Yes, it is true. Our brains aren't always purely rational.
For example, paying more than the equivalent cost of rent to purchase a primary residence.
Or perhaps buying an 'investment' property that has a capital yield of a government bond, with a risk profile like a stock and the potential to bankrupt the owner because of the leverage involved.
43 comments:
Oh Dear!
Another clip that attempts to explain behaviour finance. There's a 60 minute feature at Nova: Mind Over Money that aired two nights ago. It attempted to explain the issues as rational vs. irrational. Unfortunately, quite missed the point. Couldn't grasp the discipline of efficient markets.
I believe that markets are efficient over the long run but manias and panics can punctuate this long run efficiency.
This is what behavioural finance attempts to explain or at least recognize. That is, people are not always rational, evidenced by loss aversion, herding, overconfidence, etc. These are well documented behavioural phenomena and I think can help explain a lot about where we may find the markets from time to time, including our current housing market - - mania.
Markets may very well be efficient (for certain definitions of efficient) in the long run; but people aren't terribly rational actors, and that's got a wealth of scientific data behind it. Game theory and psychological testing all can show in a controlled fashion how predictably irrational people can be (and how someone can manipulate the decisions of others); and market discipline, like any discipline, doesn't prevent the irrationality from happening. It just reacts to it.
Bubbles are great for producing extra supply, I will say that. But mania and panic extract a social cost. Watching this bubble (first in the States and now here), has made me better understand the Chicago school and how government interference set certain groups in motion, and I see and appreciate how the market works in a way I wouldn't have before - but at the same time, watching this bubble has convinced me beyond all doubt that the market is no solution to creating and maintaining the values I have for stable society: community, health, productivity, sustainability, security...
markets are good for producing a wealth of stuff, really. It's a cramped but hungry goal.
Right! Behaviourial finance (BF) is an extension of psychological research into decision making models using information theory. Win/Win vs Win/Lose.
This is different from a moralist viewpoint that people (or some people) are inherently lazy, stupid, crazy and/or evil.
BF is very relevant to investments and economics because decisions are frequently required with clear win/lose outcomes ($$$).
http://en.wikipedia.org/wiki/Behavioural_finance
It is a fact that in SOME SITUATIONS non-optimal decsions can be induced in SOME PEOPLE. Players can be induced to make high risk investments and even money-losing decisions because of ego,social status and fear/pleasure.
The advertising/marketing industry draws heavily from these insights in order to part you from your money.
The efficient market people would counter by saying that it doesn't matter if some people are emotional. As long as there are enough sensible people who can sell/buy the people who over or under-value assets.
Therefore, what matters is that a collective market acts rationally though it may take time to stabilize (weak form of efficient market theory).
The extremists like Shiller take the view that irrational behaviour occurs frequently and powerfully. Herd instinct is often cited as the reason why momentum is created as careful people are drawn into bubbles.
Therefore, collective markets are subject to violent boom/bust/boom. However, we have to ask whether markets are really as emotional as claimed? Why do bubbles not break out more frequently? What's holding irrationality back?
The famous Tulip Bubble may not be such a clear example of mania. Some would argue that the surge in prices was primarily caused by a change in the rules. That is, rational game playing. See Modern Views in ...
http://en.wikipedia.org/wiki/Tulip_bubble
Moreover, exogenous shocks may produce volatile results because of heightened uncertainty. Are buyers/sellers acting rationally (optimizing) based on the new situation, or irrationally?
Therefore, we need to understand the basis of market valuation. Usually, the stock market discounts the public information so well that no investor (working from public information) can consistently outperform the market. There may be emotions involved, but calmer heads prevail and we arrive at the correct prices.
As long as all the information is available to all the players, correct prices are maintained. Markets should not be over-priced on a sustained basis because rational owners (majority) will keep selling until the irrational buyers (paying too much) are satisfied.
Therefore, the strongest deterrent to mania is the availability of information. Disciplined players use information in a logical way. Emotional players get a reality check if they are willing to listen and think.
There are bias. For example, value stocks are often under-priced for substantial periods of time. Good for long term value investors like Warren Buffett. Similarly, desirable RE can be expensive for long periods of time until gentrification is complete. But, this is not the emotional excess that Shiller is interested in.
Stock markets have a better chance of being rational but there are at least four addtitional things going against the real estate market being so:
1) Government programs that work almost exlusively on the demand side of real estate (and agressively so).
2) Real estate is usable for a basic human need.
3) Real estate is very personal.
4) High transaction costs.
RentingSucks,
Another major difference between equity and RE markets is the wealth of independent research that is available to sophisticated investors in equity markets, while RE is dominated more by the great unwashed victims of propaganda by the industry.
Jim Tan seems to be stuck somewhere in the middle as he appears to sincerely believe his own BS.
In the States, buyers pushed prices up to historic levels of low affordability. Not just in boom districts like Silicon Valley and Manhattan, but in non-boom communities. As expected, supply caught up with and exceeded demand.
Prices fell. Forced sales and foreclosures. Empty apartment blocks and estates. Tears for speculators and foolish borrowers. Will they never learn? Blah Blah Blah! Surely this is an example of an irrational bubble.
But, there is one complication in the narrative of the bubble enthusiasts. Much of the fuel for the RE boom came from the explosion in subprime mortgages ($2 trillion) from 2001 to 2007. See High-risk mortgage loans and lending/borrowing practices ...
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#High-risk_mortgage_loans_and_lending.2Fborrowing_practices
It was a fact that some market players like John Paulson were able to take advantage of the subprime crisis while smart economists were taken by surprise. Therefore, the reason that the subprime crisis occurred was that critical information was not publicly available. The size, scope and nature of the new industry (subprime lending and repackaging as securities) was unreported, unsupervised and unregulated.
Decision makers would have acted differently and no crisis would have occurred. The American RE markets would have undergone only the regular cyclical downturn.
Borrowers would not have signed ARM where the true interest rate was 13%. Lenders would not have financed fraudulent loans. Insurers would not have guaranteed the securities. Credit agencies would not have rated them AAA.
Buyers would not have have bought the securities, Economists would have taken note of the risky enterprise. Regulators should have showed the red flag by 2005. Instead, they choose to blind the public and themselves.
Note that the subprime 'bubble' is different from the dotcom 'bubble'. In the tech bubble, the private sector was the main driver with stock market information fully available. The regulators were aware of the risks, but did nothing to encourage or slow the action.
On balance, I have to give this one to the efficient market people. The failure of information efficiency was the cause of the subprime disaster. The impact of $2 trillion of subprime mortgages helped magnify the general RE exuberance. People just didn't know there was a ticking time bomb. Information inefficiency was the primary cause of the RE crisis. Shiller's 'bubble' behaviour was the consequence.
Why is it important to make the distinction? In the Finance Reform debate, you can see the different viewpoints at work. The left wing are taking the moralist viewpoint. Profit-makers are inherently greedy and unscrupulous. Therefore, we must build high fences around the banks.
However, the moderates are taking the efficiency viewpoint. Information must be freely available to all decision makers. So, put all OTC transactions onto derivative exchanges where all can see what's happening. And, exchanges are regulated with margin requirement.
Note that no futures/commodities exchange was in danger during the great panic.
How does this apply to Vancouver?
One theory that someone floated (maybe Garth Turner and no I'm not a fan boy but when there aren't a lot of voices of reason you got to take what you can get sometimes) was that we were burning through our subprime now as a last gasp to fuel the bubble. I'm actually suprised that there was as much left to burn through as there was.
In Canada ARMs are called variable rate mortgages and I would argue that prices couldn't be this high if there weren't a lot of people doing this. There seem to be a lot of Canada wide statistics that don't look too bad floating about to do with this but not a lot of Vancouver specific statistics which would be very interesting. This goes to your point above that a lot of stuff was hidden and in our market it still is.
CMHC has also obfuscated many things in the past. At some point, although it is hard to know if it is still happening because they never actually announced it, they were allowing people to borrow up to 42 percent of their net income. Also at the same time they were offering 0 down 40 year mortgages, insuring speculators and counting 100 percent of your rent towards your mortgage qualification. A multiple of loosenings each alone making some sense but in total adding up to a large credit loosening.
They've restricted some of this now of course but the ultra low interest rates overshadow any of these prudent measures that were to late anyway. It actually still irritates me that they can come out with the line "We're not insuring speculators any more." and spin it into look how prudent we are. Canadians should be absolutely pissed off that CMHC was doing this.
So in summary to your argument I think that not all of the things that CMHC has done have come to light yet (hiding crucial information from us) and that Vancouver specific stats are hard to come by (also hiding crucial information from us). If anyone cared to look the inventory graph on Wil Wertheims blog is starting to look a lot like 2008. Nobody in the industry or in government (and certainly not people purchasing Vancouver property) are likely looking at this sort of data. So if blindness equals ineffeciency we're blind as bats.
"Therefore, the reason that the subprime crisis occurred was that critical information was not publicly available"
This is reasonable and fits with your markets being 100% efficient all the time. I don't really agree with that but having covered it quite a bit I see why people do (for instance arguing that the market is efficient but that information delivery wasn’t efficient is a paradox in itself). What bothers me is that people label only one cause to the crisis when in fact I would argue it was a mess of problems.
"The advertising/marketing industry draws heavily from these insights in order to part you from your money."
I'll agree with you on this one... The problem however is that they use it to "turn" portfolios to increase their yield. Implemented properly BF you can make money so long as you don’t approach things as a casino.
"The left wing are taking the moralist viewpoint. Profit-makers are inherently greedy and unscrupulous. Therefore, we must build high fences around the banks."
I dont think thats fully their point (but maybe the spin). The issue that must be resolved is that you have a disproportionate part GDP being represented by the banks and it is affecting policy. Sadly this all has happened before. :(
There is something called the "Financial Instability Hypothesis" which I think is very relevant to this conversation
"Over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.
In particular, over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance"
Note the quote uses terms from the article...
http://neweconomicperspectives.blogspot.com/2009/06/financial-instability-hypothesis.html
We're all subprime now. I thought it was obvious!
“In Canada ARMs are called variable rate mortgages and I would argue that prices couldn't be this high if there weren't a lot of people doing this.”
Dear Sucks,
Let me clarify. The ARM that I am referring to are predatory lending practices. For example, teaser rates (sub-market rate) is charged for the first two years. Then, the rate resets at 13% for example. Speculators used these ARMs because they could over-leverage themselves and hope for a quick profit.
Unfortunately, borrowers were contractually obliged to pay 13% interest. Therefore, it is considered predatory because the loan is against the ultimate interests of the borrower.
Moreover, mortgage lenders sometimes used salesmen operating door to door to sell these mortgages. The salesmen neglected to tell genuine homeowners that the monthly payment would double upon reset.
Please note that Canadian variable rate mortgages are not predatory. They are merely variable in interest rate. In Canada, the banks use the three-year mortgage rate as a threshold. Therefore, variable rate mortgages do not contribute to RE boom as some would think.
In fact, the CAAMP statistical analysis supports my view. Present borrowers are comfortable with their debt service payments. There are many variable rate borrowers, but they can afford the switch to fixed rates.
This is what I mean about information efficiency. No surprises here. No fraud. No time bomb. The borrowers know what they are getting into. They can plan rationally for the future. Results = low default.
“This is reasonable and fits with your markets being 100% efficient all the time ... for instance arguing that the market is efficient but that information delivery wasn’t efficient is a paradox in itself).”
Dear Buff,
I am not saying that markets are efficient 100% of the time. Indeed, I pointed out that markets are often efficient only in the weak form. And, there is bias e.g. against value stocks.
I am saying that the evidence points to the failure of information efficiency because critical subprime information was hidden from the public. Therefore, the general RE market was inefficient during 2004-8 and RE was mis-priced.
Let me clarify. The ARM that I am referring to are predatory lending practices. For example, teaser rates (sub-market rate) is charged for the first two years. Then, the rate resets at 13% for example. Speculators used these ARMs because they could over-leverage themselves and hope for a quick profit.
I'm saying that there has been enough little things tweaked to add up to something bigger (maybe something approximating 13 percent ARMS although that seems a little higher than I remember resets being). Nobody that gets a loan thinks can I pay this if interest rates go up or will paying this for 35 years be painful. They think if the bank says it's OK it will be OK. Under traditional lending standards this has proven true over a long period of time. When you tweak nearly all the numbers we just don't know if it is true any more or what is going to happen if there are stressors.
Actually this kind of thing is what led to the credit default swap problems. All modelling of risk was based on previous standards of lending and everything went down the dumper when things went sideways.
Here's an example of an economist predicting that the Canadian RE bubble will burst. Wrong?
http://www.realestatetalks.com/viewtopic.php?f=8&t=38949&st=0&sk=t&sd=a
In October 2008, Shiller offered the opinion that Canada would follow the States down. Didn't happen. It's not a case where he would be right EVENTUALLY. He was certain that the same conditions applied to Canada.
We now know that Canada is not like the States. Canadian and Vancouver RE followed a different trajectory. The bubble enthusiasts were 180 degrees wrong.
Why were they wrong? Shiller is a smart educated economist. But, his paradigm is limited to 'bubbles'. He identified symptoms similar to the States (surge in debt, rising prices, lower affordability, RE mania). He didn't identify the fact that Canada did not have a subprime crisis. No 13% mortgages. Mortgage fraud was not a thriving industry. Banks were conservative. No time bomb.
Cause and effect! The cause for a bubble was missing. Players in Canada (and Vancouver) worked with public information that was adequate. They knew the risks. They did their numbers. Unlike the States, there was lack of panic and momentum. The market was information efficient and RE was correctly priced for the context.
P,H&N analyzed the growth of mortgage debt, and RE valuation (IMF economist).
https://www.phn.com/Default.aspx?tabid=1234
“The author used an ECONOMETRIC MODEL to calculate an equilibrium or fair value price using demand (based on disposable income and demographics) and SUPPLY. The study found that while prices were somewhat above equilibrium in Alberta, BC and Saskatchewan, they were close to equilibrium in Ontario and Quebec. They also noted that the overvaluation in the Western provinces was largely a catch-up from persistently undervalued prices in the very weak housing market of the early 1990s. The report concluded that, on balance, the Canadian housing market was not significantly overvalued.” (Fall 2008)
I think that the main flaw of the bubble theorists is that they do not consider SUPPLY to be a factor. Indeed, they don't do econometric modeling.
IMO, you cannot have a steep sustained price decline without a flood of new supply. The exception may be in abnormal situations where the price runs up suddenly by 50% within a year, and reverses itself the next year.
The IMF working paper, the CAAMP statistical analysis, and the behaviour of the market in late 2008 and 2009 suggests to me that there was no bubble prior to September 2008. Therefore, the price decline during the great panic could not be sustained. RE remains expensive.
In Vancouver, developers and landowners have shown strong discipline. In the last twenty years, the rental vacancy rate has mostly fluctuated between 1%-2%. Compare with Calgary 2009 at 5% and Vegas 16%. Our developers are able to turn their taps on and off quickly.
Therefore, buying enthusiasm is being regulated by rational landowners and developers. They are allowing prices to rise without the bubble popping. The basic premise of a rational market where supply is limited.
Indeed, Vancouver buyers were acting rational in 2006/7 as the signals were still bullish. The vacancy rate was on its way down to 0.5% while the 8-CMA was still 2%.
http://cuer.sauder.ubc.ca/cma/data/ResidentialRealEstate/Vacancy/vac-vancouver.pdf
Thank you!
Told ya this guy actually believes his own BS.
Respond a bit to JimTan:
Therefore, the reason that the subprime crisis occurred was that critical information was not publicly available. The size, scope and nature of the new industry (subprime lending and repackaging as securities) was unreported, unsupervised and unregulated.
Decision makers would have acted differently and no crisis would have occurred. The American RE markets would have undergone only the regular cyclical downturn.
Borrowers would not have signed ARM where the true interest rate was 13%. Lenders would not have financed fraudulent loans. Insurers would not have guaranteed the securities. Credit agencies would not have rated them AAA.
Buyers would not have have bought the securities, Economists would have taken note of the risky enterprise. Regulators should have showed the red flag by 2005. Instead, they choose to blind the public and themselves.
All these things DID happen, did happen in the open, all players except the public DID know what was going on. The warning signs were glaring red for anyone in the public that cared to look. It's a lot bigger, sadder, more corrupt and more predictable than your little "efficient market" takes account for. Laws were changed, sometimes retroactively to accommodate it, rating agencies were co-opted, lenders advanced loans knowing full well that they made their money up front and passed the risk on. Insurers "guaranteed" without the backing to pay off if things actually went south. The FBI of all people warned of rampant fraud in 2004, and were ordered to ignore it! http://tinyurl.com/bczlxu
All this happened! And the efficient market did the thing it was supposed to do, took note of the fact that fraud and ponzi-style bubbles were now officially encouraged, and set itself up for wild swings and crashes, all to the great detriment of anyone unwilling to play by the new rules.
Let me clarify. The ARM that I am referring to are predatory lending practices. For example, teaser rates (sub-market rate) is charged for the first two years.
You want predatory teaser rates?
Free Mortgage Payments for Up to 2 Years at Marinus at Plaza 88 New Westminster"
http://tinyurl.com/ylca47u
You want 0% down?
Enjoy everything that life has to offer right now with a 0% down payment plan. Stop wasting your money on rent, and purchase a new Surrey ...! To get this zero down offer at Clayton Heights family homes, you can easily qualifty with a family income from as low as $49/hour today! Yes, that is 0% down for a fabulous new Surrey home! As for the zero down payment option, if you get a three year mortgage term, you monthly payments for a new Surrey family home is only $3300 per month.
http://tinyurl.com/y5rcra5
You want a cash-back mortgage for a self-employed declared income sub-prime borrower?
Our Canadian mortgage brokers specialize in self employed mortgages, no money down mortgages in Canada (5% cash back mortgages), sub-prime mortgages, private mortgages in Canada and debt consolidation mortgages all with expert advice and guidance you can only get from a licensed and fully trained Canadian mortgage broker. Our Canadian mortgage brokers negotiate with the banks on your behalf, getting you the best mortgage rates in Canada, best terms and mortgage products available, all at no cost to you!
http://tinyurl.com/386u6wb
All those are current, advertised, locally available. I don't think the efficient market would allow such products to be available if there wasn't a demand for them.
Subprime has more to do with the quality of the borrower than the structure of the loan itself. That a bank is willing to give a low rate to a borrower due to CMHC-perpetuated moral hazard is just as much "sub prime" as some crazy teaser schedule in the US, assuming the borrower's credit rating is the same.
I also think there was both more overbuilding and more true "subprime" lending in the US than we have seen in Canada. As much as CMHC has problems, you generally can't get a loan without some proof of income. That bar was raised last month.
It matters not. Prices compared to rents are high and, subprime or no, that's ALL I need to know to call a bubble.
It's well worth reading the Calculated Risk post on the FOMC minutes from 2004. The national price-rent ratio was thrown in the faces of Greenspan, Bernanke, Geithner, etc. Not only did they "adjust" the data to make it look less "alarming," they actually believed that a lower price-rent ratio was justified because incomes were going to rise faster than they had for generations before. I don't need a PhD in economics to see what a fallacy that was.
I wonder what data Mark Carney and his committees are looking at to formulate policy.
In the effort of being fact based here - in relation to ARM or teaser rate mortgages here in Canada. They do exist and CMHC insures them. Pool 987 in the NHA MBS program contains teaser rate type mortgages and there has been $17,376,495,464.82 underwritten in that pool 2005 to present.
More facts.
Variable Rate Mortgages contained within the NHA MBS pools.
980 $20,674,972,955.82
985 $105,400,963,811.28
Thanks mohican. Again, it's predominately the pool of borrowers, not the lender, that determines the "primeness" of the revenue side of the pool (government guarantee aside), though certainly a higher rate will be more prone to defaults regardless of the credit-worthiness of buyers.
I am aware of stated income loans being accepted through CMHC but -- and correct me if I'm wrong -- some form of reasonable documentation is required.
It makes some financial sense for a lender to get a borrower, whether prime or below-prime, into as high an interest rate as possible. Teaser rates and other predatory schemes aren't exclusively flogged on the downtrodden. I disagree that such schemes be labeled as "subprime" until we really define what "subprime" means.
Thanks for the discussion, all.
I will archive the examples gathered by alexcanuck at VREAA.
“All this happened! And the efficient market did the thing it was supposed to do, took note of the fact that fraud and ponzi-style bubbles were now officially encouraged, and set itself up for wild swings and crashes...”
Dear Alex,
Don't think so. The subprime mess caught a lot of economists and business media by surprise. Their explanation? The size of the sector was hidden in aggregate totals. The security packaging was done OTC. The secondary market was OTC. This was a new market that was unreported, unmonitored and unregulated.
By 2007, defaults were doubling (even before the recession). Some mortgage-backed securities issued in 2006/7 had a 50% default rate . Borrowers and investors were complaining. But, it was too late. WaMu and Countrywide were about to fail. Market insiders like Paulson were ready to bet against the securities. But, the government (Bush Administration) seemed to be the last to know.
Look at the estimates of growth of subprime loans. It was small (5% of total mortgages) even in 2000. But, @$2 trillion was issued between 2004-2007. By 2004, subprime had suddenly jumped to 20% and quality of the loans was terrible. See the chart 'U.S. Home Ownership and Subprime Origination Share'
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
The problem was not that subprime loans existed. Anyone can do that in a free market. The problem was that subprime loans grew so quickly in the States. Without regulations, much of that $2 trillion was predatory or outright fraudulent.
Dear Jesse,
I am sure that they are working with data prepared by economists. I am also sure that this time, they won't make the same mistake that Greenspan did. They just had a wake up call.
"they won't make the same mistake that Greenspan did. "
And what mistake was that, just for clarification?
“In the effort of being fact based here - in relation to ARM or teaser rate mortgages here in Canada. They do exist and CMHC insures them. Pool 987 in the NHA MBS program contains teaser rate type mortgages and there has been $17,376,495,464.82 underwritten in that pool 2005 to present ... Variable Rate Mortgages contained within the NHA MBS pools. 980 $20,674,972,955.82 985 $105,400,963,811.28”
Thanks Mohican. That's interesting. Please provide links so that we can all check it out.
Note that $17b (if that is all) is just a tiny fraction of the subprime origination in the States during 2004-6 (over US$2 trillion at exchange rate of @$1.20). Even adjusted per capita.
What's the teaser-rate proportion of all Canadian mortgages?
Look at the graph 'Fed Funds Rate & Mortgage Rates 2001 to 2008' in the wiki article on Subprime Mortgage Crisis.
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
Let me point out that simple variable rate mortgages worked out well for those who borrowed in 2006-7. One-year ARM rate was @5.5% in 2006-7. But, crashed in late 2008-9. Like the Canadian borrowers, those who still had jobs were in great shape because of better cash flow. Smart?
Did variable rate mortgages contribute to the RE boom? I don't think so.
One-year ARM dropped from 7% in 2001 to 4% in 2003. That's only a three percentage points drop. Quite moderate for a cycle top to bottom. By comparison, the Fed Funds rate dropped 5 percentage points. That benefited businesses borrowers substantially.
By 2006, the one-year ARM was back up to 5.5%, less than a percentage point lower than 30-year fixed rate!!!
Variable rates looked like they were priced correctly, and was not the critical factor in the RE 'bubble'.
The subprime mess caught a lot of economists and business media by surprise.
Well, yeah! The ones being very well paid to come up with quasi-logical truthinesses as to why it wasn't a classic bubble.
Being paid by the same people working hard to change the regulation.
Without regulations, much of that $2 trillion was predatory or outright fraudulent.
Right, those regulations, that were put in place to prevent such a problem, and then subverted, ignored and avoided.
The whole thing was not an accident, was entirely predictable and avoidable.
And was predicted, by a lot of very knowledgeable, independent voices, promptly ridiculed and marginalized by those intent on making personal fortunes off the bubble, aided and abetted by well meaning but naive and trusting believers in the efficient market and the wisdom of the government. Bubbles in general feel just wonderful to everyone involved right up to the moment of popping. JimTan, have a very close look at this link: http://www.mirrors-r-us.com/
"And was predicted, by a lot of very knowledgeable, independent voices, promptly ridiculed and marginalized by those intent on making personal fortunes off the bubble"
anyone remember that interview with Ben Stien and Peter Schiff? Sigh... Very sad. Note the 4 on 1...
http://www.youtube.com/watch?v=UfC2gRG9uJg
"It matters not. Prices compared to rents are high and, subprime or no, that's ALL I need to know to call a bubble"
So long as a large enough percentage is colateralized by debt, all that is needed after this is a credit cycle then poof we get to see the mechanics of non zero sum markets!
RE: JimTan
"am not saying that markets are efficient 100% of the time. Indeed, I pointed out that markets are often efficient only in the weak form"
I can agree with that, sorry for the misunderstanding
All of the information about the NHA MBS program you can possibly stand is right here: http://www.cmhc-schl.gc.ca/en/hoficlincl/mobase/index.cfm
or
http://tinyurl.com/2fd5bsm
Thanks to Mohican for the links. Grand Total of all the pools $660b. Percentage teaser/total = 2.6%. Percentage of variable/total = 19%. Trouble?
Seems to confirm the independent analysis from CAAMP...
“CAAMP’s Fall 2009 survey of mortgage consumers found that VARIABLE/ADJUSTABLE RATE MORTGAGES ARE MOST COMMONLY USED BY PEOPLE RENEWING THEIR MORTGAGES. Their current interest rates are far below what they previously were able to afford, and EVEN IN THE EVENT OF A LARGE INCREASE IN THE RATES, THEIR MANDATORY PAYMENTS WOULD BE NO HIGHER THAN THEY PREVIOUSLY COULD AFFORD. Among those who had renewed an existing mortgage during the past year, 30% took a variable rate mortgage.
• Research for this report, using CAAMP’s extensive microfile, finds that in 2009, 86% of mortgages for home purchase had fixed rates. The share fell late in the year, as an increased differential between variable rates (typically 2.25%) and fixed rates (around 4.0%) encouraged more use of variable rate mortgages. Even so, the share for fixed rate mortgages remained very high. As is elaborated below, this shift towards variable rate mortgages has not resulted in increased risk...
• It is not true that buyers who take adjustable or variable rate mortgages are borrowing to the limits of what they can currently afford. FOR INSURED MORTGAGES, FOR ADJUSTABLE RATE LOANS, LENDERS MUST “QUALIFY” THE BORROWERS (CALCULATE AFFORDABILITY) BASED ON RATES FOR THREE YEAR FIXED RATE MORTGAGES, NOT ON THE ACTUAL CONTRACT RATES. This inherently gives the borrowers considerable capacity to absorb future rises in rates. Furthermore, the vast majority of borrowers are borrowing less than they could afford to, even at
the higher qualifying interest rates. These points are illustrated below using data from the CAAMP database.”
JimTan, it is a valid point that the composition of the aggregate pools is still highly tilted towards fixed rate mortgages. What is more important is to look at originated loans, not total outstanding loans. Over the past year or two, there has been a large % increase in VRMs and other less traditional mortgage pools.
I do want to append to my previous comments. The "primeness" of a pool has to do with the credit rating of the borrowers but it also has to do with the leverage of the borrowers. For example a borrower with high income and high credit rating but high GDSR should be considered a higher risk to cause the lender pain, even though they may be considered "prime."
It may or may not be true that Canadians borrowers are more creditworthy than their American counterparts. All this really tells us is that borrowers will generally hold more of the bag than the lenders. Can prices be speculative without leverage? I can think of a few scenarios where this is true...
(The "primeness" of a pool has to do with the credit rating of the borrowers but it also has to do with the leverage of the borrowers. For example a borrower with high income and high credit rating but high GDSR should be considered a higher risk to cause the lender pain, even though they may be considered "prime.")
Jesse,
Seems to me that the CAAMP report covers all that?
http://www.caamp.org/meloncms/media/CAAMP%20%20Winter%20Report%20Black.pdf
Hi JimTan, I had read this report already. The time window for their interest rate analysis should be extended for the length of a typical housing cycle and not just a few years.
I am a believer that while mortgage rates obviously affect affordability, low rates cannot justify permanently higher prices. It is absolutely debatable however, as some smart people disagree with me!
Mohican,
This is completely off topic but do you have an updated chart of active listings over avg price?
"I am a believer that while mortgage rates obviously affect affordability, low rates cannot justify permanently higher prices".
Please note that Canada is not alone. Australia has high and sustained property prices.
http://en.wikipedia.org/wiki/Australian_property_bubble#Factors_increasing_demand_and_decreasing_supply
“In a free market, all prices are the result of an equilibrium between supply and demand. For prices to rise, it would indicate supply has fallen and/or that demand has risen. In the case of Australian property, both have occurred …
Based on the correlation of median house price divided by gross annual median household income, Australia (with 22 of the 62 severely unaffordable markets) has topped 2010 Demographia ‘International Housing Affordability Survey'. Severely unaffordable markets were considered to ones where price to income ratio was over 5.1. The other podium place-getters in the survey were the UK (silver) and USA (bronze) …
The Demographia survey cited “urban consolidation” as one of the main causes for this situation. The “first part of this high-density strategy is to artificially strangle the land supply” evidenced by “Residential land release in Sydney . . reduced from an historic average of 10,000 lots per year to less than 2,000 (in 2007)..” [6]
Citing HIA data, the same report stated that “Construction costs of a standardized house rose only 4 percent relative to inflation between 1973 and 2006 in the major capital cities. The price of the land for building has risen nearly 400 percent over the same period, inflation adjusted. This indicates that 98 percent of the increased cost was in the land, not construction.” (See Figure 1) …
Feb 2010: After only 3 quarter percent interest rate increases off 50 year lows, 45% of new first home buyers are in mortgage stress and/or defaulting on their loans.
With rising interest rates, stricter lending standards and reduced government grants, surveys shows that buyers are giving up the chase indefinitely as property has become completely unaffordable.
As interest rates rise, events mirror the sub prime collapse in America...
In March 2010 the Sydney Property Market's vacancy rate fell to 0.53%[47] from a high of 2% in August, 2009[48].
The rental impact is even more stark for some groups, where for example in Sydney, there is “one affordable and available dwelling for every 15 very low income households.”[49]
As noted in the Senate Select Committee 2008 report 'A good house is hard to find', “current supply of rental housing is severely inadequate (chapter 10). Vacancy rates are at record lows”.
The report recommended that the NRAS aim at a 50 % increase (an extra 50,000 dwellings) to the notional target by 2012”
Bottom line: It's all about supply. In Australia, they seems to have handled it badly. In Vancouver, city hall and landowners are ready to approve/sell into a large rally. Where's the bubble?
Bottom line: It's all about supply. In Australia, they seems to have handled it badly. In Vancouver, city hall and landowners are ready to approve/sell into a large rally. Where's the bubble?
Instantaneous supply and demand are driven by animal spirits and herd psychology. When prices are perceived to be moving up, supply will be withheld. When players think prices are going down, supply will be increase. Demand behaves in the opposite direction; hence you have overshoots and undershoots. -- This behaviour is true of whether or not you have total information, behave rationally or irrationally. Market players are simply greedy and are trying to maximize profits.
Vancouver RE is in a bubble; there is no doubt about it as the price to income is astronomical. The long term trend aways reverts back to the mean.
The problem with modern economists is that they alway assume everything is in equilibrium, but markets seldom stay there. They assume linear causality, but the real world is a complex non-linear system containing all sort of dependancies and feedbacks. I don't think economists apply differential equations or dynamic modelling. And so, all economic assumptions are in question. Do jobs drive real estate? or real estate drives jobs? interest rates drive risk taking? or does risk aversion drive down interest rates? etc, etc. These and other key relationships are not standing still. Correlations are always changing. Paradigms shift.
Society have been ingrained to believe that real estate always go up, inflation is always positive, etc. Perhaps, maybe that era is passe. Perhaps, we are entering a new normal where deflation and declining real estate is the norm.
Well said Mike.
"Society have been ingrained to believe that real estate always go up, inflation is always positive, etc. Perhaps, maybe that era is passe. Perhaps, we are entering a new normal where deflation and declining real estate is the norm."
Perhaps? But, it would reverse the trend of the last few centuries. At least, the trend since WW2. I don't see it happening. Asia is rising. A new day is beginning.
Post a Comment