Canada's Bubble Hits The Mainstream Media

If you thought I was exaggerating in an earlier post (here) by calling the Canadian house market a bubble consider the following excerpts from the Financial Post:

Read the whole article here.

Our unstoppable housing market may have met its match

Ian McGugan, Financial Post

Canada's unstoppable housing market faces a challenge. To stay unstoppable, it needs mortgage rates to remain low and affordable. But to keep setting new sales records, it also needs more people to land more jobs so they can afford to buy more homes.

The problem is it's next to impossible for the economy to produce both these happy outcomes. Interest rates usually stay low only if unemployment remains high. Once jobless numbers start falling, mortgage rates typically shoot upward. Hoping for both low interest rates and lots of jobs is like a farmer praying for both dazzling sun and buckets of rain.

Whatever happens over the months ahead, the real estate market will face resistance from either higher rates or continued unemployment. If you've been betting on continued strong increases in home prices, it may be time to take a moment and ponder what you would do if home prices went sideways for a while - perhaps for a very long while.

A sign of what is in store came Monday, when Royal Bank of Canada and Toronto-Dominion Bank announced that they were raising interest rates on some fixed-rate mortgages. The hikes are small -- the equivalent of an extra $70 a month on a $200,000 five-year fixed mortgage -- but they look to be the first move toward more painful increases.

You can blame the pain on the surprising strength of Canada's economic recovery, which has removed the case for keeping the bank rate at the lowest levels in Canadian history. Mark Carney, the governor of the Bank of Canada, is expected to start raising rates this summer.

How high will rates go? The prominent economists who make up the Monetary Policy Council of the C.D. Howe Institute are urging the Bank of Canada to hike its key overnight interest rate by 1.75 percentage points over the next year.

If other borrowing costs follow course, rates on five-year fixed mortgages will be nudging up against 7% by this time next year - and that will start to pinch. On a $200,000 fixed-rate mortgage, a new homeowner would be paying a couple of thousand dollars more a year than she would be now.

The last thing that many Canadians need is an added expense of that magnitude. Household debt levels have galloped ahead over the past few years. Personal bankruptcies per capita are at their highest levels in nearly 20 years.

The Bank of Canada recently looked at what a moderate increase in interest rates would mean to household finances. It found that if the "effective borrowing rate" -- a mix of various mortgage and consumer credit interest rates -- edged upward by slightly more than a percentage point over the next couple of years, the portion of households deemed to be financially vulnerable would hit a record peak of 9.6%, more than half again the average of the past decade.

The technical term for this is "scary." And what makes it scarier is that Canada's real estate market may already be in bubble territory.

Average prices for a resale home in Canada have doubled over the past decade
and with little apparent reason. If a genuine shortage of accommodation were behind the galloping prices, rents should also have surged. But they haven't.

The International Monetary Fund says that home prices in comparison to rents are higher in Canada than any other developed country with the exception of Sweden. David Rosenberg of Gluskin Sheff, the Toronto money management firm, has looked at Canadian home prices in terms of both price-to-rent and price-to-income and concluded that current home prices are 15% to 35% above levels that would be consistent with housing fundamentals.


It looks like a deflationary scenario is beginning to play out in Canada too.  Once banks start to take some write downs as housing prices drop, we can expect to see lending by Canadian banks decline accordingly.