Canadian housing bubble looks ripe for popping ?

Housing in Canada is unaffordable. International experts are unequivocal in their concern, and Canadian lawmakers are taking measures to deflate slowly rather than crash. Ironically, only Canadian homebuyers seem to think the market is sustainable. Sale prices are still rising. So when does it all start to unwind? Right about now.

Since the Great Recession, the Canadian economic model has basked in international reverence for its conservative banks and rich commodity sector. So when Wall Street rumblings about a Canadian housing bubble started becoming louder about a year ago, as a card-carrying Canadian, I took notice.

Over the last year, the “short Canada” thesis on Wall Street has evolved from a contrarian sidebar into a growing chorus. The Economist recently wrote that Canadian housing looks “particularly vulnerable” because of unsustainably high home prices compared to rents and incomes. The OECD expressed the same concern. Steve Eisman, a private investor profiled in The Big Short for shorting the U.S. housing market, recently presented several ways to short Canada. Even Paul Krugman, a fan of Canada’s economic and political backbone, recently published his concerns about Canadian home prices and household debt.

Robert Shiller, the economist who predicted the collapse of the U.S. housing market, believes Canada could already be experiencing the correction that happened in the United States, only “in slow motion.”

Canadian lawmakers and institutional stakeholders have taken notice and are positioning themselves defensively. The finance minister, the Bank of Canada and CMHC have tightened and continue to tighten lending standards to “cool” the housing market. CIBC shuttered its mortgage broker lending arm, FirstLine, and is considering selling its mortgage broker franchisor, Mortgage Center Canada.

Those closest to the industry are pulling back on the reins. Coincidence?

There are two primary issues:

• Home prices are so high relative to incomes that average households are very vulnerable to rate or income movements.

• Housing is such a big part of the Canadian economy that any small shift can be problematic.

In Toronto, the median income is around $73,000, according to Demographia. The median home price is $455,000. After coming up with a 20-per-cent down payment, a “median” mortgagor would be on the hook for $22,200 annually, even at a 3.5-per-cent mortgage rate (which has to go up). If we include other housing costs (real estate taxes, maintenance, insurance, etc.), costs climb to $30,000 every year. Throw in cable, cellphones, groceries and Internet, and the family budget gets quite thin, quite fast. What happens when rates hit 5 per cent, or 8 per cent?

My gravest concern is that Canada is fast approaching a 5:1 home-price-to-income ratio, a benchmark achieved by the U.S. at the peak in 2006. Since the correction, the U.S. ratio now hovers at approximately 3:1.

To compound the problem, household debt in Canada has breached 150 per cent of income and continues in the wrong direction; households are not cushioned against a blow.

Housing is big business in Canada, making up 19 per cent of GDP. A slowdown in housing production can be very hurtful and job losses can be severe. Furthermore, CMHC guaranties $600 billion worth of Canadian mortgages, the equivalent of the entire Canadian federal debt. A rise in mortgage delinquencies could be debilitating.

I believe we are witnessing the crash right now in, as Robert Schiller put it, “slow motion.” In most major Canadian markets there is an increase in listings and decrease in sales (even though prices are still somehow rising). The Bank of Canada recently voiced strong concern over the number of unsold highrise units in Toronto, and how a housing correction could have a severe spillover to income and employment.

Lawmakers appear to be facing the problem head on. The trick will be allowing home prices to glide down while combating the accompanying job and economic losses that a housing correction entails.

Artificially low interest rates helped inflate this asset bubble and now present a Catch-22: raising rates in order to cool the housing market could push many homeowners into default (yet another lesson about the dangers of low interest rate environments).

Although housing corrections are brutal, Canada could handle its correction in a more orderly manner because:

• It will (hopefully) not be accompanied by a meltdown in global credit.

• The system is not as fraught with fraud and the complications of securitization.

• The banking industry is far more consolidated and co-ordinated with the central bank.

• Lawmakers see it coming more clearly.

Orderliness, however, does not compensate for the loss of jobs, home equity and consumer confidence that a housing correction brings.

The Bank of Canada’s new leader, Stephen Poloz, has stated that for balanced and sustained economic growth Canada needs to focus on corporate capital expenditure and higher exports. I agree. That will drive higher wages and more diverse sources of economic output over time, but the pivot will take time, patience and creativity.

In the meantime, the housing market is flashing red.

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