Where Did The Perception That Banks Were Good Investments Come From?

There is no question that if you look at banks historically you can see the factors that investors promote when looking for a "good" investment. My friend that encouraged me to invest at the time was waiting for a huge market correction. That was back in 2006 and he was already more then half cash. One that he mentioned he wanted to pick up was HSBC, and his price was in the $65 range. The reasons, years of growing dividend, expanding into emerging economies, steady in their years of showing growth, etc. There is a list somewhere, I am sure.

He also talked about how dividend stocks tend to bounce back better after a downturn, at least that's what happened with the last down turn.

There is no question that banks had a very good run, but I doubt what was known to be true historically is going continue to be true moving forward.

When I look at where the increasing profits came from a see a sector that will have years upon years of disappointment to investors that fail to think this through.

You have the maestro idiot who for more than a generation gradually stepped interest rates down. So, what exactly does that do for bank profits? Consider that the dollar value of loans have been increasing over the years much more then wages. Banks are increasing their profits as that dollar value of loans increased. This has gone on since the 80s. It has enabled some troubled borrowers to refinance at lower rates and avoid the messy businesses of defaults, and of course there is an enormous fee that goes with this. Heck, there were borrowers that weren't in trouble that refinanced and just paid the penalty. I did so twice as it was in my interest to do so, and there was up to 3 months interest penalty on my mortgage each time.

Banks also added those fancy securitization products which they made a bundle on.

Well, now that there is a rate reversal in progres, so just what are all the ways that banks will lose out on in terms of how they were increasing their profits?

Loans aren't going to be getting bigger. Wages will finally have to catch up. Just how many years do you think this will take? A decade or two would not surprise me. Moving forward banks will have decreasing values of loans. Trying to increase profits through increasing rate spreads will simply increase this effect. So years of declining loan values is a given.

And, now that interest rates pretty much went as low as they could go, well, just how are those troubled borrowers going to refinance? I suppose those with massive credit card debt at high rates might be able to, but what about troubled mortgage borrowers? Or over extended big car loan borrowers? Now some of the defaults that were traditionally avoided by refinancing aren't going to be avoided. I suspect it will be years of higher defaults then historically. There will be a large wave to start and then a much higher steady stream as life's challenges hit people that were doing their best but had no room for those life's challenges -- relationship break-up, job loss, unexpected pregnancy, illness, natural disaster and so on... So, years of higher defaults for banks is a given.

You think the securitization of debt market is ever going to be as profitable again? I don't. So years of reduced profits from secutitization is a given.

Then of course there is the massive dilution of stock as banks work to raise capital. So, you have this declining profit environment on this growing equity base.

It seems to me that there is going to be a move to less debt in this environment, so not only will loan values be smaller, people will go back to the "old fashioned" way of making purchases, saving a good portion before borrowing. If you think it through what the stepping down of rates did to housing, well, it increased the loan amount that people qualified for and the responsible saver who wanted 20 or 25% down was forever finding that out of their reach. It lead to the masses jumping in early in terms of saving for a down payment because you could never earn in wages what you'd lose in equity as home values went up. They watched the market go up for 2-3 years they were wanting to buy and finally jumped in. It is what happens to young people.

Generations just young enough to miss this massive bubble will learn from the financial hardships they see around them. Many will wait and they will save for a proper down payment.

So, where do I see banks? I think loan values will cut in half and raising equity to cover losses will double the number of shares out there.

I can't see the business sector of banks doing much better.

And then there is the investment side of it. I think so many people are going to be hit hard by the markets there will be a trend back to safer investments. My idiot investment advisor argued with me over an investment I wanted to make and then I was charged $400 on the one trade. This garbage is already on the decline. Look at all the competition for $10 trades now.

So, no kidding banks were a good investment. There many things happening in their favor that whoever was running them would have to be worse then Bush to screw it up. But now the reversal comes and it isn't just reach a bottom and go back to business as usual. Moving forward the business environment is going to have those things that worked in banks favor working against them, and it is going be years of challenges and little opportunity for profit growth.

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Backroom Deals

Calculated Risk has a post about a back room deal BoA is trying to get taxpayers to fund.

According to the proposal $739 billion in mortgages are at moderate to high risk of defaulting. So, tax payers buy the mortgages at deeply discounted prices and pay to forgive the debt above current market value and tax payers pay the difference to refinance these borrowers at lower rates.

The marketing strategy to the public is that you present this as a bailout of homeowners, not the bond market or the banks. At all costs steer away from the fact that the banks get off scot-free for their gross negligence and are immediately able to line the pockets of their executives again and that the bond owners get their money back.

Additionally, completely steer away from the fact that taxpayers would then be on the hook for even more should the mortgage market decline further and these people simply walk away anyways.

Gotta hand it to the banks, "We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market."

I am sure their information processing psychologists were coaching, "the way you present this thing is that it has nothing to do with you, it is about the bond holders and the home owners. Keep it along the line that you are the Robin Hood for home owners and bond holders alike. Do not answer any questions about the banks and bring the focus first to the homeowners, and if necessary, the bond holders."

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Where Are The Regulators?

I was reading an excellent piece by Nobel Prize winer Joesph Stiglitz on his thoughts on the World Economic Forum.

One of the things that he said that is proving to be a lesson that Wall Street sociopaths, morons, idiots, scam artists, con men, swindlers bankers refuse to acknowledge (or perhaps once a swindler always a swindler) that Stiglitz said is:

Bankers – and the rating agencies – believed in financial alchemy. They thought that financial innovations could somehow turn bad mortgages into good securities, meriting AAA ratings. But one lesson of modern finance theory is that, in well functioning financial markets, repackaging risks should not make much difference.

If we know the price of cream and the price of skim milk, we can figure out the price of milk with 1% cream, 2% cream, or 4% cream. There might be some money in repackaging, but not the billions that banks made by slicing and dicing sub-prime mortgages into packages whose value was much greater than their contents.

It seemed too good to be true -– and it was.

These are supposed to be intelligent people. US and European banks are working together to try and "shore up" the the mortgage insurers. I can't help but think this anything but smoke and mirrors to delay the day of reckoning when the risk comes home. I can not help but believe it is perpetuating a further fraud on the markets.

From my understanding of what I read in a letter from one of the largest share holders of one of these companies many of these insurance contracts have time limits. They expire and new insurance contracts will not be written.

Give the appearance that everything is ok and that the nay sayers really don't know what they are talking about and more get suckered into taking this junk off the banker's hands, or get suckered in to believing that a discount is a deal when without the appearance they are insured in fact the junk may be worth zero.

Naked Capitalism thinks that the worst thing happening here is that the bankers are spending money shore the insurance companies up when they will lose their AAA rating later.

I have more sinister beliefs, they are trying to delay the inevitable for either personal interests or because of cost is less than if it enables them to get rid of more of their junk.

So, where are the regulators and how did they let this happen?

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World Economy Slow Down

I am looking forward to the next stream of financial and annual reports that will be coming soon. I predict that the press releases will focus on the annual earnings and completely gloss over the 4th quarter earnings, which I expect will not be rosy for any base metal company. However, the 4th quarter earning are probably more representative of the company's next quarter earning potential rather than looking at the full years.

In a recent post I was asking if base metals would fall off a cliff. There were many indicators that economic growth was slowing.

The US is of particular concern. According to Nobel economist Joseph Stiglitz the US has been drawing down home equity at a rate of $700 to $800 billion per year.

That's a lot of unsustainable US economy. Further, the US consumption economy is about $9.5 trillion. The home equity borrowing has been 7-8% of the consumption US economy. Now that lending standards have tightened, and home equities have declined, that borrowing is not likely to continue at anywhere near the same rate. It has to be a strong US slow down in the economy and the trickle down effects can not possibly be pretty.

Emerging markets are not likely to make up the slack. China's consumption economy is a mere $1 trillion, so $700 billion is 70% of their economy. Anyone who thinks China will pick up the slack is smoking something pretty strong.

This can't possibly be good for base metals. There are a lot of base metals that go into consumer goods. Additionally, commercial construction is rapidly declining as well, and municipal budgets that might do big capital projects that require base metals are in trouble because municipal budgets are in trouble due to declining revenue from declining home prices in the US. Cities are demanding all departments cut budgets.

Mining projects in the process of being developed do not just stop in the middle of hundreds of millions of dollars being committed to them, so increases in supply tend to strongly lag changing economic conditions. Data showing slow downs for material usage tends to be lagging rather than leading. In the US housing starting were going full throttle as late as last March, and all of the materials that go into housing would have continued to be used until some time in the fall or winter, yet by then housing starts had plummeted, but the actually declines in demand from that reduction will not be fully showing up in financial reports until the end of Q1, and it should be significant. So far Q4 earnings are down about 20% for companies that have reported Q4 earnings. That's gigantic and it is crazy to not think that that isn't have an effect on commodity demand.

Base metals have had enormous leverage of earnings from record commodity prices and they've been bid up in price, valuing the base metals stocks like a coca-cola stock, only base metals are at far more risk to supply and demand price fluctuations that demand a low P/E when prices are strong. When the market looks good and the company has good growth prospects I'd never give a second look to a base metal stock with a P/E of 12 or higher. It has room built in for down side risk and a opportunity to exit without wiping you out should the market turn, which it appears to have done.

There are numerous examples now of how the downward leverage affects earnings. From Q2 07 to Q3 07 FNX mining's revenues declined 28.3%, but earnings declined 64.3% despite the fact that "the total tons of ore, pounds of nickel, pounds of copper and ounces of precious metals produced and sold was were higher ... than in any previous quarter," according to the Nov 1, 2007 news release. According to google finance the current P/E is 21.7, but that has earning of $12.5 million (the last report), $35 million, $30.2 million and $19.7 million included. Go four quarters forward based on last quarter and you get $50 million per year of earnings compared to the current last four quarters of $97 million. It means the P/E for last quarter reported is about 43. Average nickel price was $11.65/lb and copper price was $3.57/lb. FNX is still richly valued despite being down 37% from its high. The $24.87 shares earned 15c/share last quarter. Even if you believe they can double earnings, the shares seem richly valued.

Teck Cominco's earnings declined from $2.01/share to $1.16/share for the same two quarters, only Teck Cominco did not get so insanely valued. Their revenues were down about 1/3rd yet earnings were down 42%. Their loss of leverage of earnings was not nearly as drastic as FNX. Teck's current P/E is 6.46 and forward P/E is 10.63. It is down 40% off its high. The $32.51 shares earned $1.16/share last quarter.

It is likely any base metal company examined will show a higher decline in earnings than revenue because of the leverage and it is also likely that all established companies will experience a significant decline in earnings due to the declines in commodity prices, which are at risk to decline further due to the economic slow the entire world seems to be experiencing.

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The Glory of Ignorance

We ought to be able to go about our lives blissfully ignorant about many things. For example, I was blissfully ignorant about serious home design problems which in Vancouver led to what we called our "condo rot" problems.

I would look at a development and never see the design issues that scream you have to be moron to put this design feature in homes being built in a rain shadow. You would think that the people trained and educated in home design would hear the screams, but they did not and we had serious water seepage design built into many of our new homes in the 90s. We had thousand of home owners that had rot in their building envelope due to water seepage. My new home had rot in 3 years. I was not bless with being able to remain ignorant about key features of home design to prevent water seepage. We had thousands of home owners hit with assessments of $30-60k to fix rot in their relatively new homes. I was fortunate as my assessment was only about $5k and the rot was limited to balconies, not in the building envelope. I was very lucky, the rot had spread to one inch from the building envelope and that $5k bill almost became $20-25k. And with blissful ignorance, we had homeowners in our complex rallying other owners to vote to delay to fix the problem.

You ought to be able to trust the so called experts and remain ignorant. But in Vancouver, being normal cost homeowners millions of dollars in the 1990s and Vancouver was sprinkle with new homes covered in tarps for years.

The same thing ought to be said of understanding investments. You ought to be able to trust a financial adviser, or trust the so called experts. If an investment has a AAA rating you ought to be able to trust that the investment has a high level of safety, as defined by the rating criteria.

A year and a half ago I had never heard of a credit bubble, economic bubble, stagflation, asset inflation, Austrian economics, monetarist, Keynesian, Ponzi, credit swaps, discount window and well today, "Term Auction Facilities." I read this article, but I didn't quite understand it. I would like to remain ignorant about what it is saying, but powerful people have been grossly incompetent at all of our peril and the way you best protect yourself from what they have done is to study it and keep on top of what they are doing.

Powerful people have been doing things to change the "rules" for the past twenty years, things that have gradually built up enormous fundamental problems in the economy. I guess it was about 13 months ago that I was first steered towards looking a fundamental problems in the economy and started assessing how they gave the appearance of getting around the disaster they were creating in the past but were instead increasing the fundamental problems. I started to assess what these problems would mean to me once the problems started to surface.

These are things we ought to remain ignorant about, but unfortunately, we are seeing the consequence of being normal being played out throughout the world. Yukon has $1200/person of tax payers money "frozen." They might get back their 30-day investment over the next 10 years, at par, if they are lucky. Small towns in northern Norway have lost half their municipal savings. A few Australian municipalities are now suing from losing 70% of their municipal funds to AAA rated mortgage bonds. Countless municipalities and counties across the US are finding their liquid, safe, short-term investments are not.

We ought to be able to trust financial advisers and analysts, but their behaviour is more in line with the snake oil swindlers of the past. This article, "Analysts in fantasyland" points out the degree to which they get it wrong.

My conclusions that I came up with around last February was that banking stocks would be a disaster, and I have been encouraging my friends to sell them.

I also concluded that pension funds would be hard hit and most likely our pensions as we believe them to exist do not. By my assessment, a realistic assessment not built on 30 years forwarding of fantasy beliefs, I only pay for about 40% of what my pension promises me. I suspect I shall see even less than what I currently pay for as people who are collecting are collecting 2.5 times what they paid for and I am 19 years down the pyramid. Most people live in this glory of ignorance and so we continue with this ponzi pyramid scheme of pensions.

I know nothing of US law, but interesting, in my assessment, our pension systems are in gross violation of Canadian pyramid laws.

What is further interesting is that I come up with that we are currently only paying for 40% of the promise, yet the "experts" say that those currently collecting will get about 1.25 times what they paid and they say my age group will break even and that those in their 20s will get about 0.8 of what they've paid in. That 1.25 figure leaves me absolutely dumbstruck as to how they came up with it. It is based on what is being paid out now and this figure can be calculated and it is beyond me how they came up with such nonsense.

I did not foresee the degree to which local governments are being hit. Every hit they take means we pay the taxes twice.

We ought to be able to remain ignorant about things that ought to not concern us.

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Political Idiotism on Taxation, Again

This topic is a little stale in terms of current news, Government proposes $60B in tax cuts, with further GST drop, but I never got around to writing about it when it was current and it is so negligent and stupid.

There is a booming economy. The economy will not always be booming. These proposed cuts will NOT be sustainable with a down turn in the economy. It is one thing for an individual to be so ignorant to stretch their resources to the limit in good times and then rightfully deal with the consequences of such imprudent behaviour. It is unacceptable from government and we have a high level of debt because of this kind of negligent behaviour in the past. It is time be responsible and say no to a short term gain for long term pain.

Our collective greater good would be best served by debt reduction and working to ensure we have maneuverability for an economic slow down. The only reasonable thing to do in the whole proposal is to increase the personal tax exemption. That is a tax neutral action that is offset with increased tax revenue due to wage increases. More importantly it is the only thing that reverses some of the gross inequities to the working poor.

I can assure you that the working poor are unlikely to see their income increase by $700 this year and if we have any sense of humanity we should be questioning why anyone who IS working and CAN'T afford to PAY RENT, BUY FOOD and BASIC NECESSITIES is taxed at all at the slave labour minimum wage rates? Indeed, every cent these people get goes directly into the economy because they are trying to live on a deficit level of income despite genius greater than Einstein in budgeting. You simply can not get water out of a stone and they ran out of places to cut spending YEARS ago.

Give me a tax cut and guess where I'm going to spend -- NOT in Canada. I am taking my discretionary income, and going on vacation in another country. Why should tax cuts continue to subsidize this kind of behaviour of the "haves" when we having increasing numbers of working poor lining up at food banks? Giving me a tax break will do zero to stimulate the economy and will increase my ability to take Canadian dollars outside of the country and this is true for where the majority of the proposed tax cuts would go. As a nation we have enormous debt, we should ensure debt is paid back at a faster rate in boom times. Together we will be stronger in an economic down turn.

Better yet, it is high time we took a serious look at where the tax breaks need to be. We have seniors who make up 20% of the population controlling something like 60% of the wealth and we given them an age exemption on top of pensions that they never paid for except for but for a pittance towards it . A pension is something that is supposed to be paid for by those receiving it. At the very least it is high time we got rid of the age exemption and replaced it with a means exemption for the working poor and put some fairness and humanity into the tax system.

How can any nation think they are great when there is such theft of dignity for the working poor?

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Bad Feeling Good Times

I've been reading some of Jim Jubak's writings and I appreciate his pieces for their deeper understand and broader look at how the world has been changing.

His piece, Why these good times feel so bad, gave me a lot to think about.

In particular what got my attention was the "The churn in employment,"

My Dad, to take an extreme example but one shared by many in his generation, worked for the same employer all his life, from his start at 17 as a sweeper on the factory floor to his retirement at 62 as a maintenance electrician. For him, except for his service in World War II, the churn didn't exist. It was something that happened to other guys. Until the last few years of his working life, when the company began to talk about shutting down the plant where he worked, as far as I can remember, he never worried about losing his job and having to find another one.

Contrast his experience with the churn experienced by the generation of workers born between 1957 and 1964. Unlike my Dad, born in 1917, these workers held an average of 10.5 jobs between the ages of 18 and 40, according to a study by the Bureau of Labor Statistics. In those 22 years of work, 21% of workers in the study, which ran through 2004, held 15 or more jobs. Only 15% held fewer than four jobs in that period.

Being a part of the born between 1957 and 1964 I can relate to the "job churn." On the surface the new reads that people change careers more often today and there is no insight into the unrest and lack of satisfaction in people's lives that are leading to these changes.

When I look back the truth is I'd have done better economically for myself if I'd stayed at my job as a waitress at White Spot that I got when I was 15 in 1977. Minimum wage for a 15-year-old was $2.60/hour and my rate of union pay was $3.92 and I got tips on top of it, making the wage about $6-7/hour, 30 years ago.

What 15-year-olds today can expect? In BC they get $6/hour for their first 500 hours of work, and then they go to $8/hour. With just 2% inflation $6/hour 20 years ago would be $10.87 today. If you look at what young people spend their money on, like university tuition, well, I remember paying $18/credit hour in 1980 and today it is $151.70, so 2% increase on $6/hour to 1980 would be $6.50 and to increase that buying so that young people have the same buying power to pay for post secondary education would give a wage of $54.73/hour.

I just saw Linda Blair's head in the "Exorcist" just twist around 3 times at the idea that my buying power as a 15-year-old waitress to improve my life's prospects was in the range of what, what an reasonably well paid engineer gets paid today.

When I worked in the restaurant industry tipping was not automatic and there was not the strong social expectation for tipping that exists today. My tips worked out to about 5% of total sales. I'd say a good 1/3rd of customers did not leave tips and it was rare to get a tip over 10%. I was doing about 20% better than my co-workers on tips. I was very good and if you were a regular customer of mine and I knew what you liked, well, I had your coffee poured and your order written before your seat hit the chair. I got tips out of customers known to never leave tips.

I don't know the base rate of pay at White Spot today, but a quick check of the menu and prices shows that the $2 hamburger platter now costs $10. So, I would suspect social pressure has increased tipping so that it is more like 10% of the sales and with 500% increase in prices, that would make tips come to $20-30/hour, and most certainly restaurant works are not claiming and paying taxes on 100% of their income like those of us with 100% of our income going through a payroll.

Waiting tables, politician and corporate executive or high level management are the few occupations that come to my mind that have exceeded reported inflation in terms of income growth over the past 30 years. A hamburger platter increased from $2 to $10 over 30 years is an average price increase of 5.5% per year. Just looking at the goods I sold, to be able to afford them as well as I could as a teenage worker I'd need to earn $30-35/hour. Had I stayed with my White Spot job I'd be making about $30-40/hour with tips and because of not paying full tax, my buying power would likely be that of a worker making $35-50/hour.

What did I do instead? I went a "better" job with a "future" in banking, which immediately paid less, but the promise was that there was supposed to be "opportunity." So much for opportunity when I just so happened to get into banking right before ATMs were invented and as the economy slipped into a recession. I lost work and I found it difficult finding new work. I won a job competition in which about 60 applications were made for a low entry level position and the pay was less than I had been making.

In two of my banking jobs I had alcoholic bosses. My view is that many of the limited jobs that were available were because the working conditions were disgusting and despite an exceptionally tight economy, they had enormous job turnover because of the unsavory working conditions.

The one small credit union I worked in with that abusive alcoholic boss had an annual turn over of more than 100% of the staff and I survived 18 months in the place, training new employees on average every three months, before I'd had enough run ins with with the alcoholic pig. And then I ended up a job with another alcoholic boss. During this period of what I see as enormous turmoil in the labour market both of these alcoholic men lost their jobs within a year of my moving on and to my knowledge neither returned to the workforce. One was about 60, but the other was only in his 30s and last I heard he was in his 50s and had not worked again. I perceive that many alcoholics were successfully integrated into the economy prior to the 1980s, but when the economy got tight, many were displaced, but not before they left an enormously sour taste in those that were employed below them.

I'd say the 80s brought in an era where good workers were overlook through no fault of their own and it was the end of the era of dead weight workers thriving. The news featured layoffs daily, and less experienced workers were pit against a glut of more experienced workers for not enough jobs to go around. The news featured the woes of the $50k per year 50-year-old workers being replaced with younger workers willing to work for $30k and the media bite was that "older workers are being discriminated against," when the truth was that wages for the work they had been performing had imploded. They'd have been working had they been willing to work for the same pay as younger workers.

What I know about my salary working in the banking industry, and having a window on everyone else's pay cheque, is that my wage relative to many occupations was low, with the exception of the retail industry. I was making about $7/hour in 1984 and union jobs paid about double. Some union jobs, like being a checkout clerk at Safeway, paid $17/hour.

I believe the extreme inequities in pay is what ultimately broke the union. Minimum wage was $5/hour at the time and you'd have had a line a mile long of workers, including me, willing to work for $10/hour.

And then, when I look at my mother passing away and the bank foreclosing on her home and eating all capital in her estate the inequity screams. The mortgage was $26,000, and the total payments came to around $300/month. Seriously, if I'd dropped out of high school and worked full-time with an income of $1000-1200/month and the ultra low tax environment of the day, I could have afforded the payments, and with a protected rising income due to tips, it would have simply gotten easier each year, and I had an extra bedroom I could have rented. Indeed, I could have afforded to make extra payments.

I just did a search on two bedroom apartment in Kitsilano, 30 years or older. The cheapest that came up is $449,000 for 717 sq ft. Assume I had that 25% down, the mortgage would be $337k and I'd need a qualifying income of $101,000. With 5% down I'd need a qualifying income of $129,000. Just where does one find a job with that kind of pay today? Beginning teachers start at about $42k, and that's with taking 6 years out of their working lives and taking on student loan debt that averages $40-50k.

I had an excellent grasp of math and budgeting as a teenager. Indeed, I was supporting myself at 17 and my first "major" life purchase wasn't a stereo or any of the things you associate with youth, but it was a washing machine. I'd calculated that it was costing me $10/week for taxi and washing machines at the laundromat and I could buy a washing machine for about $400. In less than a year it would be paid for with saving from having to take a taxi and paying the high prices charged to clean clothes.

When I go back an look at the "Churn in Employment," well, no wonder people people in my age group have been changing jobs. The rate of decline in buying power has been enormous, at least where I live.

And I went to university after having series of unsatisfactory jobs in the banking industry. I came out to triple the price of housing and no jobs. I had a friend who had a 2 year technical program that had made $36k in 78. Three years ago I applied for a job with greater qualifications and that was about the pay they wanted to start at. In 78' my friend's wage exceeded was about 150% of my mom's mortgage amount. Today that wage would be about 10% of the mortgage.

I feel like my generation just missed the boat. It is no wonder I see so many professionally educated in this age group in Vancouver no longer making ends meet.

But, you have to ask, will there ever be a boat for the younger generation?

How many violated "truths" can be counted here?

1) Waitressing is a dead end job. Just what is dead end? Seems to me having economic stability gives a heck of a lot more prospects then doing the "right" thing and going to university and giving up six year of income and finding absolutely zero prospects of even coming close to the same standard of living that being high school drop out would have given.

2) You always do better by getting an education. Sure, and today they come out with $40-50k of student loans and job prospects that leave them in a student loan debt ration comparable to the mortgage debt ratio of years prior. Our university educated come out with a rock to tread that is so big, they are truly lucky if they don't drown, and if you actually open your eyes, you'll see that a great many of them are in fact economically drowning. And here's the biggest joke going, the baby boom expect them to pay their pensions and health care. I can't wait to see that one play out.

Seriously, it is time the gross inequities in the distribution of wealth start to show a little equity. The only thing that can come out of this is a perilous resentment towards age, and if nothing is done to correct it will indeed be well earned, as will the consequences.

One thing I'd have to say that I am truly tired of hearing is how irresponsible younger groups are for not getting their act together and living with in their means. I'd like to see how well the judge and jury mouth pieces that never had to navigate the economic disaster facing youth would have done.

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The Pension Bet

An article I saw today was about the Yukon government investing $36.5 million in bonds that are now frozen and they might see some of this money returned over the next 10 years.

I am distressed over the Canadian government's "solution" to the short fall in the Canada Pension Plan. They have set up a system where taxpayers are paying more into the system right now than what is being paid out, and our CPP payroll deductions are indexed to be a percentage of the average wage in Canada.

This part of the plan does not distress me. What I'm betting on is the second part of this plan is going to be a disaster for Canadians. They are investing the extra money into the markets instead of paying down our debt, or at least that's my belief from what I've read on it and I believe it is about 5 years of pension money. They are thinking they will do better on the markets then paying back debt and do better for Canadians.

If you went to sleep for 20 years and saw what are markets looked like by comparison to when you went to sleep you'd be in an utter panic mode to sell everything and preserve the wealth, yet the almighty Canadian government has started taking our hard earned pension dollars putting them into that over valued mess. I don't see those dollars going anywhere but the toilet.

I'm just wondering how much asset backed bonds Canadians own. I was distressed the first time I read the plan, and that newspaper article just makes me wonder when we are going to be told how our government lost our tax pension dollars.

It is such a sad bet.

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Gold – What’s in a Currency?

Whether a currency is weak or strong seriously affects buying power. Being Canadian, I have traveled the US when it took $1.50-1.60 to buy one US dollar. It keeps the cost of imports expensive. It helps export businesses and it helps tourism as people from countries with strong currencies see tremendous value in their vacations.

Gold is not a currency, but it does act like a form of money, and it preserves wealth in countries experiencing currency devaluation. It can work the opposite for countries whose currency is gaining strength.

We think we have cost of living issue, have you checked out Zimbabwe? According to this May article, Zimbabwe inflation in May, the cost of living double last April/May. It is predicted to be as much as 100,000% over this year, Zimbabwe inflation up more. The official exchange rate is very different than the black market rate where when converted to US dollars teachers make $100/month at the official rate and $6/month at the black market rate, Zimbabwe teachers on strike. Clearly demanding pay in grams of gold would protect buying power. Check out the video on life in Zimbabwe, Zimbabwe living in hyper-inflation. Currently, foreign currency is king.

Zimbabwe is experiencing hyperinflation. Check out their stock market and the graph goes straight up. Check out the early warnings, as this 2001 article shows, Zimbabwe 2001 decsions and one starts to see that the burden of debt and the inability to attract foreign dollars as investors did not see that the interest rate offered would protect their investment from currency devaluation. Life has gotten very bad, indeed, Zimbawe lifestyle lost to hyper-inflation.

Canada’s weakened dollar through the 80s and 90s was due to debt. Few Canadians appreciate the debt of gratitude Canadians owe former Prime Minister Brian Mulroney and finance minister Michael Wilson. They took over a Trudeau government that had program spending exceed tax revenues by $39 billion per year, never mind the cost of debt servicing. By the time Mulroney left office program spending match revenue. Canada still had a deficit in that tax revenue still did not cover debt servicing, but the changes they made during their tenure was outstanding.

Anyone who says other has a poor understanding of calculus, which tells us that if a graph is concave down, the rate of increase is coming under control. The graph for Canada debt was concave down for the entire time this team worked together. The graph of increasing debt under Trudeau is concave up, straight up. Many older Canadians look back at the Trudeau years as the glory years, but he left a burden of unsustainable program spending and debt that many Canadians blame the Prime Minster’s that were left to deal with the problem. No kidding the times feel very good indeed when fair share of taxes are not paid and the burden of paying for yesterday's lifestyle is passed on to future generations.

To that end, Mulroney and Wilson harped on and on about our debt problem and they set the stage for Canada to control debt and eventually move to surplus budgets, $13.8 billion for 2006-2007, Canada surplus budget, Canada budget highlights.

The US has increased debt, and they have increased it to levels that I believe are worse than Canada ever faced. And US currency is devaluing because of it and US congress is asking to increase the level of debt a few times per year. You can see that US debt was under control with Clinton, but out of control with Regan, Bush and Bush, graph of US debt. Last month the US Senate Finance Committee approved increasing the limit on debt to $9.8 trillion. Canada’s debt is $587 billion. With roughly 1/10th the population it means that the US level of debt per person at the federal level is about 1.7 times as high, and unlike Canada which currently has surplus budgets, there is no evidence that US government spending is coming under control, yet another increase to US debt.

Gold has protected wealth for Americans as government has continued out of control. With lowering the Federal Reserve rate last month from 5.25% to 4.75% the US government has chosen to devalue the US currency. The US dollar lost about 6% buying power in September alone in contrast with Canadian currency.

Gold has strongly outperformed many investments for US investors because of currency devaluation, but has not been nearly the performer for Canadian investors.



Over five years gold is up 41% for Canadian investors, or about 7.1% per year annualized. For US investors gold is up 126% over 5 years, or 17.7% per year annualized. Over a shorter term, say 6 months, gold has not been a good investment for Canadians.



Gold is down 6.1% for Canadians and up 8.3% for Americans. Gold is offering some protection of wealth from currency devaluation for Americans. If I were American I would consider owning some gold bullion as part of a diversified investment strategy. The Canadian dollar has had the fundamentals to strengthen the currency through debt management for a long time and it is showing up in a stronger Canadian dollar, from about $1.60 to by a US dollar five years ago to par today.



Surely, if the US government reduces the Federal Reserve rate, the US currency will devalue more and gold will increase in price in US dollars. It may or may not increase in price in Canadian dollars. If the Canadian dollar gets stronger relative to the US dollar, it is likely gold will decline in Canadian dollars.

If Americans panic about preserving wealth from a declining currency and do it through buying gold, gold will likely skyrocket and even currencies gaining strength relative to the US dollar would see gold increase. Should this happen gold will also be a very good investment for Canadians.

Gold behaves like a master currency against all currencies, gaining when a currency declines, and losing when a currency gains. It is subject to the same market forces that lead to selling-off and under valuation and speculation leading to over valuation, which makes the contrast to currencies relative to how gold is valued in the market as a whole. But it is ultimately a master currency. Gold stocks are not bullion and have very different fundamentals that need to be looked at one at a time. A gold stock with costs in foreign currencies will see costs going up due to currency devaluation and will not necessarily see a leverage of earnings that investors expect. Some gold stocks have very strong leverage of earnings expectation built into their price, completely ignoring the explosive cost increases due to currency devaluation.

Currently gold stocks tend to sell off all of their gold, trading it for the very fiat currency their philosophy claims to abhor.

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Par!

US/Canadian... 1.0006

I am in shock...

What a joke, everyone put on their born yesterday hats. The US government reported consumer prices fell in August by 0.1%. Energy prices fell 3.2%. I guess no one noticed that crude oil is over $80 month...

End of message

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2% inflation in one day

In one day or so the exchange rate for a dollar US went from $1.03 to $1.01 Canadian.

Today the US had 2% inflation on imports from Canada, or Canadian exporter to the US just saw their revenue drop by 2%. Either way, it is going to be ugly.

End of post.

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Canadian/US at Par?

I couldn't help but notice I'm getting US coins back in my change. That was not happening even 3 months ago... US, $1.0375 Canadian. Wow, the US dollar has come down fast and hard.

US importers are going to be hurting badly, as will Canadian exporter. I wouldn't want to be owning those kinds of investments through their next earnings reports, or even now...

All of a sudden US exports got a whole lot cheaper and more competitive, so Canadian importers should be looking good.

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Long Live the Credit Bubble!

Today Bush announced plans to essentially bail out irresponsible lenders, developers, borrowers, brokers, basically anyone involved with the subprime mortgage mess, as this news release outlines.

There are a number of responses, critical as in Mish's post, and I do think Mish is right on with his analysis.

I am not sure what to make of "Parting the Bankrupt Sea." He points out that those hurt by this move are those who correctly assessed that these were bad investments and there would be a crash. I simply don't get the part of this post that says:

This is a good move by our government (unless Bush does something really odd during his speech later today or Bernanke usurps President Moses Bush with comments that are at less than positive and supportive)

I don't see at all how it can be a good move to bail out highly irresponsible activities. Governments role is to regulate highly irresponsible activities, not dip into taxpayer's pockets to make irresponsible activities ok. At best, it is a short term solution that allows the wealth to cut their losses.

Another post, just a graph, shows the degree to which US debt has risen relative to that which makes a nation strong. The graph screams to me the degree to which today's promise is short term, unsustainable and further cannibalizes the future.

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Currency devaluation, social policy - Reflections from vacations

I just got back from a three week vacation in Costa Rica, where one US dollar gets you about 520 Costa Rican colones.

I know little of Costa Rica's economy, except that their main export is from agriculture and their main "industry" is tourism. Currently there is negotiations for a free-trade deal with the United States and every where you go graffiti shows opposition to a free-trade deal with the US. Their taxes are low with universal health care and education being the two most important items taking up the majority of the taxes.

I went to Costa Rica to explore the idea of learning Spanish, so I went for a two week introductory course and I stayed with a home stay family. The family consisted of grandparents and young adult grandchildren. What was strikingly different from Canada is this family with "retirement" age adults did not have entitlement attitudes towards pension, but continued working. They were a hard working family.

I would have to say our Canadian attitude towards entitlement and social programs leaves a foul taste in my mouth. First, not a senior currently collecting a pension paid for it. I so clearly remember my amazement as a very young adult with a job in the bank and seeing this pittance of a tax for pension and then also seeing how much seniors were getting in pension and I brought it up with my employer about how little the pension tax was compared to the pension payout and I was told that over the long term the money put in would pay for the pension and I was shown a bit of compounding, which still made no sense to me, but I simply assumed those older and wiser understood these things better.

I now know that our pension system was set up based on a pyramid scheme that would be illegal under today's law. The relative amount -- meaning correcting for wage increases -- we pay for pension today is much, much, much higher than what was paid in my youth, but it is still utterly unsustainable in terms of the pension entitlement expectations, and political leaders saying anything otherwise are either ignorant or lying. One day I will post more on the topic as I believe that I live in one of the greatest countries, but the unraveling of this pyramid scheme has the potential to destroy us, and could ultimately pit youth against age when age is defenseless. Certainly our currency and savings are at extreme risk from unsustainable debt and entitlement expectations and we are at risk of seeing it unravel as Mexico, Costa Rica and Zimbabwe have all experienced, unless we change our attitude and work together to make something sustainable and fair.

But, the Costa Rican people do not burden their children with their entitlement expectations, but instead continue to take responsibility for their economic future.

I wondered about the huge numbers for the currency in Costa Rica and I remembered traveling in Mexico in the 90s after their currency was grossly devalued and they were in the process of switching from old pesos to new pesos at a rate of 1000 old pesos is one new peso. They had periods of inflation of 30-40% per year, perhaps more. My Mexican friend in university in the 80s had talked about Mexican inflation and how her family had worked to move their money to more stable currencies as they saw the buying power of their savings rapidly decline. My last vacation in Mexico in the 1990s a Canadian dollar traded for about 3 Mexican pesos. Today it trades for 10.5 Mexican pesos so Mexico has continued to have a rate of inflation that grossly destroys the buying power of savings.

The young man at the school I attended talked about how over the previous few years if you had a US account you saw the number of colones increase pretty much daily as their currency deflated relative to the US currency. It made me wonder what had happened with government management of Costa Rica's economic resources. The young man in my homestay was highly interested and informed on political issues and he talked about the many social programs Costa Rica had at one time and their glory years of spending beyond their means and increased wealth. He mentioned the huge consequences to Costa Rica when one of their Presidents failed to yield to demands to cut social spending when their debt load to other nations was high. I do not know Costa Rica's full story, but it appears they faced a hyper-inflation due to high debt, an inflation that is not yet under control. I saw price increases of up to 25% at retail establishments in the mere 3 weeks that I was there.

There is something in place to control the currency exchange rate for the past year or so. The young man at the school said that you could no longer see your colones increase dramatically by holding a US account. What is this control? Currently in Zimbabwe there is an "official" exchange rate mandated by law. They have hyperinflation running at 4500%. At black market rates the exchange rate for 44,000 Zimbabwean dollars, the price of a loaf of bread, is about 18 cents. At the official rate mandated by law that loaf of bread costs $176.

Costa Rica is an inexpensive country for travel, but the tourist areas have become grossly expensive for the local people. The average price of meal in the tourist areas that I visited seemed about twice the price that I paid in San Jose in close proximity to the school, and other students said they visited tourist areas on the Pacific side where the price was double again to what we were paying in the Caribbean coast. A policeman`s monthly wage in Costa Rica is about $350 per month and with the prices I saw, inexpensive by Canadian standards, I can not imagine how they make ends meet. It seemed to me that the prices were anywhere from 20 to 75% less. Bottled water was about $1 as was pop. A lunch you`d spend $6-12 here was $2.50-5 in town, but as much as $7 in the Caribbean coast.

I discovered it is wise to always ask the price first because if you say what you want and then it is packaged, they will take you to the cleaners in terms of what they expect you to pay. I paid $2.65 for a coffee in a very small cup with two refills, whereas when I cautiously shopped for my coffee the next day I paid 70c for a coffee that was twice the size of the cup of the previous day.

In another example, the going price for the locals for a bag of cut mango fruit, the fruit of two very small mangoes or one large mango was 40c. I paid 60c, but my last day at the beach this other vendor, after I had confirmed the 60c price in the morning, had halved the amount in the bag and made it look the same by loading the bag with pits, which I only discovered after I returned to my friends, who had given me 60c for a bag each. He tried to charge $1.20 in the afternoon and I settled at 70c. I did not ask the price again before I just asked for it. So even asking the price earlier you still have to confirm the price again before you order. I found in many places Costa Ricans do not think twice about changing prices and the terms of what you think you`ve agreed to simply because they figure you can pay more.

Anyway, Costa Rica is a great country to visit right now, and depending on where -- ie Atlantic versus Pacific coast -- it is inexpensive by Canadian/American standards. The tours arranged for tourists are perhaps a little less expensive than a tour in Las Vegas or Disney World, but overall they are not cheap. They wanted $50-60 for a 3-4 hour jungle tour, and $70-80 for a river rafting tour, whereas you can find a room with a private bathroom for two people for as little as $35 per night close to the waterfront. Shop around and your meals will be less than $10 per day, but even going for the finest dining you would be hard pressed to exceed $25 per day.

I do wonder about how the currency is being set and about the rate of inflation as to whether Costa Rica will remain highly attractive for tourism.

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Subprime, Spending and Lending Laws

In a news story, Bernanke: Subprime hit could top $100B, Bernanke says that if prices drop consumers could cut back spending as much a 9c for every dollar of lost wealth.

So, a half million dollar home declines to $400,000 and the person would cut spending by $9k. A $200,000 home to $160,000 and they would cut by $3.6k.

It looks like businesses of non-essential items are going to be in for a hit.

They also state they are working to strengthen lending regulations. I'm sure they will be marginal at best. Having worked in the banking industry during a period where people lost their homes and were left with further debt to pay back, over the years I have thought dearly about this topic, and I have previously on interest rates, Low Interest Rates - As Destructive as Usury.

I have been a private advocate of strong laws and regulations around lending as interest rates decline due to the crazy amounts that people can borrow based on income. It makes no sense mathematically to apply a fixed standard to borrowing rates that have increasingly leveraged effects on the amounts that people can borrow as rates decline.

Legislation that would protect the consumer would be lending laws that limit the amount a consumer can borrow based on a fixed evaluation of income, down payment, amortization period and interest rates.

I have a 4.4% interest rate mortgage.

Qualifying for a mortgage should not be based on current interest rates. The leverage of the potential increase in payments is utterly enormous when interest rates are down, and the amount of money people quality for at low interest rates is insane. I qualified for 53% more mortgage that I borrowed for interest rates at 4.4%. If they'd been 3%, well, then I'd have qualified for 76% more than I borrowed. Based on the payments I chose to make I'd have qualified for 85% more at 4.4% and 115% more at 3%.

Qualifying for a mortgage should be based on being able to afford the payments with 30% of your income with 25% down and 8% interest for a 25 year mortgage. I'd have actually only qualified for 10% more than what I borrowed with that criteria.

So, then comes the fudging factor on how to change that to change with difference in individual's financial situation. Zero down loans are actually fine, if you afford them with 30% of income at 10% interest. I would not have qualified for my mortgage with this criteria. The maximum I would have qualified for would have been 6% less than I borrowed.

And there's nothing wrong with having it go the other way, say 30% of income at 6% if you have 50% down. Under this criteria I would have qualified for about 30% more mortgage that I took based on the interest rate, but I would not have qualified for the mortgage because I did not have half down.

The actual length of the mortgage should be based on the criteria given. You have a repayment schedule based on a 25 year mortgage at 8%, but with current interest rates you will pay it off in x-years. This criteria would have me paying off my mortgage in 13-14 years. With nothing down my smaller loan qualifying amount with larger payment would be paid off in 12 years. If I had the half down the last example would have had me paying off the mortgage in 19 years.

Anyway, these are guidelines that I've come up with from thinking about the issue over the years. I think qualifying based on fixed criteria, such as 30% of income to cover 8% at 25 years, is how lending should be regulated, but how this fixed rate criteria is set should be open to debate.

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Stealing our Children's Future

I live in BC. Our news papers this week boasted that tax cuts work because we had a record win fall in a revenue surplus this past year, and it was significant.

But, here's the truth as I see it. BC's economy was strong in the past because of our commodity based economy. It died a painful death as mines were closed due to poor commodity prices beginning in the 80s.

Commodity prices have been exceptionally strong and the commodity sector has been booming beyond people's wildest expectations. Check out the venture exchange commodity based businesses and read the line-up of Vancouver addresses.

Through this boom that is unmatched in our economic history our provincial debt has increased by $13 billion dollars, from $20 to $33 billion dollars. I am a teacher and I know our wage increases are far below inflation through these boom years. Relative funding for something as important as education has grossly declined through these boom years. Indeed, if you were to contrast our wages to Ontario you would find that BC teachers have a 17% higher workload and a %17 smaller wage, and we have the highest housing costs in Canada. It is enormously scary to see that massive increase in debt and to know we are have stressed important services pretty close to a breaking point, certainly beyond my breaking point as I work towards removing myself from the education sector. It makes me sick to think "what happens in a recession?"

They take credit for their policies for being responsible for our booming economy. $1 copper prices to $3.50 copper has nothing to do with it, it is about their tax cuts. We ought all shudder in our sleep at their inability to assess what has happened beyond their living in box the size of an atom with black hole walls that expand the universe.

So, this year we will see $1.3 billion paying down debt, debt that there was zero excuse to allow to increase in the first place, making us $12 billion further in debt in a booming world economy unprecedented in history.

Furthermore, people ought to know and check out Mr. Campbell's record on debt while mayor of the City of Vancouver.

Debt simply transfers this generations economic responsibility to the next generation and this government has stolen from children at unprecedented levels.

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I'm a banking bear

Over on Motley Fool I was asked why I rated Citigroup, a banking stock that is paying a 4.2% dividend and has a P/E of 11.39 as under perform and I thought it a question exceptionally worthy of an answer.

I do not usually rate under perform for a stock paying a good dividend and having a low P/E, however, I do not believe any financial institution will ride out the subprime fallout very well and I think the consequences of the sub prime lending market will be felt for years. These mortgages have been repackaged and sold and repackaged and sold again. They are hiding everywhere in financial institutions and investors would be very hard pressed to figure out any individual institution's exposure to risk.


I think there will be more than one wave of people in trouble with their sub prime mortgages, estimated to be at about 30% of mortgages. First wave is those that are not meeting interest payments now. Their mortgages are essentially increasing every month as unpaid interest is added onto principal.

There are lots of people who have bought on plans that offered lower interest rates the first 1, 2 or 3 years. These people are at risk as their interest rates readjust.

There are people who were barely able to make their payments and may be increasing credit card debt every month right now just due to the increase in the price of gas alone, and so many other costs have gone up. Expenses are increasing faster than wages and they lack any buffer zone in their income.

There are people who have been living off equity, borrowing more as their equity increases. If they've put the money into other investments they'll probably be ok. If they've been doing this to pay off their credit card debt that gets out of control every 2-3 years, well, obviously they already have money management problems and this is going to be big trouble for them.

Many have variable mortgage rates and coming into the market at a low rate and then finding the rate increases is an enormous negative leverage for the household budget. I worked out that each $100,000 of mortgage costs $474.21 per month at 3% for a 25 year mortgage. It costs $527.84 at 4%, or an increase of $53.63/month per $100k of mortgage, and that is an 11.3% increase in mortgage payment. I don't know about you, but that eats up 4.5 years of wage increases for me.

I do not believe that any banking institution will ride this out without taking some pain, as will the shareholders of banking stocks.

I would also like to point out what I believe to be a difference between Canadians and American because of public policy. In Canada you can not deduct mortgage interest from your taxes and if you buy a home with less than 25% down you must pay up to 2.5% mortgage insurance.

I believe that you are ultimately better off by paying off debt even if you get a tax exemption on interest paid, but I think there is a perception of getting something for nothing, or getting more if you have more debt, almost stick to the government, taxes are so ultimately evil and I figured out how to pay less. That's probably an exaggeration, but ultimately this policy that allows you to deduct interest has lead to a higher acceptance of debt and even a strong shift towards public perception that a level of debt is ok and perhaps even a level of debt relative to assets is wise... (Ekkk!!!!...)

Canadians are more motivated to pay off debt as there is no perceived benefit from holding debt and they are also much more motivated to try and have a larger down payment. That isn't to say they manage the 25% down, but what will typically happen is they might come up with say 15%-20% down, find another 5-10% through short term debt and finance their first home with a highly aggressive debt repayment plan for the first 5 years or so as they work to pay back that 5-10% in a short term. If they can only come up with 10% down they just fork out that 2.5% insurance because they don't have hope of paying back that short term debt in a reasonable time line. It is difficult to get a subprime mortgage with Canadian law. You have to have 5% down and have to pay that 2.5% insurance.

I don't believe the differences in behaviour is universal, no people or countries are monolithic in all things and I didn't say this is a universal thing, but I do believe that if you look at the facts you would find a greater percentage of Americans borrowing against their equity than Canadians, and this is one of the ways that public policy affects behaviour to the detriment of the economy as a whole.


And even another point, the policy of allowing interest to be deducted has leveraged an ever higher level of hyperinflation in the housing market, but that's another topic.

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Why Aren't You Saving -- The Death of a Bedrock Belief

The purpose of Low Interest Rates - As Destructive as Usury was to show how much less empowered people have become in their ability to get ahead by paying down debt through two mechanisms:

1. Grossly reduced leverage of benefit of reducing total amount to be paid back from increasing payments.
2. Low interest rates are because theoretically inflation is low, so wage increases are also low further disabling the ability to increase mortgage payments.

A third problem is revealed in Making Less Than Dad. The study points out that American men in their 30s are earning less than their father's generation, a 12% drop.

A significant point in the article states that American families had a 32% increase in income levels between 1964 and 1994. Move that forward by 10 years, from 1974 to 2004 household income growth slowed to 9%.

A "truth" I was repeatedly told when I was growing was that each generation does better than the generation before them, and article suggests the death of this bedrock belief, but I would suggest that belief has been dead a long time, through reduce earning power, as the article above shows and increased taxes that disproportionately burden younger people.

I became highly aware of the degree of the declining buying power when I was involved with the 1997 Census. I was shocked to often see 3 young adults sharing a one bed room apartment out of necessity.

That was not happening with my peer group when I was a young adult. You could afford to share a reasonable 2 bedroom or even a dumpy one bedroom on minimum wage. I worked in a bank so I saw what all occupations were paying and my wage was at the lower end of the wage spectrum. Sharing a two bedroom apartment cost me 15% of my gross income. I could fill my economical car's gas tank with one hour of wages. I had a girlfriend who supported herself in grade 12 renting a basement suite on working 20 hours per week.

I often bring up the declining buying power of minimum wage with students. "When I was a young adult minimum wage was $3.65 and my share of a two bedroom apartment was $112.50," I tell them and I get them to calculate how much minimum wage would have to be today to keep up. They will come up with about $13/hour.

I continue, "A course at Simon Fraser University cost $54 and today it is $453.30," and they calculate $31/hour.

And never mind the grossly reduced buying power, look also at the grossly increasing tax burden.

"You would have to pay $111 per year towards Canada Pension Plan, and you'd be at 57% of the maximum pensionable earning, today those at 57% of the maximum pensionable earnings pay $1066." Minimum wage would have to have gone up to $35 to have the same proportion of wages going to Canada Pension Plan. But, even on another issue, maximum pensionable earnings was 1.73x minimum wage and it is now 2.63 times minimum wage. At the very least, if minimum wage went up as much as the maximum pension amount it would be at $12/hour, but they be taking home way less because of the gross increase in pension contribution for low wage earners.

There is no question making less than dad grossly impacts on ability to work toward financial security, but I question how much the study corrected for how the tax system grossly favours the old over the young.

And they go on and on about the reduced savings rate...

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Low Interest Rates - As Destructive as Usury?

I was 17 when I first got a job as a teller in a credit union in 1979. This is where I first studied mortgages.

Qualifying income was such that no more than 30% of your gross income would be needed to pay the mortgage. Mortgage rates were about 10-12%. You needed qualifying income of $36,345 to qualify for $100,000 of mortgage at 10%. Most mortgages at the time were under $50,000, and people in their 30s were paying off their mortgage on their house, not a condo or a townhouse, but a house with a yard.

The credit unions had technology far ahead of the times and they had a program where I could change the variables in mortgages and view amortization tables, much like you can do today.

The changes intrigued me. I studied how much money a person could save by increasing their payments by relatively small amounts. For example, at 10% the payments on $100,000 mortgage would be about $909 per month over 25 years, and 10% was about what mortgage rates were before they spiked. Increase the payment by 10% and you would have saved 7 years, or 28% of your payments. The table below shows what happens with each 10% increase in payment.

Effects on Amortization Period of increasing payments at a fixed rate of 10%

Example A: $100,000 @ 10%

Payment	Amort (months)	Months Reduced (+/- 0.5 months)	Increase in Payment - (total)	Decrease in Months to Repay - (total)	Total Interest Paid	Interest saved from last 10%*
$908.62	300	N/A	N/A	N/A	$172,600	N/A
$999.48	216	84	10% - (10)	28% - (28)	$115,900	$56,700
$1090.34	174	42	10% - (20)	14% - (42)	$89,700	$26,200
$1181.21	147	27	10% - (30)	9% - (51)	$73,600	$16,100
$1272.07	128	19	10% - (40)	6.3% - (57.3)	$62,800	$10,800
$1362.93	114	14	10% - (50)	4.7% - (62)	$55,400	$7,400
$1453.79	102.5	11.5	10% - (60)	3.8% - (65.8)	$49,000	$6,400
$1544.65	93.5	9	10% - (70)	3% - (68.8)	$44,400	$4,600
$1635.52	86	7.5	10% - (80)	2.5% - (71.3)	$40,700	$3,700
$1726.38	79.5	6.5	10% - (90)	2.2% - (73.5)	$37,200	$3,500
$1817.24	74	5.5	10% - (100)	1.8% - (75.3)	$34,500	$2,700

*As number of payments have been averaged to +/- 0.5 of a payment, the error in the total interest can be as much as +/- 0.25 of the payment.

The leverage of how much you could save rapidly declined as you increased payments. Where that first 10% increase brought the number of years from 25 down to 18, increasing by 20% saved an additional 3.5 years, or 14%. By increasing payments by 30%, the number of years to pay back the mortgage was cut by more than half.

Furthermore, the interest saved with that first 10% increase is enormous, 56.7% of the original mortgage amount -- about 1/3rd of the interest overall. And even more amazing, double the payment and you pay only about 1/5th the interest and can pay it off in a little over 6 years.

Effects on Payments of changing interest rates for fixed amortization

Example B: $100,000 over 300 months

Interest Rate	Change in Interest Rate	Payment	Increase/ Decrease	% Change in Payment
9%	-10%	839.14	-69.48	7.65%
9.5%	-5%	873.62	-35.00	3.85%
10%	0%	908.62	0	0%
10.5%	5%	944.09	35.47	3.9%
11%	10%	980.01	71.39	7.86%

At those interest rates, 0.5% changes did not make huge differences to payments. When 10% is the current mortgage rate, a 1% decline or increase means the interest rate has changed by 10% (change in rate/rate*100%). The relative payment changes by less than the change in the interest rate. Interest rate increases cost more, but are manageable.

If you look at percent of that family income, a 1% increase would cost 2.36% of qualifying income. For most households income would have increased by at least that amount by the time a mortgage needed to be renewed.

Something not shown on the table is that if interest rates went down by 1%, and you kept your payment the same, the amortization would decline to 19.5 years, and you did not give up an ounce of lifestyle. If interest rates cut in half, to 5%, the amortization would decrease to 12.25 years.

The other thing I "played" with was how much would you have to change the payment to reduce amortization by a year at a time?

Effect on Payment of Reducing Amortization Period

Example C: $100,000 @ 10%

Amort (years)	Monthly Payment ($)	Increase to reduce 1 year ($)	Total increase ($)	% Total increase	Total Interest Paid ($)
25	908.70	N/A	N/A	N/A	172,610
24	917.39	8.69	8.69	0.96%	164,208
23	927.18	9.79	18.48	2.03%	155,902
22	938.25	11.07	29.55	3.25%	147,697
21	950.78	12.53	42.08	4.63%	139,597
20	965.02	14.24	56.32	6.20%	131,605
19	981.26	16.24	72.56	7.99%	123,727
18	999.84	18.58	91.14	10.0%	115,966
17	1021.21	21.37	112.51	12.4%	108,327
16	1045.90	24.69	137.20	15.1%	100,813
15	1074.61	28.71	165.91	18.3%	93,429
14	1108.20	33.59	199.50	22.0%	86,178
13	1147.85	39.65	239.15	26.3%	79,064
12	1195.08	47.23	286.38	31.5%	72,091
11	1251.99	56.91	343.29	37.8%	65,262
10	1321.51	69.52	412.81	45.4%	58,581

When interest rates were 10% small changes to a family's overall budget to increase mortgage payments brought in enormous financial reward in terms of reducing the number of years to pay back the debt - - it explains how the economic conditions enabled so many people to be paying off their mortgage in their 30s.

For simplicity, $100,000 was used, but when I first started working in the bank few mortgages were over $50,000 and I remember we were shocked when someone applied for and took out a $100,000 mortgage!

I worked in the banks through the period that interest rates doubled. There were two groups of homeowners, those that had gotten into the market recently and those who had been homeowners for a while.

It certainly made things harder for those who had been home owners for a while, but few lost their homes. For most, income had dramatically increased through the 70s, so although it hurt for that renewal period, wages had kept up enough to enable them to keep their homes.

Many who recently bought found themselves over extended and with insufficient income to cover the huge increase in mortgage payment. In Vancouver it was complicated by a housing price bubble. People who bought at the high point lost their homes, their down payments, and in some cases stilled owed money after the home was sold. In retrospect, the lucky ones failed to qualify for a mortgage.

The usurious interest rates were hard, and very, very destructive for some.

Low Interest Destructive?

Low interest rates have been looked at as a good thing for homeowners, but I beg a difference.

No question that if you owned your home, had a mortgage and interest rates decline, you gain, or if you live in a region with emigration. But what happened if you did not own your own home before interest rates declined, live in a region with population growth, and interest rate went down to 4%? First one must compare what changes on low interest rate mortgages look like.

Effects on Amortization Period of increasing payments at a fixed rate of 4%

Example D: $100,000 @ 4%

Payment	Amort (months)	Months Reduced (+/- 0.5 months)	Increase in Payment - (total)	Decrease in Months to Repay - (total)	Total Interest Paid	Interest saved from last 10%
$527.84	300	N/A	N/A	N/A	$58,351	N/A
$580.62	257	43	10% - (10)	14.3% - (14.3)	$48,925	$9,426
$633.41	225	32	10% - (20)	10.7% - (25)	$42,199	$6726
$686.19	200	25	10% - (30)	8.3% - (33.3)	$37,142	$5,057
$738.98	181	19	10% - (40)	6.3% - (39.7)	$33,191	$3,951
$791.76	165	16	10% - (50)	5.3% - (45)	$30,016	$3,175
$844.54	151	14	10% - (60)	4.7% - (49.7)	$27,405	$2,611
$897.33	140	11	10% - (70)	3.7% - (53.3)	$25,218	$2,187
$950.11	130	10	10% - (80)	3.3% - (56.7)	$23,360	$1,858
$1002.90	122	8	10% - (90)	2.7% - (59.3)	$21,761	$1,599
$1055.68	115	7	10% - (100)	1.3% - (60.7)	$20,369	$1,394

There is no question that increasing payments reduces the interest to be paid back, but the benefit of increasing that first 10% increase in payment is about half of what it was as a percent in example A, and look at the difference in overall interest savings, $56,700 versus $9,400, about 600% more savings in interest. The leverage of what you can do to improve your economic position by increasing payments and paying is severely compromised when interest rates are low.

Doubling payments resulted in reducing the amortization to 74 months or 6 years and 2 months, but at 4% interest doubling only reduces the amortization to 115 months or 9 years and 7 months. With low interest rates when you double your payment you have to pay for an extra 41 months or 55% longer to pay off the mortgage.

Effects on Payments of changing interest rates for fixed amortization

Example E: $100,000 over 300 months

Interest Rate	Change in Interest Rate	Payment	Increase/ Decrease	% Change in Payment
3%	-25%	474.21	-53.63	10.16%
3.5%	-12.5%	500.62	-27.22	5.16%
4%	0%	527.84	0	0%
4.5%	12.5%	555.83	27.99	5.30%
5%	25%	584.59	56.76	10.75%

The one percent increase from 4% to 5% results in the payment going up 10.8% when interest rates are low compared to 7.8% when interest rates are higher. Overall, that comes to about 3.24% of qualifying income. It does not sound like a lot, but compared to the 2.36% in example B, the overall relative increase is 37% more.

If interest rates go down to 3% and you keep your payment the same the amortization would decline to 21 years 5 months, 35% less benefit than when when interest rates were higher.

Effect on Payment of Reducing Amortization Period

Example F: $100,000 @ 4%

Amort (years)	Monthly Payment ($)	Increase to reduce 1 year ($)	Total increase ($)	% Total increase	Total Interest Paid ($)
25	527.84	N/A	N/A	N/A	58,351
24	540.69	12.85	12.85	2.43%	55,719
23	554.75	14.06	26.91	5.10%	53,111
22	570.18	15.52	42.43	8.02%	50,527
21	587.18	16.91	59.34	11.2%	47,969
20	605.98	18.80	78.14	14.8%	45,435
19	626.87	20.89	99.03	18.8%	42,926
18	650.20	23.33	122.36	23.2%	40,443
17	676.39	26.19	148.55	28.1%	37,984
16	706.00	29.61	178.16	33.8%	35,551
15	739.69	33.69	211.85	40.1%	33,144
14	778.35	38.66	250.51	47.5%	30,762
13	823.12	44.77	295.28	55.9%	28,406
12	875.53	52.41	347.69	65.9%	26,076
11	937.67	62.14	409.83	77.6%	23,772
10	1012.45	74.78	484.61	91.8%	21,494

In the last example, to reduce the amortization period by one year you must increase the payment by 2.43%. Overall, this is an enormous difference in comparison to example C where the payment was increased by 0.96%, relatively speaking about 2.5 times as much.

The big difference is to look at the change for paying back the mortgage in 10 years. In example C if you increase the payment by 45.4% the mortgage is paid off in 10 years, where as when rates are 4% the payment has to be increased by 91.8%.

Enter Housing Costs

On the surface, lower interest rates look like win-win. On $100,000 payments start at 58% of what payments were at 10% interest, and that is an enormous savings. However, the big problem is that in many cities housing costs have increased far beyond the rate of inflation, to the point that people buying are often qualifying for their mortgage with the same parameters as those that first bought when mortgages were 10%.

There are tons of examples that could be used, but I will use what I know. In 1976, after my mother passed away, her two bedroom condo in Kitsilano lay fallow for more than a year for not being able to sell it for about $30k. In that over a year period it ate all of the equity she had built into it as well as the equity of her 3-year-old car. Indeed, when the bank foreclosed on it, her estate owed more than it had. So, $30k for a two bedroom condo in 1977 is what I know to be true.

Today the cheapest two bedroom condo I could find is priced at $379k. This represents an annual rate of return of 8.8% over the past 30 years. Minimum wage at the time was $3/hour. To put it into perspective, if minimum wage had kept up with the increase in housing cost for that period, minimum wage would be about $40/hour, but that's another issue.

To keep things simple, I'll ignore down payments, maintenance fees, property tax, etc. and just do a comparison on the two condo values.

To qualify for 30k at 10% you would have needed about $11,000 of income, or a wage of $5.64/hour. Monthly payments would be $272.61. Total amount paid would be $81,783. Interest is 63.3% of the repayment amount.

To qualify for 379k at 4% you would need $80,000 of income, or a wage of $41.03. Monthly payments would be $2,000.50. Total amount paid would be $600,150. Interest is 36.8% of the total.

On a side note, something that is utterly amazing about this to me is in 1977, as a 15-year-old, I worked part-time as a waitress and with tips I was making about $6/hour. I wonder how many 15-year-olds today could get a part-time job that would pay them $40-45/hour? In light of this enormous economic difference, no wonder so many 30 something year olds were able to pay off their mortgage!

Principal must be repaid, interest repayment is flexible

Ignoring the gross decline in wages relative to housing costs, a serious difference in the two examples is the amount of interest in the payments. By comparison, today's new buyer is grossly under privileged in their ability to get ahead by accelerating payments because the majority of the amount to be repaid is principal. When the majority was interest, that repayment could be drastically reduced by modest compromises in lifestyle.

I would further suggest that had interest rates remained higher, housing prices would be lower because less people would qualify for mortgages, and housing prices are determined by supply and demand.

So had interest rates only declined to 7% that 35-year-old $379,000 condo might be for sale for $283,000, a price that would also require $80,000 of income if interest rates were 7%, only in this case 53% would be interest. The increase in the price of the condo would still be way ahead of inflation at 7.7% per year.

If interest rates had remain in the 10% range one would only qualify for $221,000 with $80,000 of income and 63.3% of the repayment would be interest, and rate of increase in the price of the condo would be 6.9%.

Low interests rates have enabled housing prices to increase beyond reasonable levels and drastically reduced a new home owner's ability to reduce their repayment burden as most of the amount to repay is now principal.

Low interest is a function of inflation

Probably the most important disabling point for newer buyers is that low interest rates are a function of inflation. Low interest rates mean inflation is lower, which means wage increases are lower. When interest rates were high home owners could count on wage increases of 5-8% and the housing burden in their budget rapidly declined, enabling them to make far more discretionary income decisions. With low interest rates inflation is low and wage go up slowly. Indeed, many workers have experienced years with no wage increase. Increasing repayment of mortgage debt is not so easy when wages remain relatively flat.

So, Are Low Interest Rates as Destructive as Usury?

The usurious interest rates cost most people a couple hard years. Newer buyers will have a lifetime of hard years repaying their mortgages because flat wages disables them from being able to increase payments very much, if at all, and since most of the repayment amount is principal there is little power to improve financial position from leverage of increased payments. Furthermore, it isn't likely that new home owners will enjoy wealth creating due to appreciation of their home values. They have significant downside risk.

Very few who had been a home owner over 3 years lost their home from usurious interest rates of the early 80s. Housing prices doubled from the late 70s to the early 80s and it was the ones who paid the high prices who lost their homes and were left with massive debt to repay, the rest had to tighten their belts and deal with loss of lifestyle.

So, it depends on who you ask. There is no question they were a boom for people in the housing market early and that today's buyers will never enjoy the wealth creation it gave to generations before.

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