Mortgage Watch

The youthful central banker has made three public pronouncements in the past two weeks that have surprised listeners for their foreboding tone on economic developments, particularly since Carney is widely regarded as being in the glass-half-full crowd.

But just as many economists are pointing to signs of recovery - with the World Bank a notable exception - Carney has been warning about putting too much stock in so-called "green shoots" - the now-common catch phrase used to indicate the first signs of life in a moribund economy.

In recent speeches in Montreal and Regina, the bank governor was almost dismissive of indicators of economic improvement, warning that whatever good news existed was caused artificially by massive government and central bank stimulus. The private sector "is not there yet," he cautioned.

And in a report from an off-the-record speech Tuesday at the Woodrow Wilson International Centre for Scholars in Washington, Carney broke with official Ottawa dogma in declaring Canada's recession to be as deep as that in the U.S.

Bank officials refused to confirm or deny the remark, instead pointing to Carney's last official forecast in April, which indeed has Canada's gross domestic product shrinking by three per cent this year, as opposed to 2.4 per cent for the U.S.

"Nobody expects policymakers to be cheerleaders, but do they have to be naysayers?" asked Douglas Porter, deputy chief economist with the Bank of Montreal, who is among several who wonder at Carney's transformation from Mr. Sunshine to Dr. Gloom in four months.

"The Bank of Canada is one of the few forecasters in the world that sees Canada underperforming the U.S. this year," Porter notes.

But there's more. Carney is also in an exclusive club of economic forecasters that sees Canada rebounding from the bottom at twice the rate of the U.S. next year, a prognosis he was reported have repeated last week in Washington. Most see the two economies returning to slow growth of between 1.5 and two per cent next year.

As economists will readily admit, predicting how thousands of businesses and millions of consumers will behave next month or next year is part science and part black magic, particularly in volatile times such as these when stock markets appear to fluctuate wildly on the thinnest of premises.

And Carney has bristled in the past of criticism that he is too optimistic.

"We don't do optimism; we don't do pessimism," Carney responded in February over criticism of his rosy and now discarded 3.8 per cent growth call for the Canadian economy in 2010. "We do realism at the Bank of Canada."

One explanation, says economic consultant Dale Orr, who was among Canada's leading forecasters when he worked for Global Insight, is that Carney is overcompensating for his most widely criticized forecast in January.

Even former bank governor David Dodge dismissed as "unrealistic" notions that Canada would soon return to normal as if no fundamental damage had occurred.

Another, however, is that Carney is seeing dark clouds forming on the horizon and is setting the stage for yet another downward revision of his outlook.

"I think he's walking down the middle, not prepared to revise his forecast just yet but the tone is definitely shifted toward all the downside risk," said Derek Holt, vicepresident of economics with Scotia Capital.

"They (bank officials) are less convinced that the domestic fundamentals are looking as rosy as they were just a few months ago."

Carney has a long way south to go before he becomes as pessimistic in the numbers as he appears to be in his tone. The Bank of Canada's 2.5 per cent growth projection for next year is at least half a point above consensus, and some, like the Organization for Economic Co-operation and Development, see Canada growing a paltry 0.7 per cent in 2010.

Orr notes that the governor has expressed concern about the impact of the stronger Canadian dollar, and he may be attempting to "take the steam" out of the currency lest in keep a lit on recovery by hamstringing manufactured exports.

There are other problems coming into view, says Holt.

"We lag most other countries in terms of the speed by which we've addressed the problems," he said. "Japan started to burn off its excess inventory in quarter four (2008) and quarter one (2009), whereas Canada still had in quarter one the highest inventory to sales ratio as we've had since the early '90s recession and it's trending upwards."

Another sign of trouble is in bond yields, which have pushed long-term mortgage rates up just when the economy desperately needs Americans and Canadians to start buying homes again.

And there's the long-recognized hangover from the pre-recession spending binge which depleted household reserves, points out TD Bank economist Diana Petramala. Households have lost $510 billion in the last three quarters through a combination of lower home values and stock market deterioration.

"The damage to the household balance sheet... will take time to repair, and during the period, consumers will continue to scale spending growth increase savings," she predicted.

Holt, who remains bearish about the next few years, agrees with Carney about the lacklustre response of the private sector economy to government stimulus. He says although central banks have done all they can to cut interest rates, consumers and businesses are just not borrowing.

Porter concedes that most of the recent good news points to an ailing economy that has entered a period of convalescence. There could be a relapse, he admits, but it is also possible for the patient to make a better recovery than many suspect.

"I'm concerned because part of the puzzle that we need is to see some repair in confidence, and to have one of our policy-makers stepping on the green shoots is not helpful," he said.

Given the fragile nature of the economy, a little encouragement couldn't hurt and might even help, he says.

To some real estate agents, the market looks as good as it did before the global financial crisis began to bite last summer.

“Without getting nitpicky, yes it does,” said Toronto real estate agent. “I just lost out on a multiple offer last night on a house, and my client asked me to have a look at what's going on with that sort of a house. In that price range and style of home, 14 out of 19 sales in the past 30 days have been at or above the asking price.”

The average national resale home price in May reached a record $319,757, up a tick from the previous record set in May, 2008, the Canadian Real Estate Association (CREA) reported this week. The group noted that the sales activity behind this increase was skewed by expensive markets such as Vancouver, Calgary and Edmonton, but it nevertheless declared that the “national resale housing market activity returned to prerecession levels in May 2009.”

Crisis averted in the housing market? Forget it. Prices may be climbing in some markets, but so are the interest rates that have fed the recent rise in sales. Meanwhile, incomes are stagnant, and jobs are disappearing in bunches.

If you're thinking of getting into the housing market right now, mind the cracks in its foundation.

The house that Mr. Jeffrey's client failed to get was a semi-detached, two-storey, all-brick home in the leafy mid-town neighbourhood of Leaside. With three bedrooms, one bathroom, a detached garage and a mutual drive, it was listed at $529,900 – and went for $551,000. According to Mr. Jeffrey, houses in that price range have sold for an average of 105 per cent of their asking price in the past 30 days.

And Toronto, where the number of homes sold rose 1.9 per cent last month, wasn't even one of the hottest markets in terms of sales activity. CREA figures show that sales in Victoria, Vancouver, Calgary and Edmonton were up between 11.3 and 18.7 per cent.

It would be reasonable to expect that housing sales would be in a slump during a recession. But strangely, the economic downturn has actually helped to propel the real estate market higher.

For one thing, many people were too unnerved by the global financial crisis to buy late last year. So pent-up demand for housing in the first several months of 2009 played a role in the spring numbers.

“The kind of month-over-month increases we've seen in the last four months can't go on forever,” said CREA chief economist Gregory Klump.

The Bank of Canada has also helped to juice the market, though inadvertently. By ratcheting interest rates lower to stimulate economic growth, the central bank has cleared the way for mortgage rates that remain at historically cheap levels even after recent increases.

Fixed-rate mortgages with a five-year term can be had for about 4.25 per cent with a top discount right now, compared with 5.5-to-6 per cent in spring, 2008. A couple of months ago, five-year mortgages were less than 4 per cent.

But low rates are also one of the reasons analysts are worried about the surprising surge in the housing market. “It's all happening because of the crack cocaine of housing, which is rock-bottom interest rates,” said Garth Turner, author of Greater Fool: The Troubled Future of Real Estate . “They're so irresistible, especially to inexperienced first-time buyers. That's what's propelling the market.”

Mr. Turner's concern is that rising rates will eventually propel the market lower by making houses less affordable. His level of confidence that the boom will last? Zero.

In his book, published in early 2008, Mr. Turner warned that the Canadian housing market was in a bubble just like its U.S. counterpart. After a peak-to-valley decline of almost 14 per cent in Canada's national average price, he's predicting another plunge for home prices that will be triggered in large part by rising interest rates.

“We're now into the housing bubble, Part Two,” said Mr. Turner, a former member of Parliament who now gives financial seminars and promotes his books. “I think this bubble is going to burst later this year. It's going to be short and intense.”

In the near term, though, he sees rising rates being used to get buyers to jump into the market immediately. “People are being told, ‘Your affordability is going down if you don't buy now, you're going to be forever shut out of the market.' It's the eternal siren song of real estate.”

Many economists doubt that the prime rate – the rate banks use as a base to calculate other lending rates – will increase before next spring, but it's a different story with the longer-term rates that influence fixed-rate mortgages. They've already bounced off the lows they hit in the depths of the global financial crisis, and more increases are expected.

Rising rates make houses less affordable, but this can be offset if housing prices are falling and incomes are rising. In many cities, though not all, prices are actually rising. As for income gains, they're constrained by the recession.

Robert Hogue, senior economist at Royal Bank of Canada, said wages are still creeping higher, but many families have been affected by job losses. “Over all, household income has at best increased very slowly, if not kind of stalled for a bit,” he said.

For Mr. Hogue, rising rates and house prices are a threat to a housing market that appears to be stabilizing. But his outlook isn't all negative. When the job market improves, he believes that household income will rise and help make houses more affordable.

“The moment we have the labour market picking up, to me that would be the sign that says we're in the clear now.”

Soaring bond yields have set the stage for a second round of interest rate hikes on residential mortgages in about a week.

After nudging rates higher on longer-term mortgages last Wednesday, Toronto-Dominion Bank yesterday raised borrowing costs on its five-year, fixed-rate loan by 40 basis points to 5.85 per cent, effective today.

Last week, TD and the other banks increased rates on five-year, fixed-rate mortgages by 20 basis points to 5.45 per cent.

While no major competitor had followed TD's move by late yesterday, experts suggested higher rates are likely inevitable because banks are facing higher borrowing costs on the bond market. Banks tap the bond market to finance mortgages because they lend out more money than they attract through deposits.

"We don't have a fully matched book and I would guess that none of the Canadian banks have a fully matched book in terms of deposits matching loans," said Joan Dal Bianco, vice-president of real estate secured lending at TD Canada Trust.

While mortgage rates rose slightly last week, that move was insufficient to offset the bank's higher costs because bond yields have climbed higher since then.

"And unfortunately, we're now having to cover that gap, or at least close it a little bit," Dal Bianco said.

When asked if consumers should expect more mortgage rate increases, she replied: "I think we're going to see, over the next year, lots of changes as the economy starts showing positive signs."

The sharp spike in bond yields is a global phenomenon and the rise in Canadian yields has been milder compared with other countries, said Doug Porter, deputy chief economist at BMO Capital Markets.

The main reason that yields are rising is because the bond market is beginning to price in the prospect of an economic recovery later this year or next year, he said.

"I guess that's the good news part of the story. The bad news is that there is actually a cost for the economy in terms of raising the cost of money for some borrowers."

To a lesser degree, longer-term yields are also rising because the bond market is worried about the future prospects for inflation as governments around the world issue massive amounts of debt to stimulate economic growth.

Porter, however, also noted that home sales have "perked up" a bit in the past couple of months, fuelling more consumer demand for mortgages. "That's probably played a small role in this rise in mortgage rates as well," he said.

While TD is experiencing increased demand for mortgages, Dal Bianco insisted that played no role in the rate change. "It is strictly the bond market," she said.

Mark Chandler, a senior fixed income analyst at RBC Capital Markets, said long-term mortgage rates are still at near-historic lows.

"The hope that you can do better than that – or even maintain that for an extended period of time – that may be hoping for a little too much, really."

Every downturn has its upsides -- and in the case of condominium buyers, current economic conditions mean lower prices and mortgage rates, making now an ideal time to buy.

According to the 2009 TD Canada Trust Condo Poll, this is only one of the reasons why homebuyers are looking towards the multi-family lifestyle.

"For Canadians looking to purchase their first residence or make a long-term investment, condos offer a lower maintenance and lower-cost alternative to houses," says Joan Dal Bianco, vice-president of real estate secured lending for TD Canada Trust.

"This is a good time to explore a condo purchase, given that mortgage rates are very attractive right now and many condos have dropped significantly in price."

And thanks to increased affordability, survey responses show the perceptions of the condo market have improved significantly over 2008, with 44% of urban Canadians believing the current conditions have improved for buying a condo as an investment -- versus 21% in 2008.

In Calgary, affordability is key -- 23% locally versus 21% nationally say price is an important factor in whether to make a purchase.

And 52% say market conditions are better than they were one year ago for buying a condo.

However, condo purchasers won't throw money at any old multi-family development.

In fact, for a two-bedroom condo, 64% of Calgarians say they'd be willing to pay between $200,000 and $400,000, while 57% say they would pay between $200 and $400 per month in condo fees.

Dal Bianco says that's because prospective condo buyers want to keep their costs low.

"I imagine there are many people who believed just a year ago that they would not be able to get in to the housing market," she says.

"Now, current market conditions are allowing them to reconsider their options."

Lower costs and improved affordability aren't the only things potential buyers consider, though.

What makes a condo an attractive investment, respondents say, are low condo fees (97%), good security (96%), energy efficiency (93%) and an attractive design (95%).

Also important to survey respondents is buying new -- 58% say they would prefer to purchase in a new building as opposed to an older one.

Of course, with new buildings come new amenities. But it turns out it's old favourites that have the widest appeal.

Parking is a driving force in deciding whether or not to purchase a particular condominium.

Calgarians were most likely to pass over a particular condominium due to lack of parking at 87% versus 75% nationally.

Altogether, Dal Bianco says condo buildings that offer everything buyers are looking for should have no problem selling in today's market.

"Low interest rates, affordability, the range of condo options and amenities make a condo an attractive purchase for many Canadians.," he says.