Jul 132020

The new normal

low interest rates will lead to greater economic expansion, but also more debt.

The year is 2030. Self driving cars are delivering fast food right to people’s front doors. China surpasses the U.S. as the world’s largest economy. Everyone uses mobile wallets instead of credit cards. Increasing wealth inequality has created constant social unrest. But one thing hasn’t changed. Interest rates continue to remain at rock bottom. You can still get a mortgage for less than 2.5%. ūüôā

The economy has fallen into a deep pit of debt – so deep you can find Adele rolling in it. Policy makers around the world manufactured liquidity and bailed out corporations. Everyone has become accustomed to cheap money. If interest rates were to climb by just 1% then a third of mortgages will become delinquent.


Inflating money with impunity

Today in 2020 the United States government is already technically insolvent. But it can continue to make its debt payments because…

  • It has the ability to borrow money from a line of credit with no credit limit. And..
  • It can choose the interest rate at which it borrows thanks to the Federal Reserve.

From the total revenue collected by the U.S. federal government, 17% of it is used to pay interest on the debt it owes. If interest rates were to rise by just 1% then nearly a quarter of the federal revenue will have to go towards interest costs. That would be insane. Doing so would be the equivalent of someone with a $50,000 salary taking on a $500,000 mortgage at 2.5% interest rate. Nobody can qualify for a mortgage 10x their annual income. Even if the borrower thinks he can afford it, good luck finding a lender audacious enough to approve his loan application. Most mortgages are only 3 to 5 times one’s income.

Typically if a debtor starts to borrow more than he can adequately service – market forces will begin to push back. Lenders will either reject any new credit increase requests, or they will raise the interest rate to compensate for the debtor becoming a higher risk. But this doesn’t happen for governments with their own printing presses. The result: massive asset price inflation.

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Feb 082016

Mortgage Investment Corporations Returns in 2015

The Toronto Stock Exchange lost about 9%¬†last year.¬†But one group¬†of investments that performed well in 2015 were¬†mortgage investment corporations (MIC.) In the beginning of 2015 I held three¬†different MICs. Since I didn’t add any new positions throughout the year it’s easy to calculate my total annual returns from them. Let’s take a look at the results. ūüôā

Liquid’s MIC returns in 2015:

  • Antrim Mortgage Fund: +4.5% return (on $10,300 invested)
  • Atrium Mortgage Investment Corp (AI): +8.2% return (on $2,100 invested)
  • Timbercreek Mortgage Investment Corp (TMC): -0.6% return (on $2,600 invested)

Total returns = 461 + 172 + (-16) = $617

Overall Return on investment = $617 √∑ $15,000 = 4.1% return

The chart below shows the unit price of my AI and TMC investments compared to the S&P/TSX index, throughout 2015. It does not include dividends or interest.


MIC Analysis

My total return for holding $15K in MICs last year earned me 4.1%. This rate of return was lower than the historical average of 5% to 8% one would normally expect from a basket of mortgage based investments. I believe a number of negative factors played into this outcome.

  1. Our economy in 2015 was weaker than economists had expected. The price of oil lost around half its value. As a result, the Canadian economy fell into a recession because it’s very¬†dependent on strong oil prices to grow.
  2. Another reason is because the Bank of Canada cut interest rates not once, but twice in 2015. Lower rates are bad for mortgage lenders like MICs because they make less money if borrowers pay less interest on their loans.
  3. Furthermore the annual account fee I paid to my trustee lowered my Antrim Mortgage Fund return by 1.3%.
  4. The last reason is because one of my holdings, Timbercreek (TMC) severely under-performed other MICs. I don’t know if 2015 was just a bad year for the stock or if the drop¬†is due to¬†something more substantial.

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Dec 172015

Federal Funds Rate increased to a range of 0.25% to 0.50%

The Federal Reserve finally increased the interest rate by 0.25%¬†after 7 years of essentially being at 0%. It was the talk of the financial news world yesterday. Is this good or bad? Well, that depends on who you are. ūüôā

15-12-us-rate-hike-25-bps federal funds rate

The winners are people¬†who hold¬†the U.S. dollar. For example if you have U.S. investments in $USD, then you are in a good position. Anyone who makes money in U.S. dollars will also get a boost in purchasing power. These lucky folks¬†include Canadian exporters, and¬†other Canadians companies that do business in the U.S.¬†such as TransCanada, which rallied 15% this week. ūüėÄ American based banks also¬†benefit from the rate hike since it gives them an excuse to increase their prime lending rates, which¬†means they can charge consumers more for mortgages and car loans. Not surprisingly bank stocks such as Goldman Sachs and JP Morgan were up over 2% after the news yesterday. ūüėČ Major international banks such as Switzerland’s Credit Suisse and Britain’s¬†HSBC also liked the news, both gaining over 2.5% at the day’s close. Canadian banks with U.S. exposure such as Royal Bank and TD also saw some gains, but to a lesser extend. As a whole, stock market investors can celebrate. In the past, equities in developed nations have “reacted pretty well¬†to a Fed tightening,” according to Brian Davidson, markets economist at Capital Economics. Savers and conservative investors, many of who are seniors, can also rejoice as their savings accounts, CDs, government bonds, and money market funds should produce more attractive returns, not immediately, but gradually over the next year or so.

The losers¬†of this Federal funds rate hike, on the other hand,¬†are U.S. borrowers, commodities, U.S. real estate owners, and Canadian consumers. According to the¬†Consumer Financial Protection Bureau, more than 94% of general purpose accounts in their credit card database have variable rates, the average being 12% APR. The quarter rate hike by the Fed will make it harder to service those credit card debts for a lot of U.S. consumers starting from their next billing cycle.¬†Interest has such accrual way of accumulating. ūüėõ The increased value of the U.S. dollar relative to the Canadian¬†loonie will mean Canadians have to pay more to import goods from south of the border. I don’t know about the rest of the country but around my¬†neck of the woods we important most of our fruit and vegetables from the U.S. I’m expecting higher grocery cost in 2016. Prices of commodities such as oil, copper,¬†and other resources will fall because they are valued in $USD, so a¬†stronger greenback means they become more expensive to most buyers around the world.

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