Concerns about the housing market are not really about what happens to the market for houses per se; its role as a driving force for the recovery was done long ago. The real concern is the risk is a US-style financial crisis. I think it's a valid concern, but I don't think it's very likely.
UWO's Jim Magee has written a couple of very persuasive - that is, persuasive to me - commentary pieces on the topic:
- "Why didn't Canada's housing market go bust?" (Federal Reserve Bank of Cleveland, 2009)
- "Not here? Housing market policy and the risk of a housing bust" (CD Howe Institute e-brief, 2010)
Another important difference is that Canadian mortgages are, for the most part, 'recourse'. If you don't pay your mortgage, creditors have recourse to other means to force payment: seizing other assets, garnishing wages, etc. If your house goes 'under water' - that is, if the market value of the house drops below that of the mortgage - then those with recourse mortgages have little incentive to engage in strategic defaults: they're going to have to pay the mortgage anyway.
But if your mortgage is 'non-recourse', the only thing your creditor can do is put a black mark on your credit record. There is going to be some point where the costs of having a bad credit record are going to be less than the benefits of ridding your personal balance sheet of a house that it worth less than its mortgage.
We've already seen how big a difference this makes here in Canada. In this post, I produced this graph of the change in mortgage payments induced by changes in mortgage interest rates:
Unsurprisingly, the number of mortgages that fell more than 90 days in arrears also spiked in the early 1980s. But this effect was not uniform. In Alberta, where mortgages are non-recourse, the percentage of mortgages in arrears jumped to levels much higher than those in the rest of the country:
(Monthly data from 1990 are taken from the Canadian Bankers' Association statistics page; the data for the months of December between 1982 and 1989 were kindly provided by the CBA by special request.)
What strikes me about that graph is that even when mortgage payments were increasing by more than 50%, more than 99% of homeowners with recourse mortgages did whatever they had to do to continue making their payments.
And this is what we're looking at. If and when mortgage rates increase and housing prices stop rising, we're unlikely to see important increases in the number of homeowners outside Alberta who can't/don't make their mortgage payments. And any increase in Alberta won't be enough to cause a US-style financial crisis.
(Of course, another important main reason that we wouldn't see a US-style financial crisis is that banks are holding CMHC-insured mortgages. The banks would be fine. The problem would be passed directly along to the federal government: an automatic TARP, as it were.)
What we *are* more likely to see is a sharp reduction in other household expenditures, as people cut back in order to make their new, higher mortgage payments.
To a certain extent, this isn't really a big deal: we already knew that contractionary monetary policy will have contractionary effects. But this time, the effect of an increase in the policy interest rate on aggregate demand will be much stronger than it has been over the past 20 years or so.
[This is the third post of a three-part series. The first post is here.]