Category: Accounting tips

  By Guest Blogger Doug Rowat

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Some things don’t age well.

Take, for instance, the famous 2014 Oscars selfie. Posted by Ellen DeGeneres to Twitter it immediately became (for a time) the most retweeted post in history and it even made Time’s list of the 100 most influential photographs of all time.

But look more closely. Brad Pitt and Angelina Jolie are now engaged in a bitter divorce, DeGeneres has seen her reputation (and ratings) trampled after allegations of a toxic work environment and Kevin Spacey, well…. Even Meryl Streep has had to since awkwardly defend herself for once referring to Harvey Weinstein as “God”.

In short, a selfie that could have been forever viewed as simply fun celebrity indulgence has now become cringe-worthy.

But, in contrast, some things age very well.

Take, for instance, the TFSA (how’s that for a transition?). In the beginning, it faced indifference and scorn, but it’s now grown into a powerful investment vehicle. When it was launched in 2009, the $5,000 contribution limit caused it to be dismissed as inconsequential. Then it became a source of political gamesmanship as Justin Trudeau heavily criticized it during his 2015 election campaign. And right from the start, its usefulness has been entirely misunderstood by most Canadians.

But, of course, investors who saw its potential early and used it correctly have benefitted greatly. Trudeau, of course, followed through on none of his threats and the TFSA contribution limits have steadily grown during his time in office. The cumulative contribution limit currently stands at a meaningful $75,500.

And here’s how an investor who maximized the contribution limit every year would have made out if they’d placed their TFSA funds in a simple, plain-vanilla equity ETF with an annualized growth rate of 9% (this rate of return is conservative–many equity ETFs have experienced much higher annual returns since 2009). For simplicity, I also applied the 9% growth rate for this year as well. Here’s where that hypothetical investor’s TFSA would be today:

Hypothetical TFSA growth

Source: Turner Investments

While just about anything can be plunked into a TFSA (GICs, bonds, stocks, etc.), the best strategy is to overweight well-diversified growth assets, such as equity ETFs. Capital gains in a TFSA are, as its name implies, tax free, therefore it’s to your advantage to tilt a TFSA towards growth. In the simple example above, almost $67,000 in capital gains would be entirely tax free.

Unlike an RRSP, you can also draw from a TFSA without consequence, though we recommend investors refrain from doing this—let it grow.

Amazingly, Canadians have still not clued in to the true value and utility of a TFSA. A recent BMO survey, for instance, indicated that 38% of Canadians cite cash as their primary TFSA investment. (If this is you, read the above paragraph again.) Another recent survey, this time from TD, also indicated that 27% of Canadians still don’t understand the difference between a TFSA and an RRSP. And a client sent me this recently, which was displayed prominently at their local bank:

A vacation? Stop thinking short-term with your TFSA

Source: Turner Investments

Is it any wonder that Canadians misunderstand TFSAs when the banks themselves are advertising them this way? Yes, technically, a TFSA can be used to save for a short-term expense, such as a vacation, but this is hardly its best use. TFSAs should be viewed as a tax-advantaged, long-term investment vehicle that, if focused properly on growth assets, can significantly contribute to retirement wealth.

TFSAs aren’t perfect. Contributions made to a TFSA aren’t tax-deductible. This is the TFSA’s main disadvantage compared with an RRSP. So don’t pile a chunk of money into a TFSA expecting a big cheque from the government at tax-return time. And, unfortunately, you can’t utilize capital losses within a TFSA to reduce tax liabilities. However, most equity ETFs, for instance, have a reliable tendency to move higher over time, so the inability to utilize capital losses should have limited impact on low-turnover, long-term TFSA investors. In other words, all things being equal over the long term, capital gains will be the more likely outcome from transactions within a TFSA. Finally, know your exact contribution limit. You’ll be penalized for over-contributing and dealing with the CRA to fix the over-contribution is an enormous pain.

Will the TFSA contribution maximums continue to increase? Only time will tell.

If tax avoidance becomes too favourable for investors the federal government does have a history of moving the goal posts. Witness the income trust ‘Halloween massacre’ of 2006. However, the government’s consistent history of adding TFSA contribution room each and every year for more than a decade, combined with gradually increasing the annual contribution amounts (exclude the $10,000 figure from 2015 to get a smoother picture), suggest that TFSAs will only continue to become even more significant investment vehicles.

Finally, let’s end with a selfie that’s aged perfectly.

You might recall me posing in my skivvies and Air Jordans last year, telling you all about the benefits of alternative investments (https://www.greaterfool.ca/2020/06/13/save-the-last-dance/)? Well, look what just made the cover of Bloomberg Businessweek:

Trust the man with the hairy legs

Source: Turner Investments

But that’s why you come here every day. Because we’re usually right.

I was right about my Air Jordans. And I’m also right about your TFSA.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.

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Soon we get a budget. Don’t expect pretty. Red ink to the horizon. All will blame Covid.

Fine. We get it. Pandemics are rare and hideously costly. But they also pass, as this one will. However some things don’t pass, and are far more consequential.

Like age. Currently Canada is sliding into a demographic crapstorm which will have a bigger effect than any virus and impact everyone. Our insane, unhealthy, addictive obsession with real estate is just making it worse.

Here are the facts. You should remember these.

What’s the single biggest thing the feds spend money on? Old people’s pogey. Annually the OAS costs $56 billion. There are 6.5 million oldsters, which is about 15% of the population. But age is unstoppable. In a decade and a half the wrinklie cohort will be massively larger. So OAS is on the way to over $100 billion by 2030. Ouch.

There’s more. Even without a slimy little virus, health care is the biggest expenditure of the provinces, at $180 billion. Guess how much of that is spent on people over 65 – just 15% of the population? Almost half. And it’s about to go through the roof with the aging wave.

Conclusion: governments don’t have this kind of money. And they can’t get it, either. Total federal revenues are now $320 billion and even with robust population growth that might increase in 15 years to $370 billion. Increased OAS alone will suck all that up – and health care transfers will explode. In short, this is utterly unsustainable – without major spending cuts and tax increases.

What to cut? Transfers to provinces for health care? CPP and OAS payments? Child care? Military? Already we’re in serious deficit, with a bloating debt. We can’t stop servicing a trillion-dollar debt. And it seems there’s zero appetite among Canadians to see government support wither or to face broad-based tax increases. Clearly ‘taxing the rich’ or diddling with the ranks of public workers will do nothing to stem this tsunami of need.

But there’s more.

Two-thirds of Canadians have no company pension plan. Of those who do, a minority will see defined benefits and most are stuck in glorified, mutual fund-based, low-T, group RRSPs. And speaking of registered retirement plans, only a quarter of people contribute anything. Together we’ve used less than 20% of the allowed contribution room. Close to half of all working Canadians have zero RRSPs. And no pension. In fact among Boomers who so have savings, the average is just $178,000 – enough to blow through in five or six years.

Let’s summarize. Pension plans are disappearing. Personal retirement savings are scant. Half of us have nothing. And there’s no way OAS or health care needs can be publicly financed in as little as ten years. In fact governments are coming out of Covid crippled by historic levels of deficit and debt.

This is a demographic time bomb. If you’re in your 50s it means don’t count on OAS in retirement. Expect rationed health care and LTC fees, in your eighties, of ten grand a month. And did I mention life expectancy? No? Well, it’s going up. Most people should count on having to finance at least 20 years after a work income ends. Women, more.

Why aren’t we talking about this in our national life? If millions are people are heading for a retirement disaster and expecting support that will bankrupt every other generation, how can this not be a political topic? Hello, Erin and Justin? What’s the plan, boys?

If you think the political class will wake up to the irreversible, unstoppable and inevitable demographic crush heading our way, cool. Carry on. Put all your net worth into one inflated asset, buy a cottage and a quad, save nothing, borrow big, don’t take advantage of tax shelters, don’t invest in assets that will pay you an income and wait for the government cheques.

But if you understand the threat, welcome to reality. You’re on your own.

Except for me. Stay tuned.

About the picture: “As you have mentioned,” says Andrew, “each day with our dogs is a gift. Bandit at 15 years lived a long life for a Chow. Maiyen lived to 16, but Kaedo encountered health problems and her life was cut short. Both of our Songshi-Quan’s are long gone yet never forgotten. Would love to see you use this image in your blog.”

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Just in time for spring showers, spring flowers and puppies (at four grand a piece), we have new lockdowns. Covid ain’t giving it up. BC is shuttered. The crazy Kelowna ski hill kids are all fired. Ontario hears the bad news today. ICUs are full. Public health officials are scary. Schools going remote again. Every province is screaming for vax, and the variants are winning.

As you know, real estate open houses are gone. Home inspectors (if you’re lucky enough to engage one) get sixty minutes to do a five-hour job. Appraisers are turning mean. Even realtors in PPE have not been enough to scare off house-horny, FOMO-infested buyers.

It’s a weird, mystifying time. Are things getting better or worse? Will downtowns ever repopulate? Why have only 14% of Canadians received one jab when 30% of Americans have been dosed? Why are financial markets at record levels when we’re entering the second year of a global pandemic?

Here are a few notes. Try not to throw up.

“For the first time in 5 years the two heavyweights of the Canadian housing market have broken above their previous peaks,” says YVR housing analyst Dane Eitel. “Both real estate market values are now in uncharted territory, implying a new growth cycle is in its infancy.  The new highs created in February were $1.869M in Greater Vancouver & $1.684M in Toronto.”

Why has this happened, other than pandemic-bred demand for space?

More importantly but less obvious was the banks’ ability to issue new mortgages to the increased applicants. This was enabled due to the Mortgage Bond Purchasing Program (CMBP) introduced by the Bank of Canada beginning in March 2020. The program enabled the BoC to purchase up to $500 million in secondary mortgage monds per week.

By the way, this easy-mortgage program has cost the central bank (and us) $8 billion.

And what does the Bank of Canada boss say our most inflated, dangerous and ubiquitous asset? “Canadians are stretching and that is worrying.” Governor Tiff Macklem told the Financial Post. “If Canadians are basing their decisions on the kinds of price increases that we’ve seen recently are going to continue indefinitely, that would be a mistake. They’re not sustainable.”

Suck. Blow. Creds, zero.

Meanwhile 63% of Canadians have FOMO, expecting house prices to keep rising. So they carry on spending, buying and borrowing.

Are speculators, flippers and scuzzy renovestors making this market insanity worse?

In a shocking report, Re/Max says no (seriously). “Bully offers and bidding wars are commonplace in the current market, with demand outpacing supply in virtually all areas of the GTA and the winner buyer paying top dollar. The current environment is simply too hot for investors and builders.” So why is this happening – other than oceans of ridiculously cheap money, pimp bankers, manipulative realtors, greedy sellers and widespread social insanity?

Low interest rates, of course. Plus big equity gains, “inspiring existing homeowners to trade up to larger homes or better neighbourhoods – both in and outside of the city.” Also the Covid cash that governments have thrown around plus savings caused by WFH have swollen household cash reserves, says the real estate-flogging firm. The savings rate of 1.4% in 2019 is currently 13%. And bidding wars, blind auctions and inflated offers have just pumped up more demand – because people really, really, really what the stuff they can’t have.

And what are the vaccines doing now that the overlord Boomer class is getting jabbed?

More will be listing, realtors say, as they feel immune from the virus and decide to cash in their chips, selling in the midst of an historic storm to some crazed Millennials willing to swallow a lifetime of debt to buy their old house without conditions, caution or common sense. And what a retirement bonanza that will be – sucking windfall gains out of torrid, teetering real estate and putting them into financial markets now on the verge of a Roaring Twenties, post-bug romp.

Did you see the latest?

The S&P 500 – the world’s most important equity market – just broke through 4,000 for the first time. Inflated like a bungalow in Etobicoke? Nope. This is solid, broad-based and likely the precursor for a lot more to come.

US consumer confidence is the highest in years. Two million people a day are being vaccinated. The jobs stats to be unveiled in the morning are expected to be awesome – maybe a million new hires in March. Biden’s unveiled a $2.5 trillion infrastructure bill. It comes atop the $2 trillion Covid recovery bill. Tech stocks have taken off again as bond yields moderate. Cyclical, old-school issues are also climbing because the economy is reopening. Virtually all 11 sectors of the market are flashing green.

Don’t tell the house-lusty Mills, but the game has changed. Enjoy your forever mortgages, kids.

About the picture: “Don’t know if this fits in,” says Scott, “but the wife came back in the house to see Toby walking around with AC grate attached to his collar. He looks so humiliated, maybe because he can’t blame it on the cat. Or maybe it was the cat.”

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Ride with me to a medium-sized city east of Toronto. My sidekick and I have something to share.

He’s a lawyer. A real estate guy, handling deals for a decade now. After reading yesterday’s post about blind auctions and the effect they have on property values, he offers this experience.

• Single family ranch home in a small town market 2 hours outside the GTA.
• List Price  $396,000
• 42  viewings on the weekend, offers held until Tuesday
•  12 offers
• One (winning offer) at $504,000 no conditions
• One offer at $465,000 with typical financing, inspection, etc  conditions
• The 10 other offers? … all between $425,000  and $450,000

Why did this home sell for almost 30% more than the vendors asked? Was it purposefully underpriced by a manipulative realtor? Here’s what our legal beagle thinks…

The information asymmetry effect was pretty clear as the vast majority of the buyers valued the home in a relatively narrow range and the two outliers (especially the winning bidder) unnecessary paid significantly more than what the rest of the market was willing. I am sure the “winner” would love to know what the other 92% of bidders thought the house was worth.  This of course this will lead to the inevitable knock on effects as the house down the street will have this inflated price as the comparable resetting everyone’s expectation of what everyone else thinks the value is inaccurately higher – snowball meet hillside.

Over and again this story is playing out. In a multiple-offer situation and blind auction there is zero transparency. No goalposts. The only known is the asking price. Prospective buyers must guess wildly, muster up their best offer, throw caution to the wind, eschew conditions, gamble and bid. They may never know the final selling price, the competition faced, nor the reasons an offer was selected and are usually denied a chance to alter their submission. All cards are in the hands of the vendor and their agent. It is a repugnant system designed to inflate prices, reward greedy sellers and grant absolute power to the listing realtor.

Agents argue holding back offers until a certain date and time allows a property to be viewed by more interested buyers. But in essence the hold-back has but one objective: to create that blind auction. Maximize value for the seller. Harness emotion, desperation, FOMO and competition to jack values to a new crescendo. Plus generate more commission.

Well, things gotta change.

And the Covid real estate crisis is surely bringing that reform closer.

Steve is a commercial real estate agent with three decades of experience. “Although sometimes I think of switching over to the cesspool that is residential real estate,” he says, “I cannot bring myself to make the switch.” One reason is the blind auction. It irks him, too.

The process is beyond ridiculous. The entire process should be transparent. However, RECO (the regulatory body in Ontario)and as you called it the “Residential Real Estate Industrial Complex”, will not have it.  The regulator is useless and residential agents are like an unorganized union that is more militant than the teachers union. Love your Blog –  hate Adele and Drake!

It’s notable that in a landmark report this week, economists at BMO are calling for immediate action to douse the flames of real estate, and also share disgust at the bidding process. “Implement an offer system that eliminates blind bidding in real estate transactions,” says the bank. “This would keep the sale price from settling well above the price of the next willing buyer, and keeps the comparable more appropriate for the next property to list in that location. While this won’t cool the market on its own, it would limit the ballooning that we’re now seeing in a very tight market.”

There’s more. The BeeMo guys are the latest bankers to push politicians into facing a growing accommodation quagmire. “We believe policymakers need to act immediately, in some form, to address the home price situation before the market is left exposed to more severe consequences down the road. As it stands now, prices are going parabolic across a number of markets and the price strength appears to be feeding on itself.”

The action needed today is one that immediately breaks market psychology and the belief that prices will only rise further. That would dampen the speculation and fear-of-missing-out that those expectations are creating.

Besides trashing blind auctions, the bankers are suggesting… (a) The central bank should raise rates, or at least stop saying the cost of money will stay low. (b) A spec tax – a special capital gains tax on the sale of residential real estate purchased from today forward, with the rate falling to zero over five years of holding the asset. (c) Allow all capital gains on non-principal residences to be taxed at the full marginal income tax rate – potentially doubling the hit. (d)  Implement a national non-resident buyers tax similar to those currently imposed in B.C. and parts of Ontario. (e) Make it harder to get a mortgage. Increase debt service ratios. (f) Tighten the rules for borrowing against a property to buy another property. (g) End the exemption of principal residences from capital gains taxes.

Well, blog dogs, there you have it. Lawyers, agents, bankers – and us – we all have eyes. We see the damage being done by the few to the many. If our leaders do not act, maybe a coup?

About the picture: “We escaped the crippling high RE prices and craziness of Vancouver early last year,” says John and Jane. “Packed everything into our Jeep and drove with our beloved Briard dog ‘Dougal’ to Lunenburg where we now live. Sadly, Dougal just passed at 13 years. He is sadly missed but we thought you might like to use this picture for your blog. Feel free to do so if you wish but just keep on blogging!”

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Blog doggess Sue borrowed a bunch of money against her home from her bank. The one with the Penguins.

She knows the drill. Get a HELOC. Invest the proceeds in non-registered financial assets. Make interest-only payments. Then deduct every dollar from taxable income. All good. Especially when the loan is so damn cheap – the prime rate (2.45%).

But whoa. What’s this letter from the bank?

The loan rate has changed. Now it’s prime +1%. Sue quickly beat on TNL@TB and as a result the branch has agreed to review things. But here’s the question:

I’m reaching out to you now as I don’t know anyone else on the planet that speak to this unequivocally.

•             Can Canadian banks unilaterally change rates on HELOCs?

I presented the facts of this matter to our banker and she replied: I will forward your concern to customer care department . To see if they can give you an answer on the changes that took place.

I have not received any correspondence from CIBC since. I look forward to your comments… given the indebtedness of our nation, it would be a great shock for thousands of Canadians to learn their HELOC’s can be unilaterally changed.

My response: Duh. Yes. “If you look at the fine print on your agreement you will likely see that the ‘prime +%’ is a guideline, and the bank has the right to change it arbitrarily (so long as you are informed) just as they have the ability to call the loan immediately without recourse. The bank always wins, Sue…”

And her reply was as expected:

Thank you… not what I was hoping to hear but you are 100% correct. It wasn’t under ‘Interest’, or in soft wording, it’s spelled out clearly on the last page under ‘Guarantee’… “We may, at any time and from time to time, without the consent of or notice to any guarantor… increase or decrease the Interest Rate…”

I wonder how many people leveraging themselves to the eyeballs know that tidbit. It seems like a good plan… using home equity for wealth generation… but clearly not without risk.

Indeed. Borrowing money to invest is an intoxicating concept when (like now) relatively boring balanced & diversified portfolios pump out robust returns, yet loan rates are historically repressed. And when the interest is deductible at your marginal rate, it’s party time. But, as Sue reminds us, there is always risk.

Not only can markets fluctuate but so can rates. HELOCs are demand loans. They can be called on a banker’s whim. The rate of interest can be changed with one email. They’re registered against your property’s title. And they essentially turn your house into an ATM, offering a seemingly ‘free’ giant pot of money that can go to work earning more money, plus tax advantages. Accepting a home equity line of credit and using it appropriately takes discipline and planning. If it’s called and you lack liquid assets to repay the loan or a higher rate means you can’t handle the payments, well, yer pooched.

Having said that, money borrowed at less than 2.5% with deductible interest to plow into a portfolio turning out 6-7% is a no-brainer. But, but, but… (a) understand it’s a long-term strategy and don’t hyperventilate during inevitable downturns, (b) be balanced, diversified and consider professional help, (c) no crypto or Reddit suggestions (d) know the loan can be called anytime or the rate upped, (e) don’t tell your MIL, (f) always have a strategy to repay the principal and (g) borrow modestly – not 65% of your home’s entire equity, as allowed,  but more like 20% max.

And yes, the bank always wins.

Now, a question from Sal who sees his Mama as a useful investment vehicle.

I have POA over my mother’s financial affairs.  She lives month to month on her pensions at 80 years of age and does not have a TFSA and wouldn’t know what one is.  I’m thinking of opening a TFSA in her name and fund it with money from selling my house, and assigning myself as the beneficiary.   What issues do you think I might have with such a plan and is it wise?  I’m concerned that the CRA might look at this unkindly should they find out.    Should I avoid linking my bank account with the TFSA and funnel money into her accounts and then into it?  Should I do it in small amounts to avoid potential flags?

So it’s perfectly okay to open a TFSA for your spouse or adult kids and fund it. Technically the money becomes theirs, but you can always have an agreement with them to repay you. Stuffing your aged mom’s account with your money when you’re power of attorney – just to designate yourself as beneficiary and benefit when the old gal kicks – is, well, despicable. And illegal. And you deserve two quarts of fire ants in your shorts.

A POA cannot designate him/herself as bene unless the document clearly states so. Sal, you need to know what a power of attorney is – someone legally obliged to put the interests of another person above your own. The POA must keep accurate records, act in complete good faith, avoid all conflicts of interest and keep their property separate from that of the one who granted this authority.

Did Mom bring you up to be such a scheming weasel?

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Three weeks out from the maiden Chrystia budget, the stats are toe-curling. The virus may be vanquished by the end of 2021 but the legacy will live on.

In other words, hide your money.

From April of 2019 until the end of that year Ottawa spent $10.6 billion more than it took in. That’s called the ‘deficit’, which is then added to the debt – so your children can grow up, find work and pay interest on it.

From April 2020 until three months ago – the same 10-month period – the feds spent $268.2 billion more than was collected. Yes, a 25-fold increase in the deficit. Never happened before. It pushed the debt to $1.09 trillion, a sum equal to half the economy. Also a record.

But here’s the thing: government spending nearly doubled (by two hundred billion) and taxes crashed (by forty billion). CERB payments alone topped $75 billion, with tens of billions more for enhanced child pogey to families, payroll subsidies and pandemic loans to businesses plus a bail-out for cities.

So we’re on track for a full-year deficit disaster in the $350-billion range. Will this hemorrhaging stop? Will spending be slashed as the virus recedes?

The prime minister has said otherwise. Covid is an opportunity to build back better. The budget will, he’s stated, among other things address wealth inequality, set aside up to $100 billion for new initiatives and be ‘feminist’. On the spendy side of the ledger there’ll be a whole lot of new money for health care (the provinces demand it) and the climate change/green agenda. A UBI is unlikely (too radical and expensive) and no government is going to start taxing house profits (yet).

Business taxes can’t really be increased, since the virus pretty much wiped out Main Street and crippled some economic mainstays like travel, hospitality and tourism. So the Libs will go after the WFH online giants, the financial sector and others that have done well because of Covid. Plus you.

Some moves which have been actively debated:

• Ending OAS universality.
• Implementing the 10% luxury tax on cars, boats, RVs and other consumer items selling for a hundred grand or more.
• A wealth tax of 1% on family assets of twenty million plus, as the NDP demands.
• An extra percentage point on the GST/HST to help pay for the CERB.
• Scaling-back RRSP contribution limits, which most benefit high-income earners.
• A super-tax bracket for those making over $400,000 a year.
• A hike in the capital gains inclusion rate, from 50% to 66% (or more).
• A speculation tax on vacant residential property.
• Changes in stock option treatment to eliminate deferred tax.

But even if all of these things were to occur, they’d not reduce the deficit by half. It would take something drastic – like the entire elimination of new RRSP contributions or the elimination of OAS payments – to really move the needle.

Why?

Because we have an unsustainable system.

Four in ten households pay no net tax, since their government benefits exceed obligations. Meanwhile the ‘income inequality gap’ critics decry is probably smaller than it appears, once a growing tax load is deducted from the cash flow of those who foot the bill. It’s fashionable to say, as our prime minister did, that government “must find additional ways to tax extreme wealth inequality.” But is this realistic?

Well, figure it out.

There are but 764,000 people (of 38 million) who have taxable assets of a million to five million. To be in the top 1% of income-earners requires an income of $234,000, and the average is $477,000. The top marginal tax rate for them is 53%, and they number just 277,695. Already the top 10% of income-earners pay 55% of all taxes. So the other 90% finance the remaining 45%. Recall that four in ten pay nothing, net of benefits. By the way, Canada has only 41 billionaires. Most of their wealth is tied up in corporations which employ a few million people, and pay corporate levies.

So do we really have a tax problem, or a spending issue?

The past year of virus, pandemic, lockdowns, quarantines and upheaval brought new distortions to our nation. Public finances are a mess. Politicians are ricocheting between achieving equality and social justice and staving off a fiscal crisis. You can’t do both. Meanwhile there are too few rich people around to Hoover.

So perhaps the budget could be radical this time. It could tell the truth. What a moment in history that would be.

About the picture: Hansel, an arson-detecting dog, and his handler, firefighter Tyler Van Leer of the Millville, NJ Fire Department. The pit bull was rescued by the SPCA in 2015 from an alleged dog-fighting ring in southwestern Ontario, along with 20 other canines. They were all scheduled to die until animal activists won a court battle to spare them.

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   By Guest Blogger Ryan Lewenza

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No I’m not talking about the person who comes by and repossess your sketchy friend’s car and TV from time to time. Today I’m talking about the arcane but important ‘repo’ or repurchase market. I hope you have your coffee ready as I’m going to cover a dry but critical part of the financial markets.

What is the repo market?

The repo market involves financial institutions swapping cash for government securities on a short-term basis. Below is an illustration of a repurchase agreement. One financial institution (Bank A) needs cash for one day (maybe some of their big clients withdrew money from their bank account accounts) and they enter into a one day agreement to sell US treasury securities for cash with another institution (Bank B), and promises the next day to buy back the securities at a slightly higher price. The slightly higher price is the repo rate, or the rate at which two financial institutions borrow/lend with each other, often on an overnight basis. This happens every single business day as banks with excess cash lend it out for a day or a week to a bank that requires cash.

Some years ago I used to work on the trading floor at one of the big Canadian banks and I remember how at the end of the day these specific traders would be on the phones with other banks’ lending out hundreds of millions of dollars of bank capital for just one day. I got to see firsthand how this all worked and while it’s not the most exciting thing, I learned how important this function was for the banks and financial markets.

A Repurchase Agreement Example

Source: Wikibanks

Why is the repo market important?

First, as briefly noted above, it allows financial institutions with lots of securities to borrow cheaply, and allows institutions with spare cash to earn a rate of return of their funds at low risk. It’s low risk to the lender since they own the securities, which are pledged against the loan. So if the other institution fails to pay back the short-term loan, then the lender just keeps the securities.

Second, the repo market allows the Federal Reserve and other central banks to conduct their monetary policy and help maintain a functioning financial system. So the repo market allows financial institutions to lend between themselves and for financial institutions to borrow/lend capital with the central bank (e.g. the Fed). This is particularly important during times of financial stress like the 2008 financial crisis or more recently during the Covid-induced recession and market meltdown last March.

This little known market sees $2 to $4 trillion in daily trading of these repurchase agreements so it’s a big deal. Essentially, the repo market is the grease that keeps the economy chugging.

Without it trade doesn’t happen, corporations don’t pay their employees and you don’t have some ‘benjamins’ to spend on your main squeeze.

And when it does go south, as we saw in September 2019, it can have huge consequences for the markets and economy.

In mid-September 2019 the repo rate spiked to an intra-day high of nearly 10%, as financial institutions with excess cash refused to lend it out. The repo rate typically tracks the Federal Reserve’s overnight benchmark rate, which at the time was 2% to 2.25%. What caused the repo rate to spike that day and completely detach itself from the Fed’s benchmark rate?

It’s believed that two events in mid-September 2019 led to this scary spike in the repo rate. First, was that quarterly taxes were due for corporations so there were large cash withdrawals from the banking sector. Second, it was settlement date for previously purchased US Treasury securities, so again cash was needed to pay for these securities. These two events led to a shortfall of cash in the financial system, which caused the repo rate to spike violently on the day.

The Fed was then forced to respond and clean up the mess. The Fed announced that they would better support the repo market by offering $75 billion in daily repos, which was subsequently increased to $120 billion of daily lending. Basically the dam and had sprung a leak and the Fed had to come in and fix it up. If they hadn’t and the dislocations continued then we could have been looking at something far worse, possibly the start of another financial crisis.

US Repo Rate Spiked in September 2019

Source: Bloomberg, Turner Investments

For now the repo market is functioning well and not much of a concern. However, there are some out there that believe the repo market is at risk from all the central bank money printing and QE. Sure there will be the occasional blip but the Fed stands ready to step in during any times of stress so I’m not too concerned at present.

Now you know a bit about the repo market. You’re welcome!

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.

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For the past nine months he’s been chronicling the bizarre housing in his neck of the woods on IG. “It’s crazy,” he says. “Each day I posted listings that were either insanely overpriced, missing photos, photos that were poor quality, houses that were messes, interesting features like stripper poles, etc.” Apparently that’s an appealing feature in Kitchener-Waterloo.

Now, for context, K-W is a citystate of about 250,000 people 110km west of the Big Smoke, down the Killer 401. On a good day that’s a 90-minute drive. Once Covid leaves you could double that most mornings.

Last month gives a nice snapshot of what the slimy little pathogen has done to a cute city with a cutting-edge university and robust hi-tech sector. It ain’t pretty. FOMO everywhere. February sales were 67% higher than January and prices have swollen 35% in a year. The average property is closing on $780,000 and in the last few weeks a detached passed the $900,000 mark. First time.

One year ago that average detached home cost $673,825. A year before that, $597,965.

“We continued to see dramatic increases in the average price in February due to the persistent and fierce competition for homes in our region combined with short supply,” says the real estate board. “Buyers are very frustrated competing in this hyperactive market. The low inventory and mortgage rates are resulting in multiple offers, higher prices and creating a fear they are missing out on the chance to become homeowners in this unprecedented market.”

So the realtors have adopted the industry Frankenumber, called the MLS® HPI, which seeks to smooth out price trends and thereby mask current conditions – like buyer insanity and social destruction.

Well, back to our Instagram guy, chronicling all this.

“I would often post the sold prices of the houses I posted. Each week I also created a summary chart of the number of houses sold, how many went over/underasking and by house much. I had nearly 1500 followers, including many realtors when I received a copyright strike on March 23 from Instagram. It said that the Canadian Real Estate Association filed a claim and my account has been suspended for up to 30 days. The person who filed the complaint was the CREA’s legal counsel

“People want to talk about what’s going on,” says the face behind LOL Listings, “and yet the CREA is like some mafia of controlling information. It’s garbage. Just thought I would vent to you as this has been a topic on your blog for quite some time.”

Why would CREA move to shut this guy down – a little local social-media fishy with a scant fifteen hundred followers? Well, it could be because current conditions are extreme, dangerous, spiraling out of control and the housing guys know they’re short strokes away from being squished by a government hammer. It’s also an industry skewed to serving sellers, not buyers.

Look at the blind auctions. They’re all over K-W now, as in Langlely, Barrie, Kelowna, Ottawa, Halifax and every little habitation within two hours of urbanity. In Toronto properties are going for up to $700,000 more than asking. All thanks to this tactic. Realtors pick a price out of a hat, set a date for reviewing offers, then let buyers guess how much money it will take to succeed. There’s no visibility. No reporting. The seller can capriciously select any bid, or send several back for sweetening. Each potential buyer has no idea what others are offering. No context. The result can be an absurd overvaluation, setting the bar for every other house on the street.

Like this place.

The condo townhouse in Langley was priced at $820,000 – a healthy premium over the last comparable sale of $770,000. In days there were 110 showings, then 20 offers – in a blind auction. The ‘winner’ paid $1.4 million – or $500,000 above asking.

By the way, Langley has a pop of about 25,000, sits an hour south of Vancouver, with the average household income a little under $60,000. The realtor handling the sale said it was a feeding frenzy among seniors. “Nobody wants to go to a care facility.”

So this week a Toronto semi also received 20 offers, and sold for $575,000 above the ask. The last guy standing parted with $1.675 million for half a house. “It was wild as we saw the offers were rolling in,” the smiling realtor Anushki Bodhinayake told CTV News. “We knew it was a great house. We knew it was in a great neighbourhood. We didn’t really think it would get this much attention.”

Well, feeling pooched yet? This has the potential to destroy the livability of every major community, create two classes of citizens, cement a wealth divide, disenfranchise an entire cohort, create structural household debt, make shelter unaffordable and hobble the economy as billions a week flow into vaporous housing equity. In short, it’s an epic policy failure. It’s time those who have greased the wheels – realtors, central bankers, political leaders and our federal housing agency – stand accountable.

On Thursday CMHC said the Toronto, Hamilton, Halifax and Ottawa markets are dangerous and prices increase unsustainable. Realtors don’t believe it. March stats, they say, will prove so. They’re right.

“We are of course watching housing markets across the country very, very closely and carefully,” says Finance Minister Freeland. “We are very aware, also, of the challenges that many Canadians face — particularly young Canadians — in buying a home,” she said. “So it’s something that we’re looking at carefully.”

What does that mean? Measures to dampen demand, quell FOMO, make houses harder to buy and finance, leading blind auction players to realize their immense gamble?

Or will the feds try to ‘help’ newbie buyers with more incentives – throwing gas on the conflagration?

It’s your moment, Chrystia. Don’t blow it.

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Are the bankers worried?

One of them – a big poohbah at the nation’s largest lender – says it’s time to reconsider tax-free house gains. Gulp. Heresy. The country’s dominant real estate board has reacted in unvarnished disgust. And from the trenches, here’s the report of one of our own – slogging daily to hand out fresh loans, many in refinancing as people use their homes like ATMs (to buy more real estate).

I watch this and am shocked.  Like some mindless stampede.  Why this would happen during such a time of pandemic, virus and uncertainty is a puzzle, or perhaps not.  This smells a lot like some kind of societal breakdown, when I just know looking at these applications that there will be jobs lost and reversals galore. You have said, ‘This won’t end well’.  It won’t.  Best to stay lean, mean, with dry powder and a low profile.

Hmm. As noted there’s a budget coming down in Ottawa in three weeks. The first one since before the pandemic hit, when we entered the housing maelstrom. Once the March stats are published it will be evident the country has lost its mind. Our housing bubble is the biggest on the planet. Canadians devote more household income to paying off debt than any other G7 country. We fork over 65% more than American families for shelter. In the GTA there are almost 60,000 realtors and fewer than 10,000 listings. Unemployment last year was over 10% yet we borrowed $120 billion more. Two-thirds of people say the highest prices ever will only go up.

Does any of this sound, er, dangerous to you?

The International Monetary Fund says Canada’s at risk of having housing “destabilize” the whole economy. It’s calling for lenders to turn off the spigots and the country to slap on a speculation tax. Meanwhile even the Bank of Canada (as noted here yesterday) admits concern over the flipping in places like steamy Brampton, plus the FOMO seeping into the hick cities, burbs and backwoods where people used to live less stressful lives.

And did you catch the vibe at RBC? No flies on chief economist Robert Hogue. The bank is practically telling T2 the property bonfire must be doused.

“It’s overheating… Making matters worse: buyers and sellers expect prices to continue to escalate. Until recently, Canadian housing-market worries mostly reflected conditions in Toronto and Vancouver. Now, it’s a national concern.”

Should the feds act? “Yes,” it answers. And as this pathetic (but chiseled) blog had laid out, the reasons are obvious. First, real estate will correct. Inevitable. Nothing rises forever. And the bigger we let it get, the more guts will fly. Second, 60,000 realtors in one city show how we’re turning Canada into a house-horny economy, selling each other real estate instead of building stuff to sell the world. And housing inflation, FOMO and speculation are creating two classes – owners and serfs. The wealth divide grows daily. The kids can’t buy. Rotten social policy.

So, what to do?

Maybe whack investors, the bank says, by not letting owners of investment properties deduct financing costs (like in NZ). Ouch (half the condos in Toronto are investor-owned). Plus, FOMO has got to end. Canadians need to know prices will not rise forever.

“Policymakers should put everything on the table, including sacred cows like the principal residence exemption from capital gains tax. These considerations will be complex, controversial and no doubt fraught with unintended side-effects. Yet this support was largely designed during times when interest rates were much higher, and in some cases to counter the effect of high rates.”

To the Realtor Industrial Complex, them are fighting words. Lisa Patel, boss over at the Toronto Regional Real Estate Board, is aghast.

“Piling on a capital gains tax would mean homeowners get dinged when they buy (land transfer tax), every year while they own (property taxes), and when they sell (capital gains tax). Enough is enough,” she says. Of course, folks with financial portfolios are taxed every year on income received, pay HST on fees and capital gains tax on dispositions.

Lisa also claims this is an ugly idea because, “homeownership is the cornerstone of retirement planning for many people.” True enough, but this may flow from the abnormal tax break on house sale proceeds, coaxing people to have a risky one-asset strategy.

And this concern: “Many younger homeowners and buyers already feel like they have greater challenges than previous generations to become a homeowner, and now this would penalize them on the back end when they sell, something that previous generations were not subject to.” Again, true. But today’s buyers have 2% mortgages – a massive discount from the historic norm – plus 5% down payments (thanks to CMHC) along with tax-free RRSP deposits, a shared-equity mortgage and first-timer tax breaks. The hurdle is price. And prices might be a lot lower if residential real estate were not the only asset in the nation allowed taxless profits.

What next?

Don’t expect a capital gains tax on houses on the 19th. Not happening. Too rad. But I hear a national speculation tax based on length of ownership is in play. That might be enough.

Remember the 2017 dominoes? Everybody who buys in bubble must sell. When you can’t close because the guy you sold to can’t close because the guy he sold to couldn’t close because… well… FOMO ends in a hurry.

Will Justin man up?

About the picture: Madison, a shepherd-mix, waited in the ruins of her family’s burned-out home in California for an entire month until her owners returned. Rescue workers fed and watered the pooch, who refused to leave her station.

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A row house on a leafy street an hour (by car) west of the urban core sold last week with a flurry of offers and for hundreds more than asking. Yawn. Old news. This crazed behaviour is everywhere.

But it’s still interesting a decidedly middle-class home with no new renos increased 50% in 24 months, from the fives to the eights. Of course, this pales to recent flips in smoky hoods like Brampton, where flippers have been feasting on 6% monthly appreciation.

Now that mortgage rates have been gently rising and the vaccine’s started to flow, the market may mollify. But not soon. It’s spring. Time to grow antlers, sow oats and make offers. March stats could be epic. April will be orgasmic. And then you should expect significant change.

Next month also brings tax reality. Last year the feds pushed the tax-filing deadline way into the autumn to accommodate pandemic mayhem. The American IRS has done it again, giving people there until the end of May to get their stuff together. But in Canada your 2020 return has to be finished and submitted in six weeks.

Last year Ottawa sent $82 billion in CERB cheques to nine million people – that’s 61% of all the 14.8 million folks in the workforce. Of those, 650,000 were self-employed who filed incorrectly and were not eligible for benefits, but the Trudeau Liberals have forgiven them. Also not paying back money will be the 300,000 teenagers who collected $636,000,000 in CERB, while living at home, having no expenses. And let’s not forget the 114,000 people who earned well over $100,000 and also took the pogey.

Well, here’s the point. The federal government is spending $400 billion more than it’s taking in. Provinces are also a mess. Like Ontario’s $40-billion hole (the next budget comes on Wednesday). Toronto has a $2 billion shortfall, despite Covid cash coming from the feds. Every major city has, like provinces and the nation, seen revenues plunge and costs rise.

Meanwhile, what’s been happening with citizens?

Yup, all good. At least for the millions of WFH warriors who have kept jobs and incomes, seen living costs plunge, pocketed extra money in enhanced government benefits, and plumped their savings accounts by a collective $100 billion. Ah yes, and those with real estate have seen their net worth bloat since the pandemic started – as this pathetic and breathless blog has chronicled. Cheap money, aggressive nesting, WFH, urban flight and sheer FOMO have shoved personal net worth higher at the same time public finances have cratered.

It won’t last. It can’t. You know it.

This is why Vancouver has an ownership tax on non-residents plus a vacancy charge, and why Toronto’s about to do the same as well as mulling a land transfer tax jump for lux homes (over $2.5 million). Everywhere, property taxes will increase and the debate is being kicked up again about taxing homeowners on their unearned, windfall, capricious and often-obscene capital gains.

Will any such move happen in the maiden Chrystia budget, expected next month? Nope. Not a chance. T2 is eying a majority win now that O’Toole was hoisted upon the socon petard a few days ago. Nibbling away at homeowner equity gains will not be happening until later.

If the Libs increase the inclusion rate for capital gains on stocks, funds, rental properties and other assets in the federal plan (possible in April) it will only make more people ask a simple question: why not tax where the big profits lie? These days two-thirds of all capital gains sit in residential real estate. Not taxing them is a $7 billion gift to property owners, while the average family is shut out of owning the average home.

The US taxes gains on houses, albeit with an exception that spares most people. Around the globe some cities (New York, Paris) also tax them. Canadians selling properties in places like Florida are hit with a 15% withholding tax on gains. And everywhere Covid has pushed housing to an historic level, increasing real estate lust and speculation, taking valuations to absurd levels in the midst of a public health emergency that’s killed millions and pushed governments into debilitating deficits.

If there was ever a catalyst for ending this nonsensical exemption for residential profits, here she be. There are not enough rich people to whack with more tax to finance government largesse. It’s therefore inevitable the house tax will come. You may wish to factor that into your retirement strategy.

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