A Canadian Story of Woe

 

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A Canadian homeowner going for a relaxing swim in his mortgage…

 

One of the challenges of being a financial advisor is finding ways to convey complex financial issues in simple ways to my clients and readers. I believe I do this to varying degrees of success, and I am informed of my failures by my wife who doesn’t hesitate to point out when I’ve written something boring or too convoluted.

One such subject where I feel I’ve yet to properly distill the essential material is around the housing market. While I’ve written a fair amount about the Canadian housing market, I feel I’ve been less successful in explaining why the current housing situation is eating the middle class.

In case you’re wondering, my thesis rests on three ideas:

1. The middle class as we know it has come about as a result of not simply rising wages but on sustained drops in the price of necessities.
2. The rise of the middle class was greatly accelerated by the unique historical situation at the end of the Second World War, which split the world into competing ideological factions but left the most productive countries with the highest output and technological innovation to flourish.
3. A global trend towards urbanization and a plateauing of middle-class growth has started reversing some of those economic gains, raising the cost of basic living expenses while reducing the average income.

The combination of these three trends has helped morph housing from an essential matter of accommodation into a major pillar of people’s investment portfolios and part of their retirement plan. The result is that homeowners are both far more willing to pay higher prices for a home in the belief that it will continue to appreciate into the future, while also attempting to undercut increases in density within neighborhoods over fears that such a change will negatively impact the value of the homes. In short, stabilizing the housing market is getting harder, while Canadians are paying too much of their income to pay for existing homes. All of this serves to make the Canadian middle class extremely vulnerable.

 

Household Debt
You may be tempted to think “Wow, debt levels really jumped through 2016” you should remind yourself that this chart STARTS at 166%!!!

 

Proving some of this is can be challenging, but there are some things we know. For instance, we know that Canadians are far more in debt than they’ve ever been before and the bulk of that debt is in mortgages and home equity lines of credit (HELOC), which means much of that debt is long-term and sensitive to hikes in interest rates. We also have abundant evidence that zoning restrictions and neighborhood associations have diligently fought against “density creep”. But to tie it all together we need the help of HSBC’s Global Research division and a recent article from the Financial Times.

FT Global Leverage

Last week, HSBC issued a research paper on global leverage. Providing more proof that since 2008 the world has not deleveraged one bit. In fact, global debt has settled just over 300% of global GDP, something that I wrote about in 2016. An interesting bit of information though came in terms of the country’s sensitivity to increasing interest rates. Charting a number of countries, including Canada, the report highlights that Canadians (on average) pay 12.5% of their income to service debt. A 1% increase in the lending rate would push that up over 13%. For a country already heavily in debt, a future of rising rates looks very expensive indeed.

It would be wrong to say that fixing our housing market will put things right. There is no silver bullet and to suggest otherwise is to reduce a complex issue to little more than a TED Talk. But the reality is that our housing market forms a major foundation of our current woes. A sustained campaign to grow our cities and reduce regulatory hurdles will do more to temper large debts that eat at middle-class security than anything I could name.

Greece’s End Game; Unravelling The #Grexit

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Tom Janssen / The Netherlands, PoliticalCartoons.com

On Friday, the Greek Prime Minister Alexis Tsipras, after months of fruitless negotiations, asked for a referendum on whether Greece should accept further austerity in exchange for continued bailout support from the IMF, or whether it should reject creditor demands, a decision which would mean defaulting on its sovereign debt obligations and effectively leaving the Euro.

If this is meant to terrify Greece’s creditors, they seem ready to call the bluff. The deadline for Greece’s current payment to the IMF (1.5 billion) is June 30th, the proposed referendum is to be on July 5th. This means that Greece will default before it’s had a chance to decide on whether they should default. If this seems like a grim picture for Greece, you have no idea how bad it is about to get.

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Since 2008 Greece has limped along, periodically looking as though it is going to default on its massive and unmanageable debt. In 2010, when it seemed like a default was inevitable a bailout was organized that mandated strict and painful austerity in exchange for the financial aid needed to keep Greece within the EU. That austerity has left the Greek economy in shambles. Unemployment sits at around 25%, while pensions have withered, as have government jobs and a shrinking healthcare budget. Greece lost nearly 25% of its GDP from the pre-crash high, a rate unmatched by any other heavily indebted Euro country facing similar austerity measures.

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Hindsight being what it is, that bailout was probably a mistake. At the time however, following the collapse of the American banking system, sidestepping a default likely seemed the best idea for every party. But several years on the Greek people were desperate for anyone that could change the fate of Greece within the Eurozone. The seeming saviors for Greece came from the leftist coalition Syriza, which promised to end the tyranny of austerity while retaining Greece’s place within the Euro.

Greece’s history with finances is checkered, if we are being generous. Greece has defaulted on its sovereign debt obligations five times since independence, and has been in default for nearly 50% of its time since gaining independence. Greece’s financial problems are also largely of their own making, having borrowed extravagantly at low interest rates and greatly expanded its government services while ignoring taxes has not earned it many sympathetic allies within the Eurozone.

This guy is Alexis Tsipras and he is the PM of Greece. He is not going to be remembered the way I think he wanted to be remembered.
This guy is Alexis Tsipras and he is the PM of Greece. He is not going to be remembered the way I think he wanted to be remembered.

But Greece’s situation is now quite dire. Greece produces little, has only a modest economy and owes far more money than it can ever reasonably expect to pay. Its economic prospects are slim and to retain any economic stability means adhering to austerity measures that gut and change pension obligations, raise taxes, reduce government sizes and heavily restrict benefits. That may be necessary tough love but it is also deepens Greece’s depression and throws into chaos the future of many Greeks, who only a few years ago thought they knew when they could retire and with how much money.

Syriza’s attempt to win concessions from Greek creditors and ease the austerity it was facing have largely backfired. Incorrectly assuming that a default would produce more pain for Europe than Germany and the ECB would willingly endure was a miscalculation that has left Greece in an even worse situation. With no cards to play the only options now facing Greece are more austerity within Europe, or even greater austerity outside of it.

Choosing austerity within the euro would at least mean keeping some of the economics on track, and would allow the government to access in excess of 15 billion in continued bailout funding. But the path now set by Tsipras, seeking a referendum five days after the deadline seems to have set in motion an even worse set of events.

From The Economist. Greece remains an outlier within Europe, even amongst other heavily indebted nations.
From The Economist. Greece remains an outlier within Europe, even amongst other heavily indebted nations.

The continued uncertainty in the negotiations through June has been putting considerable strain on an already taxed banking system. As negotiations have dragged on, Greek citizenry have been making significant withdrawals and transfers at their banks. To avoid a run the banking system it has been propped up by the ECB with Emergency Liquidity Assistance. But after yesterday’s referendum announcement the pressure on banks reached a breaking point. Thousands lined up at ATMs to get their hands on as many Euros as possible. In response the government has suspended banking for the next week and promised new capital controls to restrict transfers and withdrawals. That’s only the beginning of Greece’s banking woes.

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Rick McKee / Augusta Chronicle

The ECB has said that if Greece defaults the emergency liquidity assistance will end, which means also a collapse of the Greek banking system. And while there is no official requirement for this ECB position, the unofficial reasons are obvious. Default cannot seem like a viable path for the austerity stricken countries, and financial markets need to be reassured that EU members won’t willingly walk away from their financial obligations to satisfy voters.

This means that a Greek exit will be worse than accepting continued austerity. It will mean more unemployment, poverty, government cutbacks and shrinking services. There is still time for a deal. The government can accept the creditor demands, institute further austerity, avoid a banking collapse and continue to use the Euro. But that may only postpone a fate we all know is coming. Greece’s debt is still too large, its economy too small, its creditors too stubborn and its options too limited to change the course it is on. Greece was always destined to fail, and sometimes we must come to learn that not all problems have solutions, only outcomes.