Sunday, January 30, 2011

Household Credit Expansion in Canada

This post will look at the household credit in Canada and it's contribution to economic activity. The link between the two has been a common theme of blogs such as AmericaCanada and Financial Insights for awhile and is recently becoming mainstream. The idea boils down to this:

Point 1. Credit has been growing at an unsustainable rate
Point 2. This has artificially inflated the entire economy
Point 3. Once credit contracts this artificial activity will disappear

This has been used to explain the difference between Canada and U.S. economic trajectories; Credit is contracting in the U.S. while still expanding in Canada. I do agree that credit growth has been unsustainable but not to the same extent as others. Consider the following from Financial Insights:
Let’s not forget that line of credit growth, particularly HELOCs, have significantly boosted consumer spending. CAAMP data suggests that home equity extraction alone has added 9% to the after tax income of the average family’s budget. When this slows, consumer spending (65% of our economy) slows with it. The new mortgage rules aimed at limiting home equity withdrawals will certainly act as a catalyst to strengthen this trend.
The explanation of this 9% is in a previous post.
Let me reiterate some basic math: If 18% of all households with mortgages (~60% of total) have withdrawn equity in the past 12 months, and the average amount was $46K, that means that when averaged across all households, it would be equal to over $5,400 in additional household spending per household in the past 12 months. Given that the median after tax income of Canadian households was most recently calculated at $63,900, this equity extraction has ‘boosted’ income and spending by an additional 8.5%.
No actual payments are considered in the above calculations. While many are taking withdrawals there are also households with who have made regular or lump sump principal payments over the past year. Some HELOCs may have been taken to pay others down. I think it would have been more suitable to look at aggregate HELOC growth to determine it's impact on consumer spending. I would guess this number is less than the 9% calculated here.

Also, there is some amount of household credit growth which could be sustained. Theoretically, credit could grow at a sustainable 4% with 1% from population growth and 3% from rising wages.

So I agree with point 1 in the model is true but to a lesser degree. What does this mean for the entire economy? Lets consider point 2 that above trend credit growth has boosted the entire economy. Consider a hypothetical couple, John and Jane Smith, and their consumption without credit expansion. They can only use the income to buy goods and services.
  • Debtor Income: $50,000
  • Debtor Consumption: $50,000
Since these people are impatient, shallow and reckless with money (like most Canadians are) they take a credit line against their house to "purchase" a new vehicle. They also buy granite counter tops and a Blackberry they otherwise would not have if the funds were unavailable.
  • Debtor Income: $50,000
  • HELOC Withdrawl: $50,000
  • Debtor Consumption: $100,000
Once the bills come due income is diverted away from purchasing goods and services.
  • Debtor Income: $50,000
  • HELOC Repayment: $25,000
  • Debtor Consumption: $25,000
If this happens to the balance sheets of household on masse the implications are clear. From Financial Insights:
I suspect the true state of the economy will become evident as credit demand dwindles and home prices normalize.
This example shows credit expansion as an outside entity artificially boosting economic activity. During the austerity phase debt repayments disappear into this abyss and cause widespread pain. The missing element here is that each loan has both a debtor and a creditor. It is not like debt repayments are sent to an inferno somewhere and disappear from the economy forever. First look at the creditors and debtors consumption before a reckless loan is made.
  • Creditor Income: $300,000
  • Debtors Income: $50,000
  • Creditor Consumption: $300,000
  • Debtors Consumption: $50,000
  • Total Consumption: $350,000
With the loan the Smiths spends an amount greater than their income but this is offset by the creditor's increased savings.
  • Creditor Consumption: $250,000
  • Debtors Consumption: $100,000
  • Total Consumption: $350,000
In this case it is theoretically possible that during the repayment phase there is no drop in total demand. Instead consumption is shifted from the debtor to the creditor.
  • Creditor Consumption: $325,000
  • Debtors Consumption: $25,000
  • Total Consumption: $350,000
The Blackberry, the granite counter tops and the new car the Smiths bought are all real. The debt played no part in their actual design, production or distribution. So the economy was not operating at a level higher than it's capacity which has been implied.

While I disagree that the economy was ever above a true state there still are downside risks. If the loans are not sound then this can cause shocks which will reduce activity below capacity. Hence the high unemployment rate in the United States right now. The economy will likely have to adjust from the middle class using debt to finance their lifestyles. So the model would differ somewhat:

Point 1. Household credit has been growing at an unsustainable rate
Point 2. The transition to sustained credit growth could trigger a period of time where economic activity is below capacity

And that's good news! After the economic shock subsides, John and Jane Smith will be given the privilege of toiling well into the future to fund the consumption of their creditors.

Friday, January 14, 2011

Edmonton New Construction Update

The number of single family homes under construction in Edmonton is declining slowly as starts have decreased. As of the most recently available monthly stats starts have fallen 30% YOY while completions increased by 90%.

When considering all types of residential structures under construction things have been holding steady now for over a year. It is interesting how activity has shifted towards SFH as the condo glut lasted longer after the boom.


Saturday, January 8, 2011

Edmonton Market Stats December 2010

Once again the updated sales, listing and seasonally adjusted charts for Edmonton.

Sales remain above the dismal pace of the financial crisis but below the more robust pace set during the 2nd half of 2009.

Listings are following the rate set during the 2nd hald of 2009.

On a seasonally adjusted basis home sales have recovered somewhat from earlier this year.

The spike of listings which contributed to the year over year increase in inventory has settled down.

The seasonally adjusted sales to new listing ratio has increased due to more sales and reduced listings. The rate currently stands at 57%. I would be cautious reading too much into this due to the lower volume in the winter months. However, if this ratio stays at this level into the spring market we may see YOY inventory drops and prices stabilizing. The question is how big of a listings rush will there be this spring?

The last chart shows sales, new listings and inventory over the years.

The median price of single family homes has moved down considerably since spring. Down to $336,500 from $370,000 in May, or almost 10%. These price declines are a combination of real market deterioration and seasonality as I mentioned in June.
The seasonally adjust sales to listing ratio is 42% and has been flat for three months. Expect price drops soon.

I think that some of the price measures are elevated right now due to seasonality and high level of luxury sales (see Edmonton Real Estate Blog for price stats). This works both ways as it shows prices have been rising all year (when they haven't) and will exaggerate the drops during the second half.
It comes as no surprise that the EREB was way too optimistic on their revised prediction of 19,000 sales half way through the year. I was also optimistic guessing 16,576 when the preliminary total right now stands at 16,241.

Saturday, January 1, 2011

Calgary Stats December 2010

Sales decreased last month but not as much as expected.

New Listings fell dramatically as expected this time of the year.

On a seasonally adjusted basis sales have partially recovered when compared to the dismal pace set this spring.

Fewer new listings are coming onto the market now when compared to the rate earlier this year. This will be a key indicator to watch going into next year as the unknown variable is how many will be re-listed and how motivated they are to sell.

The sales to new listing ratio improved on a seasonally adjusted basis as sales held up better than expected.

The last chart shows sales, new listings and inventory over the last 5 years.

Raw data from Bob Truman's site
Explanation of benchmarks

Happy New Year!