Opinion
Is the Bubble about to Burst?
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By Paul Gambles
Sitting here in cramped Bangkok, it seems strange that the world’s second largest country with the second lowest population density has been experiencing a consistently rapid increase in house prices since 2009. If you factor in the boom-and-bust errors which could be learned from Canada’s immediate neighbours to the south (or what must feel like on all sides for those in Windsor ON), it is positively incredulous. Yet that’s exactly what’s going on: an overall increase of nearly 18% in the last 3 years, close to 30% in 5 years and over 70% in the last decade. Al this while price rises in the US have steadied (see charts).
Low rates and high insurance
Officials in Ottawa may like to suggest that the situation highlights the relative prosperity of the Canadian economy but I’d agree it actually shows how badly it is being run. Various governments have played an important role in creating a housing bubble by using two instruments: interest rates and backstopping. Since early 2009, the Bank of Canada’s benchmark lending rate has not been higher than 1% and is currently at just 0.5%. Maintaining extremely low rates was meant to be an emergency measure, designed by central banks in practically every major economy, to give a boost to demand. The idea is that lower lending rates to commercial banks encourages them to offer discounted rates to customers. This is all well and good in theory; however, there was already a massive amount of private debt around – and Canada has the largest debt-to-income ratio amongst all G7 countries since 2000.1 With all that private debt in play, there are two likely outcomes: already burdened by hefty debt repayments, consumers and businesses resist the temptation to take on cheaper debt, demand does not increase, thus the economy slides slowly into debt-deflation; or, people and businesses take on yet more debt, inflating the bubble further until the day it bursts with even greater consequences. Given the rate at which house prices are increasing – particularly in Vancouver and Toronto – it’s apparent that Canadians have
largely taken the latter of these options. That could be put down to further government incentives for people to buy property, such as backstopping. Backstopping has nothing to do with Blue Jays catcher Russell Martin but is instead an underwriting of a security – in this case offered by public agency Canada Mortgage and Housing Corporation (CMHC), to support people who put only 5% down on mortgages. I’m all in favour of avoiding a scenario like in Spain, where by 2014 banks were evicting hundreds of people from their homes every
day. However, I’d prefer to see governments and central banks pay out money directly to reduce private debt, and also quasi-private debt – a debt jubilee. With this everyone benefits without a bubble. Michael Hudson, my colleague at IDEA Economics,2 has probably done more than anyone to prove that a functional economy, with a more equal share of the pie, not only benefits the weakest in society but also produces greater wealth for the richest. However, the lethal combination of low interest rates and CMHC backing encourages demand in the sector of the economy where prices are already at nosebleed levels. In 2014, the Crown Corporation insured 175,169 new home loans worth C$41.7billion, around 54% of the whole market. Whilst that number fell to about 50% in 2015, it still seems exceptionally high to me. Some parts of the media suggest that this isn’t a bubble and the Canadian housing market won’t crash – partly because of the CMHC’s insurance. However that is to ignore experiences around the world in the past and the present. According to a recent study by Demographia, Vancouver is the third least-affordable city – after Hong Kong and Sydney – in the 367 markets and nine countries researched. Apparently the median price of a house in BC’s largest city was 10.8 times greater than the median household income.
1 http://business.financialpost.com/investing/outlook-2016/canadians-householddebt-highest-in-g7-with-crunch-on-brink-of-historic-levels-pbo-warns 2 http://www.ideaeconomics.org/a-modern-jubilee/
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Voyageur
Several examples – of which Japan in 1990 and the US in 2008 are just two – show that such imbalances are not sustainable. At some stage, prices reach a level which people can no longer pay and this can be exacerbated by worsening economic circumstances overall. Between 2002 and 2014, soaring demand – and thus rapidly increasing prices – in Canada’s abundant natural resources poured money into the national economy. This was largely due to the Chinese economic boom and commodities bubble and helped further fuel already increasing house prices. China experienced a rough 2015, however, with a stock market crash and official reports announcing poor economic results (which many experienced observers suspect to be heavily understated). Added to that, commodities markets have dropped to record lows and stayed there for the last two years and show few signs of recovery. Then there’s the impending global financial crisis. It is impossible to forecast when this will happen but it will. Although if analysts continue to insist it will occur in 2016, it could well become a self-fulfilling prophecy as investors draw back in anticipation of the pending disaster. Putting all this together points to a bubble burst in Canada’s housing market sometime in the near future. The CMHC may be liable to pick up the tab for this but don’t be surprised if Ottawa panics at the sudden hole in national coffers and launches austerity measures which cripple the economy even further into a the vicious cycle of debtdeflation. After all, that is what has happened in Japan, the Eurozone, the UK and the US. As one analyst pointed, however, one slight counterbalance to a Canadian bubble is that even if property prices are overvalued, healthcare is mostly free. http://video.cnbc. com/gallery/?video=3000500718
Paul Gambles, co-founder of MBMG Group MBMG Group is an advisory firm that assists expatriates and locals within the South East Asia Region with services ranging from Investment Advisory, Personal Advisory, Tax Advisory, Corporate Advisory, Insurance Services, Accounting & Auditing Services, Legal Services, Estate Planning and Property Solutions. For more information: Tel: +66 2665 2536 e-mail: info@mbmg-group.com Linkedin: MBMG Group Twitter: @MBMGIntl Facebook: /MBMGGroup