Coverage in today’s National Post
National Post – October 3, 2005

Here is an excerpt:

In 1968, a miraculous financial innovation crystallized this big-spending trend: The big banks introduced Chargex, the credit card known today as Visa.

Many shops had always offered their customers credit, but Chargex caught on like wildfire, and debt moved from the concrete into the abstract for millions of people.

"Plastic moved the dollar bills out of your pocket and postponed the actual impact," Mr. Meredith says. "Once that caught, you really created a whole new generation of consumers with a whole new attitude. We come back to the point that debt is good."

Duke Stregger, executive director of the Credit Counselling Service of Toronto, says credit cards are usually the final undoing of the clients who come through his door. "It just doesn't seem like money," he says."If you go into a restaurant with $50 in your pocket, guess how much you're going to spend? You go into a restaurant with a credit card and no cash, and your bill is always more than $50."

Fast forward to the current housing boom, and these same cultural and psychological trends are in play. My neighbour Maria put nearly 50% down on her house. But in the current housing boom, Canadians don't blink twice about a 5% down payment and a large mortgage. And when housing prices are moving so quickly, there's no time to save for a down payment.

"I'm getting a lot of young professionals who are new out of school, so while they're paying off their student loans, they haven't had a chance to save for a substantial down payment," says Ann Pope, a mortgage broker at Assured Mortgage Services in Toronto. "I have a few clients who have bought around the half-million mark with 5% down. I have no doubt they'll carry that mortgage and pay it, and never miss a payment. A few of them are just getting married, so the wedding bills are there. But if you look at their history, their income in two or three years will have doubled. So why should they wait to buy?"

Continued evolution in the financial industry and mortgage market has also kept the ball rolling. Scotiabank, for example, will pay the 5% minimum down payment for prospective buyers who take out a five- or seven-year fixed-rate mortgage -- under the right conditions.

In the United States, lenders are even offering interest-only mortgages, where the homeowner will pay interest only for a fixed term, but will then be obliged to pay off the principal or refinance -- possibly at a higher rate.

Even the Canada Mortgage and Housing Corp. (CMHC) is in on the game. In April, it lowered mortgage loan insurance premiums for the second time in two years. And under its "Flex Down" program, first-time buyers can now borrow the minimum 5% down payment from a variety of sources, including other loans or even a credit card, as long as the loan isn't tied to the house.

And just as the credit card made debt an abstract concept, for many people today a $200,000 mortgage is a fuzzy concept, too. Dilip Soman, professor of communications and marketing at the Joseph L. Rotman School of Management at the University of Toronto, says research has shown homebuyers see the obvious attraction of a house with a great view or big rooms, but minimize an extra few years on a mortgage.

"People underestimate the importance of the price tag when making a decision," Prof. Doman says. "They become insensitive to the extra payment, but the extra bedroom, they can understand."

Paula Seimens, a broker at Invis, Canada's largest independent mortgage broker, agrees. She says Canada has become a payment-driven society. "People have changed from looking at the dollar amount of the mortgage to looking at the payment," she says. "In our parents' time, they bought a home for $50,000, and if they had a mortgage it was a big, big, deal."

Marg Green, a mortgage consultant at Mortgage Intelligence, says a lot of her clients opt for a lower down payment, then use a line of credit to renovate or furnish their new homes. "Everybody wants a satellite dish and all the bells and whistles," she says. "And they're not willing to wait."

Full article:

The new nest egg: Part II of a six-part series: These are not our parents' debt loads
National Post
Mon 03 Oct 2005
Page: A1 / Front
Section: News
Byline: Jacqueline Thorpe
Source: National Post
Series: The Housing Boom

My neighbour Maria and her husband, Frank, bought their three-storey detached house in the heart of downtown Toronto in 1952 for $13,500. Maria, 82, her memory razor-sharp, recalls the mortgage they took on to buy it.

They put $6,500 down, borrowing $1,000 from Maria's brother. They took on a $7,000 closed mortgage at 7%, and paid it off entirely by the end of the five-year term.

Only then did Maria and Frank start saving for a car. They bought one in 1958 and used it to go on family camping vacations in Northern Ontario. In 1959, they'd saved enough money to buy a television.

"Our recreation was the zoo," says Maria. "Sometimes we went to High Park, but not very often, because you had to pay for the TTC tickets."

She raised three children. Her family prospered. Her house was a place to live. To this day, Maria does not have a credit card.

Angelo, a budding real estate tycoon in north Toronto, has been investing in property for the past five years.

In September, he flipped a waterfront condo after a year and made a $50,000 profit. He sold another in North York and made $20,000. He also still owns a condo on the waterfront, one downtown that hasn't been built yet, a six-plex further north and a duplex in the suburb of Newmarket. In early September, Angelo bought a house in North Toronto that he plans to tear down and build anew.

Burned in the stock market meltdown of 2000, Angelo hopes to build a real estate nest egg to retire on. His goal is to double his down payment with each sale.

So far, he's managed to put 25% down every time, but he says if it weren't for today's low interest rates, the numbers just wouldn't work.

On the teardown, he clinched a three-year, 3.4% variable-rate mortgage -- even after the Bank of Canada began a long-awaited rate-hiking campaign, taking its key rate to 2.75% from 2.5%.
"If rates were up a couple of points, I wouldn't be buying them," Angelo says. "That makes it feasible."

For Angelo, debt is a means to an end, and it doesn't worry him. "As long as I get the rental to cover the mortgage," he says, "I'm not in any fear."

As the great Canadian real estate boom rumbles on, the only thing matching the headline-grabbing prices -- one six-bedroom Toronto gem sold for $300,000 over its asking price in September -- is the stomach-churning mortgages homeowners are taking on to fund them.

Fanned by a potent mix of economic, cultural and psychological factors, Canadians are embracing debt with unbridled enthusiasm. The numbers are jaw-dropping, reflecting not only the surge in housing activity, but also a surge in credit card and other borrowing to fund all the trimmings to fill those homes:

• Total residential mortgages outstanding grew 10% year-over-year to $619-billion in June, double the pace of growth five years ago, when the economy was growing twice as fast.
  
  
• Total personal lines of credit outstanding rose 25% year-over-year to $104-billion in June, breaking the $100-billion mark for the first time.
  
  
• The ratio of total consumer credit to personal disposable income stood at 37% in the second quarter, compared with 29% five years ago.
  
  
• The debt-to-personal-disposable-income ratio is now at 117%, versus 96% five years ago.
  
  
• The personal savings rate -- what's left over after the monthly bills have been paid -- continues its relentless decline, reaching 0.5% in the second quarter, its lowest since the 1920s.
  
  

Forty-year-low interest rates may be the key economic driver behind our willingness to take on a heavier debt load, but there's also been a huge attitudinal shift toward debt among a younger generation that has never known depression or war.

It's easy to see why Maria, an immigrant from Slovenia, hated having a mortgage hanging over her head. She spent three years in a refugee camp in Austria during the Second World War, so she knew what it was like to have everything ripped away from her.

Lindsay Meredith, a professor of marketing and economics at Vancouver's Simon Fraser University, says Maria shares a mentality shaped by the economics of the Second World War and the Depression. "It was very much one of conservative financial behaviour because you never knew when your world was going to implode," Mr. Meredith says.

"You save everything you've got, put your money in the bank, don't be throwing it around. If you buy something, shop like hell for the best price. Never, on pain of death, ever, buy anything on credit. One thing you might have to buy on credit is the house, but in that case every red penny you had went into paying the mortgage off as quickly as possible."

Related to this conservative financial ethic was an attitude of minimal expectations. "If you never had much, you didn't want much," Maria says. "Even our children were brought up differently. They had more than we had. We didn't wish to have much more. Now there are so many things."

The economic boom of the 1960s not only brought a surge in prosperity, but also an explosion in the amount and variety of consumer goods available -- and an increasingly sophisticated and aggressive advertising industry to sell them. Canadians began to have more money to spend and fewer qualms about spending it.

In 1968, a miraculous financial innovation crystallized this big-spending trend: The big banks introduced Chargex, the credit card known today as Visa.

Many shops had always offered their customers credit, but Chargex caught on like wildfire, and debt moved from the concrete into the abstract for millions of people.

"Plastic moved the dollar bills out of your pocket and postponed the actual impact," Mr. Meredith says. "Once that caught, you really created a whole new generation of consumers with a whole new attitude. We come back to the point that debt is good."

Duke Stregger, executive director of the Credit Counselling Service of Toronto, says credit cards are usually the final undoing of the clients who come through his door. "It just doesn't seem like money," he says."If you go into a restaurant with $50 in your pocket, guess how much you're going to spend? You go into a restaurant with a credit card and no cash, and your bill is always more than $50."

Fast forward to the current housing boom, and these same cultural and psychological trends are in play. My neighbour Maria put nearly 50% down on her house. But in the current housing boom, Canadians don't blink twice about a 5% down payment and a large mortgage. And when housing prices are moving so quickly, there's no time to save for a down payment.

"I'm getting a lot of young professionals who are new out of school, so while they're paying off their student loans, they haven't had a chance to save for a substantial down payment," says Ann Pope, a mortgage broker at Assured Mortgage Services in Toronto. "I have a few clients who have bought around the half-million mark with 5% down. I have no doubt they'll carry that mortgage and pay it, and never miss a payment. A few of them are just getting married, so the wedding bills are there. But if you look at their history, their income in two or three years will have doubled. So why should they wait to buy?"

Continued evolution in the financial industry and mortgage market has also kept the ball rolling. Scotiabank, for example, will pay the 5% minimum down payment for prospective buyers who take out a five- or seven-year fixed-rate mortgage -- under the right conditions.

In the United States, lenders are even offering interest-only mortgages, where the homeowner will pay interest only for a fixed term, but will then be obliged to pay off the principal or refinance -- possibly at a higher rate.

Even the Canada Mortgage and Housing Corp. (CMHC) is in on the game. In April, it lowered mortgage loan insurance premiums for the second time in two years. And under its "Flex Down" program, first-time buyers can now borrow the minimum 5% down payment from a variety of sources, including other loans or even a credit card, as long as the loan isn't tied to the house.

And just as the credit card made debt an abstract concept, for many people today a $200,000 mortgage is a fuzzy concept, too. Dilip Soman, professor of communications and marketing at the Joseph L. Rotman School of Management at the University of Toronto, says research has shown homebuyers see the obvious attraction of a house with a great view or big rooms, but minimize an extra few years on a mortgage.

"People underestimate the importance of the price tag when making a decision," Prof. Doman says. "They become insensitive to the extra payment, but the extra bedroom, they can understand."

Paula Seimens, a broker at Invis, Canada's largest independent mortgage broker, agrees. She says Canada has become a payment-driven society. "People have changed from looking at the dollar amount of the mortgage to looking at the payment," she says. "In our parents' time, they bought a home for $50,000, and if they had a mortgage it was a big, big, deal."

Marg Green, a mortgage consultant at Mortgage Intelligence, says a lot of her clients opt for a lower down payment, then use a line of credit to renovate or furnish their new homes. "Everybody wants a satellite dish and all the bells and whistles," she says. "And they're not willing to wait."

While there has been a seismic cultural and psychological shift in Canadians' attitude toward debt, there are also very good economic reasons why we're willing to carry a heavier load.

Chief among them is the fact that borrowing is dirt cheap. Unlike the last boom, during the late 1980s, when the Bank of Canada pushed interest rates into the double digits to tame inflation, today's rate of 2.75% is hovering just above 47-year lows.

Ms. Green tells the story of one client who came in with a substantial down payment and was shocked to discover just how cheap her monthly payments would be. She didn't want to pay more than $2,000 a month, taxes and utilities all in, and was looking at houses in the $350,000 range. But she had a down payment of $175,000 -- essentially half -- and with a fixed five-year mortgage at 4.4%, her mortgage was only $958 a month. Even if she cut her down payment to 35%, she could get a $475,000 mortgage and still be within her $2,000-per-month limit.

Ms. Green's client was prudent -- she opted to carry through with the lower payment. But plenty others out there have chosen to buy more house instead.

Benjamin Tal, senior economist at CIBC World Markets, says another reason Canadians have been willing to turn to debt is that incomes have stagnated over the past decade or so. The growth in real disposable income -- after-tax income adjusted for inflation -- has drifted down each decade from an average of 6% in the 1970s to 3.5% in the 1980s to 2% in the 1990s. Since 1999, disposable income per capita has risen roughly 1.5%.

"The last 15 years were basically lost in terms of income growth," says Mr. Tal. "Clearly income in Canada is not rising to the extent that it's consistent with the lifestyle we're living."

Mr. Tal says there are several reasons for this: slow employment growth in the early 1990s; a trend toward lower-paid part-time jobs and more self-employment (40% of all jobs created since the beginning of 2005 are self-employment); an increase in contract labour and the waning bargaining power of workers due to globalization. "The bargaining power of employment has been hurt significantly by the competition from China and India," Mr. Tal says.

On the other hand, it could be that the emergence of debt as a driving force in both the United States and Canada is simply a sign of a maturing economy. We're no longer a population of blue-collar workers with only a monthly paycheque to rely on. We have assets and net worth -- stock market portfolios and appreciating housing prices -- to act as collateral against our ever-increasing debt loads. The debt-to-income ratio looks downright scary at 117%, but the debt-to-asset ratio is a much more palatable 17%.

Alan Greenspan, chairman of the U.S. Federal Reserve, said in a recent speech that monetary policy might have to evolve to take this development into account. "[Our] analysis of economic developments almost surely will need to deal in greater detail with balance sheet considerations than was the case in the earlier decades of the postwar period," Mr. Greenspan said.

"The determination of global economic activity in recent years has been influenced importantly by capital gains on various types of assets, and the liabilities that finance them. Our forecasts and hence policy are becoming increasingly driven by asset price changes."

In the end, says Lawrence Smith, economics professor emeritus at the University of Toronto, people's propensity to assume debt adapts with the financial circumstances of the times.

Those interest-only loans? In the 1920s, they were called "balloon mortgages." The problem was that, after the stock market crash, many homeowners just walked away from their homes, leaving financial institutions holding the bag.

As property prices kept falling during the Depression, lenders sought to protect themselves, obliging homeowners to pay off both interest and principal. Long-term amortized mortgages were born.

In the 1970s, there was a new wrinkle -- inflation. Mortgage terms got shorter so financial institutions didn't have to lock themselves into lower rates.

Now we're back in a low-interest-rate environment, and it's not surprising homeowners are taking on higher and riskier mortgages.

We know where it all ended in the 1920s, as interest rates began to rise. Let's hope it doesn't happen all over again.

For media comments and inquiries, please contact:

Steven Moyes
604-879-0228
E: Steven Moyes