Is Canada Headed for a Housing Bubble?

February 15, 2012

When the United States saw a vast housing bubble inflate and burst during the 2000s, many Canadians felt smug about the purported prudence of their financial and property markets.  During the crash, Canadian house prices fell by just 8 percent, compared with more than 30 percent in America.  They hit new record highs by 2010.  "Canada was not a part of the problem," Stephen Harper, the prime minister, boasted in 2010, says The Economist.

Today the consensus is growing on Bay Street, Toronto's answer to Wall Street, that Mr. Harper may have to eat his words.

  • In response to America's slow economic recovery and uncertainty in Europe, the Bank of Canada has kept interest rates at record lows.
  • Five-year fixed-rate mortgages now charge interest of just 2.99 percent.
  • In response, Canadians have sought ever-bigger loans for ever-costlier homes.
  • The country's house prices have doubled since 2002.

Bankers are becoming alarmed.  The bosses of banks with big mortgage businesses have all said the housing market is at or near its peak.  

  • Canada's ratio of household debt to disposable income has risen by 40 percent in the past decade, recently surpassing America's.
  • And its ratio of house prices to income is now 30 percent above its historical average -- less than, say, Ireland's excesses (which reached 70 percent), but high enough to expect a drop.

The consequences of such a bubble bursting are hard to predict.  On the one hand, high demand for Canada's commodity exports could cushion the blow from a housing bust.  However, the Canadian economy is still dependent on the consumer.  Fears about the global economy have slowed business investment, and all levels of government are bent on austerity.

The inevitable landing will probably be soft.  Increases in house prices and sales volumes are slowing, and the 2015 Pan American Games in Toronto should prop up builders.  Moreover, the government is trying to cool the market.

However, the state has refused to use its most powerful tool.  To protect business investment, the central bank has made clear that it plans to keep interest rates low.  As long as money stays cheap, the balloon could get bigger -- perhaps big enough to become a fully-fledged bubble after all.

Source: "Look Out Below," The Economist, February 4, 2012.

For text:

http://www.economist.com/node/21546057

 

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