A Different Take on the FHSA

April 13th, 2022 by Potato

Budget 2022 proposes to introduce the Tax-Free First Home Savings Account that would give prospective first-time home buyers the ability to save up to $40,000. Like an RRSP, contributions would be tax-deductible, and withdrawals to purchase a first home—including investment income— would be non-taxable, like a TFSA. Tax-free in, tax-free out.

The new Tax-Free First Home Savings Account (FHSA) is pitched as a way to save up for your first home. It’s like a super-charged RRSP: you get to put pre-tax money in, and in one specific circumstance (buying a home), you can take it out tax-free. And if you don’t buy, you can roll it into an RRIF like a regular RRSP.

There’s lots to nit-pick with this idea: the $40k lifetime limit doesn’t make it much more effective for saving for a home than the old HBP option did. And while this is even better as you don’t have to pay it back and get to keep that tax savings, that’s a benefit you only see in later years vs the HBP — the $35k HBP was already letting you put that much pre-tax money to work for the purchase itself. On top of that, the $8k yearly limit means it will take 5 years to max out (and 4 to match what you could do in 90 days with the HBP and a regular RRSP). So at least it will push demand out if some people want to max it out before buying.

It’s a bit regressive, in that people in the highest tax brackets will see the biggest advantage from using the FHSA.

However, ignore all of the talk about using it for a downpayment. The fact that they took out the age limit and let you roll it into an RRIF mean that the FHSA serves another purpose: it helps renters shelter more investment income, functioning basically as more (and with an embedded option!) RRSP room. Someone who buys a place gets any increase in equity as a tax-free gain thanks to the principal residence exemption. That’s been a huge windfall in recent years, and can push people toward buying in an environment where prices are going up double-digits every year. That tax advantage also makes it even harder for those who don’t own to keep up. Someone can choose to rent instead and save the difference in monthly cashflows, but may soon run out of TFSA and RRSP room. An extra $8k/yr will help them shelter more of those gains.

And of course, provide that option to take the whole FHSA out at some point in the future to buy, tax-free.

Imagine a world where the cap and 15-year lifespan were removed and renters continued to get $8k/yr in room until they bought or turned 71 (and rolled it into a RRIF). Someone renting in a big, unaffordable city like Toronto could prioritize their FHSA, knowing that it would make it that much more possible to eventually buy when their indentured servitude in the city was over. $8k/yr at a 5% return would leave someone with nearly $400k after 25 years*. You could make a solid plan to do your time, renting happily along the way, and know that you could — tax-free — have nearly enough to buy a place in the boonies outright when your commuting days were done. Or, have more in your RRSP to support the costs of lifelong renting in retirement if you stayed in the city.

So while I don’t think this was a necessary thing to create (indeed it adds more complication to our tax and savings account system, and yet another financial literacy hurdle), and don’t think it’s going to do a damned thing for housing affordability… I welcome the FHSA. For many people, it will be the obvious first account to fill (even edging out a TFSA for those who plan to buy eventually). However, to be truly great and to help incentivize more people to rent and invest the difference and keep open the option to buy in the future, they’ll have to remove the fairly low lifetime contribution cap.

Indeed, I’m not sure many brokerages will bother to offer registered accounts that can only ever accept $40k, and are only available to the subset of renters who save money to invest — see how few bother to offer RDSPs.

* – remember that this is a hypothetical where they remove the cap and time limit. As it stands, the 2022 Federal Budget proposes a $40k lifetime cap and a 15 year maximum term to either buy a home or roll it into a RRSP/RRIF.

Housing Bubble Harms

August 27th, 2021 by Potato

Adam Vaughan made himself the face of government callousness and inaction earlier this year[0]. It started with an appearance on TVO’s the Agenda, where when talking about what the government should do about housing, he said “We’re in a safe market for foreign investment but we’re not in a great market for Canadians looking for choices around housing.” Which wasn’t news to a lot of people, but it was news that the government knew and was choosing to do nothing rather than just being incompetent and unaware.

He then continued to say (and followed it up and in various Twitter battles) that the government would not do anything if it meant risking even a 10% decline in house prices — which in the context of the time (over 20%/yr increases, and not just in the big cities) would have been rolling prices back just a few months. But even that was too much for them.

In other words, he said the quiet part loud. And now we all know that they know, and that they don’t care.

He’s tried to make the case that housing prices falling is bad, as have others throughout this decade+ run-up in house prices. People don’t like seeing their biggest asset fall in value, and recent buyers could be underwater and financially stressed. If it gets rolling, it might lead to a recession.

And sure, it’s pretty obvious that if we have a housing crash, it would have many negative effects. The problem is, high prices also have negative effects, and there’s a chance prices will fall anyway in the future, and inaction just delays and exacerbates that.

Why Housing Bubbles are Bad

A housing crash and its associated harms is hard to miss, but the harms of a bubble are more subtle and insidious, but just as bad for society.

Bad? The wealth effect? Our cities becoming “world-class”? These are bad things? Well, those aren’t the only side effects of a housing bubble.

There are much more serious effects on people’s lives. There’s rising inequality, though that’s just part of it.

Housing is the biggest cost in most family’s budgets, and for young people that can be by a huge amount[1]. When housing gets more expensive, they feel the squeeze: literally, if they have to settle for being under-housed to make ends meet. That has real-world consequences.

I can write about the rent-vs-buy decision and raising a kid in a rental all I want, many people out there still want to put off starting families until they can buy sufficient housing for a family. The frenzied speculation makes rentals less secure even if rents themselves have lagged price appreciation. With higher prices (and rapidly rising prices), buying is harder — much harder — and young families have to settle for less space, and delay their purchases to save up. That means they put off having kids longer, and having fewer when they do. Toronto’s fertility rate dropped 16% in the last decade[2]. If anything else had caused our fertility rate to drop that much in just a decade (in the face of millennial demographics that we might have expected an increased fertility rate from) we would be rioting in the streets for the government to do something, holding up signs about the missing 10,000 babies. We’d be banning chemicals, exterminating mosquito vectors, or adding fertility treatments to OHIP coverage. But when it’s economic: crickets. Housing insecurity and microcondos are just the way of life here in a world-class city, and a few thousand unconceived babies are acceptable collateral damage for muh price growth.

Mike Moffat has also pointed out Toronto’s troublesome population movement patterns: the largest cohort of people leaving the city are newborns (followed by other young children and those in the parents of young children age bracket) — so even when a kid is born here, there’s a good chance its family promptly leaves.

Lower interest rates (that somehow keep going lower) have helped support housing prices: mortgage payments have not increased as much as prices. But they have gone up quite a bit, and even if more and more of that payment goes toward principal, the principal still has to be paid back. 10 years ago, a $775k average detached house required that, at some point, you paid back $775k. Spread evenly over 25 years, that’s $31k/yr. A big chunk of a couple’s after-tax income, but doable if you were pulling in $100-120k combined (and a monthly payment including interest of $3.1k). At $1.7M, that’s $68k/yr to pay it off in 25 years, which doesn’t leave much else for having kids or supporting the economy (and the monthly is up to $5.4k at lower interest rates).

This is a big black hole for the velocity of money: more and more of our salaries are going to paying for our houses. That’s money that isn’t circulating back through the economy, or investing in something productive. Wouldn’t we be better off with lower house prices, and more of our disposable income going to services, innovation, transitioning to a low-carbon economy, charities, etc., instead of having housing sucking up all the cash flow?

In conclusion, while a crash can be harmful, high (and rapidly rising) house prices also have harms. So far the government has made it clear which set of harms they see and care about.

Election Time

A federal election has been called, and more and more people are saying that housing is a big issue for them. Each party has come out with an ineffectual do-nothing housing plan, and not one has acknowledged the elephant in the room: that a solution must allow at least the risk that house prices will drop. The cure to affordability is not to create more loan programs and tax breaks to help people pay higher and higher prices for housing[3] — it’s to get prices lower.

The first step is admitting that there is a problem[4]. I’m a left-leaning voter — often ABC — and while there are a lot of issues I care about (science funding, the environment, electoral reform, etc.), man, at this point I would vote PC if they actually came out with a housing plan that was willing to actually address prices and affordability.

[0] And stealing that crown from DoFo in a pandemic was quite the achievement.

[1] Though for the wealthy who haven’t read my book, investment fees may edge out housing.

[2] And that’s before the effect of the pandemic and lockdowns, which looks to have created its own “baby bust”. Also, other cities did have birth rate declines over the last decade too, though they were lagging Toronto’s — Calgary and Halifax had held steady through to 2016 (which would be about 9 months after Alberta’s oil bust started) and then a step down; London had a small decline in 2016, which was then exacerbated in 2018, while Toronto just heads down and down the whole decade.

[3] which in a tight market just gives people more money to bid which drives prices up further — many of the proposed programs are counter-productive that way.

[4] Update: Rob Carrick had a similar take here (and he got around to hitting publish first while I was dicking around in MS Paint). “Only a major price reversal can restore mass affordability and the federal parties won’t touch policies that would make this happen.”

Ontario Covid Update – Jan 12

January 12th, 2021 by Potato

Ontario provided its updated figures and modelling for covid today. The slides are available here if you want to look at the data without squinting at the video.

It’s not all that unexpected — I was sketching vaguely similar curves and worried about what an even more contagious version might do. But hearing it made real was just crushing. Covid’s on track to challenge heart disease and cancer for the top cause of death in Ontario this year (and will make the top 10 easy). And the strain on the hospital system is delaying treatments (esp. surgeries) which will make those other conditions worse.

But the big, not entirely surprising bad news is the hospital system and ICU beds: we’re just about out of empty ones, and the curve is still rapidly going up and to the right. Surgeries are being cancelled (again), and we’re not far off from very painful decisions about what happens if there’s a car accident.

One thing that’s crushing is that we were so close to getting to zero in the summer, and just opened back up a few weeks too early, without the testing and tracing capabilities ready. Still, the cases were low, everyone had stocked up on masks, and I genuinely thought we could get back to normal-ish with masks, handwashing, and social distancing*. I signed up for curling, expecting we would get a season, esp. with the modified rules of play (everyone wears masks, and things like using one sweeper to maintain 2 m between players at all times) — I had my mask rotation all planned out, and even got contact lenses so my glasses wouldn’t fog up. Schools reopened, and we kind of talked about how important that was for parents to be able to go back to work.

Then the cases started rising in the fall, and we did nothing about it until we’re now finding the hospital capacity getting crushed again. More people are going to lose their dads and other loved ones to cancer because surgeries had to get postponed, again.

I’m depressed and angry and just crushed at the whole thing.

I’m also a touch confused. They showed some data about how many people were moving around — people going to work has stayed steady since the summer, even as Toronto, Peel, and York went into lockdown (code red or grey or whatever). How there was a big spike in people visiting other residences at Christmas (to the surprise of no one). But I haven’t heard much on contact tracing and explaining what’s behind all the transmission. Are masks and handwashing and social distancing working, but some people aren’t compliant, and it’s that movement that’s the problem? Is it schools or workplaces or superspreader weddings? A little bit of everything adding up?

For most of those questions there isn’t much I can do on a personal level. I’ve tried to cut out contact with the outside world as much as possible, stretching out the time between grocery trips to two weeks or so, and our social circle is a completely closed bubble of 5 people. Wayfare has been making homemade masks since the beginning, and she did a lot of research on the best patterns and designs. They’re 3 layers, with two layers of regular (cotton?) fabric sandwiched around a layer of non-woven interface material. They have metal strips to conform to the nose (important to minimize glasses fogging and get the air moving through the material for filtering and not around the material), and straps to tie tightly around the head, which keeps it pretty well sealed all the way around the face. Though she made a few models with noses or cone shapes or whatever, I wear the basic pleated rectangle ones, so there’s no tiny holes from stitching a seam right in front of your nose. I’m sure they’re a step up from disposable surgical masks, even after a few washes. And I’m very good about wearing it whenever I’m indoors (or with another person outside — though I don’t wear one on solo walks).

However, are cloth masks enough, especially with the new B117 variant? Should we all (but especially should I) be wearing a N95-equivalent to go grocery shopping?

* – Circling back around to add: I thought the masks, distancing, etc. precautions would be good enough to get r < 1 so life could return to more-or-less normal. It doesn’t look like those were sufficient in practice (whether it’s non-compliance or whatever is a bit of a moot point as we will have non-compliance, esp. as covid fatigue sets in). We are a long, long way from Covid-zero (and we were really close in the summer!), but that may be the only strategy that lets us avoid the hammer and the dance through the fall based on the current vaccine roll-out projections.

On Lags and Exponential Growth

January 7th, 2021 by Potato

Ontario hit 89 daily Covid deaths today. We could lockdown tonight, go full Wuhan and weld peoples’ doors shut, and it wouldn’t stop us from hitting 100/day by next week — those people already have the virus, it’s just taking time for them to get sick and die. [Though I’d be happy for the universe’s constant need to prove me wrong to kick in here and save a bunch of lives as this turns out to have been the peak]

Lags make it hard to manage things, especially when that management also involves really hard decisions. It’s hard to call for a lockdown when cases are barely into triple digits. But that’s when it has to happen when you only have a few hundred spare ICU beds in the province. Ah well, back to home schooling for at least a few weeks now, though I still don’t actually know what the plan is. Is it Covid-zero?

And of course this is also why we wanted to start curbing the growth in greenhouse gas emissions in the 90s… or now, I suppose.

Does Fraud Create Alpha?

January 4th, 2021 by Potato

[Editor’s note: I’ve been sitting on this draft for a few months. Other than compiling some ideas from others and ranting a bit, the post as it is isn’t all that original. I thought the really clever bit would be to add some actual research and back-testing on fads and frauds to semi-seriously answer the question, but that turned out to be too much work and I now realize I’m never going to do that much research and stats even if there’s a chance that it’s more than just a lark. Anyway, I figured you may as well get to read it instead of killing it off. This one certainly isn’t investment advice, and I’m not alleging any companies or people are frauds here — I’m linking to the allegations and cases where I can, innocent until proven guilty, etc. etc.]

Elon Musk tweeted out in the middle of the trading day: “Am considering taking Tesla private at $420. Funding secured.”

Funding was not secured, not remotely. It was one of the most egregious and blatant cases in living memory and the SEC filed fraud charges. It revealed significant problems with corporate controls given that his Twitter account was identified as a channel for official company communications, and looked like a slam-dunk open-and shut case for the SEC.

Yet he settled for a slap on the wrist: no D&O ban, no forced divestiture of his holdings, just a requirement to add two new independent directors, and a $20M penalty (the company also paid $20M). Less than two years later, he got an incredible pay package tied to the stock price, orders of magnitude larger than the fine, despite the company still not producing an annual profit [at the time — it has eeked one out between drafting and posting this] and even clawing back bonuses for its workers. Oh, and despite coming very close to driving the company into the ground along the way (though there was no going concern language in its reporting at the time).

Securities regulators are broken. They are not working to protect investors or provide for rational, functioning markets. It was only at the last minute that the SEC stopped a bankrupt company from issuing more stock that it knew to be worthless. It’s the golden age of fraud.

And it’s not just a SEC problem. Germany’s BaFin failed spectacularly in regulating Wirecard, even prosecuting people working to expose issues at the company, instead of taking their leads and investigating the company (i.e., their jobs). And here in Canada, we have a patchwork mess of regulators. Not just the provincial securities regulators, where even when they get someone, the penalties can be the cost of doing business, but even within a province we can have different regulatory bodies letting problems slide. Bad actors can use the courts as a weapon, and even if you win a SLAPP suit, it can be costly and disruptive to your life, while bad actors buy themselves months or years more time to keep fleecing investors as critics and defenders of everyday investors are forced into silence.

Bad actors have free reign in the capital markets. None has put it quite so boldly as Musk’s “I do not respect the SEC,” (or the 2020 remix) but the days of fearing the wrath of the regulators appear to be a quaint figment of history. And regulatory capture is such a joke they don’t even try to hide it any more.

Indeed, I have heard it said1 that frauds are some of the best investments out there. After all, they don’t have earnings misses when the numbers are fake anyway.

Or as some have so eloquently put it: Fraud creates alpha2.

As an investor, you almost have3 to assign some portion of your portfolio to frauds and fads to keep up. And given that there is no downside any longer, as a CEO or Director of a company, you have a fiduciary duty to commit fraud2.

That’s a fine angry rant against the state of the markets as they sit today. If we had elections for OSC or SEC head, I might be just ticked off enough to throw my hat in the ring (or go campaigning for someone with a more protectionist bent). But that’s not how it works. There’s nothing to do but rant and carry on. Yet I keep coming back to that lovely, infuriating phrase:

Fraud creates alpha.

It’s a thing that we say — shaking our heads and laugh-crying — to encapsulate the absurdity of our times. But… is it true? Does fraud create alpha? Like in a systematic way? Should we be checking if it might be a 6th factor in the Fama-French schema to round out size, value, profitability, and investment?

Let’s make it F&F — fads and frauds, because that’s another area where there has been some outsized stock performance lately. Indeed, it’s almost like that litmus test of the Nigerian scams, where the emails are purposefully full of spelling mistakes to try to weed out those who may not be sufficiently gullible. The business models in some cases have no hope of working, or at least will never reasonably justify the stock price4. But that’s likely the point — as long as no fundamental analysts are buying it anyway, then the sky’s the limit. 3X revenue may be crazy-sauce in a low-margin business, but once you’re already there, 7X is really no crazier! And with a touch of what some may interpret to be stock manipulation, why not see if we can shoot for 20X while we’re at it?

Many modern “success stories” are incinerators of capital, serially selling stock to fill the hole created by losses and growth for growth’s sake, though as a side effect they have created a world where our lifestyles are subsidized by dumb capital. Oh, and skirting (or at the very least, bending) the law is a key element of disruption for many of these start-ups — from how they pay and treat their workforce as independent contractors, to flaunting municipal taxi, zoning, or other laws, if not securities laws themselves.

We who can recite the Litany of Saint Graham (“In the short run the market is a voting machine, but in the long run it is a weighing machine”) believe that fads and frauds will one day crash. Some people even make their living shorting them. But far too often, they go up first. They go up a lot.

And therein is the question: do fads & frauds create alpha? Now if you hold until they crash — assuming they do eventually crash and burn — then you’d think not, it would be trivial. To cite the Disciple of Graham, a string of impressive numbers multiplied by a single zero is still a zero. But if you take an approach where you rebalance away as they go parabolic, there might be something there. In an equal-weight portfolio of shit, you may not care much when your German payment processor is finally de-listed if your California vapourware company has sextupled in value. It’s skewness of returns in over-drive.

So let’s build an index and backtest. For example, if you buy in as soon as a report or article or forum post first suggests something fishy, and then rebalance away after each doubling (to other F&Fs or a core market portfolio if you run out of ideas), would that generate alpha?

This is the point where I thought actually doing a bunch of research and math would make the post more fun (and maybe even prove or disprove the point instead of just ranting), but it’s also a lot of work and it’s been many months since I first drafted this and I don’t think I’m ever going to get the research/math part done. So I will leave the idea there — maybe someone else with some time on their hands can go back a few decades and see if you can construct an index of fads & frauds and some rules (equal weighting? trend-something?), and see if it provides improved risk-adjusted returns.

1. Likely Carson Block on a podcast — apologies to whoever said it as I didn’t keep the source, but I think it was a podcast and not an article if that helps.
2. I think this can be attributed to TC. There’s probably more in here that can be attributed to the Chartcast.
3. No you don’t especially if you’re a smart passive investor, this is a whiny post and not actual investment advice.
4. I have heard it said (Chanos?) that one of the worst things for a fad company to do is to make a profit because it’s stock will crash when it suddenly goes from being valued based on some dream about TAM to being valued on a price/cash flow or price/earnings basis.