You ain’t seen nothing yet, Prime-1.00 Variables

Pettis Law #17: You have not entered into the final stages of a bubble until you hear repeated use of the phrase “You ain’t seen nothing yet!”

via China Financial Markets

That is the concluding remark of Michael Pettis from his rather shorter article on excessive railroad investment in China and (ironically) the growing demand for luxury goods.

I wonder if Law# 17 applies to Canadian housing…given today’s housing affordability report and remarks like these (via Canada Mortgage Trends):

John Bordignon, EVP Strategic Development at Paradigm Quest, says, “Consumers have been asking for adjustable rate mortgages (ARMs) more and more, which in my view is one of the reasons we’ve seen such competitive pricing.”

Let me remind you that one of the biggest reasons why US housing went bust was because of variable rate mortgages or ARM – adjustable rate mortgage as they are called down south.

“In the broker channel at least 65% of the volume has been ARM versus fixed,” says Bordignon. “Historically it’s the other way around—65% fixed, and the balance ARM.

I wonder if there is a way to find out…something akin to MBA (Mortgage Bankers Association) in US. My guess is that CMHC has to have this data.

Anyway history always repeats itself… and we will return to historic norms with or without a housing bubble.

George Hugh, Vice President, Lending Sales at ING Direct, tells us: “We can’t expect much more discounting.” Hugh senses that profit spreads on variable mortgages are near their minimum.

“We’re in very abnormal market conditions. Mortgage pricing is being driven by excess demand for mortgage business from balance sheet lenders (big banks).  For the most part, these needs are being driven by securitization and other debt issuance programs.  In addition, the Big 5 banks still have a ton of deposits where they pay ‘zero’ interest…and they have to put that money to work. This excess demand is causing mortgage spreads to deteriorate. But now we’re pretty well at a floor.”

Again, it was excess demand for securitized products (MBS or RMBS to be precise) that goosed the great housing bubble.

Another cause of the housing crisis for very low mortgage rates… needless to say, rates in Canada are still pretty darn low.

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Price-to-rent ratio

One of the metrics used by housing analysts, economists and real-estate investors to determine fair value of a house is the Price-to-rent ratio. One of the two simple and sometimes contested metrics (price-to-income is the other).

I think the burst US housing bubble should be a great post-mortem learning exercise for Canadians, especially those active in the housing market (agents, realtors, mortgage brokers, banks, buyers, sellers, etc)

I’ll get to the point now, the chart and summary below (via GreaterFool) shows the price-to-rent ratio globally for the last two decades.

The data is normalized with 100 being the long term average. Here are some quick take aways:

• Japan’s real estate continues to slide into an abyss
• US housing market doesn’t seem so bad now, does it?
• not surprised to see Spain at the top but am surprised at Canada being second
• data hides a lot of regional disparities – for example, within the US, Florida and California would trump Spain
• Ireland is ahead of other markets in correcting – but it also started earlier

Here is a long-term chart of price-to-rent ratio for US

Many US financial/economics bloggers have blamed the government/fed for not reading this very apparent bubble sign among many others.

Where does that leave us? While I couldn’t find a central source of rents across the nation, I put together data from the Toronto real-estate board to come-up with this chart…

Note: I have used a crude way to determine the average rent and price but the focus here is trend, the level is clearly out of whack since early 2000.

When you compare the top graph of global price-to-rent ratios to the one above, I think it can be reasonably deduced that the Price-to-rent ratio has only gotten worse since 2007.

I would really appreciate your thoughts/comments on this topic.