G&M Likens Housing To Income Trusts – “The blowback if housing falls hard will be worse because homes are widely believed to be a special kind of asset that benefits the entire population.”

“If the slowdown in the housing market worsens, Mr. Flaherty will be blamed as he was after effectively killing income trusts in a surprise announcement made on Halloween night in 2006. The Minister, and his government, will be accused of being bad economic managers if the housing sector falters. But what people will really be saying is: “How dare you, Mr. Flaherty?”
People are funny about financial assets that soar in value, be they income trusts or houses. They see them as being special in some way, a phenomenon of nature that should be left untouched so as to allow folks to make some serious money.
But assets that soar in value are the ones we need to worry about most. Everything in finance is cyclical, which means there are ups and downs. The more an asset rises in price, the more vulnerable it is to a nasty pullback that causes damage both to individuals and the economy.
Mr. Flaherty moved to cool the overheated housing market last summer by capping the maximum amortization period at 25 years for people with down payments of less than 20 per cent. The impact of this move so far has been negative, but not alarmingly so. House sales were off 17.4 per cent in December on a year-over-year basis, but prices were up 1.6 per cent, on average.

Mr. Flaherty snuffed out trusts by announcing the government would start taxing them in 2011. In response, most trusts converted into dividend-paying corporations that pay far less cash than they used to. The complaining from investors about the demise of trusts was long and loud, although it never seemed to hurt the Conservatives in an election.
The blowback if housing falls hard will be worse because homes are widely believed to be a special kind of asset that benefits the entire population. It’s an easy impression to come away with after watching the rules shift over the years for home-buying down payments.
Decades ago, buyers had to put down a minimum 10 per cent and amortize over 25 years at most. The minimum down payment briefly fell to zero a few years ago and now it’s 5 per cent. Amortization periods expanded to as much as 40 years for a time, before being reeled back.

Housing’s stature has been further inflated by its cultural and economic importance. Multiple TV channels celebrate housing, and a fair chunk of the retail industry is directly home related (think of HomeSense, Home Depot, Home Outfitters, Home Hardware, Sears Home and the like). Also, housing-related spending accounts for close to 20 per cent of economic output. What’s good for housing is thought to be good for all of us.
Mostly, though, housing is thought to be special because of its value as an investment over the past couple of decades. As mentioned in a recent column (online at tgam.ca/Dlfb), housing prices nationally have risen about 5.6 per cent annually since 1980.
After five years of up and down stock markets, Canadians have become very possessive about their gains in housing. If housing prices plunge, they’ll be looking for someone to blame. That would be Mr. Flaherty, even if he was just doing his job.”

– from ‘First income trusts, now housing? Careful, Mr. Flaherty’, Rob Carrick, The Globe and Mail, 16 Jan 2013.

We like the way that this article emphasizes the ‘special’ place that housing has achieved through the 10 year national housing bubble. Nowhere more special than in our own Vancouver, of course.
A few thoughts:
1. Flaherty’s mortgage rule changes in 2012 were simply a slight tightening of restrictions that he himself had allowed to become far too loose in prior years.
2. When Flaherty announced the income trust rule changes in 2006, he exempted one class of income trust – those in real estate!
3. In trying to quantify the difference between the effects of changing the tax laws of income trusts, and tightening mortgage rules, it would be good to know how many Canadian’s had how much of their net-worth in income trusts in 2006. (Can any readers direct us to such data?) My hunch is that, even though that move was significant (and caused a massive brouhaha), it doesn’t come anywhere close to the magnitude of significance of mortgage tightening. Over 70% of Canadians own their homes; a large percentage have the majority of their net-worth in their homes; a significant percentage have their net-worth highly leveraged to the market value of their homes. In addition there are innumerable knock-on economic effects of a falling housing market.
The unwinding of the RE spec mania will completely eclipse memories of the 2006 income trust tax changes.
– vreaa

23 responses to “G&M Likens Housing To Income Trusts – “The blowback if housing falls hard will be worse because homes are widely believed to be a special kind of asset that benefits the entire population.”

  1. Many articles of the time pegged the sell-off in the sector after the announcement at 15%. I found one that put it in dollar terms, $36B. Not sure how accurate that is, but it would suggest the sector started out with $240B invested. Some portion of that would have been owned by foreign investors and other corporations.

    I’m also not sure how much of a parallel can be drawn.

    Part of the income trust brouhaha was the nature of the decision: secretive, with the calculations not released, and completely contrary to an explicit election promise just a few months prior. Plus, it affected everyone currently holding trusts directly. With mortgage rules, it only affects those entering the market later (though indirectly it will affect those who currently hold), and it shouldn’t have been a surprise.

    • The secrecy was absolutely necessary. They did not want a repeat of what happened to the Liberals the year before, when they announced a review of trust rules. The the market first plummeted on the news, then shot up again in overnight trading – the night before the announcement was made to leave trusts untaxed. No one can ever be sure whether it was Scott Brisson’s email to his banker friend or some other leak. But it was the investigation into that leak – started right smack in the middle of the 2005 election campaign, that ultimately handed Harper his first election victory. You can bet he wasn’t going to allow the same thing to happen to him. When the announcement was made, journalists were gathered in a press room and stripped of their cellphones. It was just like Budget lock-up.

      As for the ultimate release of the documents with the redacted pages, I can speculate, as someone who worked for the government myself, that any mention of any private company in those documents would have necessitated redaction of almost the entire page. The government is so anal on privacy, you really wouldn’t believe it if you didn’t work there. Most people don’t realize that corporations and trusts have the same right to privacy of their tax data as citizens do. Yes, they have reporting requirements if they are publicly traded corporations, but that does not give the government the right to release any tax data about individual corporations. I know this because I used to deal with tax data. Data that identified individual corporations had to be treated in an identical fashion to data on individual taxpayers. And leaking it was a potentially career-ending mistake.

      The main – and really the only – controversy we’re left with is the fact that the decision was a direct betrayal of a very explicit election promise. However, I would maintain it was the promise that was irresponsible, not the ultimate decision on trusts. Much like Chretien’s promise to get rid of the GST in 1993 (“I will get rid of it. It is gone.”), it was a foolish, reckless promise to make, and breaking it was the only smart thing to do. Personally, I prefer politicians who break promises to those who carry through on their really stupid ones. There are a few other promises I wish Harper would have broken as well.

      • Robert Dudek

        Personally, I prefer politicians who break promises to those who carry through on their really stupid ones. There are a few other promises I wish Harper would have broken as well.

        In the long run, the former leads to a totally cynical political system, so the latter is preferable.

      • illustrates well the point of a charter of rights or constitution … some things are unmanageable by popular process … the proper solution for too low tax revenues is spending cuts … aside: jobs had a great observation about the music industry and, by extension, people in general – about which he was adamant … set a fair/reasonable price for your service and people will pay it instead of spending all their time trying to avoid it … http://tinyurl.com/bj5zxmz (lol punchline – pfffft!)

  2. Yes because thinking something, wishing something, hoping and even praying for something will make it happen.. this will end poorly.. much more poorly for some than others.. and I think the most painful aspect will be how long this will last. The measurement will not be years but decades.

  3. The dog will guard his master. The master has lured you to his house in an effort to assist you. But while the master lays about, you are trapped in his yard, while the previously docile pets become aggressive.

    • Pretzels...thirsty

      And the dog will always wag his tail, unless, of course, you wag the dog.

      • The master is watching from his closed-circuit camera, as you fend off the attack. You back out of the yard to the garage door, and exit from the carport. Later you check the alignment of the stars at the Exact moment this takes place. Much has been written about the astrology of ‘Dog Bites’

  4. It’s not REITs it’s income trusts in general, and the government rightly stepped in when the likes of phone companies and food distributors started structuring themselves as income trusts.

    REITs weren’t affected hugely by the government’s move iirc.

    The major parallel IMO is the government clamping off what’s viewed as a free lunch, either as a tax dodge or free hedge. Either way the government’s ledger is going to take a hit.

    • The government stepped in (rightly so) in 2006, when all sorts of companies announced intention to restructure as income trusts to avoid taxes… Bell Canada, for one.
      And, yes, RE ITs were made exempt.

      Another parallel is how the industry involved immediately denounced the moves as dangerous:
      The President of the Canadian Association of Income Funds was quick to denounce the change Tuesday.
      “Finance Minister Jim Flaherty’s announcement of a punitive tax against this important sector of the Canadian economy was done precipitously and without consultation with the industry,” said George Kesteven in a statement. “The government’s action will directly affect the savings of millions of Canadians who have benefited from investing in income trusts.”

      CBC News 1 Nov 2006

      Very similar to the mortgage industry’s response last year.

  5. 70% of canadians don’t OWN their homes, rather 70% of them have their names on the title and own the debt obligation against that title. How many canadians raelly own their homes outright, with no liens (especially after the HELOC orgy etc in this past decade)?

    I bet less than 50% of the 70% own their homes with no debt against the title.

    • Owning with debt is still owning, just as owning with material deficiencies is a future liability, no debt required but still a de facto pledge.

    • Wouldn’t surprise me if it were more like 65% of “homeowners” actually have a mortgage. These figures must be available somewhere.

      • About 28% own without a mortgage in Canada. It’s been dropping. Which is a difference between how the cycles played out in the U.S. and Canada. The percentage stayed fixed in the U.S. through the run up and crash. Given the boomer bulge hitting the age where they should be paying off, the number should be rising. That the number has dropped in Canada implies to me that more first-wave boomers have overextended more in Canada relative to the U.S.

      • AG Sage, is that 28% of all owners or 28% of the population?

      • 3.15M homes have no mortgage and no HELOC.

      • Thanks Ray.
        So, about 33% of Canadian owners have no debt against their homes.

  6. Vancouverites cherish their home value more than any other people in the world because Vancouver has terrible job opportunities, low wages, no industry, nothing to create any real wealth

    • UBCghettodweller

      Real Estate prices have worked as a cash machine so far. Many people have become quite rich and essentially won themselves a small lottery jackpot.

      Additionally, the extreme jumps in housing prices reinforce the “Best Place on Earth” and “Everyone wants to move here and those who can’t are butt hurt” mentality.

      Don’t get me wrong, I really, really, like Vancouver. I just don’t like the elitism or exceptionalism I see.

      • Funky monkey

        The elitism is what bothers me too. People think they are some kind of financial geniuses because they bought a house.
        Hey I bought I house too it went up in value I am lucky. At the time it cost the same to rent as to own now its cheaper to rent. I sold it because it went up to much in my mind.

      • Funky monkey – > “I sold it because it went up too much in my mind.”
        Well done (The timing of the buying may have been luck, but the ability to recognize overvaluation and sell is a skill.)
        The majority of owners won’t respond as you have .. they hold tighter on the way up, and fantasize about even greater profits, and then panic and try to sell when prices plunge. Classic momentum style investing.

  7. …”The blowback if housing falls hard will be worse because homes are widely believed to be a special kind of asset that benefits the entire population”…
    Really, i live here, so that makes me part of this population and all the housing bubble has done for us is to make it unattainable to ever reasonably afford a place where we can raise a family without having to worry about signing yearly lease agreements that might be canceled at a moments notice because the owner needs to sell and “cash out”.

    • When Carrick says “believed to be a special kind of asset that benefits the entire population”, what he really means is “believed to be a special kind of asset that benefits the population whose voice is heard“.
      Nobody has (thus far) been listening to the voices of the non-owners (their opinions are most often dismissed as sour grapes), or of the (very few) owners who have tried to speak out about the terrible implication of the RE spec mania.

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