Butting heads: The boy who cried bubble vs. The optimists
Sep 1, 2010
September 1, 2010
I don’t want to sound like a broken record, but there’s been a lot of buzz about whether Canada is in a housing bubble or not. Most recently, two reports were issued that came to highly conflicting conclusions.
One released by the Canadian Centre for Policy Alternatives insists that prices in six major cities are overvalued and are due for a correction. The other, released by the think tank C.D. Howe, insists that due to our more stringent regulatory practices, Canada will be fine.
So what’s the deal?
THE BOY WHO CRIED BUBBLE
I am of the opinion that economists, especially after a bubble pops in one place, point fingers at anything that might be a bubble. After all, if there was no bubble their study just gets lost in the mess of all the other economic projections. But, if a bubble does pop they can pull it out and say “See, I told you so”.
But more seriously, the report presented by the Canadian Institute for Policy Alternatives details some pretty interesting statistics about trends in the Canadian market. But keep in mind that this is a left-of-center organization funded largely by trade unions and individual donors. I’ve noticed that left-leaning publications tend to cry bubble more often than center or right-of-center publications because they really HATE speculation messing up the actual “productive” economy.
Housing prices have stayed in a narrow range of 3 to 4 times income in the 20 years before 2000. The problem is, says Macdonald, is that housing prices adjusted for income today are anywhere from 4.7 to 11.3 times annual income in the six major areas.
That sounds pretty scary. In the online discussion on the Globe and Mail website regarding the report released by the Canadian Centre for Policy Alternatives someone brought up an interesting point about rising debt-to-income ratios. Although it has changed for the worse (i.e. our mortgage payments are eating up more and more of our income) that could just be a permanent change that the Canadian real estate market has to swallow. Other countries have permanently high debt-to-income ratios.
That sounds pretty scary. But, it doesn’t necessarily mean a US-style crash. I mean, there are definitely market corrections that don’t end catastrophically. Who’s to say that prices will plummet instead of plateauing and decreasing a moderate amount (say 5-10%)?
The C.D. Howe Institute is a non-profit, independent think tank that espouses to improve the standard of life for Canadians through sound policy decisions. They’re funded primarily by individuals and corporate donors, so you can bet they concluded that the housing market is going to be okay. But, that being said, I largely agree with them. It’s just important to be aware and take what they have to say with a a grain of salt.
Phew. Okay, enough preamble. The C.D. Howe Institute is arguing that the crisis in the US was caused by problems with regulatory practices that Canada doesn’t have. What are those problems? Oh, you know, giving out mortgages to people with no income and no job. Or allowing people to make interest-only payments (basically providing the same payment structure as a credit card).
So I have to admit here that Canada did have some pretty lax policies for a while there. According to the Globe and Mail:
Indeed, after a short period of looser standards from 2003-2006, the government clamped down and forbade zero-per-cent-down mortgages with amortization periods longer than 35 years. It further tightened standards this year, insisting buyers qualify for mortgages at the five-year rate instead of the lower variable rate, and insisting on higher down payments for investment properties.
So what they’re saying is that we have a capable government that can handle it. But the other report was quoting a bunch of price statistics, while this report draws on a qualitative assessment of our regulatory structure.
IT’S LIKE COMPARING APPLES AND ORANGES BUT…
So in the end, it’s somewhat difficult to compare the two reports. But you have to keep one thing in mind. A housing crisis begins with foreclosures. And a lot of them. It’s not about whether this city is overvalued because of this population growth statistic or that income-to-debt ratio. It’s about whether or not individuals start to become unable to afford their homes. Maybe people are adjusting the amount set aside for mortgage payments and spending less on other things (especially in Vancouver).
I think the Canadian government has done everything a government can be expected to do to control this housing bubble. And they’ve done it well. To project that Canada will experience a US-style crash is almost an insult to a federal government which has taken prudent steps to avoid the bubble.
Come on, Canada. The world has faith in us. The head of our Central Bank even made Time’s list of most influential people. We need to have faith in our government and Central Bank too.