The Big Picture

Let’s get something on the table once and for all:  Are we facing an American-style housing meltdown?

We are likely NOT!

Any rational person who has objectively looked at some of the lending antics that went on during the American boom times has to concede that we never reached those same levels of irrationality.  The US market experienced more speculation, more overbuilding, and more outrageous lending practices.  Even the most ardent bear (and I count myself among them) has to admit this.

However, we need to keep things in perspective.  What we are witnessing in the US is perhaps the greatest destruction of household wealth in human history.  The average home price in the US is now approaching a 30% peak-to-trough decline.  With the massive amount of homes on the market currently sitting at over a year of inventory plus up to 7 million additional homes hiding on the wings as part of the shadow inventory of delinquent but not yet foreclosed homes, it’s easy to see that supply will remain at extreme levels for some time.

Compounding this is the fact that debt deflation is still intact as total credit continues to fall, meaning less demand for homes.  Plus you have a foreclosure fraud issue which is still simmering below the surface.  Bottom line is that the US housing market could conceivably fall 50% nominally from peak-to-trough before organic demand once again puts a floor under house prices.

So, yes, we’re not as screwed as them.  But should you take comfort in that?

Well let’s first note that we’re really not that different from our American neighbours when it comes to things like immigration, incomes, consumer debt levels, and homeownership rates.  Secondly, house prices are significantly overvalued by any measure of fundamental value.  To point to the massive excesses that went on south of the border and not at least acknowledge these inconvenient facts is a bit ridiculous.

As I’ve said before, one of the great injustices that our mainstream media has done is perpetuate the notion that since an American-style meltdown is unlikely, we are somehow out of the woods.  This is folly!

Last week David Larock, a mortgage broker, wrote the following piece over at

How the US Lent Its Way to a Housing Bubble and Why It Didn’t Happen Here

The article is quite well written and the facts are virtually indisputable.  But his conclusion is so off base that it illustrates how people can miss the big picture.

Read the entire article for a good overview of how the US got themselves into their predicament.

Let me focus on a couple of quotes from the above article that I strongly disagree with.

“Canadian lenders did become marginally more aggressive, but to nowhere near the same extent as their US counterparts.”

“The bottom line is that US lending conditions and practices acted as the primary inflator for their housing bubble, and that Canadian lending standards have been much more responsible by any measure.”

This would seem at first glance to be intuitively obvious, and the author obviously believes it to be as he failed to back up these claims with some data.  Allow me.  If someone can align these quotes with the data I’m about to show you, please explain it to a simpleton like me.

Back in January the McKinsey Global Institute produced perhaps the most in-depth report of the past year on the state of international debt levels.  It’s well worth the read.

According to the report, in 2000 household debt (including mortgages) in the US totaled 72% of GDP.  Ten years later, that figure had reached 97% of GDP, for a ten year increase in consumer debt of 34.7%.

Meanwhile in Canada, our household debt in 2000 was 64% of GDP.  In 2010, we had reached 88% of GDP for a ten year increase of 37.5%, eclipsing the total debt accumulated by US households during the same ten-year run-up.

So I’m curious what the author meant by “Canadian lending standards have been much more responsible by any measure“.  Apparently not by the measure of total debt created as a percentage of GDP.  Our consumers have blown their brains out on credit just the same as those in the US.

Admittedly, our households do not hold as much debt relative to GDP or disposable income as our American counterparts, but we’re far from the prudent angels we’re made out to be.  We have increased household credit at a greater clip than our American cousins.  Anyone who thinks that this is sustainable needs to get their head checked.

Now as I’ve maintained all along, you cannot have a meaningful discussion about real estate without understanding how real estate and credit creation via mortgages and HELOCs affect the broader economy.  I’ve spent plenty of time dissecting that angle, so I won’t go too much further into detail right now.

So if personal debt levels are not sustainable, what does that imply?  It implies that a consumer retrenching is in the cards, and I would suggest is perhaps even happening as we speak.  Without the massive expansion in consumer credit artificially buoying the economy, our consumer-driven economy will slow markedly.  Whether the initial retrenching is started by a broad-based realization that debt levels are too high, or whether it starts when people realize that their home values have fallen even marginally (as the author notes is quite likely), and therefore stop tapping HELOCs, is irrelevant.  Once the retrenching begins, it becomes a self-feeding cycle of falling consumer demand, falling employment, falling home prices, and then falling demand again.

The McKinsley report agreed that household deleveraging is highly likely here in Canada:

In a country like Canada where consumer spending provides the lion’s share of economic growth, you simply cannot have households go through a deleveraging and saving phase and not have it severely affect the broader economy and home prices by extension.  If history is any guide, these periods of deleveraging last longer and hamper economic growth far more than people realize.  Perhaps not to the same degree as the deleveraging in the US, but let’s not delude ourselves into thinking that we’ll escape the consequences of a decade of unsustainable debt growth while our neighbours to the south reap their whirlwinds.


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4 Responses to The Big Picture

  1. jesse says:

    It’s also worth remembering that the national and regional figures will be different. Even in the US many states have experienced a relatively benign shock to GDP in the past 2-3 years. I don’t think Canada will be immune to such regional differences either.

  2. Get Real says:

    My take

    House prices in Canada

    Plateau, Cliff and Plateau again over the next 3 years

    Vancouver (-25 to -35 percent)

    GTA (-20 to -25 percent)

    Rest of Canada (-15 to -20 percent)

  3. Pingback: “Why we won’t see a housing collapse”….more media nonsense | Financial Insights

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