Canada’s bubble goes mainstream

By Leith van Onselen

Friday’s article, Canadian Bubble Trouble, noted how the mainstream media (MSM) appeared to be turning from cheerleaders of the rapid rise in Canadian house prices to warning of a possible bubble and/or projecting falling housing prices.

Over the past few days, the Canadian MSM appears to be shifting into overdrive, headlined by the dire warnings of the nation’s leading current affairs magazine, Macleans.ca, which has the following front cover for its upcoming March issue:

Talk about alarmist. “You’re about to get burned… Why it’s officially time to panic”.

The upcoming Macleans front cover ups the ante on Canadian Business’ effort on its January 24 to February 20 issue:

In addition to the above magazines, there was an swag of newspaper articles published late last week and over the weekend warning about Canada’s record level of household debt and the risk of falling house prices.

Much of the latest coverage of the Canadian housing market has been driven by the Bank of Canada’s release late last week of a series of papers examining household debt, house prices, and consumption in the economy.

I read these papers over the weekend, and if you read between the lines, they paint a worrying picture of a nation of highly indebted households that are highly exposed to falling house prices, as well as an economy that is too reliant on unsustainable debt-fuelled consumption.

Some key quotes and charts from the Bank of Canada papers are highlighted below.

First, there’s this quote and chart from the paper on Canadian house prices:

After more than 10 years of appreciation in many parts of the country, house prices have reached a historically high level relative to income and, given the increase in household indebtedness, the exposure of households and the financial system to fluctuations in house prices has increased markedly…

Note the huge run-up in prices in Canada’s bubbliest provence, British Columbia, which is home to one of the world’s most expensive housing markets, Vancouver.

And from the household debt paper, the Bank of Canada notes that the strong growth in overal household debt has been driven by both higher mortgage debt as well as personal debt primarily secured against rising home values (called “home equity lines of credit” or HELOCs). Just like the Americans did, Canadians have been using their homes as ATMs:

As shown in Chart 2, the ratio of consumer debt to disposable income was relatively stable until the mid-1990s when it began to move persistently higher. The predominant source of this upward trend has been secured personal lines of credit (PLCs), which grew at a much faster pace than more traditional forms of consumer credit such as credit card debt. Secured PLCs, which are mostly secured by housing assets (i.e., home-equity lines of credit), have risen sharply both in absolute terms and as a share of total consumer credit. In 1995, secured PLCs represented about 11 per cent of consumer credit; by the end of 2011, this share was close to 50 per cent (Chart 10).

The Bank of Canada paper on household borrowing and spending brings the above points together and highlights the key risks now facing the Canadian economy from falling house prices:

The sizable increase in the ratio of household debt to income in Canada over the past decade has coincided with a period of sustained strong growth in house prices. The main driver of the rise in household debt has been home-equity extraction — household borrowing against equity in existing homes through increases in mortgage debt and draws on home equity lines of credit…

…if increases in household debt are used primarily for spending, a fall in house prices that reduces home equity could decrease household borrowing and consumption (i.e., owing to a reduction in the value of the collateral)…

The evidence indicates that a significant share of borrowed funds from home-equity extraction was used to finance consumption and home renovation in Canada from 1999 to 2010. Such indebtedness constitutes an important source of risk to household spending, since it makes households more vulnerable to a potential decline in house prices…

Simulation results suggest that a 10 per cent decline in house prices can generate a peak drop in consumption of about 1 per cent…

These findings suggest that household indebtedness constitutes an important source of risk to household spending, since it makes households more vulnerable to substantial negative economic consequences in the event of a correction in house prices.

The Vancouver Sun, which published an article summarising the Bank of Canada’s findings, also quoted the Canadian Finance Minister, Jim Flaherty, who warned Canadians that the current level of mortgage interest rates – currently at all-time lows – have nowhere to go but up:

“Interest rates are going to go up. They have nowhere to go but up. So people need to ensure that they can afford higher mortgage interest, for example,” he told reporters in Toronto. “It isn’t necessarily for everyone to have most expensive house they could possibly buy, maxing out the 10-year mortgage they can get from a financial institution.”

Finally, the below video extract from the Canadian Broadcasting Corporation provides a nice quick overview of the issues highlighted by the Bank of Canada:

It looks like interesting times ahead for our friends in the north.

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