Kiyoko Fujimura

Buzzbuzzhome Corp.
August 17, 2010

Paul Krugman, one of the most renowned economists in the world, wrote an article about Canada yesterday which, at first glance, had me worried.

According to Krugman’s article in the New York Times:

My trip yesterday was actually to Niagara Falls, to talk to the Canadian Bar Assocation. In preparation, I did some homework; and to be honest, I came away a little less sanguine about Canada than I started.

But my worries subsided when I read the very next line:

Everything I and others have said about the Canadian banking system and its virtues is true.

Phew.

See, that’s what really matters in my opinion. The policy makers have to know how to create incentives to ensure the economy is on track. And, if the Bank of Canada is handling it, then individuals will too. Canadians have certainly developed an undeserved international reputation as conservative borrowers. We don’t scrimp and save, but our central bank keeps us on track.

THE US SITUATION

In the US pre-crisis, there were a lot of crappy mortgage-backed securities being bought and sold that, in the end, had to be purchased by the US government because otherwise they would have been deemed worthless. The opportunity to create these securities is what eventually led to the US collapse. The individual Americans taking on debt was certainly a symptom of the underlying problem, but not the cause. It was the set of incentives created jointly by the White House and the Federal Reserve which led to the problem.

According to an article by MSNBC:

The financial crisis even prompted the Republican Greenspan, a staunch believer in free markets, to propose that government consider tougher regulations, including requiring financial firms that package mortgages into securities to keep a portion as a check on quality.

Greenspan was the guy who was in charge of the Federal Reserve during the crisis.
In layman’s terms, banks gave out mortgages to people who couldn’t pay them back because it didn’t matter to the bank. They just resold them and passed on the risk to other people.

THE CANADIAN SITUATION

What Krugman found troublesome is that we’ve got really high debt-to-income ratios. They’re approaching the levels that the US had. But, you’ve got to remember that it’s easier to carry debt right now because of low-interest rates. So it makes perfect economic sense that people would take on more debt in times like these.

In fact, that’s exactly what lowering interest rates is supposed to do (see the wikipedia article regarding expansionary monetary policy here). Basically, when the Bank of Canada lowers rates, they expect people to spend more because they can borrow more.

So that all makes sense. And when necessary, the Bank of Canada will raise interest rates. After all the talk about a housing bubble, they began to raise rates on June 1. That also makes perfect sense.

I’m not saying that Canadian property values are necessarily going to stay where they are. What I’m saying is to not buy into the hype. Our banking system is still far more stable than that of the US. And, when it comes down to it, that’s what’s really important for staving off a bubble.

THE BOTTOM LINE

The fact of the matter is, no pricing bubble is evident yet. Sure, sales are declining, but so are the number of new listings– so prices are remaining pretty stable. It’s a market correction, but not a bubble. Plus it was intentional. I mean, it was basically orchestrated by direct government involvement.

So, everyone remember…we beat them in hockey and we’ll beat them in real estate, k?

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