This is essentially a rerun of this earlier post, which produced no answers I found convincing. It's provoked by Livio's recent post, which produced comments raising questions similar to one that I've been asking for many months now. The question is: what are the mechanics behind "there's a housing bubble in Vancouver" (it's always Vancouver) to "therefore, Canada is doomed to a US-style balance-sheet recession"? There are any number of pundits who are willing to make this jump in logic, but the intermediate steps are almost never enumerated.
I don't have any problem imagining that housing prices in Vancouver and elsewhere will fall when the Bank of Canada starts its next cycle of interest rate hikes. What I'm having problems seeing is why that means we will follow the path the US took.
Of course, before we get too concerned with the power of the Vancouver housing market over the Canadian economy, we have to answer the question: "What is so special about Vancouver?" After a sharp increase during the mid-2000s, Calgary prices peaked in mid-2007, and fell more than 15% before bottoming out in 2009. They have yet to recover their peak. Why is a fall in Vancouver housing prices a national crisis to be dreaded, while a fall in Calgary housing prices is not?
Anyway. Brad DeLong claims that
In order to have successfully predicted that we would be where [the US is] now, you would have to have predicted a large number of things:
That a global savings glut and a period of low interest rates would produce a housing boom.
That the housing boom would turn into a housing bubble.
That the housing bubble would lead to a collapse of mortgage underwriting standards.
That risk management practices on Wall Street would have been nonexistent.
That the Federal Reserve would not be able to construct its usual firewall between finance and the real economy.
He continues on, but says that the most imaginative got to point 5 at most. Canada is running a current account deficit these days, so point 1 can't be dismissed out of hand. Point 2 is a definitely a possibility - but if all the bubble stories are datelined Vancouver, then it's hard to see how much of an effect it will have on the rest of Canada.
Point 3 seems to be where we have to stop the analogy to Canada. After a brief flirtation with longer amortisation periods and zero down payments - which is as far as we got to reproducing the subprime excesses of the US - Canadian regulators have spent the last few years tightening mortgage requirements. Is there any sign that Canadian mortgage underwriters have adopted pre-crisis US-style practices? The Canadian business press has been very keen to match the horror stories coming out of the US, but no amount of digging seems to have produced anecdotes corresponding to the 'liar loans', 'teaser rates' and 'NINJA loans' that were the standard fare of the pre-crisis US financial press.
The CMHC's short-lived and long-dead experiments pale in comparison with such exotica. It's not at all clear to me that an eventual weakening in prices will bring about a massive entry of houses on the supply side of the market. Who would be selling those houses, and why? And if there is no sudden influx of houses on the market, why would prices crash? It seems more likely to me that house prices would stay stable or decline slowly as nominal incomes grew to levels compatible with existing home prices.
Point 4 also seems moot - Canadian mortgages haven't been securitised in the bewilderingly opaque way that pre-crisis US mortgages were. If there were to be a massive wave of Canadian mortgage defaults, there wouldn't be much mystery about who would be on the hook: it would be the CMHC, and, by extension, the federal government. I don't see why financial markets would seize up in a fit of counterparty confusion the way Wall Street did in the fall of 2008.
Moreover, the odds of a massive wave of Canadian mortgage defaults seem small. As everyone know by now, Canadian mortgages are generally recourse, so the incentives to walk away from homes that are underwater are greatly reduced. If Canadians refused to default in large numbers when mortgage rates went above 20% in the early 1980s, why would they do so if they go up a couple of points from where they are now?
I'd like to think that point 5 is also moot, to the extent that the Bank of Canada is - so far - more insulated from partisan politics than the Fed is. And of course, the Bank can also learn from the Fed's mistakes.
But I may be missing something in the roadmap that takes us from here to housing market Armageddon. If so, could someone tell me what it is?