Levered

2000 years ago, the philosopher Archimedes proclaimed ” Give me a firm place to stand and a lever and I can move the earth”. Of course, 2000 years ago the term leverage meant something completely different than it does today. Today, society seems less concerned with lifting heavy objects, and instead laser focused on using leverage to compound returns.

We all know how leverage works. We have all seen how leverage can work. Many of us, in fact most of us, have used leverage in some form or another to help achieve our clients objectives. For the last 20 years, whoever had the most leverage had the biggest returns.

But now we are entering a different period. We are now entering a period of time where we are seeing first hand how the power of leverage can cut both ways. While leverage has always amplified returns – it will also help speed up losses. Leverage will, if it has not already, become a 4 letter word. In the words of Warren Buffett ” you don’t know who is swimming naked until the tide goes out”. Well, I am here to tell you that the currents are changing, and the water is dropping.

Over the last several years, and the last 3 in particular, we have all witnessed the seemingly overnight successes. People that went from poor to instantly wealthy – or so they would have you believe, almost overnight. Leverage, combined with ultra low rates ( Commonly referred to in financial circles as ZIRP for zero interest rate policy ) combined to create a powerful drug. Much like any other drug – the people who took it got addicted, and felt extremely powerful. These same people felt that they had the winning formula, regardless of why. It personally amazes me how many people thought that they were just that damn good, when in fact they just had a lot of tailwinds at their backs. Well, those people are starting to realize that maybe their luck has changed, and if they aren’t realizing it, then they are in need of a shrink to help them work through their massive case of denial.

As we start to see the morning after side effects of leverage in a hot market, we need to take a second, and ask what it could mean, what will the side effects be for all of us, and how do we attempt to navigate the road ahead.

It is no secret that I have been downright negative on the Canadian economy as of late. It is not a position I enjoy nor want to have. While I am extremely poor at many things in life ( wy wife could write her own blog just on that topic and never run out of ideas ) I have always been extremely good at changing my opinion when the facts change. I learned very early on in my career that dogma is a killer in the financial world. Doing something a certain way because it had always been done that way is a recipe for disaster. Doing the popular thing, or the ‘ thing ‘ that used to work is not a way to stay on the edge.

Many people may remember the days leading up to the Great Financial Crisis in 2007 and 2008. Ben Bernanke, the Chairman of the Federal Reserve at the time, famously uttered the words ” subprime mortgages, and the US housing crisis is likely to be contained “. Of course, that statement was about as accurate as Tiff Macklem assuring Canadians that ” Rates are to remain low for long” , and lets not forget the classic ” inflation is transitory”. This also proves that the smartest people in the room, and the ones responsible for setting monetary policy have no more insight than anyone else. Bernanke could not have been more wrong on his comment, and the exact opposite happened, and dragged the entire world into a credit crisis not seen since the great depression. There are many people that will give you many reasons for the crisis. The big driver of the credit crunch was that leading into 2007, the American consumer was over levered. Americans had one of the highest consumer debt loads in the world at the time. Sound familiar?

I often repeat the phrase that ” slaves of the modern day are not in chains – they are in debt”. Debt and leverage go hand in hand like high blood pressure and heart attacks, and the outcome of both is usually about the same. I don’t think I need to pull up current Canadian debt loads, debt to income, avg car payment etc. statistics. You know them all, or at least you should. The numbers are bad. The numbers are getting worse, and a lot of it is because of leverage. What worked for the last 3 years will now be the leading reason we experience a decline.

Here is the most important part. Canadians need to de leverage. Canadians need to pay down debt. Canadians need to reduce interest costs. We all kind of know that. But, what most people fail to realize is : Deleveraging is a process – not an event. I will say it again: Deleveraging is a process – not an event. Never forget this. Deleveraging debt, paying balances down, saving up an emergency fund etc, is something that can take years, and sometimes a decade to do. Canada is in for a good 7 – 10 years of deleveraging. That is the process. It takes time ,and it is not something that happens easily. We witnessed this in the US after the 2008 collapse, and it took about 9 years – until 2016 to 2017 to get back to where people were spending again. Even if interest rates drop, the party may not continue. People will be scarred from the recession, they will ( hopefully ) have learned their lesson, and will start to use cheaper rates – if they come, to pay down debt, and to de lever their personal balance sheet. It has happened every time there has been a financial shock for the last 1000 years , so I see no reason for it to be different this time.

A consumer that is in the process of deleveraging is a consumer who does not spend. They buy the essentials, they pay down the debt, and they don’t tend to take on more debt to buy items. The Canadian economy has been completely propped up for years now with debt based spending. People have used their homes like ATM’s to finance a lifestyle. That will not, and cannot continue. Bank credit will contract in conjunction with a de levering consumer. It takes 9 months to have a baby, but you cannot impregnate 9 women at once, and get a baby in 1 months time. Deleveraging is the same – it takes time, and it will play out on its own schedule.

If your business plan is to return to the good ol’ high flying days in 2024, you may want to re think and go back to the drawing board. The de leveraging that will take place will take some time. A healing consumer will take time to get back into financial health. Of course there will be money to make, people to help, and deals to do, but it will go to the broker that can navigate what an economy that is de leveraging looks like, and finds solutions to the client problems of the day. Convincing clients to go all in on a variable because rates are gonna drop is not what clients will need. Talk with your clients, walk through their finances, become a master in helping people budget, and ensure that you have strategies to help your clients eliminate their debt load and payments. This is what people will be focused on. The days of the annual refinance for full pay are over. Rates, flexibility, and pre payment options will become a huge part of what clients want. Showing your clients the road map to the other side of the current problems will help you solidify your relationship, and ensure that when the good times return – which they will, you will have cemented a place as the go to person.

People that are once bitten are usually twice shy. The people who were busy partying the hardest during the recent run up will feel the hangover the hardest. Don’t expect them to be back at the punch bowl of low rates and high leverage anytime soon.