Blessed by the Potato

A fairly exciting few weeks. My last lecture at UWO (at least until I get invited back), yet my first as a full-fledged PhD. It was not as polished as the version I gave last year, which is a shame since the students this year seemed a little more bright eyed and bushy tailed; that may have been helped by the fact that it was a decent day in an unbelievably mild winter, and not… ugh, I don’t even want to think of last winter.

Then I found out I won tickets to the Book Lover’s Ball, via a contest to write an attention-catching opening line to a novel. The ball is a fundraiser for the Toronto Public Library, so I entered hoping to win since it would be the perfect gift for Wayfare: a lover of both fancy parties and libraries!

The Ball was very much not what I had expected. I know of basically two definitions for ball: a fancy dance party, and a round thing you kick, bat at, or throw. The key part to the first definition being the dancing, and Wikipedia backs me up on that. There was no dancing. There were black ties and ballgowns and an excellent dinner, but no dancing. Which is just as well, because Wayfare is progressing from very pregnant to extremely pregnant, which would have made dancing awkward and painful. While I can see the poetic symmetry between Book and Ball, I think perhaps some more descriptive titles could have been chosen, such as: the Author’s Affair; Book Lover’s Banquet; the Knowledge Feast [which I particularly like since it could also apply to the library itself]; the Library Soiree; the Book Lover’s Benefit; or the Public Library Gala.

We met some famous authors, as well as a number we were assured were famous, though we had to take the organizers’ word for that (certainly more famous than me, anyway, which counts). We were asked to adopt a branch or implored to bid on the charity auctions several times, had some drinks, chatted, had dinner, and then the lights came on and we were asked to leave since people had to get up for work the next day. It was a fun night, and in support of a cause I can easily get behind.

We had a last chance to get dressed up in our finery and have a fancy night out to ourselves before having to worry about babysitters, which was fun. Please, take that as the take-home message before I get into the painful financial blogger OCD part below (in fact, feel free to skip the next two paragraphs, look for the bold text to start the link summary).

The tickets, won in a contest, were free. Given the face value (which granted is in large part a charitable donation), it was quite the contest win and a fantastic gift. Yet we spent hundreds of dollars on a tux and gown to go. Then hundreds more on a hotel room for the night. Then a surprisingly large amount on overnight parking downtown: I figured it would be expensive: $20 or maybe $30 for less than 24 hours near Front St.; I was shocked and angered to find it was $66 for 21 hours. Even though it was the least consequential cost of the evening, it really burned me up. Partly because I didn’t take a few minutes to research my parking options and to know in advance what to expect, and partly because I blindly followed the hotel’s instructions on where to park, and they should have warned me or had some kind of reasonably-priced option (a voucher or something if they don’t have their own lot). All told, the event ended up costing a majority of the vacation budget for the year, though I don’t think we had big vacation plans this year since we’ll have a newborn and I’ll have a new job which may not allow for a vacation this first summer anyway. The whole experience reminded me of the story of Diderot’s dressing gown (which is in recent memory thanks to reading The Wealthy Barber Returns — review to follow).

And speaking of Diderot’s dressing gown and creating new obligations, I now have a winning opening line to a novel, so there is some expectation that I follow that up with, if not a novel, at least a story of some kind. The thing is, I had no inkling of a story to go with that line: I was just reaching for something humourous and attention-catching that would fit within the strict character limit of the twitter contest. But if I’m unemployed anyway, no harm in trying to write a story, I guess (as long as I keep up the job applications)…

Links: The notion of housing risk goes mainstream.

A slew of articles recently on the risks associated with sky-high housing prices, like most everyone is waking up to the reality at once, including: the Globe’s connect-the-dots, Canadian Business’ prediction that the market will crash, and several others.

Macleans is surprisingly straightforward: “Yes, we’re in a bubble, and it will probably pop soon.” which was bolded in the text. I wasn’t happy to see “A whopping 75 per cent of mortgages in Canada are fully insured by Ottawa, according to the Financial Stability Board.” put forward as a reason not to worry.

The Financial Post reports that banks are dumping their exposure to even “prime” mortgages on the CMHC or securitization market. “Financial institutions are required to have mortgage-default insurance when a consumer has less than 20% equity. However, the banks have been seeking insurance on loans with even high downpayments — something not required by law — so they can securitize those bulk lending loans, thereby getting them off their balance sheets and reducing their capital requirements.” This is bringing the CMHC close to its limit for providing coverage, and it’s asking the banks to slow it down.

Just a few weeks ago, the news was dominated by the rush to the bottom in medium-term fixed-rate offerings by the banks. Now, those special offers are coming to an end.

A neat new hedge fund opportunity. Have a read, and no matter what you end up thinking of it, trust me and click on the “invest now” link to have a look at what comes next.

A very short post over at Divestor about selling Rogers Sugar after appreciating so much. I’ve had many such dilemmas this last year or so: with prices on things like Rogers Sugar, REITs, or other low/no-growth dividend payers hitting all time highs, am I being paid to take on equity risk? Sure, they’re towards the less risky, less volatile end of the equity spectrum, but I’m not sure if I’m comfortable locking in at 6%, especially when many preferreds are in the 5% range.

An article about behavioural economics.

Stats Canada is apparently going to refine the CPI calculation, which if it lead to a lowered CPI figure could lead to savings for the government (as many payments are inflation-adjusted). The article indicates that CPI is currently overstated, and I find that a bit odd, as I’ve long thought that CPI was understating inflation. Given the current government’s philosophy on stats, I wouldn’t be surprised if the revision was more about cost savings than data accuracy.

Canadian Capitalist talks about a “barbell” investment strategy. This is perhaps a good example of where combining two extremes doesn’t really give the same result as having a bunch of average stuff, or where increasing risk does not mean increasing returns.

Michael James says his MERQ measure is too extreme to be believable. But it’s really showing the impact of high fees. I still think it should be in dollars (and whenever I get off my butt will do short post on exactly that), but either way the important part of the message is that fees build up and cost an investor dearly.

Warren Buffett chimes in on investing in gold, bonds, or stocks, businesses, and other things. The summary widely picked up is that he isn’t keen on gold, but there’s also this gem: “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.” John Hempton adds some colour to that notion of investing in stocks rather than gold or bonds.

And after a few posts in a row cheerleading hybrids, news comes out that the Prius is going to get cheaper and better equipped for 2012. I’m kind of torn on that news: on the one hand it’s good for future hybrid owners, as it makes the financial decision even easier (though the Matrix also got stability control standard, so you don’t need to move up as many feature packages on the comparison car), which will be good for helping to get more on the road. On the other hand, reducing the MSRP of future vehicles means mine will now depreciate faster (not that I entertain plans to sell any time soon — I kept the last car until it was ~14 years old).

The teaser page for the Prius C (for compact) is also up, indicating it will get a fuel consumption rating of 3.7 L/100 km and a price tag under $21,000. Just a bit bigger than a $17k Yaris, that could be a tough choice for those that need a cheap, efficient commuter vehicle.

Hybrids (like my Prius) contain many awesome innovations that give it that great efficiency, leading to lower fuel use (and lower expenses!). With plug-in hybrids starting to hit the market, the ways that technology provides efficiencies increase. Yet even though hybrids have been around for well over a decade, they are still very poorly understood (particularly by auto journalists).

Quick, which one innovation contributes the largest portion of the fuel savings in a hybrid like the Prius, is it:

a) regenerative braking
b) exhaust gas recirculation
c) atkinson-like cycle engine
d) electric motors and a battery to power acceleration
e) aerodynamics, including a tear-drop shape and a plastic cover for the underside to smooth airflow
f) lightweight aluminum construction
g) low rolling resistance tires
h) continuously variable transmission
i) an engine that turns off when not in use (coasting, at stops)

All of those innovations (and I’m sure a few I’ve forgotten) add to the efficiencies. Odds are good that you answered a, or d, or i, since those are the items that are the most distinctive about a hybrid, and which get the most press. And of course, none of those three are of much good when smoothly cruising on the highway, which is why auto writers keep saying stupid, easily disprovable things like “all that hybrid gear is useless on the highway.”

Yet a quick check of fuel consumption ratings shows that indeed, hybrids get fantastic highway mileage. The gap between them and a regular car isn’t as wide in the highway cycle as in city driving, but it’s still a really good improvement. So why is that?

It’s because the actual answer is (c): the atkinson-like cycle engine. Estimates vary, but something like half of the total improvement in overall mileage (and nearly all of the highway-rating boost) is because the engine is simply more efficient at turning hydrocarbons into motion (the “thermal efficiency”). All that business with the electric motors helps, and there certainly is some benefit from pairing the properties of an electric motor (which generates maximum torque at low RPM, and is great for helping to meet peak demand) with a gas engine (which needs to rev up to produce acceleration, and which has a high-density fuel source for steady-state power demands), but it’s there largely because with an Atkinson engine, you’re not going to get anything approaching an acceptable 0-60 time. That efficient engine needs help getting going.

If you wanted (e.g.: if you’re an automotive engineering student looking for a summer project), you could strip out all the electronic stuff from a hybrid and just drive around with the Atkinson engine, and you’d get a big part of the benefit. Of course, you couldn’t actually use that in traffic since it would take you forever to accelerate, but on a closed course to prove a point…

Anyway, once you’ve got the electric motor in there for the acceleration boost, you can do all the extra tricks with it to squeeze out even more efficiency, like shutting off the engine when coasting, regenerative braking, etc.

So now that you know about the importance of the Atkinson-cycle engine, you see why hybrids still rock on the highway. In fact, improved thermal efficiency is also the reason why diesels get decent fuel consumption numbers on the highway: the higher compression of a turbo diesel is also more efficient at turning hydrocarbons into motion. In terms of litres burned per hundred kilometers, diesel (like a Jetta or Golf TDI) is on par with a hybrid like the Prius; though once you factor in the higher energy density of diesel, well, you can see who the winner is (and I won’t get into the issue of city driving, too).

And of course, knowing that this is the single biggest source of efficiency is why I was so upset that GM didn’t include an Atkinson-like engine in the Volt, instead just slapping in an off-the-shelf engine, which is why its efficiency isn’t so great once the charge from the plug-in is used up.

Another idiodic piece about hybrids in the press. It never fails that they say such inflammatorily stupid things that I get all angry at them. It shouldn’t be all that surprising: you don’t become an automotive journalist because you’re smart or know science or can do basic math, you do it because you like G-forces and want to make engine noises all day. You crave the open road and have an expense account for gas. The typical automotive journalist is about as far from a hybrid buyer as one could possibly get.

But for people who are stuck in stop-and-go and pay for their own gas, a fuel-efficient hybrid is a great choice.

Asking “why carry around the battery on the highway” is like asking “why carry around gears 1-5+R if I’m only going to use 6th on the highway?” except even dumber. If you bother to look up the ratings, you’ll see that not only is the Prius efficient in the city, it is also head-and-shoulders above any gasser on the highway — even diesels. Holy crap, it even beats out the tiny Smart Fortwo by almost 20%. There might just be something to this hybrid thing. I could go into the why of it*, but the point is it’s an extremely easy fact to check, yet I’ve seen these assclowns get it wrong so. many. times.

And if you’re a travelling salesman? Then a hybrid should be the only thing on your shopping list. With a lot of miles to put on, you’ll find the payback to be phenomenal. Ditto taxi drivers, who have found it’s cheaper to get a brand new Prius than a surplus former police cruiser Crown Vic.

“So hybrids, apart from their benefit for city drivers, have failed to sweep the world. Will anything change this pattern?”

Perhaps if instead of panning them at nearly every opportunity, if auto journalists actually came out and started writing some articles more along the lines of “well, the ride’s ok, I guess, and by paying a few thousand more up-front, you’ll save thousands in fuel expenses over the life of the car. If you do a lot of city commuting, or a tonne of driving in general like a travelling salesman, you should take a look.” Then maybe people might buy.

And on the heels of that ill-informed article, this diesel-scented turd.

“Diesel fuel should be taxed at a lower rate than gasoline for one simple reason: the fuel carries more energy than a comparable amount of gasoline, thus it is more efficient.”

Actually, that’s a good argument for diesel to be taxed more on a per-litre basis, since it’s using more barrels of oil per litre to make. But, the fact is, diesel is taxed less than gasoline: the federal excise tax is 10 cents/L on gasoline, and 4 cents/L on diesel. In Ontario, the provincial excise tax on gasoline is 14.7 vs 14.3 cents/L on diesel fuel.

“The fuel-efficient turbodiesel delivers the highway fuel economy of a Toyota Camry sedan.”

…without accounting for the higher energy density of diesel, and allowing for a very large fudge factor (using the V6 Camry vs the more popular V4, and even then, he’s off by over 6%; off by over 21% when comparing to the 4-cylinder).

Now, I’m not totally against diesel: it is more efficient than gas in many driving conditions (though not more efficient than a hybrid, and with about the same cost premium). A select few models will end up being cheaper over their lifetime than a conventional gas car. But it is a dirtier fuel, and one of the benefits of hybrids is reduced emissions as well as efficiency: diesel presents a trade-off (better efficiency but higher emissions). I simply don’t get the auto-journalists’ thinking of “diesel good, saves money and fun; hybrid bad, costs more up front” when it could have just as easily been the opposite. I suppose it’s their pre-existing bias towards diesel (more torque, grunt grunt grunt). It seems so arbitrary since those positions could easily be reversed (“The diesel Touareg is $5000 more than the gas version, a premium that would take over twenty years to break-even on.” “There is hardly any difference in fuel economy in city cycle driving, and with diesel fuel a bit more expensive than regular unleaded, there’s no point if you do anything but cruise the open road.” “The new emissions systems for them are completely untested, and with so few VW diesels on the road, good luck finding a mechanic if you run into a problem down the road.” “The AdBlu emissions control additive will need to be replaced frequently, and VW is very secretive about the pricing. Unverified rumours we are too lazy to fact check indicate that this could cost you an additional $5000 down the road.” “Diesel: fine for early adopters, but not ready for primetime.”)

* – Because the engine is more efficient. Atkinson cycle, yadda yadda yadda. And that is because the battery and motors are there for peak demand. Even on the highway they are used (e.g., to pass, or go uphill). It’s a far cry from dead weight — and even if it is, well, the numbers speak for themselves.

There has been a real barrage of articles about the housing bubble in the MSM lately. Perhaps because January is both a slow news period and a slow real estate period, so it’s a good time to get it all out, or perhaps because the topping process has begun, and the awareness of the problem has started to spread from gloomy spreadsheet addicts like myself to society at large. Based on some very non-scientific mining of Google’s news search, mentions of a housing bubble started to increase about a year before the top in the US, and really were flying wild when the prices finally turned the corner. Here, stories about a Canadian housing bubble roughly doubled last year, to about 500 hits in 2011. There have been over 200 hits already in 2012 — just one month!

Alongside the stories that warn of the danger are ones that try to explain it all away, including two recent ones by Larry MacDonald (who I respect) and Mark Weisleder (who, well, let’s just say he makes these kinds of mistakes a lot). Together, they make a few basic points:

• House prices have been stable.
• Immigration.
• Interest rates are low, and even if/when they do rise, they will be accompanied by job growth.
• Recourse mortgages.
• Low foreclosures.
• High valuation metrics… but, like, so what?
• Bears only call for a bust due to recency bias, because we just saw a housing bust in the US.

So, to the point-by-point rebuttal machine!

Though some are shared, Mark’s arguments are obviously much weaker than Larry’s. Only he would make the point that housing has been stable and the GTA is nice, so it’s an attractive buy. Of course the converse implies that if housing does start to turn, it will turn badly because that point in favour of buying goes away, and instead becomes a point in favour of selling.

Similarly for his immigration argument: we do get a steady influx of immigrants to Canada (and the GTA in particular). Beyond just immigrants, babies will still be born, teenagers will still turn into twenty-somethings, and people will still move out of their parents’ basements. That was as true in 1992 as it is today. For that matter, it was as true in 1989 as it was in 1992. These things are all true, have been true for a long time, and mean absolutely nothing when it comes time to deciding whether now is a good time to buy a house in Toronto. It means your house won’t be completely worthless, but doesn’t mean a painful 10-35% correction isn’t in the works — as witnessed first-hand by buyers in Toronto, 1989.

The point about low interest rates is also not particularly strong. Even with the recent deals on fixed 5 and 10-year rates, you will be exposed to future rates for a long time when buying a house. After all, the typical mortgage is 25 or 30 years long. It is much better to buy at higher rates and a lower price than to scramble to buy at high prices and low rates. Think of the possible outcomes: if rates move lower, you get a gift and can pay off your mortgage faster. If rates move higher, you face a hardship. If rates are as low as they’ve ever been, the odds are this is as good as it will get, with likely hardship to follow.

Now Larry makes a point about higher rates being accompanied by higher employment, which should offset the price declines that higher financing costs would bring. But to that I simply say: invert it. Prices were up 10% in Toronto last year, and apparently the economy is still just limping along, warranting low rates. So how big of a driver is employment vs interest rates for house prices? To me, that indicates that while there may be a bit of tempering if employment and wages gain along with increases in rates, those are not going to have a large enough effect to counter the decrease in prices that will come from the higher rates. Rates trump jobs when it comes to our housing market.

Recourse mortgages is a common reason thrown around to explain why Canada may be different than the US. It’s an interesting one, too. Sure, if the bank can come after you for your other assets you’re going to be less likely to strategically default and walk away from the house. That’s going to slow the positive feedback cycle, but there’s very good evidence that it’s not realistically that big of a factor. To point out the real-world evidence, again, just look at Toronto, 1989: mortgages were recourse then, too. Didn’t stop the bust. Many US states also had recourse mortgages (including Nevada, one of the few states to escape the housing meltdown — oh, no, my mistake, it’s one of the hardest-hit).

Let’s consider that point in a little more detail. Why doesn’t the recourse action save the housing market? At the core level, the simple answer is because it doesn’t fix anything in the fundamentals: the only way for price-to-rent and price-to-income to come back into line is for price to fall or rents and incomes to rise. So having recourse mortgages may stem the tide and positive feedback cycle of strategic defaults and foreclosures, but doesn’t bring any new buyers to the market. But even then, how much of the tide does it stem?

To answer that question, we have to get an idea of how many strategic defaults there might be vs. bankruptcies. If you can’t pay the mortgage, if you’re severely underwater, and if you have very few other assets, there is really no difference between a strategic default and a bankruptcy — and we still have bankruptcy here. You give the house back to the bank and you start over with nothing. Many people — far too many — have bought in recent years with nothing down and are house poor: aside from their house (with just a thin slice of equity in that), they have very few savings and investments. So to them, there’s no difference between a strategic default and full bankruptcy. If someone has a lot of other assets, then they may have considered a strategic default, but how many of those people are there who also have so little home equity that they’d be willing to trash their credit and walk away, if only it weren’t for that damned recourse mortgage? I’d bet not terribly many. Not enough to matter anyway.

So recourse mortgages aren’t going to stop a housing bust, and are certainly no reason to go out and buy now (if anything, it should give you pause as a buyer).

Hmm, low foreclosure rate. Let’s see, prices in Toronto were up about 10% year-over-year last year. Why are there any foreclosures? Even a 5%-down buyer could sell the place, repay their mortgage, and cover all the sundry transaction fees, taxes, and penalties if they ran into financial trouble in this market. They just had to stay solvent for a year. No, foreclosures are a lagging indicator: only when the housing market is already flat or going down and people are getting into financial trouble does the rate go up, because all other options have been taken away.

Both Mark and Larry touch on valuation metrics. Part of Larry’s point is valid: they don’t tell us about when the correction will come. I’ve been bearish for years precisely because the metrics have been out of line for years. But that said, severe over-valuations like this rarely correct neatly, with a long period of modest negative real returns — “crashes” or “corrections” are the norm. Mark’s point… does Mark have a point? If you don’t like averages, fine, use medians. But don’t compare the nominal number with one method to the nominal number from another: what was the median Toronto income to the median Toronto house price historically, and what is it now? You can’t try to hand-wave the fundamental imbalance away like that Mark, I’m too perspicacious for that.

Finally, to Larry’s point about recency bias: I disagree. I think the recency bias is not clouding the vision of the bears, but rather the bulls like Mark. The last crash in Toronto real estate was 1989, when many current first-time buyers were kids, or gametes. All they’ve known for recent history has been rapidly increasing prices with no risk.

Asides: Mark has a few other points that aren’t even remotely relevant, but I figured I’d rake him over the coals a little more.

His final bullet point about debt ratios shows how clueless he is about what these population measures are showing: for a given person, a debt-to-income ratio of 150% is nothing. Hey, a 25-year-old making $50,000/year who just bought a $400,000 house with nothing down except the closing costs would have an 800% ratio, and people still wouldn’t look at him funny. That person should be able to handle the payments and has lots of time. But what about a retired 70-year-old who has a pension of $40,000 and is $60,000 in debt? That’s only 150%, yet is clearly a much worse situation than the young guy at 800%. So the important thing with these population measures to see how they change over time. The Bank of Canada isn’t worried about one particular Joe having 150% debt-to-income, it’s worried that for a long time that ratio stood at 100% and over the last few years has climbed to 150%. I wonder how Mark would interpret a stat like the average family has 2.3 kids? He must be one of the ones envisioning whole neighbourhoods hiding kids with only a third of a body in the basement.

The closing message about the US not allowing the economy to fall apart in an election year is face-palm worthy. 2008 was an election year, Mark. The reality is that the US government, for all its nuclear missiles and predator drones, is helpless to stop a housing collapse. Ours will be even more impotent since we’ve already burned up the government mortgage guarantee, low rates, RRSP raiding, and extended amortization options.

“I have yet to meet a father who didn’t see little feet emerging and immediately feel the need to run out and throw himself at an insurance salesman.” — Garth Turner

Wayfare and I just had a very short discussion about our life insurance needs. I off-handedly remarked some time ago that one of the factors that maybe should go into the typical rent-vs-buy analysis is the reduced need for life insurance as a renter, but since I didn’t know what the cost was, it was hard to model (and I assumed, trivial).

Anyway, with a new spud under cultivation, I thought it was worth discussing seriously, and we very quickly agreed that we didn’t: she makes more than I do (though as of next week, “0” is an easy bar to hurdle), but both of us are capable of supporting a single-parent family on our own. If we both die, both our sets parents are well-off enough to take in a grandchild and not become destitute themselves (at least with our savings to help out).

As renters, we don’t have a mortgage to discharge or huge transaction costs for moving, so it would be reasonably easy (at least financially) for the survivor to move to a smaller, cheaper place. And the aforementioned savings would help with any burial expenses, additional childcare costs, or bereavement leave.

A few online calculators confirmed that our life insurance needs were basically zero (varying between a $150k policy and negative $80k depending on the calculator and assumptions used). I went ahead and got a few quotes for a $100k term-10 policy, and it’s not terribly expensive, but not trivial either: about $150/year for someone my age. This might all change once I see little feet with their widdle toes, but for now, hey, we don’t seem to need it.