The housing market: the oversold story of the Canadian recession

Here is what is hopefully one of the last of a once-robust breed - The Apocalyptic Canadian Housing Market Story:

Judging by the latest real estate data, the Canadian housing market could scarcely be better. Average home prices are up more than 16 per cent this year, and in May they hit an all-time monthly high, according to the Canadian Real Estate Association. By those numbers, Canada didn’t just sidestep the housing market crash that continues to plague the United States, it sailed right through it virtually unscathed. And yet, there are plenty of signs that the Canadian housing market is still sitting on some very shaky ground—and even the potential that Canada’s big housing crash is yet to come.

Yadda yadda yadda.

We all know that the proximate cause of the US recession was the bursting of its housing market bubble: it blew up banks, laid waste to personal balance sheets, and left millions of people stuck in homes whose mortgages were more than their market value.

And then Canada went into recession. Unfortunately, this set up the following error of logic that was repeated in all-too-many Canadian newsrooms:

1. The US is in recession because its housing market blew up.
2. Canada is in recession.
3. Therefore, Canada's housing market must be blowing up as well.

And so it was the fate of any number of hapless Canadian journalists to be given assignments to bash out pieces that fit this narrative. But these exercises were all doomed to failure. The decline in house prices in Canada is a symptom of the recession, not its cause.

Let's look at how house prices have behaved since 2003:

US house prices have fallen almost 40% (all changes are expressed in per cent log terms: 100 times the difference in the logs), while Canadian house prices are still within 10% of their peak. There are any number of lazy analysts who have swallowed the faulty syllogism enumerated above and have concluded that 'Canada is following the US with a lag'. This only makes sense if you think that Canadian house prices rose for the same reasons that US prices rose, and that they have fallen for the same reasons that US prices have fallen. This is not the case. As has been documented at great length here and elsewhere, the Canadian economy has avoided the worst of the bubble and its consequences for the following reasons (among others):

1. We never had restrictions on interstate banking, so Canadian banks spread their assets and liabilities across Canada. (So it doesn’t matter if a local housing market goes bust).
   
2. We don’t have Glass-Steagal. The investment banks joined the retail banks some years ago.
   
3. We don’t have mortgage interest deductibility from taxes. So paying down your mortgage is a tax-free investment. So most people want to pay down their mortgages.
   
4. (Except in Alberta), mortgages are fully recourse. You can’t just walk away from a negative equity home and hand the keys to the bank; the bank will come after you for the difference.
   

Yes, house prices have fallen. But the linkages that make the US story so compelling don't exist here. We don't have banks that are blowing up. We don't have massive waves of foreclosures (even the Globe and Mail has given up on its series of articles that culminated in this silliness). Nor do we have much in the way of evidence that lower house prices are causing undue inconvenience to Canadians: when Maclean's decided to jump on the OMGWTFBBQ housing market bandwagon, the best it could could come up with in the way of a victim was some flipper of 7-figure Vancouver condos who got caught mid-flip. Boo-hoo-freaking-hoo.

Moreover, it's becoming pretty clear that the decline in house prices is not so much a national story as it is one of falling house prices in Vancouver, Calgary and Toronto:

Vancouver is and always will be a special case whenever we talk about housing prices in Canada: its geography makes it extremely difficult for developers to respond to increases in demand. This is the sort of environment in which bubbles flourish so I'm not going to pretend that I can predict movements in Vancouver house prices. In Calgary, the incipient recovery in the oil sector will no doubt establish a floor on housing prices there fairly soon. And there's even not-entirely-bad news out of Toronto these days. So I don't see just how the national index is supposed to fall by another 30% or so.

It's worth following the housing market numbers. But they are going to be at best a coincident indicator in this cycle.

Comments

[Scott Sumner]

Stephen, I strongly support your argument that the causation went from recession to a weak housing market in Canada. BTW, the final question I ask in the post you linked to was a rhetorical question. Readers of my blog knew that for months I had been pushing the argument that the causation reversed around August 2008--instead of the housing crash affecting the economy it was beginning to be the economy (falling nominal GDP) worsening the housing crash. August 2008 was roughly the time when manufacturing began a steep downturn in the US, and also the time when the housing crash spread from the sub-prime markets to formerly stable areas like Texas and parts of the midwest. When I noticed that Canada also started a mild decline at about this time (despite having avoided the sub-prime fiasco) that further strengthened my view that August 2008 is when the original financial crisis started to be worsened by falling worldwide AD. Canada was the canary in the coal mine.

[Declan]

"[Vancouver's] geography makes it extremely difficult for developers to respond to increases in demand"

Not as much as you might think.

What you say is true of England and Australia and some of the coastal U.S. cities, but not really Vancouver. Supply remains reasonably elastic in Vancouver, as a glance around the horizon showing cranes as far as the eye can see (up until the last 6 months or so), or a drive out hwy #1 showed. Certainly there's few restrictions on building in the other B.C. cities (like Kelowna) that are just as bubbly.

B.C. (arguably) had a bubble of the same scale and magnitude and potential impact as the U.S. did (or larger). Lucky for Canada, B.C. is just a small part of the country and, as you note, Canada's banking system is a lot more stable than the one in the U.S., even in the face of collapsing housing prices (we don't wait for a crisis to have the government guarantee all the risky mortgages!).

I'm not sure that the cause of the runup in house prices was much different in Canada vs. the U.S. (lower interest rates, looser lending rules, increased competition, bubble mentality), just that bubble fever got a little more carried away in the U.S. Prices have also mainly fallen for the same reasons in both countries as well (all bubbles comes to an end, sooner or later). Prices in B.C. and Alberta certainly turned downwards well before the recession so it doesn't make sense to say the decline was caused by the recession.

The timing is different though, as you say. For example, interest rates were cut to 0 in Canada much earlier in the housing downturn (vs. the U.S.) since the global economy blew up just as our housing downturn was getting started. In a way, the global downturn is mitigating rather than causing the decline in housing prices by allowing the dramatic interest rate cuts.

Finally, is it just me or does your chart on housing indices (Canada and the U.S.) contradict the point you are trying to make? I'd read it to say that house prices in Canada have risen by more since 2003 than the U.S. prices did before they plunged. In the absence of other data (e.g. incomes or rents in Canada rose faster than in the U.S. over that period or we were starting from a lower base relative to income/rents) you wouldn't have much reason not to expect a similar decline given the similar run-up.

[Thomas Cook - Toronto's Real Estate Team]

Certainly the Toronto real estate market is booming. The ratio of sales-to-listings that I've been tracking since 1992 shows a 55.3% number - a neutral market is 24-28%! In fact I've never seen it as high as this.
We're encountering multiple offers continually, even in the suburbs where things typically are slower.
There's definitely confidence in the market but the 'emergency' mortgage interest rates in the mid- to high threes we had in the spring definitely were a contributer to this activity.
Now that rates have edged up by 60 basis points or so, this should take the edge off in the long term. Short term activity will be driven by people trying to buy before their 3.75% mortgage rate commitment expires.
Thomas Cook
www.BLOGTorontoRealEstate.ca

[learning james]

Stephen,

I am not advocating a housing market crash, but I am worried about the economic situation and it is difficult to see housing thriving. An adjustment is certainly possible. Most of us do not care why it happens, only that it does. Comments by Declan seem to be rather relevant and rising unemployment in Canada will also have an effect. I prefer it when your voice is strong, but would like to see all relevant factors considered. Are we simply taking another cocaine hit from lower interest rates ? Have we made the necessary adjustments to be competitive considering a 10% or 20% exchange rate ? Canadians cannot allow Health/Education/Government sectors to become too large relative to the overall economy. The Natural Resoure sector might be too small to absorb the extra workers. Unless there are income gains for the rest of us, we will be unable to support even current government spending levels which will result in further cuts down the road. Will the trigger in Canada be the employment situation ? I am sure you have seen this: http://www.calculatedriskblog.com/2009/06/freddie-mac-delinquencies-and.html

And obviously this does not help "What government stimulus? The 12-month moving average of federal government program expenditures has been falling since December" from your own post at http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/06/parsing-mark-carney-at-third-remove.html

Thank you for blogging.

[marmico]

A couple of nits on the reasons:

1. Pre-1987 regulatory reform, Canada was an effective Glass-Steagall jurisdiction. The late '80s saw the retail (commercial) banks gobble up the investment dealers (banks) and trust companies. CIBC + Wood Gundy, BMO + Nesbitt Burns and Scotia + McLeod Young Weir combinations come to mind.

2. Purchase-money mortgage interest is not tax deductible but mortgage interest for investment purposes is.

Teranet data is in an egregious error in Toronto and I will second ThomasCook.

[Jean Cooper]

There are so many things that could go wrong with the housing market, it's hard to know where to start.

Even though are prices did not rise as dramatically as those in the US, they have still risen a great deal since 1999 (Teranet shows 70 in 1999 and a value of 130 in 2008, so 80-90%?). Have salaries risen that much?

The only saving grace right now is interest rates. They can't go much lower, but can go much higher. It will be a shock to people when they reset higher.

How many 40 year, no-down payment, interest only loans have banks made? They must have made some, I know someone who is paying an interest only mortgage for 5 years. It's hard to get these numbers from the banks.

Our largest trading partner is looking protectionist these days.

Who knows what will happen when Cap and Trade hits our industries, and it is coming.

Taxes are going no where but up, the government doesn't seem to have any clue how much GST and HST harmonization will cost, but I can bet it will be more than the rebate we're getting.

Canadians are hugely in debt. Granted, not as much as the states, but still, they carry a high debt load. See this article for an eye-opener on debt of Canadians.

http://www.cga-canada.org/en-ca/ResearchReports/ca_rep_2009-05_debt-consumption.pdf

I don't think salaries are going to go up enough to pay for all the added taxes, price increases, and interest rate increases that will be coming down the line.

It's not about how healthy our banks are, it's about how much debt people can carry.

[Patrick]

I certainly hope housing isn't booming in TO. That would be a disaster. Of course, a collapse like in US would be terrible too, but a 'boom' in the midst of high and rising unemployment and a generally very weak economy would bad, as it would certainly be a speculative bubble.

The point about wages is really important. In the US, the median age for a working man is something like $800 less in real terms today than it was 30 years ago. WTF?! I wonder how Canada compares.

Elizabeth Warren lays out the US situation very eloquently here:

http://www.youtube.com/watch?v=akVL7QY0S8A

[Matthew]

I'm not a trained economist so my thinking on this may be a bit simplistic, but Canadian households are drowning in debt and wages for most people haven't risen anywhere near as fast as housing prices. How much more debt can people take on to finance continued demand in the housing market? It just doesn't seem sustainable to me.

[Stephen Gordon]

"Drowning in debt?" I'm not so sure. As Nick has pointed out several times, aggregate debt is meaningless; we owe most of our debt to each other, and aggregate net worth is positive. He had a recent post about how the Bank of Canada went about some 'stress tests' for hoursehold debt over here.

Things are worse in the US, but that is a different story.

[Matthew]

Ok, maybe not "drowning in debt" - bad metaphor, but did you take a look at that report by CGA Canada that Jean Cooper refered to above?:

http://www.cga-canada.org/en-ca/ResearchReports/ca_rep_2009-05_debt-consumption.pdf

To me, the post is a convincing argument that a housing crash in Canada won't be connected to events in the US, but a crash, or more significant correction than we are seeing now, may occur for other reasons.

[Stephen Gordon]

I just skimmed it, but it seems to focus almost exclusively on aggregate numbers. And the aggregate numbers are pretty much meaningless.

[Cory in Winnipeg]

The sooner we accept the Canadian housing market has been overcooked and needs to adjust, the better, not least because mapping out the future requires an understanding of what has happened. Canadian politicians need to accept the bursting of the property bubble as an economic coming of age and play their part in adjusting downwards expectations of wealth, wage and inflation. They must begin to focus on where we would like to be in 10 years, and not just in 10 months. The biggest mistake policymakers and politicians could make at this stage is to continue propping up the asset bubble in the property market. (30, 35, 40 year mortgages/No money down mortgages/ridiculously low interest rates/etc….) And don’t believe the housing market in Canada has improved at all. That’s just realtors and realestate related machines trying to create false hope and predictions for the future. Affordability index spells it out loud and clear. Canadians can not afford housing any more and prices will crash. That’s a fact!

[Joanna in Winnipeg]

Er, to all those hurling invective at the poor saps who are still buying homes, you do realize that those are the folks who are keeping this economy from completely tanking. If everyone suddenly stopped buying real estate, home values would plummet to near zero, and this gossamer thin recovery would turn into a depression the likes from which we may never recover. So, to all those generous, kind-hearted folks loading up on overpriced real-estate–bless you. You’re the reason I still I have a job, an internet connection and a sliver of hope.

[Wendy]

Thanks for writing this. Internally at my job I've been presenting statistic after statistic that suggests this recession in Canada is reasonably mild (unless you work in automotive manufacturing). Look at employment by city and sector -- often above levels this time last year; or look at commercial real estate vacancy, still close to historically low levels.

On another note, in Metro Vancouver, the housing price decline depends a lot on geography and product type. Strata property in the suburbs is off substantially. Single family housing in medium-good neighbourhoods of Vancouver proper remains near the peak (off perhaps only 3% if at all).

[Carter]

There are more listings on the MLS today then ever recorded. Affordability in the housing market at it's worse ever. Bankruptcies and forclosers at the highest they have ever been in history.....and climbing. Worse job losses in decades. Lowest GDP ever recorded. Need I continue?????? To paint a rosy picture on today's housing is to be very ignorant. For all the smart people who want the truth...please visit Garth Turners blogs. He has the real numbers not all this propaganda BS! Good luck to the rest in denial because all the denial in the world won't stop the CANDAINAN HOUSING BUST

[Doug]

The collapse of the housing market in the States has exposed the vulnerable balance sheets of many Americans. They are debt rich and asset poor. You can talk favorable demographics all you like. But the fundamental question for any housing decision is whether a borrower can make his mortgage payment. That's getting to be an expensive proposition here in Canada.
There hasn't been a house price crash here, like the ones unfolding in America and Britain……YET! But affordability in the Canadian housing market is clearly a problem. Of 227 cities surveyed, found 9 Canadian cities in the top 50 of "least affordable" in the world. "There are no affordable [housing] markets in Canada and there are no moderately unaffordable markets. Five of the nine markets are rated severely unaffordable."
“All of the large capital cities (Vancouver, Victoria, Calgary, Edmonton, and Toronto) are rated severely unaffordable”. Vancouver rated 8th out of 227 cities surveyed with a marginal difference between 1st and 8th place. The best ratings are seriously unaffordable in four smaller markets Saskatoon, Regina, Winnipeg, and Halifax.

[Gerry]

Existing home sales across Canada have plunged by more than 60,000 units in the first six months of 2009, according to figures released Thursday by the Canadian Real Estate Association (CREA).

The report showed that as of the end of June, 142,899 homes were sold nationwide through the multiple listing service (MLS) compared with 233,213 in the same period last year - a drop of 43%.

New listings continued to outpace sales in June, with the number of properties coming on to the market rising 8.8% from the prior month to a record 98,878, while sales declined month-over-month by 8.2% to 48,133 units. Compared with May of 2008, the number of sales dropped 35.9%.