Tired, old adage:
It’s getting a bit old, yet we continue to find articles chanting the same old mantra to soothe edgy new home buyers: “The risk of a US style housing bust is remote”
I’ve addressed both the inherent dangers in perpetuating a message that amounts to, “we’re not exactly like the US, therefore we’re fine”, as well as the factual fallacies that generally accompany these arguments.
Just last week David Larock wrote an interesting piece titled, “How the US lent its way to a housing bubble and why it didn’t happen here”
…and of course I presented a slightly different take on the subject.
Back in September, Toronto Star columnist David Olive wrote this ridiculous article: “Don’t listen to the doomsayers on housing”
…and check out my response to this drivel.
Once again we turn our eyes to another article that while predominantly factually correct, completely misses the big picture:
Right off the bat, it’s worth noting that most times that any article discusses possible outcomes for the Canadian housing market, they refer to the exceptionally remote possibility of a housing collapse.
Now just what is a collapse and how does it differ from a correction? I don’t really know, but I can tell you that the term ‘collapse’ conjures up visions of anarchy, apocalypse, and Mad Max. Scary stuff! Much different than the term ‘correction’. Why the media likes to polarize the possible outcomes into either a very mild correction to the tune of 5% or so, or a massive ‘collapse’ like the US is experiencing is beyond me.
Whatever the term ‘collapse’ entails, it’s not what I see in our future. I have said before that I would not be at all surprised to see real estate correct to the tune of 30% peak-to-trough, with some markets seeing 50% haircuts. Now a 30% haircut certainly won’t be pretty, but it’s a far cry from the pain the Japanese housing market experienced when it shed 80% in nominal terms from its peak to its trough. THAT was a collapse.
The US has now shed 25% nationwide, with over a full year of inventory on the market plus millions more in shadow inventory. It has a ways to go before it finds a floor. While fundamentals have started to come back in to line, mass psychology has turned decisively against real estate. As asset bubbles tend to overshoot the mean when psychology turns against them, we may well see a 50% peak-to-trough decline before the masses once again embrace this now unloved asset class. It may well be the greatest example of wealth destruction in human history.
But hey….compared to that carnage, we look great!
Let’s turn our eyes back to the article in question and consider some of the arguments they advance:
“On Wednesday, Dean Baker, one of the first economists to predict the U.S. housing crisis, said that Canada’s market is due for major U.S. style correction soon.”
That’s not even true. What he actually said, according the report referenced by the article, is that, “we (Canada) have a real problem”, and “there could be some pretty serious fallout.” With regards to a major US style correction, he actually said that Canada is not as vulnerable as the U.S. was during its bubble.
What he did say was that if interest rates rose rapidly by 2% (and I would assume he is referring to the overnight rate from the Bank of Canada), Canada could see a price decline of 25 to 30%. I don’t disagree with that analysis except to say that I think it is exceptionally unlikely that we will see a rapid rate hiking cycle, let alone even a modest increase, for quite a while. Let’s at least get the quotes down right!
Back to the article:
“U.S. mortgage lenders gave out mortgages to people for no money down…That’s not what happens here….It’s illegal to have a zero down payment in Canada”
Let me break the math down for you: A minimum of 5% down payment plus 5-7% cash back from the banks = a no money down mortgage.
Now is this practice as widespread as it was during the US mortgage mania? Arguably not, but let’s at least get our facts straight!
“Monthly housing costs can’t exceed 32 per cent of gross household income, while the entire monthly debt load shouldn’t be more than 40%”
Well technically CMHC guidelines says they shouldn’t exceed that, but consider two facts here:
1) Ownership costs of a standard 3 bedroom bungalow eats up 50% of after tax income in Toronto, and nearly 80% in Vancouver.
2) In an effort to prop up the real estate market in 2008 (when affordability nosedived and the economy soured), the Harper government directed the CMHC to approve as many high-risk borrowers as possible and to keep credit flowing. The approval rate for these risky loans went from 33% in 2007 to 42% in 2008.
Taken together, it suggests to me that there is a pretty good chance that CMHC isn’t enforcing these guidelines quite as fiercely as the author portends. Any one with some insight here?
“The CMHC also charges people insurance if they put down less than 20 per cent. If there’s a default the lenders are covered.”
How this can be advanced as a reason for us to NOT have a housing correction is beyond me. So if I understand correctly, because the tax payers guarantee that the banks will never take a loss on their mortgages thereby creating a moral hazard, it means that the system is inherently more stable? That’s ridiculous!
“Once Americans began losing jobs and monthly mortgage rates rose, they started defaulting on their homes. That put more supply on the market than demand, driving prices to depths not seen in decades.”
As usual the cause and effect dynamic is represented completely backwards in articles like this. In the US, it was falling home prices and then falling home sales by extension that caused the unemployment, not the other way around. We’ve discussed the great connection between real estate and the broader economy at length on this blog. Apparently the author is not a regular reader.
And as for mortgage rates in the US, they continue to hover around historic lows!
“In Canada, there’s still plenty of demand. Lee says that 350,000 immigrants come to this country each year, so creating demand for housing.”
True. But consider that our immigration rate is not shockingly higher than that of the US. The CIA Factbook lists net migration rate in Canada at 5.63 per 1000, placing it in 15th place among all countries. The US net migration rate is at 4.32 migrants per 1000, placing it 22nd. While the Canadian total is higher, let’s not gloss over the fact that the US, by world standards, is still an extremely accommodating country when it comes to immigration. Bottom line: Immigration is not the holy grail of perpetually rising real estate prices.
“The report continues to say that while home prices are high, mortgage payments “are still well below dangerous levels.”
Of course they are! We have historically low mortgage rates and have extended amortization limits from 25 years to 35 years since 2007, including a brief experience with 40 year ams. Provided that amortization lengths continue to lengthen and/or mortgage rates remain at artificial historic lows, no problem. I see why the author is optimistic!
“According to the Canadian Bankers Association, in August less than half of 1 per cent of residential homes were in arrears.”
Moot point! No one defaults on their mortgage when home values are rising. Mortgage arrears in the US hovered just above one percent at the peak of their bubble, before rapidly shooting up to 10% today.
And as I’ve repeatedly stated, research shows that the primary reason for default is NOT affordability, but rather negative equity. At the tail end of a massive bull run in real estate, what would you expect the mortgage arrears to look like? This number has no predictive value!
“The business professor says that when rates rise housing prices will likely flat line for a few years.”
Sorry to burst your bubble here professor, but let’s consider the facts. Every one percent increase in interest rates translates into a 9 to 11% rise in mortgage payments.
The CAAMP report released a few weeks ago indicated that 16% of homeowners could not manage an extra $300 increase in mortgage payments and further noted that 11% of households would run into financial trouble if mortgage rates rose only 1.5%. I can’t fathom how a normalization in interest rates can possibly equal a sideways market, given these stats.
“Of course, it’s impossible to predict what will happen to our market, but according to much of the evidence, it’s unlikely we’ll be buying $1 million homes for a fraction of the cost.”
Just what sort of a fraction are we talking about? I’d be happy to take the flip side of that bet!