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Sunday, August 19, 2012

Final Fantasies: The illusions of personal debt and Candian consumerism

Canadians as individuals are in debt. In debt to an extent never before seen in Canadian history, and to an extent never likely to be seen again. Much of this debt, as I noted in an earlier piece, is invested in the ultimate middle-class dream of personal home ownership, a debt that has been backed by the government as a dangerous and "tax-payer" insured form of speculative stimulus.
Yet that is only one side of the equation and only one side to the story of how credit has been used to artificially sustain a middle-class consumerist illusion on a continent that has for decades increasingly turned away from the production of commodities.

The other side is that citizens, spurred on by government facilitated easy credit, have also begun to use credit to create lifestyles that would otherwise be unavailable to them and are borrowing well beyond what used to be the prime component of personal debt, home ownership. They are doing so, in many cases, by using their home equity as security.

The direct result of this is that, whereas in 1980 the ratio of household debt to personal disposable income was 66%; that ratio is now in excess of 150%. This amounts to an increase in this ratio of 127.28%. Over the same period incomes of all family units in Canada rose from an average of $61,900 to $72,700 (in 2010 constant dollars). This amounts to an increase of 17.45%
What this means is that personal debt in Canada, whether partially intended or otherwise, has acted as a form of not only highly dangerous economic "stimulus", it has also acted as a de facto mechanism of wage suppression and has ensured that the bulk of the risks assumed by this "stimulus" lie on the backs of citizens and not on corporations or financial institutions.

The impulses that lie behind the development of the present situation are clear. Canadians, to an unprecedented degree came out of the "Golden Era" of the post-war compromise better off than they had been in the country's history. Most Canadians, even those that in previous eras might have been deemed to be working-class, were fully engaged and incorporated into the consumerist materialist culture of North American Capitalism to a degree entirely unanticipated by previous generations. This lifestyle had created expectations, (and not, actually, for the most part unreasonable ones) in the minds of citizens as to how they should live and what comforts should be available to them. These expectations became further amplified as the high technology consumerism of the last 25 years dawned and grew, so that now, one may safely say, most "average" Canadian families fully expect to own their own house or condo, multiple televisions, a car or two,  cell phones, ipods, multiple personal computers, high speed internet access, and whatever other endless array of trinkets or technologies that we are bombarded with as the next necessary adjunct to a bourgeois lifestyle. This does not even include the expenses of entertainment, eating-out, dance classes for the kids, yoga workshops, gym memberships, travel and vacations, cottages, etc.

Correspondingly, however, this era of the new consumerism has been built in large part by shipping the production of many basic consumer and technological items "off-shore" to the Third World or to parts of the United States with Third World labour laws, and this has had a depressing effect on wage growth at the lower end of the income spectrum, has greatly diminished the importance of the manufacturing sector, with its relatively high paying jobs,  to our economy, and has meant that our economy as a whole has become tremendously reliant not only on the profit motivated corporate impulse to push production costs down in order to maximize return and availability of product, but on the societal impulse to acquire these products even when they are not actually affordable to us in both personal and broader ways.
Meanwhile, the bottom-line driven cost-slashing impulses of the corporate world have led companies to work very hard to keep wages lower. This does not only apply to the wages of the lowest level employees. All employees are effected by this, outside of the highest level corporate elite, and the mass waves of corporate lay-offs and "downsizing" we see from time-to-time, even in profitable corporations, serve not only to directly cut wages by firing people, but also to intimidate other employees to accept smaller pay and benefit packages or increases. That this is self-defeating in that, in a societal way, it serves to lower demand for the products and services that these corporations produce or provide, is seemingly irrelevant to them. (Remember, demand in an economic sense, is not what people want but what they can afford. This is why lower wages decrease "demand", or why, if one subscribes to classical economic terminology, one could say that there was no "demand" for food in parts of the world where the people cannot afford food).

At the same time, these employees, these citizens, have been led to expect a specific and highly visible, promised and promoted lifestyle that these same corporations are supposed to provide. In a democratic society where the power of Capital is greater than it has been for a generation, these incompatible impulses have to be resolved, to a large degree, by the government somehow. If wages are not increasing to the extent that expectations are, and to the extent needed to keep pushing the production of the goods and homes necessary for these expectations to be met, to keep the profits rolling in, and to keep the country's economy rolling along, what is to be done?
One way is through the implementation of personal income tax cuts. These have highly destructive results in other areas, including on inequality and on social programs and policy, but they do give the short-term illusion to voters that they are "better-off" then they were before because they see more money on their paycheque at the end of the week.
The other is by the extension of, and relaxation of the rules around, personal credit.
If you are not making enough to afford that new car, don't worry, "easy credit" low interest financing and a personal-line-of-credit backed by your home equity will come through.
Now this credit and this "spending" by consumers does stimulate and sustain the economy and economic growth. In fact, without it, it is very difficult to see how the recession of 2008 would not have been much, much worse. The artificial housing bubble was entirely government driven. The artificially and unsustainable low Bank of Canada interest rates of recent years have, in turn, meant lower interest rates on lines-of-credit, car loans, etc. This pushes citizens to go into greater debt to purchase new items and this does, of course, stimulate production and economic activity.
However, it is also something of a house-of-cards. Inevitably, when debt increases to such a disproportionate extent, interest rates will have to increase to cool an obviously dangerous and volatile situation. It was only a few years ago that the prime interest rate was above 6%. Now it is 3%. It will revert. This is just a matter of time.

As a Bank of Canada report noted,  "the ratio of consumer debt to disposable income was relatively stable until the mid-1990s when it began to move persistently higher. The predominant source of this upward trend has been secured personal lines of credit (PLCs), which grew at a much faster pace than more traditional forms of consumer credit such as credit card debt. Secured PLCs, which are mostly secured by housing assets (i.e., home-equity lines of credit), have risen sharply both in absolute terms and as a share of total consumer credit. In 1995, secured PLCs represented about 11 per cent of consumer credit; by the end of 2011, this share was close to 50 per cent."
Thus, we see that many Canadians are using the equity they have in one form of debt, and debt that is in what everyone acknowledges, including our own Finance Minister, a housing bubble that is now cooling (at the most optimistic interpretation) to allow themselves to assume further debt. Debt that was attained during a period of low "easy" credit interest rates but that is transitioning into higher and less consumer friendly interest rates. When and if the bubble bursts, and to what extent it bursts, could have a devastating correctional impact on these PLC's and could also have a terrible impact on the economy, the personal well-being of hundreds of thousands of Canadians and a highly detrimental impact on the government's budgetary situation due not only to the fragility of the CMHC situation, but also due to the ripple-effect on the economy as a result of personal bankruptcies, foreclosures, defaults, etc.
In the end, as a society we have created a culture of debt, not to sustain ourselves through times of need, but rather to sustain the self-indulgence of our consumerism and the hyper-profits of corporations. Our debt cushion, a cushion that means that the average Canadian is now over $100,000 in debt, is the only thing that keeps the house of cards intact and is the only reason that we can have a society that is based on consumption ahead of production and that outsources the heavy lifting for its consumerism to the less fortunate of the world.

Monday, August 6, 2012

A nightmare on Main St.: the CMHC and the Canadian housing bubble

The numbers are becoming increasingly clear; the bloom is off of the Canadian real estate bubble and boom.

Among a variety of indicators, sales of condos in the second quarter of this year in Toronto have fallen by half and a record number of units were left unsold. In Vancouver July residential sales were the lowest for any July in ten years and fell 11.2% from the month of June.

While prices are not dropping yet, the fact that commentators from the business and real estate communities themselves believe a 15% downward adjustment in prices is imminent means that we can likely expect a greater decrease. These are, after all, people whose best interests are served by minimizing any potential housing market panic.

The increasingly interventionist actions being taken by the Conservative government and Finance Minister Jim Flaherty to dampen the market, counter-intuitively if one does not really understand what is behind the real estate market boom of the past few years in the first place, also shows that the powers that be are worried. Very worried.

And they are worried for good reason. It was the government itself that facilitated the creation of the overheated market  and it is the government that is ultimately on the hook for the tab should an American style meltdown occur. Which means that, in the end, you are on the hook.

Many of us have, from grade school on, been inculcated with the notion that we live in a "free market" society where prices reflect the interplays between supply and demand that fluctuate due to the rational economic decisions of buyers and sellers. For those who truly enjoy simplistic fantasies our own publicly owned broadcaster, the CBC, has programs with imbecilic "commentators"  like Kevin O'Leary or that are cheerleaders for a world that exists only in the demented dreams of libertarians, such as the hilariously summer school economic "thinking" that the radio show "The Invisible Hand" soothes those who might doubt neo-conservative ideas with. Both on, ironically, a "tax-payer" funded network.

But the actual economy is much more of a planned Pyramid Scheme where the greater a company or sector's economic clout and the higher up they are in the pyramid in terms of importance to the fundamental soundness of the country's economy in the eyes of the government, the less they face the vagaries of actual market forces. The nearer to the pinnacle, the more the government intervenes, directly and indirectly. This has been true for decades, but was made most obvious during the 2008-2009 bailouts.

In the case of housing, Canadian society has raised the concept of personal home ownership to near fetishistic levels. It is part of the "Canadian Dream" that you will own your own little plot of land (or sky, in the case of condos). It is a logical extension of what originally brought many to the so-called "New World" in the first place a hundred or more years ago; only now the land is far from free for those who wish to settle it.  A staggering number of citizens buy into the notion that owning a home represents some kind of freedom, despite the reality that "their" home is actually usually owned, for at least the first twenty-five years, by whoever provided them with a mortgage. Missing a few mortgage payments will make this abundantly clear.

Given the centrality that personal home ownership holds to the sense of self-actualization of much of the electorate, it is hardly surprising that, especially if it felt that the economy might be stalling, a government might chose to make sure that the "free market" worked in such a way that it would continue to facilitate this dream as a highly dangerous form of "stimulus".

And this is precisely what the Canadian government did in the period after 2008.

Under the auspices of the Canada Mortgage and Housing Corporation (CMHC) the Canadian government has insured the mortgages that Canada's banks have provided to Canadians to the tune of a projected $558 billion this year. This figure, one might note, represents over one-third of Canada's total GDP! This is up dramatically since 2007-2008, directly due to the fact that the government raised the limit on mortgages that CMHC could insure from $450 billion to $600 billion and loosened the rules on what types of mortgage would qualify.

Insured means exactly what you think it does. In the event that Canadians begin to default on their mortgages, and in the event that this default level were to reach the point where the CMHC could no longer cover defaults, the government of Canada, and, therefore, you will be on the hook for the bank's "losses". As Chris Horlacher of the free market, right-wing think-tank, the Ludwig-von-Mises Instistute of Canada shows, the inability of the CMHC to cover defaults in the event of a real bubble burst is highly likely. This is due to the fact that the CMHC's "assets" are largely identical to what it is insuring, namely mortgages! "In the event of a severe downturn in the mortgage market, claims will start pouring in. The CMHC (nor any kind of insurance company) never possesses enough cash to cover all of these potential liabilities, they invest it. The problem here is that the CMHC has bought the very same assets they are insuring against. If the mortgage market collapses, so too will the value of the assets of the CMHC, making them extraordinarily difficult to liquidate in order to raise the cash necessary to pay out their claimants. It’s a catch-22 that spells potential disaster and deeply impairs their ability to actually insure against this particular type of credit risk."

Given this, Horlacher goes on to conclude that "The CMHC remains highly susceptible to even a slight increase in the rate of mortgage defaults, or a rise in interest rates. With the federal government, and ultimately the Canadian taxpayer, on the hook for all of the CMHC’s liabilities we could soon find ourselves in an extremely difficult financial position."

In other words, to facilitate the accessibility of easy credit the federal government took the risk to the banks out of potentially risky mortgages and laid them at our doorsteps.

In addition, for several years, in response to the economic crisis that began in 2008, the government allowed the CMHC to insure mortgages with amortization periods above 25 years, with lower down-payment requirements and with unsustainable, artificially low interest rates courtesy of the Bank of Canada.

This had a direct and intended consequence. It allowed the banks to offer mortgages to people who, in reality, could not really afford to enter the market and this, in turn, allowed those people to, in fact, enter the market. The reality of how this plays out can be seen from the fact that housing prices have risen far more rapidly than income. (These figures also lay to the rest the myth that the Canadian housing market is only experiencing a bubble in two of its major centres. The bubble is far more widespread than that.)

Taking these steps did stimulate growth in the construction industry and helped to dig the banks out of their recently uncovered, and previously denied, liquidity crisis. But it also had the effect of creating what amounts to artificial "demand" for houses and condos in many urban markets, most notably, but far from exclusively, in Vancouver and Toronto. This, in turn, drove prices up in dramatic ways, leading the banks to extend riskier credit to citizens desperate to get in on the action who, in turn were encouraged by the government created environment to buy properties that, by any objective standards, are out of their price range.

The CMHC, an organization that was originally formed, in part, to help to put home ownership within the reach of the average Canadian has recently done so by placing them into dangerous debt situations in an artificially created price bubble where even relatively minor downturns in the economy or drops in housing prices can create an economic disturbance whose ripple effects could lead to economic consequences akin to what is happening in Spain.

The basic facts of this situation have been acknowledged by Flaherty himself who has clearly and repeatedly stated that household debt in Canada has reached levels that threaten economic stability. He has made these cautionary comments in ways that make it seem that he is warning citizens for their own benefit and against their own behaviour.

But there is more to it than that.

The real worry, enough to keep finance ministers awake at night and to get them to try to manage the burst of a bubble, is what will occur should the markets in Toronto, Vancouver  and elsewhere experience a rapid downward market adjustment in both prices and demand, especially if people who bought residential units for speculative purposes (and there are more of these than is commonly understood) or at the height of their value suddenly find themselves holding on to mortgages that face higher interest rates down the road and making payments on properties whose values have declined by 15-20% or more (should a runaway effect occur). Given that, in many cases, these people may actually have far less equity invested in their properties than one might suppose, there is a point where default makes a lot more "rational" economic sense then the decision to buy in the first place did.

The worry of financial analysts, and our finance minister no doubt, is compounded, as Finn Poschmann a vice-president at the C.D. Howe Institute noted, by the fact that "Since 2007, Canadian banks have increasingly come to the covered bond market with bonds backed, in whole or in part, by mortgages individually insured by the Canada Mortgage and Housing Corporation. This insurance cover boosts the surety of the bond pool, and marginally lowers the banks’ cost of capital and, arguably, perhaps lowers the cost of homebuyers’ mortgages. But an otherwise functioning financial market also gains government and taxpayer participation, and risk exposure, to uncertain net benefit."

While he, of course, is looking at it from the perspective of the bankers, as he makes clear there are dangerous historical antecedents for this situation, and the government and taxpayers are, as Poshmann puts it "exposed".

This is an understatement.

In the end, this is a direct lesson in how governments help to create the conditions in which the present European style austerity regime becomes "necessary". The Canadian government, to aid with bank liquidity in 2008, to generate a kind of short-term, politically popular, but relatively high risk form of stimulus by loosening the reigns on personal credit accessibility and aiding very directly in the rise of the highly overheated Canadian housing market, and to help to sustain a middle-class fantasy that everyone should be able to afford a home even when we live in a system where this is not possible unless and until the government gets into the business of building and regulating housing as opposed to being the agent that props up the riskiest end of the entire housing sector, that of credit, has put us all at risk by underwriting the "exposure" of the banks themselves.

The government has chosen the most bank friendly model of "intervention" in the housing market; they don't build affordable housing for all, rather they allow the banks, at no risk to themselves, to put citizens into unsustainable levels of personal debt to own what is completely unaffordable housing.

If a real housing correction occurs, and if it results in an entirely predictable and at least somewhat likely wave of foreclosures and defaults, and if the government is forced to cover even a relatively small proportion of the near $600 billion in insured mortgages, the cuts of recent federal budgets will look like happy times with hindsight. The economic "side-effects" will also be devastating.

Even if this is a bullet that we do manage to dodge, Canadians need to ask themselves if the role of their government and their taxes is to fund social programs, health care, direct housing and infrastructure expenditures, or if it is to put all of these necessities at risk by removing actual market and risk factors from the mortgage business for the big banks by insuring and taking on liability for their loans and the lifestyle of a certain segment of the population, potentially on the backs of all Canadians.