For some time, there has been talk of a growing housing bubble in Canada.
Robert Shiller, the economist who famously predicted the U.S. housing bubble, has toldCBC News’ Neil Macdonald, “I worry that what is happening in Canada is kind of a slow-motion version of what happened in the U.S.”
Macdonald writes that Shiller and other economists are most worried about household debt, which has ballooned from 75% of household income in 1990, to 150% today.
And most of this debt is held by the most “vulnerable households—defined as those devoting 40 percent or more of household income to paying interest charges.”
While these debt levels are said to be about the same level of U.S. household debt around the time of its bubble, Shiller does clarify that if the Canadian housing bubble were to burst, Canada’s experience would be quite different from America’s.
This is in part because Canadian banks aren’t neck-deep in a subprime lending debacle, and because the mortgages are insured by the government via the Canadian Mortgage Housing Corp.
Gluskin Sheff’s David Rosenberg has previously warned “Canada is carving out a top, while the United States is seemingly carving out a bottom.”
Rosenberg doesn’t think Canadian home prices are sustainable.
The IMF has also warned that Canadian home prices are due for a correction.
The latest report by the Canadian Real Estate Association reported that average home prices were up 4% in August, sales were down 5.8%. Meanwhile, the country’sunemployment rate stood at 7.3%.
The Canadian government has been enacting measures to cool house prices but the real concern is that a rise in interest rates or job losses could cause the bubble to pop.Macdonald explains:
“Canadians seem to think that stricter government regulation in Canada protects them. But they are in some ways more vulnerable than Americans.
Americans at least have the option of lifetime payment stability. The gold standard here is the 25- or 30-year fixed mortgage. The interest rate can be locked in for the life of the loan.
In Canada, most mortgages “renew” every few months, or years, and payments can spike by hundreds of dollars a month if rates rise even slightly.”
Canada’s housing bubble has the characteristics of most housing bubbles, according to Shiller in that people think home prices will keep appreciating. When home prices stop rising the bubble collapses. They “always have their end built into them.”
Case And Shiller Say Housing Is Better, Not Back To Booming
Chip Case and Robert Shiller are known for the gauge of home prices that bears their name, but as that indicator continues to draw cheers for a U.S. housing recovery the pair warn that things are not quite as rosy as they appear.
The latest S&P/Case-Shiller reading showed that the 20-city average of prices was up 9.3% in February from the prior year, driving talk that the housing market is ready to be a driving force for the American economy once again.
Not necessarily so, warns Shiller, who says that while housing is normalizing, the uptrend in prices is not particularly big on a historical basis and underlying indicators of economic health are not overwhelming.
“There’s a lot of breathless commentary in the media right now,” Shiller told a small group of reporters at a breakfast Wednesday morning, and he just isn’t convinced that anything beyond a modest recovery is in the offing, even though he thinks there is sufficient momentum for the gains in prices to continue for the next 6-12 months.
Case admitted to being a bit more bullish at the event Wednesday, but was troubled by last week’s figures on new home construction, with housing starts slipping to an annualized rate of 853,000 in April. He called it a “terrible number,” after the prior month’s climb above 1 million starts.
There is a tailwind though, and despite “fragile” demand Case thinks the housing recovery is a tailwind, albeit not without reasons for worry.
David Blitzer, chairman of the S&P Dow Jones Indices index committee, proved to be something of a tiebreaker. He’s “mildly optimistic” that prices could rise another 5-10% over the next year. Housing is going back to some kind of normality, but normal isn’t rising 20% a year, he adds.
When the Fed finally lets interest rates go up “it will be a whole different ballgame,” Biltzer adds, but he doesn’t expect that to happen overnight, or even this year, and for the time being he’s more worried about the people getting loans. If anything restricts his bullishness it’s the difficulty many prospective buyers have securing a mortgage.
It’s partly because of what Bernanke called “excessive conservatism on the part of banks” during his congressional testimony Wednesday and what Blitzer calls “locking the barn after the horse [ran out].”
Between the lessons banks learned from the last bubble and the increased financial regulation aimed at preventing a repeat, financial institutions are exercising far more caution when it comes to doling out loans for real estate. That’s a real challenge for banks with big mortgage operations like Wells Fargo WFC +1.3%, Bank of America BAC +1.36% and JPMorgan Chase JPM +1.44% that have to lend more in order to grow interest income, but need to be wary of easing standards given the regulatory landscape.
So while the average American may find it more difficult to buy a home, despite the current rate environment, deep pocketed buyers like Blackstone Group and other institutional investors have gobbled up home by the dozens, fixed them up and rented them out. While the big firms are likely lining their own pockets by doing so, Shiller says they are also doing a service by converting a chunk of the existing housing stock from (potentially underwater) owner-occupied to rental units.
The same trends help explain why the likes of Toll Brothers TOL -0.77%, a high-end builder, has been able to enjoy a nice recovery in demand and selling prices, given that its clientele tends to have more cash to put toward a down payment and better credit scores to secure a mortgage if necessary.
The wildcard in all this is what happens to the twin titans of the mortgage industry, Fannie Mae and Freddie Mac . While Case, Shiller and Blitzer don’t agree on everything, all three think the ultimate government decision on just what happens with the sister firms will have a major impact on housing finance.
“I think there is a profound change coming,” says Shiller. “We don’t guarantee the stock market, but [through Fannie and Freddie] we’re guaranteeing 90% of the mortgage market.”
At some point that will change, and if the demand and ability of buyers isn’t yet able to make the housing finance business attractive to private capital when it does, the market could be facing its next great challenge.
Robert Shiller joins CCTV to talk about the U.S. Housing Market in 2013. Shiller is a professor at Yale University.
Video Rating: 5 / 5