Another look at mass psychology, asset bubbles, and the Canadian real estate market

Understanding the driver of asset bubbles

Perhaps the greatest distinction between those economists who have correctly identified asset bubbles in the past and those whose economic models failed to identify them is the ability of the former group to recognize the role that mass psychology plays in building asset bubbles.

My personal belief is that an asset bubble needs several key components in order to be birthed. It’s difficult to say which comes first, but I do believe that an asset bubble requires the following:

1) A new and widespread optimistic sentiment towards an asset. This is often a ‘new era’ story in which all potential restrictions on growth are explained away. Consider the tech bubble of the late 90s in which the mind blowing prospects of a new internet economy caused people to abandon all reasonable skepticism. One company that sold toys over the internet and was in fact losing money on each transaction had a higher market cap (number of shares outstanding multiplied by the price of each share) than the largest and most profitable toy retailer, Toys ‘R’ Us. Similarly a company that sold plane tickets online and had razor thin profit margins was considered more valuable than some of the largest US airlines (and consider that these airlines actually had tangible assets like airplanes).

In hindsight, the whole thing was ridiculous. But you couldn’t help being caught up in the emotion and awe at the time.  Lest you think this same dynamic is not at work at least to some degree in Canada, let me highlight just a few memes you’ll likely hear in any discussion of real estate in Canada:  “House prices never go down”….”Buy now or be priced out forever”….”Wealthy immigrants will keep house prices high”….”Best investment I ever made”…..

In fact, we could look to the most recent RBC opinion poll which found that well over 90% of Canadians view real estate as an excellent investment.  For why this is potentially problematic, check out this primer.

2) Abundant credit. Historically, the largest and most painful asset bubbles often involved significant leverage created by loose credit conditions. It’s the nature of leverage that makes the crash so painful. Consider real estate in the US. If a new home owner purchases a $200,000 home with a %20,000 down payment, they have a 10% equity position at first. But if real estate drops by 10%, they have now lost 100% of their equity.

It’s this leveraged element that generates fantastic profits on the way up, but cuts deep on the way back down. I think we’ve spent quite a bit of time examining how this dynamic of abundant credit is impacting our real estate market. Consider that a little over a decade ago, a $20,000 down payment would get you a CMHC insured mortgage of $80,000. Today that same $20,000 gets you a mortgage of $380,000.   Not hard to see how this will impact house prices.  This is where CMHC has played such a massive role in bloating house prices….despite their mandate to “help Canadians access…affordable homes”.  Of course it’s even worse than that since you can actually purchase a home with zero equity. If you’re interested, here’s a step-by-step guide on how to blow your brains out on mortgage debt:

Step 1- Borrow the 5% minimum down payment on a credit card or from a family member…….Step 2- Take advantage of the 5% cash-back mortgage offered by almost all of the big banks…….Step 3-  Buy the house you want.  Make sure it includes granite, stainless steel, and double the space you really need…….Step 4- Once the deal closes, pay back the down payment with the cash the bank gives you as their thanks for signing up for a lifetime of debt servitude.  Enjoy your new home (which is actually just a rental as we know that a home without equity is just a rental with debt).

3)  A persistent and significant deviation from underlying fundamentals.  For stocks, people often reference the price/earnings ratio.  In the case of real estate, we can reference price/income, price/GDP growth, price/rent, overall affordability, etc.  Once these start showing a significant and persistent deviation from their long-term norms, we should get suspicious…..and house prices are doing exactly this by the way.

4)  A feedback loop where rising prices become the justification for rising prices. Once the three previous elements are in place, you have all the necessary components for a virtuous feedback loop.  The power human emotions of fear, greed, and envy become the motivator for many to jump into the market, spurred on by the stories of easy riches made by co workers and friends and fearful of being left behind.  Eventually the rise in prices becomes the justification for rising house prices.

It’s here that we are wise to remember the teachings of the Wall Street legend, Bob Farrell, whose rules for investing offer timeless wisdom. Two in particular are worth remembering:

“Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways”

Indeed it is the seemingly limitless supply of ‘Greater Fools’ who keep irrationally priced markets buoyant for longer than would seem possible.  But alas there is a finite limit.  Reaching that limit seldom (if ever) results in a sideways market while the pool refills.

“The public buys the most at the top and the least at the bottom”

Sad, but true.  Remember this at times like these when sentiment towards real estate is exceptionally high and nearly everyone is convinced of a rosy future picture for housing.

As house prices have risen, no longer do people reference economic growth as the justification for high house prices since that correlation has long since been broken.   No longer do they reference rising wages, inflation, or any other fundamental, since none of them serve to explain the rise in price.  Instead they are left explaining that house prices rise simply because they rise.  They respond accordingly by piling in and driving house prices higher…..which encourages others to dive in….rinse, repeat.

That’s a quick fly-by of the dynamic that creates asset bubbles.  Now let’s take a minute and zoom in on the element of mass psychology.

Another look at mass psychology

Interestingly, Re/Max released a ‘report’ yesterday which nicely highlights the workings of mass psychology.  (As an aside, I am constantly amazed that this self-serving propaganda is lapped up by the mainstream media as reliable and newsworthy information).

“Driven by the threat of higher interest rates down the road, first-time buyers are contributing to strong upward momentum in residential housing markets across the country”

I actually don’t doubt that this is true, though I question what that implies about sales levels going forward.

“Despite homeownership rates approaching 70 per cent, there is clearly room for growth as entry-level buyers make their moves from coast-to-coast, undeterred by higher housing values and changes to lending criteria”

This statement is highly suspect.  We’ll take a closer look at home ownership rates in a moment.

“While some may feel discouraged by eroding affordability levels, the underlying confidence in the concept of homeownership is rising….“While market conditions are one thing that influences first-time buyers, few things trump the fundamental belief in homeownership”

Well that pretty much sums it up, doesn’t it?

My position has been that the overall impact of cratering interest rates by the Bank of Canada and loosening credit requirements via CMHC has been to pull demand forward.  The propensity of humans to find comfort in herd behaviour and the impact of positive reinforcement as people have seen house prices rise well beyond incomes, inflation, and other underlying fundamentals have created the very mentality succinctly described by Re/Max.  The big question is whether or not this is benign.

One way we can quantify this dynamic at work is by examining home ownership rates which we know are at historic highs and have increased across all demographics, firmly dismissing the notion that the rise in ownership is simply a result of an aging population.

Note that this data stops in 2006.  Given the rise in ownership since that time, any guesses as to what the latest census data will reveal?

Furthermore, if we look at the new CMHC mortgage loans as a percentage of total population, we see the following trend:

Note that this includes those who have renewed their mortgage as well as new mortgage originations.  This is CANSIM table 027-0017 if anyone wants to replicate the graph (you’ll also need to track down population data).  Note also the significant difference between the 2000-2009 period and the earlier period.  My belief is that our credit bubble began in the early 2000s and intensified since 2004 as CMHC lending requirements were eased and the element of mass psychology took root.

So just how high can the ownership rate go?  This data suggests that the buyer pool is already thin.  The danger from here is that those who have not yet bought are increasingly made up of people who either can’t afford to buy or those who see high house prices for what they really are.  Given our propensity to think as a collective, all it takes to induce a buyer strike is to break that “fundamental belief in homeownership”. Exactly what will trigger that remains to be seen, though I suspect that a modest fall in house prices will be enough.  Should this fundamental belief be shaken, the same dynamic of mass psychology that drove prices higher will act as a dead weight on house prices moving forward.

Cheers,

Ben

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61 Responses to Another look at mass psychology, asset bubbles, and the Canadian real estate market

  1. Joe Q. says:

    Good post Ben. I would add one more ingredient to your bubble prerequisite list: some measure of uncertainty in the valuation of the asset in question. Seems to me that bubbles inflate more easily when no-one has a clear idea or metric for what the value of the asset is.

    If you haven’t already read it, I highly recommend The Ascent of Money by Niall Ferguson. He examines a number of bubbles throughout history and the scandals that brought them down. A good read.

  2. Tyler says:

    Ben,

    I’ve been following this blog for a few months now, and I can’t wait for the buyer strike to begin. I’ve got a sizable down payment and I have a few years to see how the market goes. Thanks for all your insight.

  3. Alex says:

    Ben, I don’t know why you’re surprised that the mainstream media “laps” this up. It is, after all, funded heavily by the real estate mob.

    I’m currently in what I suppose is the third stage of a complaint I submitted to the CRTC/CBSC over Global TV’s handling of a pair of NON-news real estate-related NON-stories it somehow saw fit to air (and totally exagerrate) a couple months back. I’ve put a lot of work into it so far, and I can only hope the ruling will be in my favor. From what I can gather, a ruling in my favor might indeed result in changes to what the media can and cannot do. I know some people will look at that and say “fat chance,” but hey, if more of us didn’t just sit back and take this bullsh*t, we’d probably be a better nation.

    My question though: Isn’t it just straight-up ILLEGAL for a “trusted” news organization to take a marketing department’s press release or a marketing department’s PR stunt and pose it as “news”? Over and over and over and over again? While at the same time minimizing any of the *real* news that might indicate housing is NOT a good investment/purchase right now?

    Considering the vast majority of the public gets their info from such “trusted” sources and believes what it sees, and considering ReMax itself has indicated in its latest propoganda that “first timers” (those who would seemingly be most impacted by slanted clips on the evening news) are most responsible for driving the current market, this filthy practice CAN’T be legal, can it?

    • John in Ottawa says:

      I don’t know whether it is illegal or not, but when I was in business the Ottawa press got annoyed with me when I didn’t send out enough press releases. I guess they needed to fill space. The Citizen once reported something to the effect that I didn’t do the press any favors.

      Most of the “product” news we read, and real estate is a product, is just press releases. Journalism isn’t what it used to be.

  4. jesse says:

    I would add a #5. People in Canada generally prefer to own. When the ability to own is enhanced by the other factors you cite, people will have a propensity to shift from rentership to ownership and will even pay a premium to do so, driving up marginal prices. This must be unsustainable because buy-to-let investors will eventually act as marginal buyers.

  5. Leo Lee says:

    The current 24/7 news cycle has really done an injustice to “public information”.

  6. MB says:

    I think it would be helpful to show detailed data for a US city that has gone through a real estate crash such as Las Vegas, Phoenix, or Miami.

    Look at what their real estate stats were showing prior to falling prices. What was the inventory doing, were sales dropping, was the time on the market getting longer? Did prices start falling in the suburbs first or the other way around?

    If there is a pattern in this for a couple of cities, then the ‘time lag’ can be calculated between, say falling sales and falling prices, and you can make a much clearer forecast of when prices will tumble.

    • Good idea. I’ll see what I can find.

      • Howdy There says:

        MB,

        If you’ve got the time, there are years worth of archives at Ben Jones’ Housing Bubble Blog that cover the US crash. Now that the US is well past the popping portion of the bubble, the HBB is more focussed on the clean up (or lack thereof) and the related politics.

  7. jwg says:

    Hi Ben,

    I recently discovered and am enjoying your posts. I’m wondering if you have ever considered property tax policy as a factor in local RE bubbles. I’ve seen it argued that one of the reasons for high Vancouver prices is that the tax burden is unusually slanted in favour of residential vs. commercial property and that tax on a home is considerably less than tax on a property of same nominal value in Toronto. In Vancouver, condo developers are responsible for various related infrastructure costs, which keeps taxes relatively low and pushes up the price of new homes, thus jacking up prices across the city.

    • Hi JWG

      Welcome to my humble blog! The tax burden for similarly priced homes in BC is indeed less than in Ontario, but the rub is that we should be comparing homes of similar characteristics, which we know cost substantially more in BC.

      Here is a link to property taxes in Vancouver:
      http://vancouver.ca/fs/budgetServices/taxrates_2010.htm

      If I’m reading this correctly, 600K house in Vancouver would pay about $2500 in property taxes.

      Here is the link for Toronto for comparison purposes:
      http://www.toronto.ca/taxes/property_tax/tax_rates.htm

      The same 600K house would pay about $5000 in taxes, or roughly double. But compare what 600K buys you in each city! Not exactly an apples-to-apples comparison.

      Ultimately we’re talking about a difference of $200 a month. If we put that in perspective, a person buying that 600K home with 10% down and the remainder financed at a low fixed rate of 3.5% and amortized over 30 years would have monthly payments of just over $2400 per month. The $200 per month difference in property taxes is not insignificant, but certainly does not justify the premium required to purchase a similar house in Vancouver.

      As an aside, consider that if said buyer had to renew at 4.5%, the 1% rise in interest rates boosts monthly payments to over $2700, or more than the difference in property taxes. The random point here is that interest rates are of far more importance in determining affordability than taxes, though both are set to rise over the next few years.

      Great question! I hope that helps.

      • jwg says:

        Thanks for that quick and informative reply. It seems to me that there is a futher point regarding our comparison of 600K apples and oranges. The difference in taxes as a percentage of the overall debt load is one issue; but how about the impact on the price of new housing? If a developer in Vancouver has to provide land for parks or schools or social housing at a higher rate than in other cities, as i have seen claimed (but not shown), raising the cost of entry into condos, then Vancouver’s lower (or more indirect and inequitable) tax environment has further consequences in blowing up prices.

  8. John in Ottawa says:

    I’m not sure I understand precisely how to interpret your graph of home ownership proportion by age group. It appears from the two graphs that roughly 68% of households in 2006 were homeowners up from 60% in 1971. How then do I read the age groups within the graph. It can’t be that in 2006 78% of homeowners were aged 55-64 and 77% were aged 65-74. The proportions should add up to 100% so I’m clearly not understanding the graph.

    There are some other valid ways to look at the home ownership data. A lot of the increase in home ownership is in the age 55-74 group. It would appear, perhaps due to better health and social programs, that they are better able to remain in their homes.

    With the 55-74 group remaining in their homes, this reduces the pool of homes available for the younger cohort to purchase. I don’t think we should worry about the ability of the 55-74 group to make their mortgage payments. Most of those homes are already paid for or have small mortgages remaining.

    It would be interesting to do the calculations of precisely how much the 55-74 group , and indeed each group, has added to the percentage of home ownership over the past forty years.

    • jesse says:

      “this reduces the pool of homes available for the younger cohort to purchase.”

      It is possible this is occurring but simply leads to under-utilization of housing, in other words, a huge “shadow inventory” of bedrooms slated to come on the market as empty-nesters start to move to smaller accommodations.

      In many parts of Canada people have large amounts of their wealth tied up in property such that they will require its equity to fund their retirement plans or simply subsidizing the lifestyles of their children/grandchildren. At some point downsizing and taking cash in hand, not tapping a LOC, is the best way of accomplishing this.

      • John in Ottawa says:

        Come on, Jesse. That’s pure speculation. The census says we are staying in our houses! A “shadow inventory” of bedrooms as a result of us poor, destitute, ill prepared boomers trading down? Just wait until we start popping off. Then you’ll see a shadow inventory, or should I say a ghostly inventory.

        I know we are all seeking a housing crash, or the rapture, or some such thing, but let’s not stretch too far.

      • jesse says:

        There has been overbuilding in Canada, not a lot but a reasonable oversupply. In terms of total bedrooms I would argue there has been a larger increase in supply than the stats suggest due to an influx boomer children leaving home and occupying condos (just look at ownership rates of under 30s on Ben’s graph), but leaving bedroom “holes” at their parents’ homes. Just throwing it out there… maybe there is more oversupply than we think by this measure.

        Don’t know much about retirement savings, but here are excepts from a report 4 years ago (these guys want mortgage interest deductibility to help with the retirement shortfall):

        http://www.actuaries.ca/members/publications/2007/Final%20CIA_Retirement_e.pdf

        “Given that approximately 70 percent of the population of our study is projected to have home equity, it appears that for a significant portion of Canadians, the adequacy of their retirement income will be dependent on the value of their home’s equity. …

        There is considerable speculation on what the impact on house prices will be as the baby boom generation retires. Some argue that the baby boomers will all wish to sell their houses at about the same time, driving down prices. This would be cruel irony if those same baby boomers are counting on the value of home equity to provide adequate income in retirement. Others argue that in major urban areas house prices are undervalued, on a global scale, and that there will be continuing demand to reside in urban areas which will continue to drive house prices upward. Rather than adopt either of these views, house prices have been projected to increase at the rate of inflation.”

      • Howdy There says:

        “I don’t think we should worry about the ability of the 55-74 group to make their mortgage payments. Most of those homes are already paid for or have small mortgages remaining.”

        John, I wonder how true this is. Intuitively it makes sense and what one would expect, but there certainly has been plenty of annecdotal evidence that many US retirees/near retirees are carrying large mortgages for various reasons. Some kept trading up or bought vacation properties. Some kept refinancing and spending the proceeds. Given the current average debtload in Canada is around the same as the US before the crash, it’s possible we have similar problems.

  9. Sams Mango says:

    Wow, the bears are really holding hands and singing “kum ba ya” tonight…

    • Will says:

      I agree! The data is pretty interesting though, and definitely spun in a way that favours the bears…

      While I would consider myself bearish as well, it would be really interesting to see this blog evolve into a balanced, two sided review. For instance, if Ben could find a volunteer Bull that would want to take the exact same data set, and give it an uncensored Bull spin, it would be very interesting to see that side of the equation. So far I have not come across a blog that offers this type of comparison and I think it could be very interesting.

      • Sounds like an offer, Will. I’ll be happy to post your alternate take on this data. If not you then perhaps one of our resident bulls….

        Ultimately this is where I post my musings. I have a bearish slant because, frankly, that’s where I see the data pointing. Not all of it, but certainly the majority. If you read my round-up of the latest board figures, you’ll note that I recognize markets with significant strength and those with significant weakness. If I am ‘spinning’ the data, I’d love to hear the alternate perspective.

      • Sams Mango says:

        the positive spin can be found on remax’s website combined with Global news in Vancouver.

      • Will says:

        I don’t think I’m nearly Bullish enough to give it a fair shot! I was definitely aiming for one of the resident Bulls to take factual, current data, and give that a Bullish spin.

        And SM – the whole idea is to have Bullish arguments based on actual data, not three month old press releases that aren’t based on anything! I think that’s the exact trouble that most have with the Bullish press – there is no argumentation, no underlying facts, etc. If there are, they aren’t made public.

      • John from Montreal says:

        ” I think that’s the exact trouble that most have with the Bullish press – there is no argumentation, no underlying facts, etc”

        Maybe the reason bullish don’t use datas to prove their point is that they can’t. Datas don’t support that view.

        I think it is a great idea though, i just think it won’t happen. I researched the web for a bullish blog that is basing opinions on facts and charts like ben does. Couldn’t find any.

      • John in Ottawa says:

        @ John in Montreal. The reason you don’t find real estate blogs with a bullish spin isn’t because the data can’t support it. It is because real estate blogs are not about bullish or bearish real estate markets.

        Real estate blogs are about whether or not there will be an American style housing crash with bank failures and tax payer bailouts that our grand children will still be paying for in their old age.

        If you are only interested in whether to be bullish or bearish about real estate, then you need to know that over a lifetime you will encounter times when GDP, inflation, what ever gets ahead of the market and there are times when it gets behind. Lately it has been behind which is bullish. To avoid the next bearish period, I would suggest you hold off on buying a house for about ten, perhaps fifteen years.

        Failing that, ensure you can handle a 10 to 15% correction. There is a reason CMHC sets their mandatory insurance threshold at 20%.

      • Sams Mango says:

        That data it self is very bullish

        Strong eco
        Strong jobs
        Low rates
        Low population

        Need I say more.

      • John from Montreal says:

        @john in ottawa : if you’re saying to me that real estate blogs are not about bullish or bearish real estate than you’ll have to define those words. For me it means optimistics and pessimistics.

        I don’t wan’t yo find a bullish blog to find out if i want to be bullish or bearish but simply to have an other side of the coin based on facts.

        Anyway, if you don’t like me using the words “bullish” an “bearish” i won’t.

        What i want to know is if there will be a sudden diminution of prices in a short period of time (like Ben is talking about) or a stabilisation of prices for the next 10 years (like re/max is saying) but with arguments based on facts and not cristal balls.

  10. John,

    The graph showing home ownership rates indicates what percentage of that particular cohort are owners. The numbers make sense.

    I’m also not sure I’d be too quick to dismiss what Jesse is saying. Granted the data is sparse, but what little data their is seems to suggest that there are many near-retirees who are woefully underprepared for retirement. Anecdotally, I personally know of a handful of such cases where they are in fact counting on their home to fund their retirement. One I can think of, two kids in post secondary, early 50s, literally refers to her home as her retirement fund.

    Take it for what it’s worth, but I do think there are a number of people counting on home equity to fund their retirement. How exactly they plan on freeing it up is a huge question. They dont NEED to sell, but it is quite likely that many of them will find that they are not particularly interested in the maintenance, heating, and high taxes that go along with the larger home.

    All speculation, but I wouldn’t dismiss it entirely.

  11. John in Ottawa says:

    Hi Ben,

    Thanks for the explanation on the graph. Now I understand it.

    I didn’t dismiss Jesse. I gave him heck for a) speculating and b) abusing yet another American term, shadow inventory. Now he wants to call my extra bedroom shadow inventory. I call it my Den! Hands off.

    Jesse answered my accusation that he was speculating by quoting some actuaries who specifically state that they are speculating. Good one!

    As for our homes being our retirement funds, I don’t know a boomer in the world who hasn’t uttered that one. My parents are in their 70s/80s and refer to their paid for home as their retirement fund. At some point they think they may take a reverse mortgage. Why the heck not? They like to take $40,000 ocean cruises every summer.

    Crash or no crash, my house will be worth a very great deal of money by the time I meet a natural end. I would like to leave this house in a pine box. If I plan my finances perfectly, I’ll stick the kids with the bill for my funeral! I’m quite sure that as we boomers age, the financial industry will find some way to help us get the equity out of our homes that isn’t as clumsy as the current reverse mortgage. Where there is a market, there is always a product.

    Maybe, being the largest and most influential voting block, we’ll figure out a way to do it with legislation and stick you kids with the bill. We’ve stuck you with everything else. Maybe something like a full equity tax credit and 100% inheritance tax. That might do the trick.

    Speaking of anecdotes, being a boomer, I have a few boomer friends. Only one of my boomer friends decided to sell. They had a home in the country, just like me, and decided that they would rather not deal with the large garden and snow shoveling in the winter. So they bought an expensive new condo downtown where they can suck lattes in outdoor cafes during the summer and a home in Florida (strong dollar, depressed prices) where they can golf all winter. Of course, now we hardly see them.

    Most of us boomers don’t want to leave our homes, our friends, our neighbors, our comforting surroundings in order to free up the equity trapped, yes trapped in our homes.

    Look, we boomers are the pig in the python. The market has had to deal with us the whole way through. We created unprecedented employment, drove up housing inventory, invented the internet, PCs, cell phones, flat screen TVs, and air bags. We also invented global warming, exhausted the bulk of the world’s natural resources and depleted the ozone layer.

    As we age and die off, we will leave a hole in top jobs which youngsters will eventually get to fill (Gen Y, not Gen X), we will use up all your tax dollars on health care, CPP, and OAS, and yes, we may depress house prices slightly as the bedrooms we leave behind prove to be too many for a smaller population. Or, just speculating, those bedrooms may be filled with Rwandan refugees.

    We wish to compare ourselves to the Americans. We adopt and abuse American real estate terms like subprime and shadow inventory. We peer deep into American statistics and try to find comparable Canadian statistics to suggest we are headed for the same disaster. Look at this depressing American list and try to come up with a comparable Canadian list. What we fail to do is look at the many, many ways we have it so much better than the Americans. They risk shutting down government because they can’t agree on whether to cut 2% or 4% of a 1.6 TRILLION dollar deficit. For all that, they don’t have health care.

    Canadian households take on new or renewed mortgages at the rate of 4%/year. The number of American households who entered foreclosure last year was just north of 2% (1 in 45). It is expected to be much worse this year. 60 Minutes did a show this past Sunday on Foreclosure Fraud, the massive mortgage fraud by the banks in the US. We’ll never see a show like that in Canada because we simply never had anything vaguely comparable to that.

    Look, long term, shelter is a losing proposition. I’ve done the math and posted the results here. We boomers who bought in the 70s haven’t made a dime on our purchase. Food is a losing proposition too. I’ve been buying food all my life and I haven’t made a dime on it. Don’t even get me started on gasoline. Buying a home isn’t an investment, no matter who tells you otherwise. It is how you put down roots in a community.

    • ATP says:

      John, I wouldn’t count your healthcare, CPP, OAS chickens before they hatch 🙂
      Check out what the young, jobless and angry are doing in the Middle East.

      • John in Ottawa says:

        Ha! There are no guns in Canada. We’ll gum you to death. And to find you, we’ll need look no further than our basements 🙂

    • jesse says:

      John in Ottawa maybe there is a different sentiment out east but in Vancouver I know many of my friends’ parents who are looking to downsize. They have not saved much beyond the value of their properties and CPP/OAS. In BC the savings rate is lower than the rest of the country. (And don’t say it is due to more retirees; the age demographics are not too different than other provinces.) Wages are lower compared to house prices and core price index. (Food gas and transportation are dearer than other provinces except Maritimes.) In sum there is good reason to think BCers are in much worse fiscal shape than their peers in other provinces but have been “saved” by their home equity. If that’s not a form of “shadow inventory” it’s as close as we can get. I’ll settle for “dormant” if you like!

    • Howdy There says:

      John, I’d like to point out a few things regarding your comments.

      First, the fraud in the US didn’t become evident until after their housing markets collapsed. Maybe there is fraud here, maybe not, but it might just take the tide going out to expose it. Fraudsters from the US wouldn’t hesitate to come to Canada or anywhere else, find a local partner and start running their racket. The only question is whether we have the systems in place to stop it, assuming the systems are functioning.

      Comparing ourselves to the US is perfectly rational. We learn from history, and why not let it be someone else’s history? Certainly conditions will be different, both over geography and time, but why discount similar critical factors because non-critical factors are different? Looking at the US won’t give us a perfect picture, but it certainly can help us predict the direction of events.

    • Financial Newbie says:

      John,

      Failing to see why you’re so against comparing Canada to the US? You seem to think we’re so much better off here, but I would suggest that just because our issues aren’t as obvious/prevalent it doesn’t mean we wont end up as bad off as the US… possibly even worse. During the Great Depression, Canadian GNP fell 40% compared to the US which only suffered a 37% decline.

      At the very least we should be looking to what’s happening in the US economy as a warning of how our economy will fare, considering the US is our largest trading partner. Their problems become our problems, even if in a different form.

      So while you’re probably right that things won’t play out here in Canada as they did in the US, they certainly could play out in different ways that hurt us just as badly. Our social programs (like health care) and institutions (like CMHC) might come back to haunt us with the debt/cost burdens they place on our already strained system. Having to adjust/scrap these programs/institutions could end up being a very divisive topic that generates animosity between Canadians…

      Anyways, I like that Ben tries to look at the risks within the broader Canadian system. A strong policy or program now could wind up being a dangerous liability in an unraveling future; it’s good to identify and discuss these issues rather than being unaware or dismissive of them.

  12. Versie says:

    Haha, a rental in debt. It’s really hard to buy and OWN an actual house these days, but I’d probably save a bit more than I need and hire a custom new home builder company to construct the house. Why would I do this? Well, think about it, you’re throwing huge sums of money anyway, why not make it personalized. I, for example, am a musician and I need large rooms with good acoustics, thus I’m getting a personalized house made specifically to suit my needs. I think it’s well worth the extra cost.

  13. pascal says:

    SHEEP SHUT UP! the bankers are putting you all with inflation and deflation …. in the street. They have done that over and over again. WHO can buy a shack house at 1-2 millions!

    • jason says:

      Who can afford these places? Well, not many Canadians, but with the immigration levels at an all time high, particularly in SK, remember that not only are people coming in, but so are there customs. Remember that alot of these people come from an upbringing wherein it is not uncommon to have 4+ income earners under the same roof. I just saw a house valued at 380G that I would not have paid more then 150G for sell to one of these “families” last fall. There are 4 cars parked out front of the house and at least 5 working adults. Thats who can afford these homes, and it’s destroying our own way of life and nobody seems to ever make mention of this.

      • Just as a correction, immigration as a percentage of total population is not near its all-time highs. The impact of immigration on house prices is negligible unless we are talking specifically about regions where building is hampered by geography or local restrictions…..and even then house prices have their limits.

        The construction industry is perfectly capable of keeping up with demand in the broader Canadian market. The real driver of house price increase is availability of mortgage credit, willingness to take on said mortgage debt, and low interest rates keeping the overall debt level manageable….for now.

      • TS says:

        It is changing our way of life not destroying it. That change was put into play a long time ago when free trade grew. As the BRIC’s rise we will have to adapt. Our consumption lifestyles are being challenged and altered. Nothing wrong with that. It will be painful but we will have no choice but to adapt.

      • jason says:

        Referring Primarily to Saskatchewan here. I know that there are incentives for immgrants to Canada to take up residence in SK, including, but not limited, a more speedy residency status/acceptance. You may be correct as well in stating that immigration is NOT an all time high, as I suspect a large number of these people are coming from out east as well. The drivers you mention are key, but I will not discount the immigration…be it from within CDN borders or not, because I am seeing it. I am seeing larger families take mortgages that a typical SK family would not be able to comfortably. I have no doubt that these new residents will head east eventually. And to you TS, as liberal as you may be, decreasing myself and my families chances of finding a home at a reasonable price is NOT a welcome change, and there is always a choice. If adapatation means having to buy a house and live with my brother and sisters under the same roof then count me out.

  14. John in Ottawa says:

    So, with a better understanding of how to read the graph Chart 3, proportions of home ownership by age group, I went and had a look at CANSIM table 051-0001, which gives us the population by age group.

    The 20 to 34 age group is shrinking dramatically. It had its peak, us boomers, in the early to mid 1990s. It is down roughly 20% since the mid-1990s. The youngest boomers, the 40 to 44 age group peaked in 2005.

    The growth in the total proportion of the population that now own houses can be explained simply as a larger proportion of Canadians are in the prime earning years than was the case in 1971. Remember the oldest boomers are just now retiring. Most of us are working and a huge driving force in the economy. On the other hand, we might expect this total to abate somewhat as the boomers finally pass through the system about 20 years from now.

    • jesse says:

      Age demographics explains some of the shift but not all of it. There has been a concerted effort by governments to promote home ownership and this has arguably led to all age demographic bins being more able and willing to own. That may well be a valid progression in Canadian society but I am skeptical that many newly-minted homeowners haven’t bitten off more than they can chew.

      • John, demographics has no doubt played a role, but it’s exceptionally difficult to adequately explain the rise in ownership across every demographic as anything other than a new and prevailing mentality towards real estate.

      • John in Ottawa says:

        It is almost certain some youngsters are going to get hurt. As long as there is a prevalent view that they should buy as much house as they can manage current payments for, instead of just the house they need, there is room to get hurt.

        The government didn’t back CMHC down for us boomers. It’s too bad they ever relaxed the rules. It probably wasn’t necessary in the first place, but the real estate lobby would have been right in there pushing for relaxed rules to avoid a meltdown.

        BTW, it has been a long, long time, but I seem to remember there was a bit of a stigma attached to having a CMHC loan. Those were for poor people. What ever happened to that?

    • Financial Newbie says:

      Us youngsters could afford a lot more house if the “oldsters” would just accept housing prices are overvalued and allow them to fall. But considering how many “oldsters” keep their wealth tied up in their home I can’t see that happening.

      As the Boomers continue to move into leadership positions throughout Canada, it will be up to them to decide if they will sacrifice their current wealth to help out youngsters and future generations or if they will allow overvalued assets and maximized debt loads to continue to devour the futures of the young.

  15. John is right that the level of rampant fraud and lending excesses experienced in the US were never paralleled here. We will likely never have a mortgage scandal along the same lines as the robo signing crap currently being unearthed in the US.

    But one look at total consumer debt levels between our two countries indicates that the notion that our banks or consumers have been prudent is entirely false. We clearly haven’t traveled as far down that road as our American cousins, but that is the road we’re on. So where does that leave us?

    I’m of the opinion that the US real estate market will likely see a 40% peak to trough decline on a national level. That’s a pretty horrifying destruction of wealth. Have we embraced half the excesses that they have and will those excesses unwind in a similar fashion? Will we experience 2/3s the economic pain that they have? I have no idea, but let’s not gaze at the worst destruction of wealth in human history and somehow assume that since we have been more conservative to a degree that somehow we have nothing to be concerned about. We don’t need a US style bust to inflict some significant economic pain. With house prices historically out of line with some key measures of fundamental value and with consumer debt levels at historic highs relative to incomes, we sit in a precarious position. Just how our current position compares to the US’ position pre-bust is really a moot point. Let’s deal with us.

    • John in Ottawa says:

      Ben, as you said, the Canadian run up in credit has been a direct result of how easy it is to get it. Used to be, you got a first mortgage, then if things got really tough, you got a second mortgage. Now, you get a HELOC and never get out of debt. That’s a problem. When I told my wife our equity was automatically being added to a HELOC, she was offended and swore we would never touch it. So much for that new radial arm saw I’ve had my eye on.

      The flip side, however, is the withdrawal of credit. The intensity and depth of the crash isn’t entirely due to over extension or unemployment. It is due to the complete withdrawal of several forms of credit. The very types of credit that lead to the bubble in the US are simply no longer available. Subprime, option-arm, alt-A, neg-am, all that stuff is gone. Homeowners who went to renew couldn’t get financing. The banks won’t lend. The big mortgage houses that existed during the run up don’t even exist any more.

      I’m not saying we won’t have a correction in Canada. Ask anyone in Calgary. They were having a correction when I left in 1982 and it seems they have been having boom and bust ever since.

      I’m saying it took eleven years for us to double our index compared to six years for the US. Eleven years is half as bubbly, if you can even call it that, as the US. We didn’t have a Countrywide stuffing mortgages down peoples throats. We didn’t have a fraudulent securitization market. We didn’t have the kinds of bait and switch mortgages that absolutely relied on the ability to refinance to make payments. And, most importantly, we are not going to have the credit crunch that the US has encountered and is continuing to encounter.

      The dot com bubble occurred because venture capital went insane. I can’t tell you how many times I heard venture capitalists tell me I had to prepare for “hyper growth.” The dot com bubble burst just as spectacularly as it rose because venture capital became impossible to get after the bust started.

      If it takes access to credit to create a bubble, to truly pop it in an equally spectacular fashion requires that credit be withdrawn completely. No money to purchase a house, no money to refinance. There would be no need for QE or for the Fed purchasing $1.3T of agency debt if there wasn’t an ongoing credit crisis in the US. Won’t happen here.

      If readers here believe credit can be completely withdrawn in Canada as it was in the US, let’s debate that. It is a prerequisite to a “pop.” But first, think about this. The agency in Canada that would have to withdraw credit, and I mean virtually all NHA securitization credit, is the CMHC. That would be the exact opposite behavior evidenced by Freddie Mac and Fannie Mae as they tried, desperately, to fill the void left by the mortgage warehousing operations.

      • Hi John

        On an apples-to-apples comparison (Case-Shiller to Teranet), you’ll find that the US doubled from 2000 to 2006 while Canada doubled from 2002 to 2010……6 years to 8 years. If the only metric we’re considering is the rate of appreciation and we’re not comparing it to the rate of change in underlying fundamentals, I’d say that rise alone should be enough to concern us.

        I agree that in order for a credit bubble to collapse requires credit growth to virtually grind to a halt or turn negative, but what you are missing is the possibility that this will be a voluntary aversion to credit. In the US, home equity loans are still readily available, but who in the world would tap their home equity when it is falling? As for mortgages, you have somewhat answered your own question. Fannie and Freddie stepped in to fill the void, but who is buying? This is where the behavioural element becomes important.

        Human behaviour is fickle. If, for whatever reason, people decide that houses are not worth buying at these prices and if prices fall modestly, it may be enough to cause this exact dynamic absent a complete removal of available credit.

        With regards to the NASDAQ/Tech stock collapse, you nicely explain what caused the collapse in new IPOs as the initial seed capital dried up overnight, but what of the collapse in share value? Clearly they were massively overbid to begin with and were realigning with underlying fundamentals which in many cases were absent all together.

        Ultimately, house prices relative to fundamentals implies to me that people are expecting a near perfect future…..low unemployment, no adverse economic shocks, low interest rates, status quo. If we get that, we may well see house prices stagnate while fundamentals catch up, but I am highly skeptical that this will be our future.

      • tw says:

        Ben.

        I read this today from the Big Picture. This is perhaps the best single article on the banking system I have read to date, and runs along the lines of Keens Cavaliers article.

        I think it is a must read and will be an excellent addition to the theme of your site.

        http://www.scribd.com/doc/52483956/QBAMCO-Apropos-of-Everything-I

      • Lumpen says:

        Ben,

        With regards to the NASDAQ/Tech stock collapse, you nicely explain what caused the collapse in new IPOs as the initial seed capital dried up overnight

        I had a front row seat at this show. It wasn’t that the lack of venture funding that caused the IPO drought of 2003-2004, it was the lack of product (from a banker’s perspective). Substantially all of the companies that normally would have gone public in that timeframe went out as “idea” companies in 2000. There just weren’t many private companies in 2003-04 that met the traditional metrics for an IPO. SOX didn’t help either – it materially raised the bar for required size.

        Where it did hurt was the lack of funding for new startups in the 2002-04 timeframe, so entrepreneurs as a group focused on smaller, cheaper problems. Hence the proliferation of social startups and web apps, as opposed to big capex companies like alt. energy, which began to get large-scale funding in 2005 onward. It also made them stronger businesses, as they focused on getting profitable earlier.

        Not sure if you can translate it into housing, but I’ll give it a shot. My sense is that people are being forced to buy smaller than they otherwise would like to, as opposed to larger. I believe there is “fundamental” pent up demand for larger residences among the 20-45 crowd, but they’re simply priced out of the market at present.

      • Lumpen says:

        John in O,

        I’d like to try a thought experiment with you, if you don’t mind, as I think you have a good perspective to point out where I go astray.

        Assumptions:
        1. House prices remain nominally unchanged for the next five years.
        2. Median price/income metrics return to historical norms over the same timeframe.

        Without having the figures in front of me (a weakness, I admit), I’m going to estimate that the median price / median family income is roughly 66% higher currently than a long-term historical average.

        So, we fix this by having median salaries rise by ~11% annually, again nominal.

        Here’s the conundrum – the last time something like this happened, in the 70s/early 80s, short rates went sky high, and even 30 year US treasuries offered 14% yields.

        So clearly rapid nominal income increases plus unchanged borrowing costs don’t go together. In your view, why is this scenario wrong? Assume CMHC is still backing loans, just at higher rates.

        1. Is the historical average price / income not going to be seen again in our lifetimes?
        2. Nominal incomes won’t grow that quickly?
        3. Central banks will let inflation get out of control, and there will be a step function applied to nominal prices? (if this one, how do you feel about things like agriculture and oil prices?)
        4. Something else.

    • jesse says:

      Well we can debate two things: the validity of the endgame when it comes to conventional housing metrics (price-income price-rent, etc.) and how long it is likely to take to get there.

      I see residential as being oversubscribed across Canada, more so in the west and larger cities country-wide. The longer that housing remains oversubscribed I see it as a net drain on economic output going forward — it is leading to more and more inefficient distributions of capital. It’s worth doing a bit of math on affordability of a “conventional” mortgage under various stress tests. Despite the US’s slow pace at reducing residential inventories, it is getting very close to having a functioning residential construction industry again and that means falling unemployment and higher interest rates. I wouldn’t discount US 5 year government bond rates doubling in the next 2-4 years. Canadian households are risking being out of phase with rising global rates but without the precursor of de-leveraging.

      I think it’s worth considering what governments can do to prop up prices in the event of a downturn in the housing market in the next half-decade. I see a couple of plausible options: FTB credits/grants and mortgage interest deductibility. Neither I agree with but we shouldn’t discount them coming into play if the debt bandwagon breaks its axle. On this front, we have a looking glass into the future if we look at Australia, whose housing market appears to have crested and, like Canada, never had American “subprime” issues.

      • John in Ottawa says:

        I think we would be much better off to look at the differences and similarities with Australia. Their bubble is even bigger than ours, but their financial system is similar. There are many parallels within our economies. Far more than with the US.

        This would be the place to spend our energies.

        On a completely unrelated note, but just to demonstrate that there is a certain level of insanity out there, two motorcycles have been racing up and down the lake in front of my house all day. At this time of year I won’t even step on the ice. This could be one of those Darwinian moments.

  16. By the way…..this are some of the best and most insightful discussion I think we’ve ever had on this blog. Let’s keep it going!

  17. John in Ottawa says:

    @ Lumpen, I think a correction of some sort is in the cards.

    The current price to income is an anomaly that may be related to the boomers. Our incomes are much higher than the “average” income. We create a weighted average problem. We are unlikely to see it again ever.

    The BoC is not going to let inflation get out of control. It impacts too much beyond just housing.

    Nominal incomes are going to grow slowly. Too bad for the young, I inflated the cost of my first house away. It was just $32,000. A nice three bedroom SFH in Dorval, QC.

    I’ll reiterate that we should watch Australia closely. They have the economist Steve Keen there to do a lot of the heavy lifting for us. They are already starting to get push back or a “buyers strike” movement. Our economies and financial systems are similar, although we should take the time to enumerate and measure the differences. They are probably two or three years ahead of us.

    I think that what ever happens in Australia will be similar here. Much more similar than what happened in the US. Best yet, we’ll get to watch it in real time and it looks like the show is about to start.

    • Lumpen says:

      Thanks for that John. I’m also of the view that it is more likely than not that there will be a downtrend, but not that there’s a huge crash in nominal terms.

      In real terms though, I’m perplexed. I don’t forsee large wage increases outside of places like oil sands country, especially with the CAD’s continuing rise and the general reliance on and integration with international trade flows.

      But this doesn’t preclude swings in the composition of the household budget. For example, food & energy growing from ~25% to say, 33% of the budget. If there’s currently <5% savings rate, something else has to get squeezed. And in real terms, housing will probably be the biggest element of such a squeeze. Although, like most things, means and medians don't tell the whole story, and it would be nice to know what the distribution looks like.

      Over the very long term, I suspect today's homebuyers will be able to inflate their debt away as well. It seems to me that prices paid roughly increase by 10x every 30-40 years. It's not linear – houses doubled in price my parents' area in two years in the 70s, but they also did nothing in nominal terms for over a decade surrounding the 90s, and took a significant tumble in real terms.

      Every time I look back to newspaper clippings from the 70s, everything costs roughly 10x now – food, gas, houses, etc. Go back to the 1940s – ice cream cone, 5c, gas, 5c/gallon, movies, 12c. Youth today will probably see the same effects in the 2040s.

  18. John in Ottawa says:

    Ben, let me tell you a little story about the high tech bubble from my own experience.

    I was friends with the guys at Fulcrum Technologies Corp in Ottawa, an early search engine company. On the way up the bubble, they were listed on the Nasdaq, one of Ottawa’s first. They wanted to raise some more cash with a secondary offering a few months down the road, but were feeling a lot of pressure from the analysts for earnings and revenue growth.

    They decided that, in order to insure they didn’t have a “miss” and mess up the secondary, they would try lowering analyst expectations just a bit during their quarterly telephone conference. Six months later, not only did they not get the secondary, they were out of business. The analysts slaughtered them and their stock tanked the very next day.

    The CEO at the time, Eric Goodwin, told me that it is a very disturbing feeling to look back and know the exact decision you made that killed your company. A couple of years later I got to know that feeling first hand and I can tell you it is very disturbing, but that’s another story.

  19. Sams Mango says:

    Many stories about failure continue to be recycled – check out the selections of financial readings available these days, basically the same story told over and over.

    This is exact reason I need to be bullish and have been. Debates can continue, but something has to make the money grow – you are not going to get help from Carney, he is telling you people something. Get into risk assets.

    • John in Ottawa says:

      Failure!?!? Who said anything about failure? I don’t remember saying failure! We don’t use the word failure!

  20. jesse says:

    Keen has been active in analyzing Australia, as have most of the dudes over at macrobusiness.co.au.

    Australia is a bit of a different case from Canada in a few ways. As John mentioned, they have a nationwide bubble; I don’t think any area is immune from having unaffordable property. They have higher interest rates and the reserve bank has tightened significantly in the last few years. Wage inflation is definitely positive. I believe their economy is more reliant on commodity exports and less on manufacturing compared to Canada. Their dollar has surged vis a vis the USD, and vis a vis the CAD.

    Their politicians have started to come out of the closet and admit prices are high. There is talk of some measures to ameliorate price drops, including allowing FTBs grants or low-interest loans. They have started to look at providing mortgage relief by issuing covered bonds. Their banks have significant exposure to foreign capital. I may be wrong but the country seems more homogeneous than Canada’s, the most obvious that they don’t have a second official language.

  21. Ray says:

    Just wanted to say that I enjoyed this entire thread. 60 fascinating comments. SAM stopped posting his trolls of jibberish and you don’t seem to have a problem with SPAM or low value comments except mine. You don’t even need a comment rating system! 🙂

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