The old saying from Trudeau that said living next to the US was like being in bed with an elephant is true. Let’s try and simplify the highlights of a US recession would affect Canada, specific to the Mortgage and Real estate space.

The biggest reason right now is that as they slow their dollar depreciates against ours which in effect keeps our dollar high despite whatever efforts we employ here to bring it down. The high dollar slows Canada’s economy.

Here is a fact, Canadian Retailers should expect significantly lower sales in their most important quarter…now and can likely extend into early next year as Canadian consumers shop south of the border either physically or most commonly on-line.

On one hand a slowing Canadian Economy will bring lower rates for sure, which will be nice for people contemplating a move.

Update…I finally found some data on the banks cost of funds, relative to the increased spread they are charging consumers for mortgages. Remember from earlier posted I reported that all things being equal consumers should be paying about .80% or so less for a five year discounted mortgage. The reason for this increased spread we have been told is the banks cost of funds have gone up, but it was difficult to know how much? did it go up the full .80% and the banks profits were the same or were the banks just grabbing more profit then normal due to the uncertainty of the times right now as we have been told? Well the cat is out now, Benjamin Tal from CIBC World Markets, my favorite economist, has said the banks cost of funds due to the liquidity crisis brought on by the US mortgage meltdown is equal to .25%!! Therefore the banks have quietly grabbed an additional .55%-.75% of additional profit from us and they are getting away with it!!

I will be continuing to follow this development, because it is not fair and this proves the banks are greedy…duh.

Oh by the way TD reported yesterday their fourth quarter profit was a mere billion dollars…in three months!!

Greg

Here we go again. I wrote the other day that spreads on five year fixed mortgage rates have been increased by as much as .80% or more over the same time last year. As you recall this increased spread is to do with the tightening of funds and consequently a higher cost of funds for the banks.

The problem is worsening though. Bond prices are shooting up, due to investors flocking there for greater security even though their returns are less. This of course drives yields down which increases the spreads the banks are making on five year mortgage money.

Here’s the rub, the Bank of Canada is not following suit of the European Union and the Federal Reserve in the US by injecting money into these markets to lower the banks cost of funds, and thus lower five year fixed rates for us.

Almost every economist in Canada is now calling on the Bank to inject 100’s of millions into the term market and do it now. This coupled with a predicted .25% rate cut in December or January will bring some reduced pressure on the consumer in terms of borrowing costs on Five Year money.

Why aren’t the banks doing it you ask? Because their defiance has effectively contributed to the slowdown in the economy which of course they LOVE. When inflation is below their target they are happy. But with the dollar appreciating, and the markets pricing in rate cuts, and now this, the Bank has to do their job and bring stability to the credit markets in Canada, or I fear we are headed for some drastic challenges.

Greg Williamson

Bank of Montreal was the first out the gate to announce it’s fourth quarter and consequently their annual profits. I have to say people should be outraged. These profits are big, despite big writedowns as a result of their exposure to the US credit woes.

Don’t get me wrong I am ok with profit and free enterprise, but the outrage is not at the banks but rather ourselves for not holding them accountable.

For instance wholesale mortgage brokers routinely have mortgage rates advertised at least .50%-.75% lower then the banks, yet the industry nationally has a 30% market share. More people have to look for ways to save money on their banking and credit and hold them accountable to better pricing.

By the way BMO’s profit was $452 million for the fourth quarter and $2.13 billion for the year.

Greg Williamson

Quick someone tell me if you can bet in Vegas on whether the Bank of Canada will cut rates in December? If you can then bet what you can because I think it is done now.

Bloomberg reported yesterday that government of Canada Bond Yields fell to yet another record low for the year due to investors continually clamoring forsafe investments amid the sub-prime meltdown and corresponding credit crunch.

Bankers’ Acceptance Futures for March 2008 fell an additional 6 basis points to 4.11 percent, the lowest since March. The reason this is significant is because since futures have been tracked the futures have settled at a three- month lending rate averaging 16 basis points above the central bank’s target which would suggest these smart people who make money on gambling right are telling us their is a rate cut coming.

The other good news is that if these yields continue to drop SOONER or LATER the banks will have to drop the five year mortgage rate. They are gluttonous in wanting these unprecedented spreads but they are more greedy for market share, someone will crack and drop the rates which will bring them all in line.

So long bet that fixed rates are dropping too.

Again, a sound strategy right now for anyone considering a new mortgage is to take a variable rate mortgage for the next six months or so, then consider locking in spring when fixed rates drop more.

Greg Williamson

Arecent article in The Star has a very profound argument for a Rate cut and a Rate cut RIGHT NOW!

“Jim Stanford, chief economist for the Canadian Auto Workers union, told the Commons finance committee last week that the 300,000 jobs already lost in the manufacturing sector could double in the next few years if our dollar remains at par with the U.S. dollar. ”

When the finance minister was recently asked what he would do about the high Canadian dollar he promptly replied “The Bank of Canada has jurisdiction over monetary policy” Yes it was probably a cop-out but in fact true.

If he wasn’t a politician he might have said “The Bank of Canada probably can’t do anything?” You see if they cut rates too much or too quickly they will have a real problem with inflation, especially in the red-hot West, which could hurt the entire economy. They will in fact bring the dollar back to parity or around that, which will still hurt the manufacturing sector.

The sad truth is that somebody has to take the fall for the economy we are in and it is probably the beleaguered Canadian Manufacturing industry that should. Let’s face it we had more problems with that sector before the dollar began it’s rise. Global competition for labour and reduced wages in other areas makes it difficult for Canada to compete.

The Bank has certainly got to be careful with this one.

Greg

So far The Bank of Canada has resisted cutting rates despite mounting pressure from politicians and the general public. We all are trying to tell the outgoing governor David Dodge that both the rapid increase of the Canadian Dollar and the slowing US economy warrant a drop of .25% in the Prime Lending Rate.

From a practical perspective those of my readers who are considering a new mortgage should strongly look at a variable rate mortgage in the short run. Why?

First I think it is a given that the Bank will not raise the Prime rate in the short run, or the long run for that matter. Second, it is highly unlikely that bond yields will rise in this short run either which means fixed rates will likely not rise which means there is no panic to lock in yet.

In fact there is a better chance that variable rates, and fixed rates could drop in this next short while, by the Bank cutting rates in December or early 2008, and the easing of the five year fixed mortgage rate spreads.

Greg Williamson

Thanks to Jonathan Chevreau from the Financial Post for highlighting a very funny, but accurate depiction of the US sub prime mess. You can view it here or click on You Tube at this link: http://youtube.com/watch?v=SJ_qK4g6ntM

Greg Williamson, The Prez

If you have been watching you will have noticed that the spread on the government of Canada long bonds to the five year mortgage rates has increased year over year.  Last year the average spread was around 1.1% when compared to discounted wholesale five year rates and this year it has almost doubled.

Technically speaking we should be paying around 5% for a discounted five year rate today but instead we are around 5.89% to 5.99%.

As we have been discussing this has been blamed primarily on the US sub-prime mortgage mess and the resulting liquidity crisis.  I for one also believe that it is because we are allowing the banks to get away with it.

Demand for mortgages, and I mean all mortgages is unchanged despite this problem of the banks increasing their spreads.  This concerns me a little bit, because one would worry that the banks will not drop their spreads instead opting for increased profits in these uncertain times.

Alas, don’t despair, what I have learned from being in the wholesale mortgage industry for over 10 years is that Mortgage lenders are at their core cut-throat amongst each other to gain market share, and I think market share is more important to them then profits on the mortgage only.  Consequently someone will come along and drop their spreads to grab market share.

Continue to use a professional mortgage broker because they will see these early drops first because it will happen in the wholesale market, likely not the retail branch network.

Greg Williamson, The Prez

To Lock or Not?

By Greg Williamson, President

Since our last commentary much has certainly happened. We have seen unprecedented rapid increases in the Canadian Dollar, we continue to see the US housing industry in a free-fall and the US mortgage industry is still reeling.

The question on the minds of all of our clients is, “What should I do?”

First, be careful about what you read in the papers. Always remembers that a newspaper’s primary concern is to sell newspapers – often times the stories that they report don’t tell the whole story at all. I recommend you still follow the news, but also ask your Professional Mortgage Planner  to decipher what they report to you.

To properly examine and recommend what people should do with their mortgages what first needs to be explained is the current landscape – that being the fact that the US led global liquidity crisis has and will continue to significantly affect our Mortgage Markets.

Let me first explain what the liquidity crisis really is so you gain an understanding of why things are happening as they are:

Two years ago when the US interest rates were so low banks were pressured to come up with more creative and aggressive mortgage products that would be marketed to a higher risk individual at higher rates, thereby earning the investors higher spreads. This sounds all good, except two major things happened which lead to the mess we currently find ourselves in:

1. Interest rates rose 2. The products were largely ill conceived

The most common sales features of those ill-conceived Sub-Prime mortgages were a low introductory rate and little or no down payment. The extremely low “introductory” rate was to assist with comfortable payments to allow people to qualify and afford their new mortgage. To top it off, they often required little, no, or borrowed down payment and were lending to people who had less than perfect credit.

These products were sold to people with the plan that they would be able to purchase in an affordable manner to start, and in two years when their price was being reset they would refinance to a new amortization and lower rate thanks to the equity they built in their homes by then.

I often wonder if people ever asked “what if” during these sales pitches?

The “what if” entered the picture early this summer. The first of these introductory rate mortgages started to come up for their reset and realized that rates had increased higher than they could certainly afford and, more importantly, the refinance mortgage option was now gone.

Ask yourself, what would a person do when faced with an unmanageable increase in their mortgage payment, coupled with no equity left in their home – or worse, a mortgage that is higher than the value of their home? You guessed it…they’d walk away.

Hence, those early price reset people began the vicious spiral down. As more and more people walked away it caused the housing market and housing prices to drop even further – causing even more people to experience ownership of a mortgage that was higher than the value of their home. And so on, and so on…

You might ask, “Why has this crisis caused global rates and mortgage banking to be so affected?”

The global market is being affected right now because the global market was heavily invested in these American mortgage pools. The current crisis continues on for two reasons: The first is because many investors feel they were lied to about the quality of the mortgage assets they were investing in, and as this mess is still on-going, most of the investors have a trust issue and are refusing to invest.

As you would expect, no investment dollars means that banks have to look elsewhere for money to lend. In this case this case, demand for mortgage money to lend is high and supply is tight. Classic economic theory dictates that in cases like this, prices go up. This has happened. Alas, if the banks cost of getting money to lend is higher, you can bet that they will charge their customers more. Now you can see why mortgage rates are higher right now than the greater economy indicates they should be.

What has to happen, then?

First, we have to see the end of the “Mortgage Meltdown”. Experts suggest we are only now at the midpoint and are looking at a minimum of 6 – 9 more months before we reach the end of this ride.

Secondly, banks and investors must continue to price in the effects of this crisis so there is not a hard crash landing at the end.

Lastly, the banks and mortgage investment companies need to rebuild trust with their investors so that they will put the much needed money back into the markets.

So, what to do?

If you can handle the stress of being in a variable rate mortgage through this crisis, then do so, and wait this out. We predict variable rates to stay flat or even have a .25% drop in 2008. We are of the opinion that this is the best strategy.

If you are convinced you need to lock in your mortgage rate, then speak to your Mortgage Planner and ask them to shop around for a new lender. All indications seem to show that the liquidity crisis is also causing banks to charge higher early renewal rates than they have in the past due to the aforementioned increase in the cost of funds as well as to capture some much needed margins.

On the flip side of this, banks are and always will be aggressive in getting new business and market share and so will be even more aggressive.

This will also allow you to look at using the equity in your home for a solid debt repositioning strategy or a tax deductible mortgage strategy. Again, your Mortgage Planner can advise you regarding your options.