An alternate viewpoint on Canada’s credit bubble

Merry Christmas!  I said I wouldn’t post again until the 27th, but I noticed this gem of a comment from John in Ottawa.  I’ve reposted a couple of his comments before.  They are always well thought out, weighted, and insightful.  This one is no different.

John sees a more muted correction in house prices concentrated in certain locations, while I fear that this mild correction will cause a negative feedback loop in credit demand leading to highly deflationary conditions.  I’m worried that this mild correction will choke off consumer spending, which currently makes up 65% of GDP and lead to anemic growth for some time.  We agree that a US style meltdown is likely not in the cards and that deflation is the bigger concern going forward, though I think I probably forecast stronger deflationary pressures.  We certainly both see the risks posed by weak household balance sheets.  Enjoy!

-Ben

I complained a few weeks ago that it is difficult to get demographic data in Canada. The data exists, but it can be very expensive to access and little of it has been digested and presented in easily accessible forms.

This paucity of information means that the public is fed averages and aggregates which can be very misleading in a heterogeneous environment.

Thankfully the University of Toronto has done some of the work for us. Their work gives us a glimpse into the demographic breakdown in Toronto and provides us with a clue as to how mortgages my be distributed and their relative size and, possibly, default risk. It also gives us some insight into the issue of so-called bubbles.

Have a quick look through the media release.

It shows that Toronto has subdivided itself into three economic tiers with upper income earners in the core, middle income earners forming a buffer zone around the core, and lower income earners in the periphery.

A commenter a few weeks ago suggested a similar situation was occurring in Vancouver.

The take away point from this is: A wealthy enclave can significantly distort average prices.

The “fact” that still seems to be in dispute is whether or not there is a “bubble” in housing prices in Canada. In the past ten years, most regional housing indexes have doubled. That’s a 7% annual increase and significantly above the inflation trend. However, in the past 30 years, the index has only doubled, and that is a very poor return on investment indeed.

In the same ten year period, housing indexes in Australia have gone up five times. The bigger the bubble, the bigger the crash. Also, it should be noted, in the US, the biggest bubbles were in lower valued homes. Higher valued homes did not rise as much in percentage terms and have not fallen as much.

Now, we still have the CAAMP report to deal with. However, the CAAMP report is proposing that Canadians are too indebted and are unable to weather an interest rate shock. This is a significant worry.

Nothing I have written is intended to suggest that house prices are going to merrily continue rising. It is provided to suggest that we may very well not see a US style collapse, or even an Australian style collapse when it occurs.

Our “bubble” is much more muted than either the US bubble or the Australian bubble. Additionally, the US mortgage situation leading up to the crash was criminally fraudulent on a huge scale, leading to the financial crisis and the bailing out of the TBTF banks. There has not been any suggestion that a similar fraudulent mortgage origination situation exists in Canada, and thus far our “sub-prime” mortgages are performing within normal risk bounds.

The meme in the US was that house prices always go up. In general that was true until last decade’s crash. We never had that reality in Canada, even though we may have inadvertently adopted the meme. House prices in Canada have had significant corrections in the recent past.

My prediction remains that, in general, aggregate house prices will soon begin to trend down. Certain classes of housing will trend down at a greater rate than others. Some neighborhoods may experience a “crash” just as some unemployed are experiencing a depression long after the official recession ended. This general trend will last a very long time as the boomer overhang is absorbed.

The risks to Canada’s financial health remain, as always, more from exogenous factors over which our government has no control, than from internal factors. The key internal risks I see are consumer debt in general (although I would like to see a demographic breakdown), pensions, municipal and provincial debt.

My long term outlook, this far, remains deflationary.

-John in Ottawa

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6 Responses to An alternate viewpoint on Canada’s credit bubble

  1. jesse says:

    “A commenter a few weeks ago suggested a similar situation was occurring in Vancouver.”

    How is this any different from 20 or 30 years ago? Toronto and Vancouver have had economic stratification between neighbourhoods for as long as I can remember. It may have been exacerbated in past years (in part due to higher prices only being able to be afforded by those with higher incomes) but the average is the average: plopping a bunch of high income owners in one neighbourhood robs such earners from the others.

    That said, a neighbourhood I’m familiar with in Toronto has seen significant income gains in the past 30-40 years. A street once inhabited by decidedly middle class tradesmen is not full of professionals and managers. From that POV that particular neighbourhood has seen prices justifiably rise significantly above inflation. The same I see true of Vancouver west side.

    • jesse says:

      A street once inhabited by decidedly middle class tradesmen is NOW full of professionals and managers.

      • Absinthe says:

        The link suggests the biggest change from 20 or 30 years ago is that the middle class is disappearing – that there are greater rich and greater poor, and so the mid space is shrinking.

        OTOH, they show the average income of the rich areas in Toronto is $200K/year. Likely other wealth, too. Still, if Vancouver’s demographics are similar, many of our *rich* are house poor and vulnerable to crash.

  2. Paul says:

    John,

    Are your predictions are still based on the fact that you “don’t want to live in a constant state of emotional depression”?
    Because if they are, they are just as worthless as the “we need energy (fusion?!… in a depression?!) therefore we’ll get it” stuff you mentioned concerning peak oil.
    What we want and what is feasible now are very different things indeed. And it seems not much is feasible at this point.

    Still I love the intellectual effort.

    Regards,
    Paul

    • John in Ottawa says:

      Paul, I have a great deal of difficulty understanding your comments. Just me I’m sure.

      As to energy, cheap oil will become more and more difficult to come by. It is well established, by the DOE and the US military, that fossil fuel dependence is a serious problem. My point, when I commented on energy, is that the rate of decline in supply will not be as drastic as was originally forecast by those looking at the Hubbert curve. The simple reason being that dwindling energy supplies will constantly throw the economy back into recession.

      As for energy replacements, the only energy source currently contemplated that can provide the enormous amount of energy fossil fuels have provided over the past 150 years is fusion. While it is not feasible now, it is surprising what technologies become feasible when the need arises, particularly when financial barriers are removed. So all we can do is remain hopeful.

      Perhaps you are a Nicole Foss acolyte and truly believe all is doom. It may well be, but that is not a reason to crawl into a hole and die. For now, it is better to be hopeful and trust in the ingenuity of the human race.

      I’m off to stimulate the economy of Florida. Happy holidays.

  3. The Masked Haranguer (Formerly Avenger) says:

    Loved your article! Thanks for substantiating the point I have made many times:
    The mortgage situation in Canada is not remotely close to what was going on in the US (This point was made primarily while fishing and waiting for a certain community college professor to tip the canoe and dump us into the lake!).
    There is a correction coming! How severe and where will be played out in 2011!
    Merry Christmas to all and best wishes for a prosperous new year!!

    T.M.H.

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