Canada Hopes to Cool Its Housing Bubble

With investors still psychologically scarred by the Great Recession, one of the great pastimes among the analyst and pundit class is predicting what will precipitate the next downturn. Although Canada’s relatively conservative banking system saved its economy from suffering the full magnitude of the 2008-09 global recession, there’s now anxiety that a housing bubble could be percolating in the Great White North.

Of course, even though Canada’s housing market and financial system emerged from the downturn largely unscathed, the relative strength of its economy was not enough for its equity market to avoid falling in sympathy with global markets during 2008. Meanwhile, the easy-money policies pursued by global central banks have forced the Bank of Canada to maintain low interest rates itself in order to avoid a currency spike. Indeed, the Canadian central bank’s key interest rate has stood at 1 percent for two years, which is the lowest rate among those developed-world economies that avoided the worst of the downturn.

Although Mark Carney, the governor of Canada’s central bank, has engaged in tough talk about eventually tightening monetary policy, he can’t deviate too sharply from the US Federal Reserve, particularly when the Fed could be poised for another round of easing. That was evidenced late last week when Carney announced that the Bank of Canada would maintain the status quo on its key rate, while still voicing his intent to eventually initiate “some modest withdrawal of the present considerable monetary policy stimulus.”

The strength of Canada’s economy coupled with its central bank’s accommodative stance on monetary policy has significantly boosted its housing market as well as consumer borrowing. The average price for a home in Canada is now over CAD353,147, almost double the average home price of $187,300 in the US. But while US home prices are finally on the rise, Canadian home prices actually fell 2 percent from a year ago. However, that was largely due to the 12.2 percent decline in the cooling Vancouver market, as prices in 70 percent of Canada’s local markets are reportedly up over that same period.

At the same time, household debt, which includes both consumer loans and mortgage borrowing, has risen 135 percent over the past decade, far outpacing disposable income. In fact, the average Canadian carries a debt burden equivalent to 154 percent of disposable income, which is roughly 24 percentage points higher than the average US consumer’s debt load just prior to the financial crisis.

Late last month, Euro Pacific Capital issued a special report that further stoked worries about the state of Canadian consumer finances. Euro Pacific is helmed by Peter Schiff, who famously predicted in 2007 that the US was heading toward a housing crash. So his firm’s prognostications on this front tend to be given extra credence.

The most surprising revelation in the report was the extent to which a market for subprime mortgages has taken root in Canada. While Canadian investment firm M Partners estimates that subprime mortages account for about CAD85 billion of Canada’s CAD1.1 trillion mortgage market, Euro Pacific’s analysts suggest that high-risk mortgages actually amount to over CAD500 billion. Additionally, the report notes that home equity lines of credit (HELOC) have jumped 170 percent since 2001.

But over the past several years, Canadian policymakers have taken steps to dampen the real estate boom with the hope of engineering a soft landing for the housing market. The latest changes to mortgage rules were implemented in early July. The most significant among these changes is the shorter amortization period for government-backed insured mortgages. The maximum amortization period for such mortgages has been reduced to 25 years from 30 years, a move which will increase the average monthly mortgage payment by as much as CAD200 to CAD300. That’s a substantial enough difference to curb demand for housing, which should lead to a corresponding drop in housing prices.

For now, these concerns remain academic, as Canada continues to enjoy membership in the ever-shrinking club of countries that still boast “stable” triple-A ratings from all three major credit-rating agencies. But it’s far too soon to tell whether Canada’s proactive measures to cool its real estate market will ensure an orderly slide in housing prices or a deflationary downturn.