Canada's Bursting Bubble

Bank of Canada may intervene in housing market

OTTAWA - Mark Carney has a dilemma: He views record high household debt the number one domestic risk to the economy, but believes he would hurt the recovery if he raised interest rates to slow borrowing.

But the Bank of Canada governor said in an interview with The Canadian Press that he would be prepared to intervene if things got out of hand.

"In exceptional circumstances, if there are issues that threaten financial stability, such as household debt ... the bank could use monetary policy for that purpose," he said. "That factors into our decision-making without question."

By Carney's telling, the situation is not that far from reaching the point of exceptional circumstances. He is encouraged by the recent slowdown in the housing market. Household debt as a proportion of disposable income was close to 151 per cent at the end of last year. The Bank of Canada's own analysis expects the ratio to approach the 160-per-cent level reached in the United States just prior to the 2008 financial crisis.

"We have never been as indebted as we are today as individuals," he said. "We've done analysis which shows that about 10 per cent of Canadians are vulnerable if interest rates returned to more normal levels, which will happen."

That's in part because Canadians keep borrowing to buy homes, or take out loans on their homes, and because income growth has slowed to below the rate of inflation.

Canadians don't think they are overly indebted, in part because super-low interest rates have not moved appreciably in several years and private sector analysts keep telling them the central bank is unlike to hike for another year despite all of Carney's huffing and puffing.

The big worry is if interest rates rise — as they must one day — with a concurrent drop in home prices, those circumstances will set off a cascading series of blows to Canadian consumers. Home owners will see the value of their assets fall at the same time the burden of servicing their debts rise and income growth remains modest.

At this point some households will be over their heads in debt; many others will be forced to cut back on spending, slowing economic activity in Canada.

Private sector economists are almost unanimous in the view that housing prices are too high in Canada in relation to fundamentals, such as incomes and the cost of renting. That suggests a correction is coming, in the neighbourhood of 10 to 25 per cent, with some hot markets like Vancouver and Toronto possibly facing an even bigger reckoning.

My View:

Canada has seen house prices rise for the past 5 years while US prices tanked leading to a general feeling of "it can't happen here" amongst Canadians.

With the bubble effects lagging for so long, Canadians have not learned the hard lesson that Americans continue to suffer through. 

An attitude that "our banking system is the strongest in the world" and other rubbish has led Canadians astray and ultimately taking them down the bubble path their American cousins experienced.

While household debt continues to climb, the sense of denial of the reality of being tied into a global economy also grows.

In my view, Canada is even more vulnerable to a housing collapse than the United States.


In the US, when the sub prime crisis hit, triggering a high number of foreclosures and subsequent falling prices, interest rates were low and continued to work their way even lower.

Canada, by contrast, has very high debt levels, similar to those in the US 4 years ago, combined with a blissful unawareness of the danger of extreme leverage. 

What troubles me is the attitude among those who never experienced the 1981/82 recession in a meaningful way.  This would be those under age 45.  Their propensity toward risk taking is extreme to say the least.  Having no frame of reference indicating that an economy can shrink or that housing prices can contract significantly, many seem determined to max out all the credit available.

This attitude, combined with socialist government programs that provide loan guarantees to banks create the dangerous 20 to 1 debt to equity situation many homeowners have naively embraced.

The CMHC (similar to Freddie Mac & Fannie Mae in the US) has guaranteed a massive number of high ratio mortgages in Canada.  Mortgage practices in Canada remain ridiculously risky, with 5% downpayments and 30 year mortgages common, if not the norm.

There is a key difference between the US housing bubble and the Canadian one.

This lies in the trend with interest rates.

As the US bubble burst, interest rates were trending down, providing some cushion to homeowners whose mortgages were coming up for renewal.

In Canada, interest rates appear to be bottoming out and gradually working their way upward.  Those with mortgages coming up for renewal in the next 12 to 18 months will likely pay higher rates as their property values drop significantly.

This has a compounding effect on residential and commercial property values.

So while American prices dropped quickly in 2008, I expect Canadian prices to drop even more rapidly, particularly if their is upward interest rate pressure as a result of more trouble in Europe.

Anecdotal evidence from the town I live in, suggests the bubble has already burst.  A small, older house not far from me was listed at $140,000 by a real estate firm that has the reputation to list close to market value.  It just sold for $116,000  - 17% below list price.