Blessed by the Potato

From RFD, but not an uncommon viewpoint:

Basically, the argument of the pro-bubble crowd here has been: ‘it happened in the US, therefore it must happen here’. But they fail to appreciate the magnitude of the mortgage mess that created the US bubble. Canadian banks are much more prudent, and we never had that sub-prime mess here. It is safe to say that 99% of home-buyers here are able to afford their mortgage payments in the long-term, therefore there is no ‘bubble’.

One sad thing about the US subprime contagion was that it lead many to believe that such terrible, terrible mortgage lending was a necessary condition for a real estate bust to take place. It’s entirely possible to have a real estate bubble form even with ostensibly sane lending — we had it happen here in 1989, and several times before that. Back then property speculation was much harder to accomplish than it is now… but it still happened. Bad lending standards can make bubbles inflate faster and higher, and the waves of foreclosures that then follow can make the correction sharper and deeper, but the bad lending is not the bubble. Over paying for real estate (or whatever asset is in question) for whatever reason is the bubble.

Imagine if you would a small, remote town. Let’s call it “Ft. Mac” for the sake of this example. Then, have some event happen that changes what people are willing to pay for real estate in that town, for instance the opening of a new business, call it “Tarco”, that’s paying high wages to workers. More people decide to move to Ft. Mac, chasing the money. But, there aren’t enough houses built and ready for the influx of new workers. People get into bidding wars for houses, paying far more than they ordinarily would so they they can get a shot at one of the lucrative jobs with a roof over their heads too. The construction guys move in and start building more houses. Eventually though, the hiring spree at Tarco peters out, and the influx to the town stabilizes. Now when a new worker comes to town and is looking for a house, they’re the only one bidding. Without the insanity of a bidding war, they don’t see the logic in paying 5X their income for a house in Ft. Mac, and so they don’t… prices fall back down.

This little story is the core of how price distortions can happen and later correct. No need for the construction guys to over-build and create a glut of houses that will never be lived in (though in real life that often happens and makes the bubbles worse); no need for speculators to buy houses and take out mortgages they have no intention of servicing (but in real life the speculators would probably show up too), and then get foreclosed on when they can’t flip for a profit. It doesn’t have to be real estate in the parable, it could be playstations, internet stocks, or tulip bulbs. Leverage definitely adds to the severity of these situations, especially when handed out like candy on Halloween, but it’s not a necessary part to the story.

Well, in my last update I reported that the trip to Turkey helped me lose over 5 pounds. Unfortunately I caught a cold on the plane, it’s Halloween which has lead to much candy eating/poor dieting, and of course I haven’t been working out every day like I was there, so I’ve already put 2 of those pounds back on :( Ah, well, on to the links:

Mike at Money Smarts puts up summary tables to review of all the online brokerages in Canada. I’m of course still a fan of TD Waterhouse (which now offers the lowered commission rate to slightly more households with the threshold of $50k), in part because of the ability to easily buy e-series funds, and in part because once you do get a live person on the phone, they’ve been great every time. Knowledgeable, interested in getting problems solved, and just generally helpful.

Preet asks the perpetual question “Is a variable rate always best?”. One important thing to keep in mind when making that decision is not just whether rates will go up, but how high they’ll go, and how fast they’ll do so. One really rough rule of thumb is to consider the case of rates that go up in a constant, linear way. In that case, you save money in the first bit of the slope vs. a fixed rate, so by the end of the 5-year (or whatever) period, rates have to go up to be as much over the fixed rate as they were below the fixed at the beginning to break even. So for example today, with a fixed at about 3.4%, and a variable at about 2.3%, you’d have to expect the variable rate to be over 4.5% at the end of 5 years to make going fixed worthwhile. The real world is a more complicated place, so of course rate changes won’t be smooth like that, and there’s also the impact of paying down your mortgage, which helps the variable case more: lower rates earlier on are more effective than the higher rates later on. You can always make a spreadsheet to figure it out, but I don’t think the finer points of the math is as important as the very uncertain rate predictions.

Canadian Capitalist has a good post on where some of the tracking error of currency neutral funds comes from. The research shows that it’s not likely that the tracking errors are purely random, so one shouldn’t expect them to cancel out in the long run. Michael James provides a good potential explanation for where this negative correlation comes from.

MacLeans has an article on the rent vs buy decision, quoting Patrick from A Loonie Saved (HT to Patrick who sent me the link :) Here’s his part:

Patrick Doyle, a Toronto software developer who writes the personal finance blog A Loonie Saved, has crunched the numbers for himself and believes it just doesn’t make sense to buy at today’s prices. Especially after factoring in all the extra costs that come with owning a home, like property taxes, insurance, utilities and general upkeep, which can quickly add up. “I choose to rent because I already have a day job, I don’t want to be a property manager, I don’t want to be a real estate speculator, I don’t want to be a highly leveraged investor and I don’t want to be responsible for repairs and maintenance. I just want a place to live,” says Doyle. “If I were to consider giving up these advantages to buy a house, it would have to save me substantial money. Instead, it costs more. For me, that makes the decision a no-brainer.”

Well-put, Patrick! Of course, I’ve got to nit-pick some parts of the article:

Above all, most proponents of home ownership argue that buying a place of your own is an ideal form of forced savings. Canadians clearly aren’t up to the task on their own. In a typical year, fewer than one-third of Canadians make use of their registered retirement savings plans, and even fewer make use of tax free savings accounts, first made available to much fanfare in 2009—though the reason for that could be because so much of their income goes toward mortgages and renovations.

As I’ve argued before, paying down a mortgage is a form of “forced savings” (which to put it another way, means that people are so bad with money that they only way they can save is if threatened with homelessness), but that’s a very poor solution to an inability to save: actually saving is better. Yet here MacLeans’ goes further and adds in renovations. But, generally speaking renovations cost money, and you don’t get that money back when you sell. The urge to renovate should be a point against buying a home for the financially strapped young Canadian.

Either way, observers like Milevsky at Schulich believe the debate between renting and buying has gotten sidetracked in recent years by talk of investments, returns and portfolio allocation. “This debate has become so financial,” he says. “It’s lost the qualitative lifestyle aspect that should drive the decision. When a 22-year-old kid comes out of college and immediately asks, ‘Should I buy or should I rent?’ the question should be, ‘What do you want to do with your life—do you want to start a family, explore the world, build your career?’ That’s more important than the few hundred you may or may not save each month by doing one versus the other.”

I disagree with Moshe — the bloggers and forum lurkers like myself have perhaps been getting overly financial in the debate, but the general public has not. Or, if they have — with dreams of increasing real estate prices and easy roads to financial freedom — it’s because the financial debate has been very superficial. Far too often I’ve seen the old “rent is throwing your money away” line, or comparisons that forget to include big items like property tax, maintenance, or transaction fees. A financial notion only, not backed by any math. The debate is not nearly financial enough for most people. Indeed, I suspect that is how we got to a ~70% homeownership rate, a level that’s even higher than the peak in the US, where people now openly admit that banks loaned money to people who had no business buying a home: by people deciding that they wanted the ownership lifestyle aspect without taking the time to do the math. Plus, those lifestyle decisions — when to move, how much space will be needed for a family and when — should factor into the financial equations anyway.

Rob Ford won in Toronto. Part of the platform was to remove the Miller taxes on car registration and land transfer. I was in favour of the vehicle registration tax when I first heard about it, but am firmly against it now that I saw how poorly it was implemented: it wasn’t a small surtax, but a big charge that was as much as the provincial registration fee to begin with, making it twice as expensive to register a car in Toronto. Plus, it was easy to avoid if you had a friend or relative that didn’t live in Toronto, so it wasn’t good on the fairness front, either. It’s a bad tax, and I won’t be sad to see that one go.

I think the land transfer tax was a good one though: it was introduced at a time when real estate prices in Toronto were climbing double-digits per year, so the 1-2% tax was easy to sneak in, and it was basically just lost in the noise of the market moves. Since it’s not an ongoing tax, it’s also been priced in now, so there’s no reason to get rid of it.

At curling last night, one guy shared the “factoid” that this October has 5 weekends and (5 fridays)… and that it won’t happen again for over 800 years! I naturally called bullshit: October has 5 weekends any time Halloween falls on a Sunday, which should happen approximately 1 in 7 years. Even in the full force of my overwhelming logic, he said no, he read it on the internet that “because of the leap years and stuff”, it won’t happen again for 800 years. Well, a quick scroll through my BB calendar shows that 11 years is all it will take (2021) for that to happen again. Besides, the extra days from leap years don’t get added to October. When I got home I tried to Google it, and sure enough the bullshit is prevalent enough that as soon as I typed “October 5 we…” it automagically filled in “5 weekends 823 years”. 81k results. I weep for humanity.

On the theme of running down of mysterious and wrong-sounding numbers spewed on the Internet, Barry Ritholtz looks into the “average holding period is 11 seconds with HFT” meme, and finds the evidence to be lacking.

Hope everyone has a fun and safe Halloween!

I looked at BP through the disaster in the gulf, and figured that they would not go bankrupt, and that it would look interesting to me at about $30. It crashed through that, bottoming out near $27, then started moving back up as news that the siphoning/recovery was at least partially working, and that the relief well was progressing well. One expert said that the team drilling the relief well had a 100% success rate (40 for 40). That lead me to buy in at $30.20 on the way back up.

I figured that the stock was cheap, overly beaten up on fears of just how high the costs for the cleanup could climb.

Now that the well is finally capped, and we can be sure that we’re not facing an Ixtoc-like scenario where oil gushes for months on end, the stock has recovered significantly, and I’m looking to sell.

BP is a remarkably profitable oil major, and many of the fines, settlements, and court awards won’t have to be paid for years and years. It’s possibly still cheap next to its peers. However, I don’t like BP as a long-term hold. Their safety record is horrendous, which may have played a role in the spill in the first place. They just sold off a lot of assets, and I doubt that they got terribly great value from the sales, given their negotiating position. I’ve made my money on the short-term inefficiency that was there due to fear, and now I’m out.

Hopefully, this crisis will serve to change the corporate culture at BP, and this may indeed be a good point to get in for the longer term as they come to put safety first… plus, if and when the dividend is restored, it will likely be an attractive yield. But for me, I’m taking my money and running.

To gloat a bit, I made 35% on the stock move itself, less 1% for commissions, 5% for the forex fee both ways (damn you Waterhouse, and your terrible USD exchange rates!!), and 2% for the move up in the Canadian dollar over the last few months, for a net gain of 27%.

As an aside, I called about buying another US security today and washing the trade. TD said they don’t do that for non-registered accounts since they have USD accounts as an option, so I’ve added one of those to my account, which should help a bit with exchange fees.

Larry McDonald pointed me to the Chou funds latest letter which describes buying into the US banks, in particular via the warrants that were issued to the US treasury in the bailout (and are now being publicly traded).

As it happens, I’ve been looking into the US banks (BAC in particular) on the theory that the worst is behind them now, and the pain is yet to come for Canada’s banks. I’m still a long way away from actually buying anything because it’s a very difficult sector to wrap one’s head around, especially in another country. However, this notion of the warrants was interesting so I decided to take a quick look.

The warrants (BAC.WS.A) allow you to buy a share of BAC for $13 and change in the distant future — 2019. They have an interesting feature in that the strike price is reduced by any dividends above the current 1 cent/qtr, so you don’t run the risk of the company paying out all the profits in dividends and the stock price going nowhere. Though warrants are very similar to call options, you don’t need to have an options-trading account to trade them. So far it sounds like an interesting option, especially if they’re cheap.

To see if it’s cheap, I need some way of modeling how much the warrant should be. That’s a tricky problem, one even the pros grapple with. Warrants provide leverage: for $7.50, I can buy the future upside to a stock that’s currently $13. So if I have $13, I can either buy nearly twice as many warrants, or one warrant and one safe security. However, with warrants you have to not only get the general direction right, but also the timing and the magnitude. I made a graph to very quickly look at what the return would be from either just buying and holding the stock, or buying the warrant, based on what the stock is at 9 years from now.

Here the formula I used was:
For going long: (future price – current price)/current price for a cumulative return in %.
For the warrant: If future price was less than the strike price of $13, -100% (warrant expires worthless), else (future price – strike price – warrant price)/warrant price.

Now this starts to give an idea of the situation: if BAC shoots the lights out, the warrants are the better way to go, thanks to the leverage. If they just muddle through, then just going long would be better. The cross-over point is at approximately $30.50, which would represent a compound gain of roughly 10%/year. I haven’t finished my research yet (which is going slowly thanks to that other research), but I’m not sure I’d be quite that bullish on it.

I am obviously not doing this according to industry standards, as nowhere do I have any greek letters, or volatility, or what-have-you. I haven’t taken into account the time value of money, though I’m not quite sure I need to with this method. This is just a quick back-of-the-excel-sheet type estimation to look at what would happen with these warrants, and under what conditions they may be lucrative. Right now, it looks like one needs to be pretty bullish (~10%/yr for ~9 years running!) on BAC for the warrants to do better than the stock; but if you’re very bullish, then the leverage may start looking good.

Another obvious point is that I’m not going to run out and buy some warrants since I clearly don’t fully understand them yet… but it’s all part of the learning process!

Edit: The maturity is in January 2019, so it’s really only 8 years plus a few months. I haven’t gone back to fix any of the figures.

It’s my 800th post! I was trying to think of ways of celebrating this arbitrary milestone, but they all involved the chocolate bar sale at RCSS this week, which means I don’t have very good news for my diet update this week. Well, actually, it’s not all bad. I’ve been much better about my regular meals, even having salad for lunch, much to the very vocal shock and surprise of my coworkers. It’s just that I’ve also been grinding away at analysis for 10-12 hours a day for the last two weeks or so, and that has involved a lot of snacking. Worse yet, I haven’t done much at all in the way of exercise through all this, and the weather’s not getting any better.

The housing bubble seemed to crack into the media’s attention this week, with numerous stories on the matter, thanks in part to some attention from reports from CCPA, Howe, the OECD, and TD.

One important distinction to make is that the US was not the only country to have a housing bubble collapse in the last few years: most of Europe did as well. So if some analyst lays out the reasons why we won’t have a “US-style collapse” here, well, that’s just playing with semantics. We could have a UK-style collapse. Or a Spanish one. Or our very own flavour. Yes, due to how our lending is set up we’re less likely to have “waves” of defaults, but that’s a fine point. The housing market in the US was not hunky-dory save for the defaults (and we didn’t really see them in our 1989 crash either). The fact is that housing is too expensive, and it will come down. There’s still plenty of debate about how quickly that will happen, and even how far it will come, and I will vigorously debate that the answers are “over the next 3-5 years” and “far enough that you don’t want to buy now” — but those are opinions vs facts. While we may not have defaults accelerating the downward cycle, we do have the experience of watching the rest of the world burn. Once it’s common knowledge that yes, our house is on fire too, I don’t think people will dick around before heading for the exits, which will help speed the process along.

In the US, Barry Ritholtz points out that the spin from the NAR did not help anything. Something to keep in mind when reading CREA/TREB releases!

David Fleming had a look at his new condo at West Side Lofts, and was not impressed. An important reminder that pre-construction is supposed to sell at a significant discount because of the risks inherent in buying something sight-unseen. Plus of course the delays, and the risk the market could move against you.

An engineering student did a cross-Canada trip in an electric car he built himself! Should (slightly) help put people’s minds at ease about range anxiety and charging infrastructure, at least a little bit.

Michael James comments on an article about using “robot traders” to move against the herd and stabilize markets. He asks the same question that popped into my mind when I first saw it on Larry McDonald’s blog — who’ll pay for all of that trading, especially if the positions lose money for years at a time?

John Hempton of Bronte Capital had an interesting post about doing due diligence on an internet travel booking company in China. It’s a long post, but a good read on some basic ways to check up on a company you may be interested in. He came to the conclusion that the company was worth shorting, which raised something of a shitstorm — UTA was the biggest decliner on the NYSE the day after the blog post. There are two followup posts as well.

I’ve long been a browser tab addict with Firefox, opening all kinds of links in new tabs to follow-up on later. I usually use the CTRL-click shortcut to have a link open in a new tab, rather than right-clicking, then going to “open in new tab”. However, Netbug just pointed out that clicking with the middle mouse button (on most mice, that’s clicking your scroll wheel) also does the trick. Efficiency!

And finally, it’s a new school year, which generally means very little to the full-time grad student. However, it did mean the replaying of our annual introduction to the department for the new students, including laying out the details on tuition support and stipends/scholarships. Which has resumed a discussion that is near and dear to my heart: Year X & funding. Funding for students is only guaranteed out to 5 years for PhD students (4 for those who already have a MSc). However, the average degree takes something more like 7 years — indeed, just finding information on the actual statistics for the time to complete a degree is proving to be nearly impossible. If you’ve got any good data on these issues (even just at the departmental level at whatever university you’re at) please share! There was also some brief talk on the fact that the funding slide was exactly the same as the one I saw when I first arrived here [redacted] years ago, which was old even then. In over a decade there have been no cost-of-living adjustments to the stipends grad students get, even though the university can’t be ignorant of inflation, as tuition has gone up 35% in that time.