It’s Alive!

November 4th, 2016 by Potato

Wow, it looks like my desktop is back from the dead! It’s a Halloween zombie miracle!

If you’re just joining us, last night my computer gave me quite the fright when it refused to turn on (no power to the keyboard, nothing on the screen, not even POST error beeps) — it looked like I had a dead motherboard. At the moment cashflow is a bit tight, and I also don’t have time to try a million fixes, and I need my computer working well so I can work from home, so there was no clear choice on whether to try to replace the motherboard/other components and rebuild the system (or a new system from parts, minimizing cost but maximizing effort), or to just order a new PC (which would cost more).

As I was searching for information on which motherboards could replace this one (a Dell XPS 8500), I came across a forum post about troubleshooting motherboard issues on this system. One poster (thank you anonymous poster whose link I lost!) suggested the most insane possible fix, which I will repeat here both for how unbelievable it is that this should actually fix things, and in case others have similar issues in the future and come across this post in their search: unplug the computer. Press and hold the power button. Pull the CMOS battery (a little CR2032 coin battery on the motherboard, just above the graphics card). Plug the computer in, attempt to start it. Unplug the computer. Press and hold the power button. Put in a new CMOS battery. Plug in the computer and attempt to start it.

I have no idea what in the CMOS/BIOS could have been so badly broken that it wouldn’t even return an error, but I’m so glad that random internet post saved me from buying a new computer (or a new motherboard and all the time needed to unmount and remount all the components).

It reset my BIOS settings (which took some attempts to get back to make all the other stuff work) and threw some weird errors, but hey, I am back online now! Weirdest damned fix I’ve ever done (but not quite to the level of “more magic“).

I still have one super weird and unsettling symptom: my computer doesn’t boot up right away when I press power. The lights come on, the fans spin up for about 5 seconds… then the lights go off, the fans turn off… then the fans spin up again and the monitors and peripherals come on and it boots. No idea why it has a false start there, but I’m just grateful it’s up and running now.

Speaking of random fixes, here’s another recent one that might make more sense:

I keep my phone in my pocket. That means it will pick up lint, including in the headphone jack.

My headphones haven’t been working lately, and it’s been very frustrating. They weren’t working at all with my phone, and occasionally would cut out on my computer. So I got new headphones. They work fine on my computer, but still cut out on my phone, and that just kept getting worse, until three weeks ago they wouldn’t work at all. I tried jamming them in as hard as I could, and they’d work for a minute or so.

Finally a tip on the internet said to clean out the lint. So I have the little floss pick things in my desk here, and they’re actually perfect for cleaning that out. Took out a fair bit of lint packed down at the bottom, and now the headphone plug goes all the way into the jack and clicks into place. Huh, it’s supposed to click — I had forgotten that.

So if your headphones start becoming funky, check for lint in your jack.

Quick Update on Life

October 21st, 2016 by Potato

Sharing bad news of a personal nature is sometimes easy on a blog (especially if there’s a good story behind it or its cathartic), and sometimes hard. Today it’s hard, but I want to let people know why I’ve dropped off the face of the earth. I’ll likely tell a fuller account of all this at some point in the future (esp. after I run it by Wayfare).

The short version is that Wayfare has been very sick, in-and-out of the hospital over the last week, until on Tuesday they figured out that she has an incredibly rare and mysterious blood disorder and admitted her to the ICU. She will be in the hospital for at least another week, likely longer, and even once out she’ll be making regular trips back downtown for specialized treatments that will take hours at a time.

Because I can’t seem to turn off the personal finance blogger in my head, I can’t help but be glad that we have a big emergency fund. There may be existential issues ahead about the cost of living in Toronto and the loss of several months worth of income (or possibly permanent changes to work structure) for at least one of us (and likely both), but we can afford to just deal with the crisis phase of this now and not worry about money for a few months — we’ll cross that bridge when we come to it. I’m also glad that I have a fucktonne of time banked at work, so I just walked out when this was happening. I’m sure there’s some kind of compassionate leave program that would have helped out here, but it’s just easier to say “surprise vacation!” and put off having to look into any policies or do any paperwork for now.

For those enrolled in the course, unfortunately it is not looking good for timely completion in November. I had originally booked a few days off work over these couple of weeks specifically to finish shooting video for the course — so in terms of timing for such a tragedy, it wasn’t as bad as it could have been (though never would have been the preferred timing) — and obviously that’s not happening right now, and I don’t know if I’ll be able to make up the lost time in November.

Blueberry has been just fantastic at dealing with all of this so far, though we’ve all been spoiling her rotten when the grandparents pick her up from school or I let her get away with murder at tuck-ins.

I think I have managed to respond to all the emails sitting in my inbox, even if it’s only with a quick “I have not read this and will get back to you later.” If not, this post will help explain where I’ve disappeared to.

Passive Investing and Non-Linearity

August 2nd, 2016 by Potato

This is a recording of a rant I put together originally for the DIY investing course, but it didn’t quite fit the tone of the course. I didn’t want to throw it away, so here it is as a quasi-podcast for you.

Click here to download the MP3 of the rant.


Markets don’t have simple stories. Market indexes are very useful for simplifying down what’s happening for a quick news report, and with index funds it’s also a handy way to relate that back to your portfolio: if a market index is up, your holdings mirroring that index are also up. But just because we can boil it down to a monosyllabic summary of the action for the day or year or whatever (up/down/flat) doesn’t mean that it’s a simple lever someone out there is pushing, though we like to think of it that way.

We want to think of it that way. We’re comforted by the fairy tales of causation in the news: condition X happened, therefore event Y happened.

It tickles the part of your brain that wants to recognize patterns and fill in the next part. “Here’s a condition, what’s going to follow, onboard pattern engine?” But the damned thing of it is, sometimes there are causal connections, and often there aren’t. If it was just totally random noise we might be able to give in to it, but it’s not — there are some really plausible-sounding stories out there, explanations so great they can explain market moves in all directions.

The stock market is a complex system. It is made up of people (and computers pretending to be people) all acting for their own interests and reasons. Many are only looking at one or two particular companies versus trading a large index. Some are long-term investors unconcerned with day-to-day moves. Some don’t look at the news or events or anything external to the market, making decisions based solely on the trading activity they see other people doing.

I think it would be a really interesting project to one day survey everyone who made a trade and find out why they made the trade that you did. I suspect you would find almost none aligned with the headline in the news that day: “market falls on worries over capital controls in China” or whatever. Instead it would be a thousand different stories that vary from an automatic investment plan to what they had for breakfast to responding to commentary someone else made.

The market average is made up of hundreds of stocks being traded by millions of people around the world, each with their own lives and stories and perception filters, and even though it will all average out to a single, simple result (up/down/flat), it is not because of a single, simple cause.

It reminds me of that quote from Men In Black:
A person is smart. A kind, compassionate being. People are dumb, panicky, dangerous animals. [paraphrased]

One thing I try to explain over and over again when talking about index investing is how hard it is to out-smart the market consistently. The whole point is to try to shut out the non-actionable noise, to avoid forced errors, and stick with a consistent, easy strategy… then move on with your life. It is a very difficult thing to do, because you have to have some kind of faith in the markets, and you have to turn off your pattern-seeker. One of the worst things that can happen to a new investor is to make a decision based on some piece of trivial news, and then make money based on that. Because then it’s nearly impossible to turn off the competitive, out-thinking, out-guessing, pattern interpretation engine.

At a library talk I gave recently I had a number of questions from the audience that I didn’t do a very good job of shutting down: things like recent articles about negative interest rates and how that will affect a passive strategy, or what the cause of Black Monday was in 1987. But the fact that the questions were coming in the first place means I wasn’t doing a good job of explaining that passive, control-what-can-be-controlled philosophy.

To try to explain it again in a slightly different way, there are a few good reasons why the passive approach is a smart one, in other words, why active investing is hard.

1. Lifestyle: it requires effort and expertise to be an active investor.
2. Evidence: even the experts do not have good odds of out-performing when picking stocks.
3. Non-linear: the links between putative causes and investment returns can be very non-linear and non-obvious.

For #3, this is the point I think a lot of people are missing on why it’s just so difficult to be an active investor and out-perform. There’s the efficient market side of it: the market is made up of people with the same information you have, so a news article about something (negative rates or employment or whatever) is difficult to use to get an edge. How much of that were people already expecting, how much will affect future business activity, and how much of that will affect future stock/bond returns?

There’s also the complexities of the connection between the real world and the stock market at play. Monish Pabrai has a flashy slideshow about this, but it’s pretty easy to pull examples out of a hat from the past. There have been many inventions where it has been easy to say “this is going to change people’s lives” and be absolutely correct. Automobiles, airplanes, genetics, microchips, the internet, cell phones — these have all undoubtedly been wildly successful inventions that have changed the lives of billions of people.

And none of that knowledge has been good enough to help you make money as an investor. Even if you knew for sure — even if you traveled back in time with the absolute certainty that in a few decades’ time the sky would be filled with jetliners, the pockets of the passengers filled with devices laden with microchips, and the roads choked so full of cars that a decent marathon runner could jog from the suburbs to downtown faster than a car could take the highway — even then, you would be hard-pressed to make money from that knowledge. Most of the car companies in the early phases of that revolution went bust. Airlines go bust so often it’s a joke amongst investors. There’s been one big winner in the cell phone industry, and it’s one of the companies that started off selling computers.

The internet did indeed change our lives. But it also led to a big stock bubble and collapse, showing the importance of higher-level thinking. Indeed, many of the would-be investors and traders of the time were faced directly with the evidence of the internet’s impact, as they placed their trades online in the new discount brokerages that became available. They could not ignore the impact the internet was making or how fast it was growing. So many of them thought the same thing, and bought the same stocks, leading to the bubble, which blew up and cost many of them a lot of money. It’s not enough to know the first part of the story, but also look at what all the other investors (humans and computers) are doing — what’s priced into a stock, what’s a real opportunity, what’s a bubble brewing?

3D printing, medical cannabis, stem cells, solar energy, machine learning, self-driving cars — Mother. Fucking. Fusion. These may be the next revolutions in our lives. Even if you correctly forecast the coming changes, turning that insight into money by way of the complex, non-linear investment market is so very hard. It is not the simple cause-and-effect relationship the news headlines would have you believe.

A final story: the physicist had a cat, and wanted to know how it worked. So he took it apart, and he had a non-working cat. Living things are chaotic and complex and it is very difficult to precisely map how all of the inputs lead to all of the outcomes. And the stock market is a living thing. You can easily share in its growth as a passive investor, or try to out-smart it – but that is much easier said than done.

The GTFO Calculator

July 18th, 2016 by Potato

I was stuck on the subway for a long time today. A really long, sweaty, stinky time. My commute this morning took two hours door-to-door thanks to numerous PAAs (Passenger Assistance Alarms — they happen so often they’re just referred to in acronym form) on the line. It’s a hot July day, and though the train is air conditioned, much of that time was spent loitering at various platforms with the doors wide open, sucking in the hot platform air (superheated by the A/C exhaust). It’s days like this that really drive home how much Toronto was not built for the enjoyment of its citizens.

Nelson had a post with a title that seemed targeted right at me today, explaining how much lower the cost of living is in small towns (mostly driven by the lower cost of housing), which is a great opportunity for teachers and other professions who get paid about the same amount no matter where they go (indeed, there is a surplus of new teachers in the big cities, while his local school has unfilled positions).

Comparing living in a small town to living in Toronto or Vancouver has a lot of subjective factors to consider, from amenities and attractions to salaries, job prospects, and the network effect. Indeed, I used to live in the virtual paradise of London, Ontario, which featured a modest cost-of-living, all the day-to-day amenities one could want, jobs within walking distance of livable communities, good curling, and all within a short drive of Toronto for weekend visits and the odd bit of ephemeral culture that wasn’t native to London. However, my family and Wayfare’s family live in Toronto, so — network effect at play — when we spawned we came back upstream to do so here in the GTA. Plus we both have graduate degrees and work in specialized fields, and we both make more in the GTA than we would have in London… though in London we might not have needed to make so much, possibly leaving more time for leisure and Blueberry.

Aside from my own situation, I see still more and more people pour into the GTA, and many of them do not have any particularly specialized jobs, family ties to the area, or difficult two-body problems to solve. Indeed, many are young and single, lamenting the costs of home ownership, and I’m left wondering: “Why are you in this city? GTFO!”

At what point does it make sense to take a paycut to move to a smaller city? At what point does a higher salary in a big city offset the higher costs of living? Enter the GTFO calculator.

Here you can enter your salary in the big city and a smaller centre, as well as the salary hit your spouse might have to take to follow you into fire, into storm, into darkness, or into Hamilton. Then you can enter the different housing costs and assume all else is equal to see approximately how much better off you’d be with the GTFO move — and how long it would take for your dirty city money to make up for the bubblicious living costs. There’s even a fudge factor cell for renters, or people who want to factor in having to get a 2nd car or whatever.

It’s set up as a Google Sheet with a protected range over where the magic happens, so you can just type right into the input range to get your answer instantly (a trick I copied from Sandi). So, how much more do you have to make to balance out the higher housing prices of Canada’s more expensive cities? Find out for yourself now!

Preview of the GTFO calculator on Google Sheets

Forced insight: you may find that seemingly large paycuts are still worth it (in a financial sense at least) because of how very expensive Toronto/Vancouver houses are now. It takes a lot of years — likely more than you have — making an extra $10-30k to outpace an extra half a million in mortgage debt.

Quibble: I didn’t (and don’t plan to) build in different rates of salary growth. Just wave the magic “real dollars” wand. Some fans of the big cities will quibble though that it’s not so much starting salaries that are higher, but that there’s more room to climb the ladder and get to a (much) higher salary with time.

Note: there is a way to parallelize the Google Sheets, so if you see more than ~4 people trying to edit it at once, let me know and I’ll get off my lazy butt and do that.

The Big Short and Canada’s Housing Bubble

January 22nd, 2016 by Potato

I’ve been off in over-time-for-a-project land so things have been quiet here. Here’s a good old-fashioned rant for you to celebrate being back to a normal schedule.

Michael Lewis’ book has been turned into a star-studded movie, which helps explain for people part of what drove the US housing bubble and collapse – and what a few people saw in advance to profit from it. So let’s talk housing bubble in Canada.

In case you’ve forgotten, I’m the biggest, most vocal bear on Canadian real estate there is.

Ok, maybe 2nd biggest.

Three other housing bears you may recognize from TV: David Madani, Hillard MacBeth, and Ben Rabidoux

Ok, I’m a bear with a blog. And I haven’t talked about it much lately because there isn’t too much to say that hasn’t been said. The housing market is a glacier: it is huge, it transforms the landscape, and it does very little until it suddenly does a whole lot at once. I’ve said what I needed to say and made the tools I needed to make to help people. The rest is waiting. And there’s the possibility that in the end, it may never correct (or have a mythical soft landing), though even then in many markets renting will be the more sensible move.

But with the movie in theatres now, maybe it’s time to revisit some points and consolidate those archives into something of a rabid bear manifesto.

Let me start with something of a mission statement: choosing a house/condo to live in is the largest single living expense you are likely to face, the biggest financial decision of your life, and it often does not get the consideration it deserves. It is challenging to make the “right” decision because there are a number of things to take into consideration, and you will not have the opportunity to learn by experience. Experts such as realtors or inspectors can tell you many interesting facts about a house, a building, a neighbourhood, or a market, but they are not able to help you on the most important aspects of the decision, such as whether you should buy at all. A realtor may be great at telling you how much an extra bathroom may cost, or how much cheaper a place an extra half kilometer from transit may cost, but they are by and large not able to tell you when you are over-stretching or when the market as a whole may be over-heated. And that’s not to mention that most people involved will have conflicts-of-interest. You also face a gauntlet of mantras, rules-of-thumb, and heuristics that have been developed over the years which sound completely convincing (some even rhyme) but which again do not actually help you make an informed decision and don’t allow for the existence of bubbles.

The first thing to realize is that you do have options. You can always rent. Many people — especially those of the baby boomer generation, parents of today’s first-time buyers — think of dingy apartments with no amenities when they think of rentals. This is a misconception: virtually every condo building going up in Toronto, Vancouver, or in the rest of the country has units for rent that are just like the ones people buy, and the renters have access to all of the amenities. Townhouses are widely available for rent. While they are rarer, detached single-family homes in good school zones are available for rent — I myself live in one, and it has a backyard for my daughter to play in, a renovated modern kitchen with granite countertops for me to cook and entertain and display my social status in, and every other feature that you would want in a house that you own. There is no way to know that I rent it unless you asked me or looked up the property tax rolls (or caught on to the fact that I’m suspiciously mum on the topic of renovating). Admittedly the selection is much reduced compared to what’s for sale on MLS at any given moment, but it is an option.

And this is the important part: it is financially better to rent the equivalent place in the midst of a housing bubble. Do the math yourself for your own situation, but when we’re looking at places with over 300X price-to-rent, the difference over time is staggering. And that’s before we even start to talk about life trajectory risk.

Consider for a moment some rule-of-thumb math: if a typical cost for shelter (in non-bubble times) is about a third of your budget, and the housing market is 30% over-valued, then that becomes ~10% more of your budget — which is about what many authors peg as a starting point for your retirement savings (which is a post for another day). And indeed, it looks as though people in bubbly cities stretch to buy houses and sacrifice their futures to make it happen. Renting and saving the difference may be the best move in this situation.

We can talk about large systematic issues, speculation, household debt, regulations, and all that jazz, but this is the main point I want you to walk away with: you have options in how to go about arranging for your shelter and largest expense. You have to live somewhere, and the rent-vs-buy decision for your neighbourhood is the only one that matters for your life. The macro factors and other discussions can be at turns fascinating or plain confusing, but ultimately it’s all esoteric and detached from your life. All that matters to you is making a rational decision on where to live and how to provide shelter for your family.

I’ll note that yes, in normal markets landlords make money (so renting should cost more/be “throwing your money away”). But note that this is not a universal, physical constant like the second law of thermodynamics. Landlords can and do lose money, i.e. subsidizing renters. Also, humans (and landlords) are prone to the yield-on-cost fallacy: by and large your potential landlord will not have paid the price you would have to pay to buy the equivalent house. They make money because they paid a sane price many years ago, and you save money by renting from them because in 2016 you don’t have the option of paying 2003 prices — your choice is between 2016 prices and 2016 rents.

The Big Short and the US Bubble

The US market in its frenzy was crazy. If you could fog a mirror, you could get a mortgage. A lot of articles focus on the aftermath of that: the bundling of mortgages into exotic securities that almost no one understood, how that nearly brought the entire system down, and how ridiculously terrible some of the lending was to generate those mortgages in the first place.

In The Big Short we get to see a group of misfit investors do the legwork to uncover the details of these subprime bundles of mortgages that everyone else was taking for granted. They find that absolute garbage is going in, assumptions are made about the risks being non-systematic (throwing enough crap together to make it diversified makes it magically not crap any longer), and the risk in these exotic securities is not understood. The system keeps getting driven in this terrible direction because the incentives are screwed up. They created incentives that helped drive the writing of ever-riskier loans to people who did not have the capacity to pay them back, secured by assets that were over-valued and could not be sold at those prices if the loose lending didn’t exist. Moreover, some of the heroes in the film see a catalyst in a cliff of teaser rates resetting in 2007, so not only is it unsustainable, but they have some idea of what the time-frame will be for gravity to re-assert itself.

Many point out that Canada’s lending system is not as bad as the US subprime market was and we don’t have all of the same esoteric products that they did, therefore no bubble. And for what it’s worth, strictly speaking that first part is true. But that’s a worthless distinction, like saying that a moose has antlers and not tusks so why are you worried about being gored like those guys who pissed off the elephant when all we’re facing is a moose that’s a tenth the mass? You don’t need conditions that specific to generate a bubble. Take the focus off the specifics of the instrument, and you’ll see that the same effects absolutely are present in our market.

Think of that scene in the movie where Steve Carrell’s character finds out that the stripper has five houses (and a condo), each with multiple mortgages: this person was only able to make that happen by rolling loans in the midst of a rising market — “a rolling loan gathers no loss” is one of my favourite aphorisms and completely applies to certain segments of the Canadian market. The risk she represented as a borrower was huge, but she had zero defaults (and would continue to have zero defaults as long as prices kept going up). And so the system kept pushing more and more leverage at her, and she kept taking it, out-bidding other people for houses, continuing to drive prices up.

And she did it because she thought it would benefit her: it was her path to riches.

And that, ultimately, is what drove the bubble. The lending enabled it, but it was people on the ground buying houses at any price that created the bubble in the first place. The banks can sell and incentivize all they want, but if people were smart about their purchases, considered the intrinsic value and their ability to pay, plus the risks involved in buying (and the financing), there never would have been a bubble in the first place. But that is not a good description of people. People are astoundingly good at seeking out relative value (which house has more bathrooms and a nicer kitchen and how much of a premium would I pay for that?) and incredibly bad at absolute valuation (is the market in a bubble? Does this price make sense relative to rents and incomes and the ability to eventually pay off the mortgage?).

A bubble is all about belief. There are lots of things that we can point to as being potential catalysts for the unwinding of a bubble, but don’t forget that loss of faith can also be one — if people don’t believe that prices will be higher in 3 years when they want to flip or refinance, they won’t buy, or at least won’t be in a rush to. And then it all spirals down, the positive feedback loop working in reverse.

The chase for yield that drove the banks to incentivize subprime lending is absolutely alive and well up here, it’s just in a different form. Instead of generating mortgages — any mortgages — to stuff in CDSs/CDOs, our banks push off loans to CMHC and Genworth. The net result is the same: if you can fog a mirror, you can get a loan — no skin off the bank’s nose. And the moral hazard exists: banks pass on the risk, so they do less work to validate and monitor (but see how fast they check incomes if you don’t qualify for CMHC).

Much is made about credit scores and subprime in the US. Up here the picture is cloudy: the really trashy stuff (under 600) doesn’t qualify for CMHC, but subprime (not rigidly defined) usually means anything under 640, so lots of what the Americans would call subprime is accepted as gold up here.

Moreover, something that gets lost in the arguments about credit quality is that the second-best predictor of mortgage default was how much skin in the game these buyers had, and even if Canada is not as risky as the US on lending to people with poor credit scores, we are awash in high loan-to-value lending (with its explicit government backing). And many hard-hit US states were full-recourse like most provinces — the ability to go after someone’s other assets is meaningless protection if they’re all-in on real estate and will declare bankruptcy if they get too far underwater.

And that’s not to mention the private mortgage market. The search for yield affects individuals just like it does the pension funds and institutions that created the market for CDS/CDOs in the US. There is no solid data on how big the private mortgage market is here, but advertising for it is everywhere in Toronto, and if you read into it the incentives are just set up in an insane way to push these products to the extreme. What’s scary is that this is possibly a real estate risk-squared situation: people with good credit are borrowing on HELOCs to fund private mortgages for those without: if prices start going down the first loan could default, putting stress on the underlying HELOC. (Unfortunately there isn’t enough data out there either way, just anecdotes).

In The Big Short, complacency was another big issue. Even as the default rate on the underlying loans was increasing, the rating agencies didn’t downgrade the CDOs. The appraisers were pressured to meet the numbers and not look too closely at fundamentals. Brokers helped clients make up incomes (where an income was even needed at all), and the underwriters never blinked. We see the same complacency here. Many know that fraud exists (and may even be rampant) in the Canadian mortgage market, but few care, and no one seems to crack down — the regulators absolutely appear to be asleep at the wheel. Look at HCG recently: they found out about a bunch of brokers feeding them mortgages with falsified incomes, but were in no especial hurry to disclose that to their investors, find out how deep the problem ran, or re-evaluate the loans in question. Their insurers and regulators also didn’t descend, smiting in fury. No one seemed to care much, which suggests a disturbing level of complacency with fraud-for-shelter in a market that’s already very easy to borrow in. (Oh, and AFAIK all of those brokers are still in business)

Lending and Mechanisms and Flawed Pricing Strategies

It’s easy to get lost in the weeds of the qualities of the lending system and the differences between then and now. That’s important if you’re seeking out mortgage securities to short, but on the ground the minor differences of kind and scale don’t matter as much: the lending could be crap, but if the people are being responsible and prices are sane, buying your place can still make sense. Even if lending is mostly fine while prices go nuts, renting will make sense.

And I think it’s pretty clear that lending practices are not stopping the rapid ascent in prices. There’s lots of fear of being priced out, but few actually are – the mortgage broker always finds a way.

So I like to think of how the system operates — the underlying mechanisms — imagining the tens of thousands of buyers each year, scurrying about. What is causing them to drive up prices? How are the individual agents behaving?

Some like to hand-wave supply and demand as the be-all and end-all, and sure, prices wouldn’t be going up if someone wasn’t paying them. But what might change the supply and demand picture, and what will happen to prices if that happens? How “firm” is the demand, what happens to it if prices stop rocketing upward (like the “gully” in the movie), or loans become harder to acquire, or employment stress and uncertainty sets in?

What factors really matter? After all, population growth does drive demand which drives price increases. And immigration exists. But these are not the only factors in the equation: the tide of immigrants to Toronto did not suddenly stop in 1989/1990, and they didn’t start making more land that year, either; immigration to the US was as strong as ever in 2006 when the market peaked. So bubbles can certainly form and implode despite stable population growth.

For sure interest rates have played a major role in the bubble, especially in the continuation of the Canadian bubble after the US one burst. That and speculative thinking (animal spirits) is where we need to look for the mechanism driving prices up.

Whether you do a full rent-vs-buy analysis or just hand-wave the monthly carrying cost, as interest rates (and your expectation of rates over the life of the mortgage) go down you become more willing to pay more for a place. Plus people generally don’t look at the big picture or radical alternatives when buying something: you may compare a Toyota to a Honda when shopping for a car, but not check out whether or how much it would cost to get by without a car and just use transit and taxis, or a car-share service, or an electric car. People buying houses tend not to consider whether the market overall is rational, or what their rental options are: the analysis likely stops at the neighbourhood boundaries and a few months of comparable sales to make sure they’re not being taken to the cleaners on a relative basis.

Combine these things with recency bias and flawed heuristics (real estate only goes up! renting is throwing your money away!) and the ever-lower interest rates clearly drive prices up.

Just look at the importance of ever-lowering interest rates and rate expectations. Take a place that rents for $2000/mo. If you were figuring on a long-term interest rate of 4.5%, you might be willing to pay as much as $400,000 for the place, but in 2012 the price may well have been $500,000. “You’d have to be nuts to buy at that price, it’s like you’re expecting to pay 3.5% forever, or for prices to keep doubling inflation!” the bears might say. “It’s 25% over-valued!” But then prices would keep going up and rates would keep going down.

So then you’re in 2014 and rates are now 2.99% and prices are up even more. Maybe you re-adjust your interest rate forecast for lower for longer and $500,000 for the place doesn’t sound too bad. But the bulls have bid it up even higher. “$600,000?! That’s crazy, you have to be expecting rates to not only stay low, but drop to like 2%!” And against all expectations, rates would drop again… but prices would take all of those shifted fundamentals and then some, going up even more. Each time the market participants seem to price in the lower rates and higher appreciation as a permanent feature when running their unconscious pricing algorithms. Indeed, to price in not just the current low levels, but anticipate even lower rates than the already-historic lows.

But then that’s why so many see increasing interest rates as a possible catalyst. For the buyer of the future, who may be facing rates of 4% (gasp!) when making their decision, it would now take a correction of 30% to get back to a fair price. If the long-term expectation goes back up to 5% (still lower than a fixed-rate mortgage could be had for in 2008), we’re looking at needing a 35% correction.

It’s also why a soft landing is so unlikely: at this point many Toronto neighbourhoods have price-to-rents that are so high you have to assume that the prices bake in not only zero-bound rates but also continued high appreciation. If a few years of stagnation puts a lie to that assumption, that alone should turn a soft landing into a crash.

And if there’s a loss of confidence, and the implied appreciation rate tanks while the interest rate assumption rises (i.e., if fundamentals matter again), it could be a ~45% trip to the bottom. At rates of ~5% and appreciation that just matches 2% inflation, break-even price-to-rent would be something like 185X (compared to over 350X in many detached areas of Toronto, and 240X for many condos). Then if you truly want to feel scared, consider that in many crashes prices undershoot, so maybe calls for a 50% crash aren’t so crazy.

You also see weird behaviour and rationalizations from people in bubbles. One that really sticks in my mind is a conversation from not too long ago when a real estate agent tried to argue that a particular condo development switching to become a rental apartment complex was taking supply off the market. Now for the usual meaning of supply — places for people to live — the move had absolutely no effect. But, as implied by the statement, the speculative purchase demand has detached from the need-for-shelter demand.

It’s important to remember that even in the worst of the US sub-prime lending spree, only about 15-20% of buyers were sub-prime. Most people buying houses were regular people just trying to put a roof over their heads, but who didn’t do the math or included a speculative component in their decision (“prices always go up” or “it’s a good investment”).

The Big Picture

I’m not much of a macro guy. You should go talk to Ben Rabidoux or someone like that.

But still, the facts are chilling and worth a moment of reflection.

  • Record household debt and debt-to-income
  • Massive financial vulnerability, with people unable to absorb even short periods of unemployment or small financial shocks
  • Leverage
  • Construction sector share of employment
  • Ownership rate

Catalysts and Risk

I’m not big on trying to predict catalysts for the implosion of the Canadian real estate bubble. Catalysts are super-important if you’re trying to short the market and profit from the downfall — and decide on the timing of that — but if you’re just looking for a smart way to arrange shelter for you and your family, it doesn’t really matter too much. Even if there’s a soft landing or it never corrects, if renting forever is vastly better financially and lower-risk, then that’s that. A crash is just gravy in that case. If there is a crash, it won’t matter what the immediate cause was – people will get hurt either way.

And even when you call them, catalysts are hard to see coming. I’ve seen all kinds of predicted catalysts over the years, some made under the assumption that the catalyst will never happen, thus the market is forever bullish. Interest rates going up is of course the big one, but some have said that it won’t be until unemployment rises that prices will drop. Some proposed catalysts are esoteric, like an inversion in the yield curve (which, BTW, we briefly saw in 2015).

Some are related to regulations, like as long as negligible down payments and a lack of rigour for income and other fraud are permitted, the bubble will keep growing, and only higher down payments and documentation standards will pop it.

Some are regional, like oil prices and Alberta real estate – and few saw that actually coming even if they did identify it as a catalyst for corrections. If you listened to a RE bull in 2014 and they said forget valuation, Calgary/Ft. McMurray prices will never fall as long as oil’s at $80-100/bbl, well, they may have been absolutely correct about that necessary condition yet it did not change the fact that you probably wish you were renting right now. Same with all these other catalysts: what are you supposed to do, buy now and then dump the instant you see the yield curve invert or the property tax rate spike or the Chinese stock market crash or whatever supposedly necessary condition is being proposed?

So that’s why I focus so much on price-to-rent and making the choice for yourself and your own situation.

Which brings me around to a discussion of risk, which is really what it all comes down to. If you buy at stretched valuations and there is a correction (or if you put little down and prices just stop going up), you face a big risk to your life trajectory. If you can’t sell for lack of equity and need/want to move (for a new job, because of a divorce, planned larger space for children, unplanned larger space for surprise children, shitty neighbours, job loss, sick parents, or whatever reason comes up), you won’t be able to.

Conversely, if you rent and prices continue to go up at worst you’ve lost some paper gains you would likely never realize and some face, but you still have your roof over your head and your flexibility. The main risk is that you get evicted if the landlord decides to take their capital gains out from under you, which if you’re a good tenant is quite rare (I know it happened to one friend of mine recently, but to be fair, he had been there longer than most people stay in condos they buy).

And speaking of condos, that discussion of risk is particularly acute there: if you’re not in a space that’s at least approximately your “forever home” and you get trapped there, life can truly start to suck. The sad reality is that many new condos in Toronto and Vancouver are only built to sell to investors and not for real-life living; many are too small for a couple to comfortably share, let alone raise a family in1.

For many rent-vs-buy analyses in Canada’s big cities you’ll find that even when renting doesn’t dominate, buying only wins by a little. Why take the risk that a bubble will pop to only do a bit better than break-even?

Foundations and Decision-Making

One thing that really irks me is otherwise smart people ignoring the housing bubble entirely and saying it’s always a good time to buy because “a house is the foundation for financial success.” Well, no, it’s a foundation for financial success. Just like driving posts down and building up from there is a foundation for a house, but so is digging a basement and pouring concrete.

And even then, it’s more of a thing that is correlated with financial success than a necessary condition for it — you could as easily say that having a paid-for car, a job with a DB pension, or kids who go to university is the foundation for financial success. Especially when many of the financial successes that were built on a foundation of houses were done so at much more reasonable pricing.

Buying anything, especially the largest purchase in your life, at any cost is not a foundation for financial success.

So you have a choice to make. If you can’t afford the risk of the housing bubble (or even stretched valuations relative to rent absent a correction), you can choose to rent. If you have more money than you know what to do with, you can decide whether the happy feelings of owning outweigh the higher cost of owning — money is there to be spent (assuming you have it in the first place). Some people are in that camp — what’s a hundred thou here or there? — but most are not.

And you have to consider the risks: getting trapped underwater can not only be a financial strain or possibly lead to bankruptcy, it can be psychologically stressful and can remove your ability to change your life trajectory. In particular, you’re not free to move to find a new job in a new city if you own.

Also remember that you don’t always get to dictate the timing of a sale. Lots of people buy thinking that they can ride out any correction because they’ll live there for twenty years or more, and can pick their exit — only to lose their job or their spouse.

Speaking of foundations, I like to think of warnings about the housing market like warnings from an engineer about cracks in the foundation of a bridge. The cracks may have been there yesterday before the report, and the bridge may keep supporting ever-increasing traffic loads (and concrete mass) despite the cracks for years to come. A collapse may even require an additional catalyst, like an over-sized load, high winds, or flash freeze. But the risk is higher, and now you know it could all come crashing down disastrously. And choosing not to take that route in to work is the smart decision, even if all your friends get there a few minutes faster on the shaky bridge — their temporary gains will seem meaningless if it all falls down.


Back to the Big Short for a moment: they had a fairly clear catalyst for the collapse, in the cliff of sub-prime ARMs resetting to higher interest rates in 2007. Defaults noticeably picked up, and Countrywide shut down. Yet the credit default swaps the protagonists had purchased somehow became less valuable when all reason screamed that they should have been cashing in just at that moment.

Markets don’t tend to crash over-night, and not smoothly. And for housing, especially not quickly.

Many people have heard so much about sub-prime and CDOs and the like that they think that caused the US bubble to burst. But that misses so much of the story: a bubble is all about belief and willingness to pay the crazy price. The subprime crisis was an accelerating factor: it helped the US market crash harder, and faster, with more repercussions for the broader economy. But don’t think that prices would have kept going to the moon if it weren’t for subprime.

How will it end here? I don’t know, but likely in tears. I would wager more slowly, at first: markets becoming illiquid as sellers refuse to lower their prices (and are not forced to sell by rates resetting higher) while buyers refuse to pay up2. Then faster as it builds up momentum on the way down and people start to worry about getting ahead of it. The positive feedback cycle starts to play in reverse: construction jobs dry up, which causes more stress on the housing market. The lenders see risk again as rising prices stop masking bad debts, cutting down the pool of buyers. We’re starting to see this in Calgary: prices are down, but only a bit, while many sellers stubbornly hang on to their anchor valuations as volumes drop and days on market and listings rise.

Near the end of The Big Short is a good scene where Brad Pitt’s character chastises the two garage-band fund guys for celebrating over how much money they were going to make. “You just bet against the American economy. If we’re right people lose homes. People lose jobs. People lose retirement savings.” I know what it is that I’m predicting. This is not just about wise readers of the site sitting things out until they can buy a home at a more reasonable price, and those who aren’t having to sacrifice a vacation or meal out to afford their more expensive housing choice — if I’m right about a mismatch in valuations and price-to-rent, and that it really only makes sense to correct the one way, people are quite likely going to be hurt by what’s coming. Not likely as bad as the US or Ireland in the GFC, but 1990 in Toronto was no picnic, either. This is an important topic — and a sleeper, because it does take years to play out. Far too easy for the human attention span to get bored and tune out after a week or two.

And importantly, the bottom — where prices might be supported by rents at even modestly higher interest rate expectations — looks a long way down for Toronto and Vancouver.

As for when, well that’s the million-dollar question. Calgary’s already in a correction, while Vancouver is fully parabolic on the upside3. It was hard to see things going on for more than a few years past the Americans, and here we are in 2016 and it’s still not obviously upon us — hitting record highs, even.

When you’re a short seller being right-but-early is tantamount to being wrong. Much of The Big Short is about the pain these guys went through on finding the trade of the century, of being one of just a handful of people who saw the disaster coming, of being in an extreme minority… but being early on it, and having to live through years of their investors wanting to back out, the margin and collateral calls, the stress. When you’re just trying to live your life it doesn’t matter if you’re early. Don’t drive across the bridge, go on and rent.


I hate trying to call the timing of a correction, because it’s a difficult prediction to make, though I am (mostly) human so not trying to extrapolate from the dots and see pictures in the stars is hard. There do seem to be ever-increasing cracks in the system, which may suggest the end is (finally) nigh.

  • Syndicated financing on a few projects appears to be running into trouble
  • The US may be increasing their rates
  • Fear: hardly anyone fears loss or a downturn, the fear is all about missing out; this could change very quickly
  • Contagion and confidence: Ft. McMurray prices are down a lot. Calgary’s down a bit and continuing to slide. These can affect confidence even outside the resource-heavy areas of the country, as it reminds people that RE is not invincible. Moreover, the dollar is down, and even though it’s not really all that meaningful, it’s one of the few pieces of macroeconomic data that people in the general public do pay attention to. And the dollar is down hard, making people think that the country is in trouble.
  • Remember that CMHC stress test with the seemingly unfathomably low $35 oil? It was under $30 today.
  • We appear to be entering a recession
  • Mortgage fraud is being recognized in at least a few areas as an issue

Whatever the broker commissions and moral hazards of the financial institutions, whatever the differences between the products of the Big Short and Canada today, the US housing bubble wouldn’t have happened if it weren’t for millions of people making poor life choices4. So the only advice I can leave anyone with is to think of downside risk, of what happens in unfavourable scenarios, and to look at whether renting for them — in their area, their lives — may be the better move rather than starting from the assumption that they’re going to buy and the only question is what.

And that is the only advice I can give because the one big difference between Canada and the US of the Big Short is that there isn’t a big short. No one has crazy mis-rated CDOs that you can bet against with payouts of 500:1 (if you do, please call me). You can bet against some of the lenders and insurers5, but that costs more for less leverage, so the timing is more important. Some people may make money at it, but I doubt we’re going to see any Canadian contrarians walk away as billionaires.

1. While I haven’t personally seen many cases of the stripper with five houses (and a condo) kind of speculation, I have seen far too many cases of the couple that gets together, finds their shitty 1-bdrm condos aren’t big enough for them both to live in, and up-sizes while keeping one or both of the condos as an investment.

2. Called the Wile E. Coyote phase, where the supporting ground has dropped out from beneath but the fall hasn’t started yet. Timing is exceptionally difficult to call, but this could be a year or two.

3. Vancouver is so stupidly over-valued that “bubble” doesn’t even cover it anymore. A few years ago even bullish commenters and analysts would say things like “aside from Vancouver, Canada doesn’t have a housing bubble…” Then this year it went up nearly 20% more — undoing just last year’s stupidity would be called a catastrophic collapse in any other city, and will wipe out the average first-time buyer with a high LTV. If you know anyone in Vancouver just tell them to cash their lottery ticket and GTFO.

4. Which, to be fair, seemed like perfectly reasonable, ordinary things to do at the time, which still seem like perfectly reasonable, ordinary things to do here, if you don’t throw much math or paranoia at it. And no, I’m not talking grad school this time.

5. Disclosure: as per the comment on the follow-up post, I have 1 put contract on BMO (that I have kept rolling forward from 2014). Having 1 put contract is kind of like being short 100 shares except different.