He may be a physicist, and a PhD, but he needs a whack on the head.

Sergey emailed me two days ago looking for financial advice. “What do I do with my TFSA?” he asked. Depends, I said. What’s your gig?

Turns out he makes a bundle, has an $800,000 house with $115,000 left on the mortgage, and this year alone paid the home loan down by $70,000. Other than that, he has $28,000 in an RRSP and ten grand in his tax-free savings account languishing in cash in the DGS.

That’s it, I asked? Yeah. Pension? No. Income? Two hundred. Mortgage rate? Prime minus three-quarters. RRSP? Three stocks. Age? 56.

Of course I told Sergey he was a financial wreck, when he thought he was doing great. Paying off a 2% mortgage when his cash could be earning him three times as much was an idiot move. Putting three stocks in his retirement plan amplified market risk. Sticking high-octane TFSA money in the orange shorts was nuts. And having more than 90% of his net worth in a single asset, now facing steady depreciation, was a massive threat. I mean, how could a guy with 32 years of higher education making two hundred large walk into such a trap?

So he took the honourable way out. Blamed it on his European mom.

“She said real estate was safe.” Yeah, but mothers can be dangerous.

Deflation stalks the land, as anyone selling a house in Edmonton has discovered. Or people who panic bought gold at $1,250 an ounce. Or the last GM workers to file out of their shuttered Windsor plan last night.

Of course, the epicentre lies to the south of us, where the moment of capitulation seems imminent (the best time to invest). This week the US Census said the number of vacant properties (foreclosures, residences for sale, and vacation homes) rose to 18.6 million. House ownership has fallen 66.9%, the lowest since 1999. And new foreclosures will top 1 million this year.

But this deflation is different, since it’s taking place while other prices are rising. In Canada, for example, 16 million people now pay more for virtually everything, thanks to the HST – a tax sure to raise the inflation rate since virtually no businesses are passing on savings from their own reduced tax overhead (duh). In Ontario, the price of electricity is set to rise 16% next week, the first of two jolts raising the cost of power by about a third. Gas is well entrenched at over a dollars a litre, even though the price of crude is half what it was when fuel was $1.50. And governments at all levels are contemplating user fees, while grocery bills and interest rates escalate.

Asset deflation, price inflation. This means what?

Stuff (cars, iPhones, blow-up realtor dolls) will become cheaper. That puts downward pressure on business income and ultimately on wages. It makes people delay buying decisions since what you want will probably cost less in October. To entice you into buying, prices fall more.

Incomes get more stressed. Already coping with record levels of debt, most households now must pay the idiot harmonized sales tax. Property taxes are set to rise, along with energy costs and mortgage rates. All this quells house lust.

Money needs to work harder. Most Canadians have the bulk of their net worth in a home and their savings in a bank vault. Bad combo. Defend yourself by investing, not saving, by growing money in a balanced portfolio instead of hiding it in a penurious GIC.  Earn 7% or so. Take a whizz on the economy.

Housing’s done. At least for a few seasons, perhaps a few years. Take a look at the chart below and note the four-year lag between the US and Canadian markets. If you think the little red line is gone to continue going higher, I have some lovely shoreline in Louisiana for you to invest in. The shrimp boat’s free.

As you might imagine, Sergey now plans to suck off a big whack of his wavering home equity with a HELOC and invest it in a sweet selection of marketable bonds, preferreds and sector ETFs. He’ll earn interest, dividends and capital gains while writing off the interest from his throbbing income. He gets diversified, spreads risk, creates his own pension, fights deflation and defies his mom.

Like every Boomer knows. Never trust anyone over 65.

It may be July. It may be hot. Yet there are those who blow hard on the spent embers of the residential housing market, hoping the flames will reappear.

Two small examples of the delusion that envelopes our society, and more incontrovertible proof real estate may be in for a fiery descent. After all, how can things work out well when you sell houses to people who have no money? Or when a vendor’s naked greed shows the emperor has no clothes?

First we whisk you to the corner of Gerrard and Parliament in downtown Toronto, better known in the day as The Projects, or Regent Park. It was once the site of a monumental public housing mistake which actually replaced a tawdry Depression-era slum. And while the buildings change, social problems remain. But, as the Daniels Group so cleverly knows, if you build it, they will come.

Even if they have only enough cash to buy a loveseat at Ikea.

This highly successful Toronto developer is flogging units in its new condo building here, called One Park West, with a unique program it developed. Of course, it sells units for 5% down, and arranges financing for the other 95%, which is backstopped by the taxpayers who read this toxic blog. And, of course, if you borrow your first mortgage from a lender like TD, you can actually get 4% back in cash – or $10,000 on a $250,000 loan – which means the bank can pay part of your 5% deposit.

But why stop there? This is prudish, buttoned-down Canada where only the creditworthy get to obtain real estate.

So, if you don’t actually have 5% to buy a condo (prices average $400 a square foot), you can buy one for less than the $16,000 needed for a $320,000, 800-sf box. How much less? Well, $3,500 is enough under Daniels’ Gradual Deposit Payment Plan. The rest you pay monthly. Just like Ikea.

But there’s more. If you are over 18, a renter and earn less than $77,900, then you qualify for Daniels’s First Home Boost program. The developer will give anyone with 5% down and extra 10% – “Boost your down payment from 5% to 15% interest and payment free!” – which drops the mortgage to 85% of the purchase price with a small reduction in the monthly. Sound too good to be true?

Well, the ‘boost’ is actually a second mortgage, increasing the overall indebtedness back up to 95%. And it’s not exactly free. If the unit is sold anytime within 20 years, the second mortgage must be paid in full, plus an amount equal to 10% of any gross capital appreciation. So if the $320,000 unit sold for $350,000 in five years (good luck), then the second mortgage of $32,000 would be paid from proceeds, as well as a penalty amount of $3,000. Then from the $285K remaining would come the realty commission of 5% (plus HST) of $16,000, for a net of $269,000.

Did I miss anything? Oh yeah, the 85% mortgage of $272,000. Is this a great country, or what?

To its credit, Daniels says if the unit is sold for a capital loss, the second mortgage will be waived. But as you can see from the above, there are several ways to fleece the lambs.

Now to Bubble City, for an historic moment in time, when we stand back and pay homage to an orgy of self-importance, myopia and wet coast animal spirits which must surely mark the demise of a market gone insane. Or maybe it’s just me. But what would you pay for this bung?

…with this dream kitchen…

…well some greater fool just shelled out $2,165,000 for an unrenovated wood frame house on a cinder block foundation built in 1940. Says the Vancouver realtor: “Water and mountain views, half block from Locarno Beach Park, 4 bedroom bungalow with full basement on prime 60 x 95 freehold lot. Hold it, rent it or build your dream home.”

Or weep. Or giggle. Or give thanks.

Say, do you smell smoke?

Note: I will be speaking in downtown Vancouver on the evening of September 16th. Reserve a seat here. — Garth

On March 8th, 2009, the stock market tumbled to its lowest point since 1997. Investor sentiment was massively negative. The media warned of a New Depression. Canadians mobbed their online accounts to bail out of equity funds.

The next day stocks turned positive, in a one-day rally. That night I wrote here: “The financial markets will lead the assault higher once it appears the absolute bottom is visible. Perhaps that was last week, but more likely it will be six months from now. In any case, Tuesday’s splendour amid the carnage should give you a taste of what’s coming.”

About 150 people commented. None agreed with me. Typical was this statement, “Even a dead cat will bounce if it hits the ground hard enough! Ever hear of a BEAR TRAP?”

Of course, the market would gain 55% by the end of the year, and that week in March proved to be the bottom.

I mention this after an interesting couple of days in which about 400 comments were made here on my assertion to sell Canada, buy America. Somebody with more time on their hands than me can work the numbers, but I’d say 75% of them looked at unloved US housing and saw only fear and danger.

Five months ago I wrote about the virtues of blue chip Canadian preferred shares, then paying a return of 6.25% with 80% less tax than GICs. Grab and lock in the yield, I said, because it won’t last. And it didn’t. Today new investors will get 5.8% – which still beats the pants off anything the nice lady at the bank can seduce you with.  The comments here? Negative, full of fear, caution and misinformation – as they were shortly afterwards when I explained how marketable corporate bonds work, and the fact a new CIBC issue was paying 4.2% – 200% more than the same bank was giving on illiquid GICs.

Of course since then, bond yields have fallen and bond prices have risen as investors fled to quality on European debt woes (now fading). Buyers of those bonds would have received not only their coupons, but also a capital gain – while taking zero risk on a security that always matures at par value.

And consistently I have preached the wisdom of a balanced portfolio – one that includes equities, preferreds, bonds, gold and real estate, only to be trashed by those who argue for 100% bullion, or all housing or nothing but cash, in a GIC or a can under the patio.

My point is not that I have been more right than wrong, but rather that the negativity of some people who come to this swampy blog is overarching. Seems legions of us have no idea how essential diversification is during unpredictable times, or how asset allocation is the greatest determinant of portfolio performance. There is no silver bullet. Not precious metals, housing, cash in the Dutch guy’s shorts or bank stocks.

In fact the absolute best defence when you don’t know what’s coming next is to have exposure to multiple asset classes – a lesson too many learned when the winter of 08-09 decimated their RRSPs stuffed with equity mutual funds, or that legions of new homeowners are about to discover now. Cash in TFSAs, stocks in RRSPs, GICs in non-registered accounts – these are the hallmarks of people who have no idea how to protect themselves from what lies ahead, which includes a tax bulldozer concurrent with asset deflation and price inflation.

But chief among the leading indicators are comments left at GreaterFool.ca.

The stock market will crash. Bond issuers will default. Preferreds will collapse. America will bankrupt. Banks will fall. Gold will ascend. Cash will save. Chaos will emerge.

That must be so much more fun that making 7%, avoiding tax and sleeping nights.

But I wouldn’t know.

Since the spring of 2006, US real estate prices have steadily eroded while confidence in housing all but evaporated. Thus ended the greatest property boom in American history, which took prices to new highs. Easy credit and a casino mentality helped fuel it.

But all booms end badly. This, no exception. In fact the bust was so pivotal its impact was felt around the world, which continues to this day.

The contrast with Canada is stark. Our housing market began bubbling in 2007, was briefly derailed in 2008, then rekindled as emergency interest rates dropped mortgages to 2% in 2009. Today this boom is also busting, but prices will remain at record levels for some weeks to come before the inevitable occurs. Our path ahead may well trace that which Americans have walked.

Two days ago I wrote, sell Canada, buy America. The logic was obvious. The asset of housing here is at its zenith and will fall. The same asset there is cheap and unloved. Take profits here. Position for recovery there. Especially now, with a dollar near par.

How can you really go wrong, I asked, selling a Vancouver bung or a North Toronto lot for $700,000, investing $600,000 to yield $3,000 a month for a luxury rental in the same hood, and using the last hundred to buy a nice vacation home in the sunbelt, at 50% off?

Some argue this is foolhardy.  America’s a country in decline, they say. Or, the obstacles to US property ownership are so large there’s no point doing this. Or, who wants to buy a foreclosed shack in a mold state made of Chinese drywall?

Let’s talk details. I quickly selected four properties currently listed for around $100,000 in two communities Canadians like to spend time in: New Smyrna Beach on the east coast of Florida, and Phoenix. For ease of maintenance and stable ownership costs, I chose only condos. I also picked decent neighbourhoods with promising demographics. You could substitute Scottsdale or Naples or Stockton or Miami, and find similar.

Built in 2006, just as the housing boom was ending, this townhome is in a gated community in Phoenix has three bedrooms, two-and-a-half baths and 1,700 square feet. Just minutes to the downtown, it includes a double garage, stucco exterior, stainless appliances, balcony, private yard and low maintenance fees. Listed at $100,000.

Close to the beach in New Smyrna and backing on a golf course, this villa has a large Florida room, renovated kitchen two bedrooms and two baths, eat-in kitchen and condo fees which include cable TV, grounds care and a sprinkler system. The lot is 45 by 75 on a quiet cul-de-sac, and the home includes all appliances, central air, carport and 1,200 square feet. Listed at $91,900.

This urban, one-bed, one-bath condo apartment has stainless appliances, granite counters and is within walking distance of downtown Phoenix’s Chase Ball Park and Orpheum Theatres. Built in 2005, the loft-style unit has 710 square feet, an in-building pool, parking and a prestigious address. Listed for $100,900.

Built in 1981 and renovated in 2009, this villa is within walking distance of two New Smyrna golf courses and has a bay window overlooking a pond. The 1,060 square foot bungalow contains a new kitchen, stainless appliances, new tile flooring, vaulted ceiling, mature trees, screened porch, two bedrooms and two full baths. The lot is 55 by 74, with carport. Listed at $99,900.

So, obviously there is value to be had – whether you like downtown, suburban, golf club or beach living. Now, how about the hassles of buying and owning?

There are some, to be sure. For example if you buy a Florida home you could pay more property tax than the locals, since they can apply for a Homestead Exemption, and you can’t – unless you move and get a state driver’s license. And if you’ve been dreaming of getting one of those 4.4% mortgages guaranteed for 30 years, forget it.

In fact, financing a US purchase is probably the biggest issue for most Canadian buyers. If you need a loan, an American subsidiary of a Canadian bank is a good bet, but the best option is to arrange your financing here, then just buy the property with cash. That could mean a line of credit, a secured HELOC, a few ounces of your depreciating gold or part of the windfall profit from selling your inflated house in Calgary. Of course, with a cash offer you’ll also probably get a better price.

Now, how about US taxes?

If you buy a house and rent if out, then 30% of the gross rent will be withheld as tax. That sucks, but you can get around it by filing a non-resident US tax return and claim the rent as income, which then lets you deduct all costs associated with ownership. Then you are taxed on the net (in this case you elect to pay your landlord-generated taxes in the States rather than in Canada).

If you sell, 10% of the selling price will be held back for taxes. But by filing a tax return you can claim this against capital gains tax. Better still, if you sell for less than $300,000 and the buyer intends to move in full-time, you get the full amount of the sale. The only tax liability – in the US as in Canada – is on the capital gain.

As for buying, well, be reasonable. Don’t buy anything off the Internet. Get a local realtor. Research property tax rates, insurance premiums and condo fees. Rent for a month while you shop the market. Get the house inspected prior to making an offer. Knock on neighbours’ doors and see if they shoot at you. The same stuff you’d do in Toronto.

Finally, why buy in an America on its knees?

Ever see Rocky?

Sell Canada, buy America.

Many months ago I wrote those words convinced that Canadian housing values would decline and that American ones would eventually resuscitate. Since then real estate sales in this country have plunged and prices commenced their crumble. The Bank of Canada is warning citizens of a dramatically slowing economy and the dire consequences of their crushing household debt.

The HST has infected consumer spending. The prime rate, and the cost of variable rate mortgages, has increased twice. Realtors, mortgage brokers and bankers are growing cobwebs. Developers are having cows. Sellers have flooded the market with listings which are now sitting for months.

So, it’s started. For reasons I outlined here in the last few days, this is the beginning of a swampy multi-year market which will attack the net worth of those who worshipped the gods of HGTV. The way to build wealth now is through financial assets, not real ones. The way to get creamed is to be illiquid.

So, sell Canada – if you still can.

As for buy America, some argue the US empire is a teetering behemoth which will disintegrate into a smouldering pile of unfilled IOUs and worthless currency. Maybe so. But not in this lifetime. Despite a $1.5 trillion deficit and a $13 trillion debt, despite an actual jobless rate of 17% and the realization the American president is mortal, the US now constitutes a generational opportunity.

After all, this one country is still the largest economy and accounts for 27% of global production. Its intellectual capital is staggering. The concentration of wealth in America was largely unaffected by the recent financial crisis. In fact, banking and regulatory reforms now taking place will strength the US system and speed recovery. Even in the aftermath of Wall Street laying an egg, US dollars and American bonds are considered the safest places on the planet to put wealth.

So, what do we make of the American real estate collapse? The inevitable result of a capitalistic excess and asset inflation. House porn remorse. Unbridled greed, bad regulators, unethical lenders, immoral investment bankers, obsessed homebuyers – it all added up to an orgy with only one possible ending. And as with all booms, when it ended the pendulum did not stop at ‘normal’ but swung wildly into ‘bust.’

So today American families make about what we do. Mortgage rates are about the same. Employment levels are roughly equal. Even our currencies are close to par. And yet the average US house costs $170,000, while the price here is $342,000 (or $428,000 in Toronto and over $600,000 in Vancouver).

US home prices have been in steady decline since mid-2006, falling about 8% a year. In some areas (Phoenix, Las Vegas, southern California, rust best states, Miami) prices have declined as much as 50%-70% from the bubblicious highs of 2005. Almost a third of all American families with a mortgage are now in negative equity, owing more than they own. Many of them cannot afford to sell, since they’d have to write a huge cheque to close the deal, so they’re simply trapped. And since Washington’s idiot program of giving people money to buy houses ended a month ago, the market has tanked again.

In short, this is not a correction. It is a fundamental shift in public sentiment. After all, prices are back to 1999 levels in many cities and mortgage rates are at the lowest point in history – making this an excellent time to get a house. But because real estate is now viewed as a dangerous destroyer of middle class wealth and a trap for the young, it is shunned.

So, how could this be clearer? The same asset. Two countries. In one it’s priced at the highest point in history. In the other, it sits depreciating and unloved. In one, the public drools over hardwood and crown moldings. In the other people cannot bail soon enough. In both countries real estate values have only one direction in which to go – and they are polar opposites.

The American market may have bottomed in certain areas (New England, NY, Chicago, Houston), but the trip down continues in Nevada, SoCal, Florida. The window remains open for a few more months. Perhaps a year. Then the climb back begins. It could be spectacular. Or the only chance in your lifetime to buy a sunbelt home at fifty cents on the dollar. Or simply a place to invest money sucked out of a Canadian home at its apex.

How many times have you heard, ‘sell high, buy low’?

How many times has it been a slam dunk?

Next: How to do this.

Whoever said running a blog was easy? The legal department alone takes up valuable floor space in the bunker. The IT guys are a pain in the ass floating by with their damn long boards and iPhones. The research dweebs are forever correcting me. And the photo editors are so constantly snorted I don’t even ask anymore.

But, man, the correspondence unit kills me. Every hour a fresh load of blog emails is delivered by vacuum tube to my garret. Check this out, just in (and these are all genuine):

Regarding your house porn blog, I recall a new home buyer at a new condo show home in Burnaby asking one of the sales reps if they are doing 5% down for new buyer. My thought at the time – what’s a new home buyer with 5% down doing buying a $450K to $500K 1,000 sq ft unit? Sounded and looked so wrong. I’m not sure what that young guy was thinking but I wanted to ask, why are you here unsupervised? Young people do feel a sense of entitlement and what I see as a “de-sensitivity” (or whatever you want to call it) to being in debt. Foreclosure and bankruptcy? No problem! It’s in vogue now. It is not limited to young people either, but also to couples with kids (in the late 30s to 40s range) who are living the house rich cash poor lifestyle. It’s extremely sad when you have a great big nice house but you can’t afford to furnish it, eat out, treat yourself, etc…! How is that a good way to live?

I was unaware there’s still life in Burnaby. — Garth

I’m a big fan of your blog and of your opinions. I must nevertheless point out that your statement, ‘You’ll be able to buy houses and write the womenfolk into the offer’  is not politically correct and kind of slimy. It is below the high standards that I, and many others I am sure, have come to expect from you.

You should have seen that line before the Social Decorum Dept. got hold of it. More hinky than slimy. An achievement at my age. — Garth

I’ve been through all your books except the latest (next payday), and though I’m convinced of your ideas, I get a “braino” when I think about applying it to my situation.  Then I get snow, sort of like a tv without cable. I’m a 57 year old working woman (shouldn’t we be a minority by now) with no debt, no house and around $180,000 in various GIC’s, rsps and stock.  Needless to say, this is not enough money to live on in my dotage. I’d be lying if I said my job is secure, after two downsizings, I’m not secure about much anymore.  Haven’t had a raise in years yet my rent continues up 4% every year.  I live in Vancouver which has the prices of New York without any of the good stuff .  I see that Kamsack, Sask. has cheap real estate if nothing else. I don’t know what to do, I’m trying to avoid living in a shopping cart.  Where do you think I should go for direction?

You should go to me. There’s always hope, and it sounds like your investment profile is a mess. Let’s get it cleaned up and doubled by the time you’re 65, when we can add in the CPP and at least give you a living income. Hell, in Kamsack, you’d be a goddess. — Garth

My friends and I enjoyed the blog you posted the day I wrote you.  Happy to say my house closed last week and that I am completely debt free.  I wiped out all credit card, loc and small pesonal debt.  My cash flow position has improved approx 4k a month and have never been happier and more relaxed in my life.  I am now off to Europe. Once again thx.

All in a day’s work on this blog. Saving Canada, one indebted dude at a time. — Garth

My husband and I have battling it out over buying a property in Florida.  I’m from the school of buy low sell high.  I don’t see how things can go any lower when we are talking only $50,00 US for a brand new 3 bedroom townhouse in a gated community with gym, pool and tennis court.  I did my research and found a city on the Atlantic side that has good employment and a College.  As a former landlord in Toronto I don’t mind renting to students.  The College will hopefully guarantee a steady supply of renters.  So if history repeats itself then why should we not buy now at the low, rent it out full time and hold it for about 10 years?  I can sell it later to one of your baby boomers who will be streaming out of the GTA suburbs.  They will be happy to pay me twice as much maybe more for my 3 bedroom townhouse. Or I can keep it and use it myself since I can retire with a full pension in 10 years.  And if history repeats itself the US dollar will be back to around $1.25 Canadian.  Where can you invest now that you will get that kind of return?  I bought in 1994 when no one was buying because of the fear of Quebec separating.  I paid $110,000 for a 3 bedroom semi.  I sold in 2007 when everyone was buying for over $500,000.  My hubby sees all the doom and gloom on the news about the US economy.  He sees potential problems with tenants (I have a property management company in place) and the time and expense of one of us having to run down to the US at the drop of a hat.  I see dollar signs.  Right Garth?

I’ve said it clearly a few times: Sell Canada, buy America. Our market’s vastly overvalued and theirs is in deflationary distress. Can it go lower? Yes it can. Could it take 5-7 years for the American real estate market to regain momentum? You bet. But when it does, lots of Florida real estate will easily double. So long as you know the pitfalls I have pointed out, take your new husband and acquire. — Garth

My husband and I follow your blog and are interested in your opinion on foreclosed properties. We are working professionals in our late 30´s/early forty´s and have been renting in Vancouver after many failed attempts to enter the real estate market.  We have one child and a second on the way and after years of being crammed into a one bedroom apartment to get ahead (or rather not get so behind) while finishing graduate school and getting through one maternity leave, we have long outgrown our apartment. Our question relates to your ´Rent or Own´ post, as we sound like we are in a similar position to this family. If the couple were to buy a house with a mortgage helper, would this not make it a better option than renting? The prices are plummeting in the North Shore (we saw one property drop $240,000) and there are record numbers of listing, so we still are holding out a glimmer of hope that we will be able to buy, otherwise we will continue to rent or relocate to a third world country!

Like Manitoba? Seriously, the North Shore is toxic right now. Prices are crumbling in a process that has just begun. So what if a property has dropped $240,000 when it’s on the way to a $400,000 correction? Vancouver is ground zero. North Van is going down. Rent a townhouse for two years, then vultch. Far better than having a creature in the basement. — Garth

Did you live in Coquitlam around 1995-1996? Ever go to a bar called Boone County wearing your cowboy boots? This is going to sound crazy, but I think we met and had an unusual encounter. Of course, if you didn’t live in BC and go to Boone County then I am sure it wasn’t you and apologize for wasting your time.
However, if it indeed was you that night then I am writing as I promised I would. I don’t know if you remember me but if you do I hope to hear from you. I would also enjoy hearing your version of the discussion that night. It really was quite unusual.

Warmest regards, Dianne

ps.. I really enjoy your blog

OK, blog’s over. And where the hell are my boots?

Days ago a prestigious national financial professional group asked me to keynote their autumn convention. Sure, I said, and agreed to deliver a talk on the causes, impact and legacy of runaway societal debt.

When asked the title of my talk, I gave it. “House porn.” Not sure, but I think I heard little fainting and gurgling noises on the other end of the line. I am so looking forward to that talk.

You know my thoughts on mortgage debt. It’s the leveller. Perhaps the greatest financial irresponsibility of this generation was to give hundreds of thousands of people with little money billions of dollars at rates which will reset 200% or 300% higher. This alone is reason to believe we are headed for a multi-year housing melt.

Slagging sales and rising listings now, price crumbles by Christmas, desperate sellers in 2011, vultures in 2012, then three years of mortgage renewals as VRM victims meet interest rate reality. If you think there’ll be housing bargains in a year or two, just wait for 2014. You’ll be able to buy houses and write the womenfolk into the offer.

But perhaps I’m a tad conservative. I received this note hours ago from a guy who was an investment banker at Morgan Stanley in Manhattan, chopping toxic mortgage paper at the height of the US housing bubble:

“Straight from the horse’s mouth, the Toronto Real Estate Board, Toronto prices in May averaged $446K, and in the first two weeks of July they’ve crashed down to $427K, putting Toronto prices on a pace to hit $340,000 in 1 years time— but in my experience, the acceleration of the downward trajectory will increase exponentially once the mortgage holders attempt to get out of their mortgages. I foresee prices breaking below $400K by Christmas, and then a steady progression towards below $300K for most of 2011.

He continues: “Canada will see the same housing crisis as the States has been, and for the naysayers, must I remind them that Canada did and does have subprime mortgages— 0/40 & 5/35 mortgages (with the 5% downpayment amortized across the mortgage essentially resulting in 0-down mortgages), artificially and historically unprecedented interest rates, and a general mentality that Canada is different, that housing prices can only go up. But we all know how that ended in the States. In Spain. In Australia. In Japan. In Ireland. Sigh.”

Yesterday US Fed chairman Ben Bernanke rattled markets when he told Congress the American economy faces “unusually uncertain prospects.” That spoiled a perfectly good stock rally, sank our dollar and dashed hope that recent bad economic news was a fluke. The reality is sinking in that even after tanking interest rates to zero, paying people to buy houses, bailing out whole industries and spending $1.5 trillion buying back crappy mortgages and government bonds, Washington is stymied.

Now I mention these things because you should know them. Most people don’t. They’re busy buying Capri pants and riding mowers.

Credit’s been so easy to come by in our society, so normal and accepted, so routine and innocuous, that we’re now addicted. Using other people’s money to buy houses cars and plasma TVs has made us immune to the fact we don’t generate enough ourselves, that we’re living beyond our means.

So, we have the phenomenon of young first-time homeowners padding around in 2,400 square feet of perfectly finished space in a manicured burb, replete with stainless and stone, while their parents never achieved anything close – after a lifetime of work. The kids get luxury. Their folks get adequate. But the old ones also have equity, and safety.

The housing market, and the Canadian middle class, is at serious risk. There’ll be no job-filled recovery here while the US stumbles. No chance mortgage rates will ever sink back below 2%. No planes full of rich Chinese or Iranian greater fools to save us. Instead, next year’s headlines will be about negative equity and the TV casts will feature first-time sellers stunned they’re losing everything.

This is the pornography of debt, thanks to the lust for houses.

Finally, to remind how we got here, believing we’re different, and could make the same mistakes as America without consequences, is former Stephen Harper speechwriter Michael Taube. In Sun newspapers this week he wrote:

“In Canada, we don’t offer subprime mortgages to potential clients. Most importantly, credit checks matter.  If you don’t have sufficient personal income or assets, you ain’t getting the deed to the house.”

Sigh.

On Monday came news 12 condos a day, on average, are selling in the 905. Last year at this time sales averaged 32 a day. This girdle of humanity around Toronto is home to 3.2 million people – more than live in metro Vancouver and Calgary combined.

In other words, house sales are grinding to a halt. In this sprawling suburban nation, where real estate’s a god and home ownership numbers stagger, condo sales plopped 41%. Detached sales crashed 40%, as did semis.

On Tuesday mortgage rates rose again – at least the ones that matter, VRMs. The current thinking is the Bank of Canada will jump them twice more (at least) this year unless, of course, house sales go to zero. In time, though, the economy will revive enough for interest rates to ‘normalize’ which means 2009 buyers with a prime minus a half will renew their 1.75% mortgages at 5%. Not the end of the world. Just them.

Here’s why: forget what the industry’s telling you. Prices won’t likely be swelling again between now and the time all these folks renew their loans in 2014. There is no return to a seller’s market on the distant horizon. No bidding wars in 2011 or beyond. No year-over-year price increases even approaching inflation. The best homeowners can hope for – especially the ones who rolled the dice and bought with 5%, a swagger and a prayer – is for real estate values to flatline.

Even then, they lose. Five years of home improvements, interest charges on their lecherous 35-year mortgages and property taxes, capped off by a real estate commission (and HST). We might avoid widespread negative equity in Canada (though I doubt it), but those waifs who bought in the bubble are staring at five lost years.

This should be enough to put a lie to the myth that Canada did not have subprime mortgages. Our banks loaned billions below the prime rate to borrowers who needed 95% leverage and loan paybacks of three-and-a-half decades – in the absolute knowledge those loans would be reset at rates higher by at least 200%. This was a political act, taken because the central bank and the government it answers to desired massive public borrowing and spending to stimulate economic recovery.

Now the spending’s over. The recovery faint. The debt enormous.

“My name is Nanci and I stumbled upon your blog 2 months ago when my husband and I were considering purchasing a 3rd house as an investment and went looking online for real estate forecasts.  Luckily we dodged that bullet and obviously did not purchase..pheewf!  Since then I faithfully read you blog everyday we have decided to become liquid and sell our houses and rent.  We live in a very desireable area called Steveston in Richmond B.C.  We have a small but very nice house and have listed with a competitive price just this week – $759,000.  Our realtor is confident that we will get a quick sale. (we’ll see).  If it was our ideal house I would not sell but in the future we will need a bigger house. In the meantime we have a line on a rental house in our subdivision that would be perfect for us as we love our area and have small children that we don’t want to take away from their school and friends.

“We could rent for a couple of years, toss some more into savings and then buy back a bigger house in our neighbourhood when prices drop.  We both have secure jobs and our annual household employment income is $110,000.

“I truly believe that you genuinely want to help people like us make the best decisions.  I have to tell you that I am having trouble sleeping at night over worrying that we are making a big mistake selling our current house.  My husband as you would say needs to “grow a set” as he really leaves all important decision making on my shoulders.  I guess what I am asking from you is reassurance that I am making good decisions for my family.  Also, how much do you really think house values in the Vancouver area will drop?  I believe that we live in one of those areas (Steveston) that may only suffer a small correction and all of this will be for not.  Please Garth…I need some sleep tonight. Nanci..sleepless in steveston.”

When you’re selling a small house in Richmond for $759,000, isn’t this obvious? The average household income in Vancouver is $83,000, which means your pokey little hovel costs nine times that amount. This defines unaffordable, especially now with mortgage rates rising, the HST in place and BC doing the Slap Chop on public spending.

The wisest thing you can do is cash out that tax-free capital gain, rent for a few years, then reassess. If Toronto real estate’s overvalued by 20%, Van houses are too expensive by twice that amount. And while a 40% drop won’t be delivered over the next months, it may well be here within a couple of years. No more $1.3 million average West Van fixer-uppers. No more seven-figure crack shacks. No more half-mil concrete shoe boxes hunkering over Robson Street.

So, Nanci, drop your asking price until you suck in a greater fool. Invest the windfall in a balanced portfolio of bonds, dividend-spewing shares and sector ETFs. Stuff twenty grand of it in your TFSAa. Load up the RRSPs with fixed income, the cash account with preferreds and the tax-frees with equity. If stocks tank 20% this autumn, go shopping. The economy will recover, along with markets and profits and rates. The only depression will be in Re/Max franchises.

Sleep tight, babe. You made the right choice. Trust me. I have a set.

Garth's latest podcast is here.

A tale of three. Rob’s a banker in Vancouver. Sara owns a home in Ottawa. And Chet’s a realtor in Red Deer. They’re all in their early thirties, and each wrote me in the last two days.

A good time to do so. Interest rates rising today in Canada. Toronto house sales crashing 38% this month. Confidence and real estate plunging in the US. More talk of a double double. And the Bank of Canada sounding the alarm over runaway consumer debt.

“Your blog is an oasis of sombre reality in a cyber world chock full of unquantifiable bullshit,” says Chet. “I have been watching the market creep to a halt around me over the past two years, and although we may be a bit more sheltered where I am, the basis still rings true. The market is taking a hit, and recovery is further away than the builders / real estate professionals want you to believe it is.”

Indeed. Asset deflation is upon us and another quarter point increase in the cost of variable rate mortgages won’t help. It’s now apparent what we did – bid house prices too high, borrowed too excessively, gambled too much. This could be Middle America, 2005. And we’ve seen how that  movie ends.

“I would love to run around blowing smoke up peoples asses that the market is heating up, or that now is the time to buy,” says Chet, “but I am a terrible liar and much too conscientious to go about business this way.”

A real estate guy with a moral compass – almost as rare as a banker with ethics. But there’s hope in Vancouver.

“I have followed your blog daily for almost a year now,” writes Rob. “What makes my situation slightly different is that I am a certified financial planner working for an excellent Canadian bank.”

He goes on: “Although the mantra by branch managers to the Account Managers and bank staff is still (to quote what I heard from one of them) “park your morals at the door”, what is important is that there is acknowledgment at the top of the house that things will begin to change.  The advice component that I have delivered to my clients, and which is what is going to become more and more common, is right on the same track as what you have been blogging about.”

The important part of Rob’s letter, however, is this:

“I am writing to you today as I had a meeting yesterday with a senior executive out of Toronto who said some staggering things that I thought I would NEVER hear from anyone in the top echelons of the banking industry.  He explained that executives have been meeting together and advising the board of directors that what the bank has been doing for the last 5 years to generate profits cannot continue.  He explained that the banks have leveraged up the canadian citizenry to unsustainable levels. He said that going forward (here is the best part) we have a MORAL obligation to provide the right advice to Canadians regarding their spending habits, budgeting, retirement, investing and borrowing desires.  I was shocked!  This was the first time I had heard a Banker expose the truths of what is going on in Canada right now and take ownership of the fact they have been dangling the carrot and enticing the population into perpetual debt.”

Would be refreshing, encouraging and inspiring if this were in fact true. The crushing embrace of debt is now the greatest threat to what’s left of our middle class. It fueled an absurd swelling of house values. It’s polluted the family balance sheet. It has erased a generation of savings. Mortgage debt, lines of credit, credit card debt, student loans – they are all at the high water mark. And as houses deflate – where most people’s net worth has carelessly been left – that debt may douse consumer spending and swamp the economy.

It’s why I’ve been chorusing for months that the best possible strategies are to be liquid and trash debt.

Sara, though, risks drowning. And knows it not.

She and her husband wrote me for financial advice, concerned about their parents. “Like many other boomers, they will likely need some level of financial support from us in the next five to ten years. Standard story here, minimal RRSPs, no pensions, minimal investments, and no real savings.”

So, Sara, what’s your story?

“We’re in our early thirties, new baby, new car, very fortunate and stable, with great jobs ($180k gross) in the federal government. We purchased our dream house last year in a great, walkable, downtown neighbourhood with excellent public schools for $800k with 10% down and a 35 year amortization. Other than the house and car we have no debt and $25k in savings. Our goal: Develop additional streams of income that we can put towards mortgage payments, savings, and ultimately, family obligations when the time comes.”

And so, a problem. This couple has $105,000 in net worth and $720,000 in debt. Eighty per cent of their wealth is in one asset, and a 15% correction in real estate values would more than wipe them out. Locked in a 35-year mortgage in which they pay off virtually no principal, they epitomize risk and should never have bought, nor been loaned more than seven hundred thousand to buy a dream home.

“Friends and family have told me not to worry since we seem to be in a good position,” she says, “but I also know how quickly our fortunes and the fortunes of those around us can change.”

Dear Sara, you have no idea.

Only a realtor would deny we’re on the cusp of something.

One like Ted Zaharko, who owns a Royal LePage franchise in Calgary (and was president of the real estate board). “We’ll get back into balance later this year,” he told the local daily as house sales crashed around him, “and maybe, maybe, by the first quarter of 2011, we’ll be in a sellers’ market.”

Actually, we won’t. By March or April of next year I wouldn’t be surprised if the real estate market is moribund, the economy flatlining and we’ve stopped talking about deflation because it’s a daily reality. There is now no denying that 2010 is shaping up to satisfying as a night with Michael Ignatieff. Or Betty White.

The journey to recovery, asset inflation and coursing interest rates has taken a detour, thanks to coddled Europeans (‘mort à l’austérité!’), uncertainty over China and (especially) serious setbacks for the US economy. Consumer sentiment has plunged because job creation has stalled, while unemployment benefits run out for millions. Reports this week will confirm the housing market is still crumbling and leading economic indicators have slipped.

In an economy now 70% fueled by consumer spending, the very fact a third of all homeowners are in negative equity means a double double could be close at hand. Without a doubt, that’s what the stock market has been saying – with the S&P 500 down more than 17% since its high water mark at the end of April. The bond market is also screaming this, as yields plunge on ten-year notes and prices rise (there is an inverse relationship between interest rates and bond values).

So, sadly, my recent forecast of asset deflation and price inflation looks increasingly likely. House prices tumble. Taxes increase. Recent homeowners in Toronto, Calgary, Edmonton and Vancouver start falling into negative equity. Governments get more broke. Furniture stores and framers suffer. And people sitting in equity mutual funds wonder what the hell happened.

There is no telling how long this might continue, but I’m thinking the real estate correction in Canada has a fine chance of lasting until 2015 or so – and maybe longer, thanks to the boomers. Because most of them have lousy investment portfolios, totally unbalanced and cobbled together by amateurs (them), and at the same time the bulk of their net worth is in devaluing houses, there’s no alternative but to alchemy real estate into cash as retirement looms. Most listings. Lower prices.

In fact, real estate alone has the potential to bring us years of deflation before the pendulum swings. This is the simple result of the recent bubble, which inflated prices and mortgages at the same time. But when house values (and wages) fall, mortgage debt does not – making debt tougher to repay and wiping out family net worth.

Want some proof? Try this. And the chart below shows a $4 trillion hit for the US middle class – the gulf between what they owe and what they now own. Do you think this cannot happen here?

Of course, there is hope. There’s even some time. And this is what I’ve been trying to make clear over the last couple of days.

This is the dilemma: Most Canadians don’t have enough wealth to get them through their lives. So, they desperately need to grow what they do have. Sticking it in the Dutch guy’s shorts ain’t an option. But at the same time, how do you invest when the stock market and the bond market are going in different directions, and volatility is the new black?

You get balance. First, make smart, careful choices to get growth from equities in a predictable way (through diversifying across geography, sectors and capitalization). Second, combine that with fixed income which feeds off deflation, plus assets that pay you to own them (capital gains and cash distributions). Third, you make damn sure you avoid taxes (through shelters, cap gains and dividends).

For example, my portfolio has 60% equity and 40% fixed income. So far this year the US market is down 4.3% and the TSX is off 2%. My stuff is up 2.2% plus giving me an annual yield of 3.5% (interest and dividends), or 1.8% year-to-date. So, the portfolio return has been 4%, or an annualized 8%.

How could that be? Because my equity investments are designed to give growth and reduce volatility, while the fixed income has torqued out capital gains as yields fall. In addition, the bonds and preferreds continue to pump income.

This is what investing’s about. As opposed to moaning.