Canada’s economic foundations are sound
Everywhere you look there seems to be another dire warning on the state of Canada’s housing market. Homes are overvalued by huge margins, screams one headline. Consumers are in debt up to their ears, warns another. We’re in for nothing less than a full-on U.S.-circa-2008 crash, claim some.
Canadian Business recently devoted its cover to the word CRASH! in large, bold letters, accompanied by the image of a house falling from the sky to crush an unsuspecting investor. Our cynical sides may be tempted into believing such prognostications are meant for nothing more than selling a few papers. Our pragmatic halves, however, may be forced to take some notice of the evidence. Are we in for a major housing correction in Canada?
It’s a national pastime in this country to distinguish ourselves from our noisy American neighbours, and in this respect it’s no different. It was an American debt bomb that exploded in 2008, sending the world economy reeling. Those were the several U.S. institutions that approved less-than-credit-worthy consumers for mortgages of several times their annual incomes that would be impossible to pay back — many were even left with monthly payments that were more than their take-home incomes. Interest-only mortgages requiring no down payment made it even easier for low-income families to qualify for overpriced homes they wouldn’t have otherwise even looked at. We virtuous Canadians would never deign such arrogance.
But once such chest-thumping is set against the evidence, we suddenly have a little less to brag about. Record-low interest rates have spurred Canadians into borrowing more money than we ever have before, bidding up the average price of a home to more than $360,000. That means prices have doubled in only the past decade.
As in most matters, the truth is likely to lie between the extremes: in this case, somewhere between a wholesale crash and a jolly continuation of the recent status quo.
The Bank of Montreal recently responded to some of the more dire warnings with a prognostication of its own: the housing market will probably cool off in the near term, but a wholesale crash is not likely. Citing low interest rates, demographics, construction costs, land-use regulations and foreign capital inflows, BMO’s conclusion was that prices in some markets were moderately overvalued and therefore susceptible to external shocks, but not extremely so. Home prices and debt ratios are fully sustainable for most Canadians in most of Canada.
It should also be noted that BMO and its counter-parts continue to offer the lowest fixed mortgage rates we’ve seen in Canadian history. With millions of Canadians locking into rates as low as three per cent for the next four, five and even ten years, much of the risk of interest-rate shock should slowly be removed from the nation’s balance sheet in 2012 and 2013 when it comes to residential mortgages. Add that to the U.S. Federal Reserve’s commitment to rock-bottom rates for the next two to three years, and the threat of Canadian households suddenly finding themselves strapped for cash due to a rate jump seems remote for now.
The much-publicized figure of Canada’s 160 per cent debt to disposable income statistic is also, at best, misleading. To compare a stock of debt to an income that repeats itself year after year is to compare oranges to apple orchards. The real story is told by our default ratio: how many Canadians actually fail to repay their mortgages. That statistic tells a different, and much happier, story than the debt to income ratio. The vast majority of Canadian borrowers repay their debts on time and in full and will continue to do so. No other form of saving offers the guaranteed, after-tax return yielded by debt retirement.
This is not to say that we can keep on borrowing at the pace we have been for the past decade and continue to lean on ever-rising house prices for insurance against all forms of economic shocks. The plain truth is that some markets in Canada will probably see some decline in average prices this year or next. But will Canada’s housing market crash into the ground? No one knows for sure. But in uncertain times (and what times are not uncertain?) the most likely scenario is always the safest bet. That principle leads me to the conclusion that we will see, at worst, a gradual slowdown in house price increases in Canada in the medium term.
