all negative facts about the company, and judge these facts without emotion. Only after finding no significant reasons not to buy the stock would you actually buy it.

Cognitive dissonance is not easy to overcome. You will be fighting natural human emotion every step of the way. Despite a lifetime of working on it, I have fallen prey at least twice, and will no doubt do so again. But by making a habit of questioning your own judgements and attempting to prove your own beliefs false, you will become a stronger and more reliable investor (and possibly a better person). Soon, you will find that your mental discomfort becomes a source of pride and pleasure, not to mention lucrative.
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“Faced with the choice between changing one’s mind and proving there is no need to do so, almost everyone gets busy on the proof.”
John Kenneth Galbraith