“Why we won’t see a housing collapse”….more media nonsense

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:

Why we won’t see a housing collapse

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!



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13 Responses to “Why we won’t see a housing collapse”….more media nonsense

  1. Leith says:

    Ben. The more I read this brilliant blog, as well as Garth Turner’s, I realize that Canada and Australia are in very similar positions, and our mainstream media, economists, property ‘experts’ and Governments are in total denial. Some times it feels like we are fighting a David vs Goliath battle against vested interests, but I know we will both be right in the end (and the end appears to be closer than many think).

    Keep up the great work.

    Cheers Leith

    The Unconventional Economist

  2. TS says:

    Here is another coming to this neighbourhood soon problem. It is foreign investment mortgages insured by CMHC. http://www.tdcanadatrust.com/mur/
    This is what fed and to some extent is still helping the condominium markets in Toronto and Vancouver. When values drop as interest rates rise these people walk. We lost good manufacturing jobs in Ontario and created an economy based on growth through long term debt at low interest rates. It was an illusion.
    Hope Toronto does not become a Detroit.

  3. rp1 says:

    I hope my house doesn’t collapse 🙂

  4. rp1 says:

    I wouldn’t rule out the Japanese scenario so quickly. It had a lot to do with demographics, an unwillingness to clear bad debts, and the tendency of a certain generation to maintain uncompetitive incomes for themselves at the expense of younger generations.

    • Some of the same factors are at play, most certainly. But when you look at a chart of Japanese home prices and their parabolic move beyond their long-term mean, we are no where near that sort of a bubble. That’s not to say ours won’t hurt, but we won’t be another Japan.

  5. Mark in Perth says:

    I read this blog, Leith’s blog and Garth Turner’s blog daily because you guys are providing exactly the kind of background info and context that is missing from even the Weekend Australian. I lived in Vancouver in the 1980s and 1990s, and have lived in Australia since 1995, and I agree that both Australia and Canada have essentially the same real estate bubble — for the same reasons — while the mainstream media are in total denial about it.

    Keep it coming.

  6. breezer1 says:

    to the point ben. now if you might also show how many homeowners that will be underwater on their #1 asset when they retire ,well ,that might be very scary.

  7. John in Ottawa says:

    Canada is a vast country and the “correction” will be different in one market to the next. Markets that are two to three standard deviations from the historic trend line should expect prices to revert to the mean. That is going to feel like a collapse to those affected.

    It is important that we not lose sight of Canadian’s debt to GDP ratio. It is on par with that of the US at the peak of their housing bubble. Americans were using their homes as ATMs, through the so-called “wealth effect.” With stagnant incomes and so much to buy, credit card debt was being consolidated into mortgages at a stunning rate.

    Americans had a huge incentive to consolidate into mortgage debt due to mortgage interest tax deductibility, something we don’t have. That does not mean that the same thing isn’t happening here. Last year 20% of Canadian mortgage holders refinanced or took out HELOCS, to the tune of $42,000 on average, and the majority used the money to “pay down debt.” Taking on debt to pay down debt is just another term for consolidation.

    While house prices are rising, it may seem safe to indulge in credit card debt with the assurance that the credit cards, with their 18% to 24% interest charges can be dealt with through the house ATM. But there is a trap. What happens when the credit cards have been maxed out again, but the ATM is closed because house values have peaked, even if the peak looks, for a time, like a plateau?

    Clearly, the spending stops! Consumption stops and saving becomes paramount. To an economist, saving and paying down debt are the same thing. In the US, the savings rate went from negative to positive in a hurry. Debt has been shrinking dramatically in the US in the Finance, Business, and Household sectors at a dramatic rate. The only thing propping up the US economy is the offsetting increase in Government spending (through debt financing). Negative real interest rates and record low mortgage rates in the US have not enticed the private sector to borrow and consume.

    It has been shown that the rate of change in savings/consumption has a dramatic impact on aggregate demand, that is as the private sector’s psychology changes from taking on more debt to saving, or debt reduction, aggregate demand plunges. In the US, it plunged further and any time in recorded history, including the Great Depression. Nothing the Government or the Fed has done has managed to do more than put a bandage on this gushing wound.

    As aggregate demand plunges, unemployment surges. The unemployment depth and breath has increased dramatically in the US in recent recessions. The current unemployment recession is the longest and most dramatic since the Great Depression. For many Americans, it is a Great Depression.

    It is difficult, actually impossible, for me to believe that Canadian’s can somehow manage to bridge a deep drop in aggregate demand, similar to the drop in the US, and somehow simply maintain, or plateau, our housing prices. The inability to go the the home ATM will dramatically affect the psychology of the wealth effect and Canadians, like our American cousins, will begin to save. The construction industry will come to a screaming halt and unemployment will rise further.

    Considering interest rates, we don’t have all the tools available to us that the US has available to them. We are not the reserve currency. We don’t have China and the Middle East (Saudi Arabia) covering our backs, let alone the Federal Reserve. The US government can take on virtually unlimited debt and engage in quantitative easing to control bond rates (with varying degrees of success). We can’t. Being the reserve currency has its privileges.

    We have to consider ourselves more in terms of European nations. Our debt levels, in their various forms, are not dissimilar to those of Ireland and Spain. The Bank of Canada is unlikely, in my view, to raise rates again soon. However, we do not have the luxury of assuming that bond vigilantes will not turn their sights on us. But Ireland has the German tax payers to bail them out. Who bails us out. At the slightest sign of weakness, Canada’s long term borrowing costs, which directly affect five year mortgage rates (think five year ARM), could increase dramatically, far beyond the 2.5% threshold that Canadians are considered able to endure. Just this week the TD bank raised it’s mortgage rate by 25 basis points in reaction to the short term rise in US interest rates.

    QE II is designed to reduce long term interest rates. The TD bank knows this and is clever enough to know that the recent rise in rates is most likely simply a very short term artifact of front running the Fed and won’t last. Is the TD bank feeling a bit sensitive, perhaps a bit exposed?

    This is a rather long comment and I apologize for that. I thank those who took the time to read it through. The bottom line is simple. Yes, our banks may be on a fairly solid footing, but Canadians aren’t. We are exposed to a very high debt load, a continuing world wide financial crisis, a capricious commodities market, and, in many markets, a dramatic housing bubble.

    Our federal government does not have the fiscal and policy tools to continuously bail us all out in a manner similar to the US. Can you imagine Harper extending unemployment benefits to 99 weeks or the Bank of Canada buying up $125B of mortgages? No other country’s tax payers will bail us out except through the IMF with the resulting forfeiture of fiscal sovereignty. Canadians will begin to save (pay down debt) again and GDP will plunge. If you, personally, want a “soft landing” you had better make sure you have a good parachute.

  8. LRM says:

    Nice comments John in Ottawa.
    Given your view, how do you see interest rates going over the next 5 years. Are you of the opinion that rates will decline as BOC tries to keep the GDP from dropping . How soon do you see the “bond vigilantes” bidding up Can bonds yields??

    • John in Ottawa says:

      I wish I could give definitive answers, but I can’t. I didn’t think the BoC’s last rate increase was justified under the circumstances. The recovery is weakening so I expect a wait and see attitude from the the Bank. Low interest rates create bubbles, but rapid rate increases can prick bubbles where what we need is a controlled deflation. We’ll see.

      As for “bond vigilantes” attacking Canada, I think that depends a lot on how the Government responds to bursting credit and housing bubbles. Canada stands alone and the Government knows this all too well. I expect (hope) Harper will continue to deepen austerity measures. Better him than the IMF. He may have to navigate a long slide down the other side of the bubbles. It isn’t good politics, but it is good medicine. Painful as it may be, I think Canadians are up to the challenge.

      Keep an eye on Australia for clues.

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  10. canali says:

    hey some realtors still insist–and even offer incentives to prove them wrong– that vancouver RE is still fairly priced…so all is good:

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