Liberal MP and well known financial author Garth Turner recently wrote an article sounding the alarm on the Canadian Real Estate industry.  He is actually predicting negative amortization (where you owe more on your house then what it is worth) in Canada within the next 18 to 24 months.

Strong words?  Yes. Better question is he right?  Well let’s look at his main argument.  He says that the bulk of the recent boom in Real Estate in the past couple of years is because of 40 year amortizations.  Of course by taking a 40 year amortization you get VERY little principal reduction for the first long part of your mortgage.  That is right.

Consider this, if you put 5% down on a property and then add back the CMHC premium you are essentially 100% financing your home from the day you move in you have no equity.  Now consider the possibility that the real estate market drops 10-15% in the next year or so, which is a real possibility in some regions of Canada, bingo you have negative amortization.  So on that he is right it could certainly happen to many borrowers in Canada.

However, let’s look at the flipside, someone I respect highly recently said to me “people need to stop overly worrying about their paper loss and only worry about their real losses”.  This is true, let’s remember that a mortgage is a long term commitment, and therefore your home as shelter is obviously necessary and is also a long term investment.  As long as you are not a speculator or flipper then you can ride out this storm and long term you will be fine.  This situation still beats out renting in my opinion.

I have to say a couple things that Mr. Turner had in his article was grossly inaccurate, and makes me wonder why some as accomplished as he is did not do more fact checking.

1. “Canadian Mortgage lenders are no longer discounting mortgage rates”

Not True.  Canadian banks are absolutely still discounting rates, they are however artificially pushing rates higher by increasing their spreads over the past six months as I have reported before.

2.  “Shaky lending practices that coloured the US Sub prime crisis are now creeping into Canada”

This is ludicrous, Canadian sub prime mortgage business is basically over, there are basically no lenders left, and those that are have significantly tightened up their underwriting standards, and that is the facts from the street Garth.

I copied this response to a blog on National Post from an unknown source because it was so good.  Well worth the read.  By the way I have proven that buying your principal residence, even with zero down and 40 years still outperforms renting.

Garth Turner, a man who knows how to sell books at the right time, regardless of the content is back at it again.  Many of you, except those who followed his advice have thus forgotten the 1998 book by Garth Turner “The Strategy: a Homeowner’s Guide To Wealth Creation”, in which he advocated regular investors borrow against the value in their homes and invest, using leverage in an attempt to create wealth and tax deductions.  

This strategy assumes increasing home values, increasing stock market values, continuing deductibility of interest and sustainable payments. One wonders how many of these investors were able to continue this program after 2000 to 2002?

That was a few years back.  Now he suggests that that was all wrong and it’s time to “get out”.  What if you’re the people now caught with a lower valued property, interest payments you may not be able to afford and market values or invested assets, down %15 or more? Easy to say get out, but it was Garth’s advice that got people into this mess to start with.

According to a 2002 Globe and Mail report, ” Duff Young recalls speaking at a seminar in October, 1997, “and the financial adviser who hired me had previously used Garth Turner. He said he’d had excellent results, which meant he earned a ton of commissions. Turner had proposed leveraged purchases of mutual funds, using home equity as security to borrow the money.”

It would be very interesting to hear from those who did follow Garth’s advice before and see what the results had been.

End result is that nobody, nobody, has any predictive ability in any sense, in any market, yet for some reason Canadians all rush out to buy the books, fill the seminars and do the dance.  As Canadian investors we must STOP this gambling addiction.

Four Pillars asked a good question- “If Garth Turner has sold his house?”  The answer would say more about the man than the concept.

This is not to say anything negative about Garth Turner, his job is to write and sell books and he does that very well, but his job is NOT to create wealth for anyone but himself and his publishers.  We Canadians must become more discriminatory in our investment ways to weed out good advice for us and bad.  Every single study bar none has conclusively shown that moving from one asset class to another, or attempting to predict markets, or time markets, or beat markets is a fruitless endeavor, but Canadians keep searching for a holy grail of investing which does not exist- take a lesson from the now wealthiest man on the planet, who has every year stated that the majority of investors should follow passive, diverse program of investing- “A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money.”

Keep costs low, avoid fads and realize that even in times like this, capitalism works.

Liberal MP and well known financial author Garth Turner recently wrote an article sounding the alarm on the Canadian Real Estate industry.  He is actually predicting negative amortization (where you owe more on your house then what it is worth) in Canada within the next 18 to 24 months.

Strong words?  Yes. Better question is he right?  Well let’s look at his main argument.  He says that the bulk of the recent boom in Real Estate in the past couple of years is because of 40 year amortizations.  Of course by taking a 40 year amortization you get VERY little principal reduction for the first long part of your mortgage.  That is right.

Consider this, if you put 5% down on a property and then add back the CMHC premium you are essentially 100% financing your home from the day you move in you have no equity.  Now consider the possibility that the real estate market drops 10-15% in the next year or so, which is a real possibility in some regions of Canada, bingo you have negative amortization.  So on that he is right it could certainly happen to many borrowers in Canada.

However, let’s look at the flipside, someone I respect highly recently said to me “people need to stop overly worrying about their paper loss and only worry about their real losses”.  This is true, let’s remember that a mortgage is a long term commitment, and therefore your home as shelter is obviously necessary and is also a long term investment.  As long as you are not a speculator or flipper then you can ride out this storm and long term you will be fine.  This situation still beats out renting in my opinion.

I have to say a couple things that Mr. Turner had in his article was grossly inaccurate, and makes me wonder why some as accomplished as he is did not do more fact checking.

1. “Canadian Mortgage lenders are no longer discounting mortgage rates”

Not True.  Canadian banks are absolutely still discounting rates, they are however artificially pushing rates higher by increasing their spreads over the past six months as I have reported before.

2.  “Shaky lending practices that coloured the US Sub prime crisis are now creeping into Canada”

This is ludicrous, Canadian sub prime mortgage business is basically over, there are basically no lenders left, and those that are have significantly tightened up their underwriting standards, and that is the facts from the street Garth.

The more I think about the US federal reserve continually dumping liquidity into the market and strong arming all the other central banks around the globe, including Canada, to do the same I keep thinking that it is just like popping champagne and passing around bottles of Crown Royal at an AA meeting.

Let’s not forget that this whole problem was started by Greenspan’s low interest rate policy, that led to “creative” new investment vehicles that were trying to bring higher returns to investors.  Then let’s talk about the US mortgage lenders who advanced very large loans to loads of high risk borrowers whose capacity for repayment of even the majority of the amounts lent was, at best, highly questionable.

So what is the answer of the current Fed chairman in the eyes of this debacle?  Let’s just try and keep the party going.  Admittedly I have mixed feelings whether this stance is the right one or not, but there is a part of me who says that if you keep enabling these guys on wall street then they never kick their habit.

If history is any guide, an army of trigger-happy traders will now start punting around in as many esoteric, exotic derivative deals as they can lay their hands on. A recipe for more trouble.

And by failing to encourage banks to ‘mark-to-market’, i.e. to value their polluted loan portfolios at anything like a realistic level, the Fed plan just puts off the Day of judgment.

Because have no doubt, for the giant hedge fund into which the United States has morphed, that cathartic day is on the way.