Saturday, November 21, 2009

Who's to blame?

Who's to blame?
My opinion on whether there was a housing bubble is well documented, but my thoughts on what caused it have never really been explored in much depth. Thus, today I present my not-humble-what-so-ever take on what the underlying causes of the housing bubble were. So, without further ado, on with the show...

That right fellow babies (channelling my inner Johnny Fever), you and me. Well, perhaps not you and me specifically, more in a general sense, you know what I mean. Ultimately the buck stops with all of us... and it's going too, and in more ways then one when you figure in our role as taxpayers.

We do dumb things, myself included, just ask my dad, he could reel off chapter and verse most of the first 18 years of my life... and probably more then a few of the ones since. We're prone to herd mentality, susceptible to greed, lust, a need for social acceptance, status... not to mention the most terrifying force known to man, the nagging significant other!


Houses are a deeply emotional purchase for most. They're not just shelter, they're "home," they're family, they're status, and they most often the largest purchase we make in our lives, and can take most of your working life to pay for.

So, first and foremost, the consumer must bear the stain of this bubble, and certainly will... we signed the papers, we dug the hole, now we have to climb out of it. There were other factors though, and now we'll discuss some of the usual suspects.

Ah yes, the brand name masquerading as a "profession." They're an easy, and seemingly popular, target for scorn. Which they largely bring it on themselves... but are they responsible for the bubble? Nah.

Beneficiaries of it? Absolutely. Contributed? In some ways, perhaps. But no one had a gun held to anyones head when they were making offers, and I'd hanker to guess that even if the agent told the prospective buyer it was a bad idea, that buyer would just find another agent that would sing the tune they liked.

Bottom line, these guys are in commission sales. So, if you're expecting any message out of their associations/boards/agencies other then "buy", you're only fooling yourself. Those groups only exist to further the interests of their membership, their membership wants transactions. You do the math.

The ethics of these obviously self-interested parties parading themselves as experts is questionable at best. Regardless, the public must take responsibility for their own actions, and consider the source. Think about it, would you expect the CEO of Ford to say anything other than people should buy vehicles? Ultimately it's all marketing, and should be viewed as such. So, while a case could be made for them contributing to the bubble... they had little if anything to do with the underlying causes.

Another group that certainly benefited, but really didn't have anything to do with the causes. These guys are just middle men, they grease the wheels and take their cut. If anything these guys probably behaved themselves the best out of all those discussed in this article.

Bank of Canada
Carney and Co. are another popular target, particularly of late. They've even kicked off the finger pointing, conveniently singling out lenders (convenient because if they point it anywhere else it'd be directly or indirectly at their overlord(s) in parliament). Ultimately though, interest rates are largely determined by the market, and that is well beyond their control.

What influence they do have, is largely ceremonial. For the most part they just follow the United States lead, as to not upset the apple cart and cause undue fluctuations to the exchange rates... which would wreak havoc on that rice paper castle that is this so called "recovery."

And as far as our bubble here in Alberta, we arrived long before the current ultra-low rate environment came around. Sure it added another big season of sales which effectively just dug us a bit deeper, particularly in regards to defaults, but we were plenty deep already... we just have a bit more company now on the domestic front.

We're getting warmer, and typically this is a group that should take heat for situations like this... but they would usually also have some skin in the game. And that is where the true root begins to expose itself.

Historically market forces keep the lender honest. On mortgages they make their money on the margin, they get access to capital at one rate then lend it out at a slightly higher one. In return for this payout, they bear the risk of the borrower defaulting... and as that is typically a timely and costly occurrence, that is why they do such thorough vetting of the borrower to ensure they are credit worthy.

In modern times we've seen a move away from this model though, particularly when it comes to high ratio loans. In Canada, we've seen the establishment of the CMHC. They basically insure all high ratio loans (those with less than 20% downpayments), this takes the risk largely away from the lenders, who can then lend to everyone at the same rate, above which the borrower pays a risk premium indirectly to the CMHC (who is then on the hook for any deficits in the event of default).

This situation presents a moral hazard then to the lender, particularly recently as prices have rocketed up and downpayments have dwindled. They are now still largely in charge of vetting the borrower, but as they now bear no risk for default... thus, it's entirely in their interest to lend as much money as possible, to as many people as possible. As long as the CMHC signs off on the borrower, the lenders have no skin in the game.

They can just sit back, collect their margin with no worry if rates shoot up or the market goes to seed and the borrower defaults, cause the CMHC has them covered. It's something of a licence to print money, and all the lenders know it. That's not to paint lenders as the bad guys though... they're playing by the rules, and exhibiting behaviour entirely predictable given the circumstances.

And that brings us to the CMHC... we're really starting to heat up now. These guys will probably be a real lightning rod for years to come. Though again, they were not so much the generals as they were the soldiers.

Their actions were what really fuelled the bubble here, which is now largely nation wide. It was the stripping of lending standards that turned a hot but sustainable real estate market in Alberta in '05, into a overheated time bomb from '06 on.

They pretty much threw gas on the fire. At the begging of '06 a borrower had to have at least 10% down and had a maximum amortization of 25 years... then it became 30 years... then months later 35 years with 0 down... then finally before year end, 40 year amortizations... and just in case that wasn't enough, you could go as long as ten years without putting a penny towards principle.

The bar was lowered, and lowered and lowered some more, and Albertans came rushing in with cash in hand... well, maybe not so much with cash in hand, but I digress. The floodgates were thrust open to a whole new group of buyers that otherwise would not have qualified, and even for those that would have it made available much larger sums.

Such rapid and extreme lowering of lending standards made the conditions rife for a bubble, and one formed. But ultimately it was not the CMHC that made those directives, they merely did the bidding. You see, the rest of the true blame lies with the...

Federal Government
I can hear the wailing already in ever so Tory blue Alberta, but I'm really not a partisan nor have an axe to grind. If you held a gun to my head and made me pick between the Conservatives, Liberals and NDP... I'd say pull the trigger.

I'm more a moderate libertarian than anything, not to be confused with the assholes of epic proportion that largely make up the ever so prevalent Randian variety (but those with borderline personality disorder need something to read I guess). I'm no more a trusting of big business then of big government, but in the presence of the former I acknowledge a need for the latter. But enough about me.

Can't hang it all on Harper and Co. though, there were moves originated all the way back to Chr├ętien that helped pave the way, chiefly among them removing the price ceiling. But it was mainly Stevie-boy who blew the doors of the barn with all those moves discussed in the prior section.

Then when the air started to leak out, down came the directive to approve "high-risk" borrowers in greatly increased numbers, which really fuelled the '09 surge. If things had stayed at 10/25, while something of a bubble may still have been possible, it would have been but a small fraction of what became.

To their credit, they apparently saw the error of their ways to a degree, and did away with the 0/40's, now the best you can do is 5/35... but most banks will lend you the 5% anyway, so effectively 0/35.

And of course, they are also a minority government, which means they couldn't have done this without some help (or at least tacit approval from the others). It was a rather shrewd political move by Harper actually... he knows the masses are happy with the illusion of wealth created with rising home prices, and figured that could be enough to get him that precious majority.

Even if the other parties were smart enough to recognize the potential dangers of a housing bubble, telling the populous that they're not as rich as they think would not be greeted warmly. The opposition parties don't want to get blamed for popping the bubble, and for the same reason the Conservatives don't want to apply the brakes.

Thus, we continue our trip down the primrose path blissfully believing "it's different here," even after having ring-side seats to see the United States blaze the trail of libertine indulgence. We just dig ourselves deeper and deeper, until the inevitable...