Bank of Canada: ‘Premature’ to talk of Canadian housing bubble

David Wolf, an adviser to Bank of Canada’s governer, Mark Carney, spoke in Edmonton today about Canada’s housing market.  I found some of his comments peculiar to say the least.  Here are some excerpts from his speech:

“In the Bank of Canada’s view, it is premature to talk about a bubble in Canadian housing markets. Recent house price increases do not appear to be out of line with the underlying supply/demand fundamentals.”

Supply & demand definitely do play a part in establishing house prices.  However, that is only a portion of the fundamentals that need to be looked at.

“It’s absolutely not debatable that housing prices cannot rise faster than incomes over the long term,” said Will Strange, professor of real estate and urban economics at the Rotman School of Management.

According to CREA, average Canadian house prices increased nearly 20% in 2009.   Did your income increase by that amount as well?   In 2010, Royal LePage forecast home prices would continue to “appreciate significantly” during the early months of the year.

So how exactly is it premature to speak of a housing bubble when we’ve already experienced a 20% annual increase, with even higher prices on the horizon?

It is likely, though, that a significant part of the surge in housing sector activity is associated with temporary factors – notably the historically low borrowing costs, as well as pent-up and pulled-forward demand – which cannot continue to drive increases in house prices and activity.

Surge. Temporary. Cannot continue to drive increases. So, according to the BoC’s viewpoint, when the pent-up and pulled-forward demand has been used up and the temporary factors such as low interest rates are no longer in play, housing prices will just stabilize? I haven’t seen many economic models that show a Boom-Plateau-Boom cycle.

This discussion leads to the following question: if the Bank did see the housing market posing a possible threat to financial stability, what should we or other authorities do about it? Some observers – those who see a housing bubble forming – have said that since low interest rates have stimulated housing market activity, the Bank should now raise interest rates to dampen that activity.

There is no housing bubble, and it’s premature to speak of a housing bubble, but let’s discuss what the Bank of Canada should/could do to stop a housing bubble (which there isn’t) if there were one.

If the Bank were to raise interest rates to cool the housing market now – when inflation is expected to remain below target for the next year and a half – we would, in essence, be dousing the entire Canadian economy with cold water,

Cool the housing market? Why would you want to cool a market that’s “in line” with “underlying fundamentals”? Why not let the healthy housing market play out normally?

Ok, so raising interest rates would cripple the rest of the economy. Understandable. So, what can we do?

An array of supervisory and regulatory instruments can be used by the government to restrain a buildup of systemic risks. These include capital requirements for institutions, leverage ratios, loan-to-value ratios, terms and conditions for mortgage insurance, and a variety of other measures. These instruments can be targeted to risks to the entire financial system that stem from particular markets or institutions…

In Canada, a system-wide, or macroprudential, approach is the shared responsibility of the Department of Finance and all of the federal financial regulatory authorities, including of course the Bank of Canada, the Office of the Superintendent of Financial Institutions, and the Canada Deposit Insurance Corporation. Ultimately, it is the Minister of Finance who is responsible for the sound stewardship of the financial system.

Zing! Take that Flaherty. Low interest rates aren’t the cause of the Canadian housing bubble (which doesn’t exist).

It’s the Minister of Finance’s responsibility. Ah, like Pontius Pilate of old, the Bank of Canada seems to be washing their hands of whatever outcome awaits.

The revival of housing activity is a reflection of the historically high level of affordability that is associated with the current record-low interest rates.

Wait, what? I thought interest rates weren’t the cause – what happened to “underlying fundamentals” and all that?

I guess I can see why it’s “premature” to speak of a housing bubble from the Bank of Canada’s view from the following statement:

The housing sector is a crucial part of the Canadian economy, and it typically plays a disproportionate role in economic cycles. Housing wealth provides collateral for household borrowing and spending. Increases in the cost of housing are an important element in consumer price inflation, and demand for housing is a gauge of household confidence.

Essentially the conclusion I gathered from the speech is: Current house price increases are good for the economy, but the Bank of Canada can’t be held responsible for the ensuing housing bubble.

Last month, when Mark Carney was asked about the potential for a bubble in the housing market, he reiterated that the central bank’s core focus remains fixed on inflation. “Monetary policy in Canada doesn’t target specific assets or asset prices,” he said. “It will be set to achieve the 2 per cent [inflation] target.”

If home prices rise uncontrollably due to low interest rates, so be it, as long as inflation is on target.

You can read the entire speech here

Here’s where I think it gets even more interesting.

David Wolf, now with the Bank of Canada, used to be an economist with Merrill Lynch.

Let’s rewind to 2008, before the BoC was his employer, and see what his thoughts on the housing market were then:

It may just be a matter of time before the Canadian housing market tanks like the U.S. market did, Merrill Lynch Canada economist David Wolf said, warning that Canadian households are now nearly as overextended as households in the U.S., and even more so than those in Britain, prior to the bursting of the housing market bubbles in those countries.

“What worries us is that Canadian households have been running a larger financial deficit than households in either the U.S. or the U.K.,” Wolf said in a commentary, noting that in 2007 Canadian household net borrowing amounted to 6.3 per cent of disposable income, which was higher than in Britain and not far off the seven per cent peak in the U.S. in 2005, prior to the bursting of that country’s housing bubble.
September 2008

In Feb ’09, Deloitte & Touche warned that the ratio of debt to disposable income had increased to a higher percentage than that of American consumers.

Throughout 2009 Canadians continued to pile on the debt. The household debt-to-income ratio rose two points to 145% – the highest level since quarterly record keeping began in 1990. That means for every $100 of personal disposable income, Canadians now carry $145 in debt, compared with $88.60 in 1990.

[David Wolf] estimates that markets with the strongest price growth in recent years, such as Regina, Saskatoon, Vancouver, Victoria, Calgary, Edmonton, Sudbury, Ont., and Montreal, were all more than 10 per cent overvalued.
August 2008

So, with the Canadian residential average price in major markets surging 20% more in 2009 (11% if you use CREA’s weighted average) how overvalued are they now exactly? Locally, the average Calgary house in August 2008 was $440,625 with a median $398,000 – slightly below last month’s figures.

In February 2009 David Wolf said:

“I know that the conventional wisdom uniformly shared is that Canada will fare better than the U.S., but I wouldn’t be so sure,” says David Wolf, chief economist for Merrill Lynch, one of the first private-sector analysts to predict a house price collapse in Canada.

So why are thoughts of a housing bubble premature when factors Mr. Wolf considered important a few months ago have gotten even worse?

Going back to his speech in Edmonton today, one last point I wanted to touch on was the following statement:

But with the recession and tumbling commodity prices, a housing market correction was inevitable. The correction was much steeper, though, for regions that had previously experienced the largest increases. Here in Alberta, as you know, the drop in prices has been larger.

Yes, it would make sense that there would be a housing correction during a recession. But there wasn’t.  The biggest price drops in Calgary didn’t happen during the recession, they happened earlier. During the recession, Calgary house prices did this:

click to enlarge

Or, if you prefer using the Teranet-National Bank HPI, year-to-date up until October 2009, Calgary house prices were down 2.12%, or -3.61% year-over-year.   Hardly the definition of a market correction.  Is it yet to come?

If the Bank of Canada says there isn’t a housing bubble there must not be one, right?  After all, they correctly predicted there would be no recession in Canada and that Canadian credit conditions were superior to the US and Europe and no new money would need to be injected into the system.

Oh wait…

Your insight and thoughts on this are appreciated.

14 responses to “Bank of Canada: ‘Premature’ to talk of Canadian housing bubble

  1. Good post!

    I had no idea it was the same David Wolf. That’s some impressive bank speak.

    Curbing the CMHC would be a good start. Even if they set some cap on borrowing that was not dependent on extremely low interest rates, such as 3x income or a qualifying rate of 6%. I believe the qualifying rate borrowers are now required to use is 3-year fixed term, which is in the 3% range!

    Raising down payments would definitely cool the markets. A good start would to at least force the 5% to come from personal savings and cap the mortgage amount. 10% would be better, but I would be surprised to see that.


    Mike Fotiou says: Glad to see you’ve started posting regularly again on your blog 🙂

  2. One of A Kind

    Good post to read , either way you slice it house prices are expensive . I still can’t believe how much they have gone up over the last few years. My big question is where is the money coming from for those massive payments. I think 10% down should be the norm , also I think people should use a 7% interest rate for a reality check.

  3. Bearclaw, One of a kind,

    It will certainly be interesting to see whether Mr. Flaherty will tighten mortgage rules since the housing market is now squarely on his shoulders.


    Statistics Canada released the New Housing Price Index for November 2009.

    In Calgary, new home prices increased 0.4% between October and November but were down 4.2% year-over-year.

    In Canada as a whole, prices increased 0.4% month-to-month and were down 1.4% from last November.

  4. Wow. It would certainly be interesting to be a fly on the wall for a meeting between the BoC and Flaherty/Harper. If they’re willing to lob these kinds of bombs at each other publicly, one can only imagine what’s being said behind closed doors.

    Mike Fotiou says: Excellent analysis on the Edmonton/Alberta market on your blog.

  5. I agree with the BOC regarding rates. Why would they raise rates when *apparently* inflation is low, Canadian dollar is relatively high and we are in a period of quantative esing with MBS purchases and government stimulus? Unless those programs are unwound first raising rates does not make sense.

    Flaherty himself mentioned changing the CHMC criteria and I’m sure he doesn’t want the BOC to raise rates right now so really it is up to him. I think mentioning the potential of the CMHC changes without actually implementing them was a mistake.

  6. Folks, as pointed out in Mike’s post but not quite hightlighted, we should not forget in the first place why we lowered the interest rate, why this recession happened and what the biggest hurted sector of economy is. The whole purpose is to save the house market, which has been the root cause of everything that went bad, including but not limited to, banking, personal wealth, layoffs, energy price….

    Now the house market is back, so what’s wrong? i.e., doesn’t a doctor expect to see a recovered patient at all?

    Unless a huge increase in house price, which of course I don’t know how big will consist a ‘huge’ increase, I believe what we see today is exactly what BOC has been hoping for -> by injecting the money into the economy, to inflate the price of everything, so that the debt ( our main problem), on the other hand, is essentially reduced, and everybody is back on track of a happier life. It is a win-win-win thing.

  7. Ed, I cannot understand how the personal debt is reduced by injecting money to the economy. The debt is reduced only if the income is increased. And when the gov. injects more money in, in the long term, tax will be increased also. I think housing is too expensive here. We do not and have no reserve to do that way in the south.

    The problem is that we do not have other clue other than housing to pull us out of the recession. Sad!

  8. DNA, give ourselves some won’t-be-too-long time. Salary will increase a lot. FED or BOC or any other central banks may tell us whatever economy indexes revealing no inflation whatsoever, but the bottom line of money itself is just like that of the housing, namely, supply and demand.

    The supply and demand rules of money itself will make the price of everything to increase, no matter the minimium salary or materials. Don’t use CPI to measure inflations. When I came to Calgary in 2002, I spent $50 a week for a trunk load of grocery. Now how much do you spend for a week’s supply? Look at th CPIs during these years, there isn’t any meaningfull inflations at all.

  9. A new CAAMP report examined 40,000 loans issued in 2009, and found that 86% of mortgages issued were fixed-term of which 70% took terms of five years or longer.

    Jim Murphy, the association’s president said the longer terms and borrowing less than the maximum goes contrary to the perception that Canadians are taking on too much debt to take advantage of low interest rates.

    CAAMP undertook the study in response to concerns about a bubble forming in the market as Canadians take advantage of historically low interest rates to take on mortgage debt.

    According to the survey about 4,000 households appeared to take on maximum debt along with short-term rates.

    “Each year, about 2.5 to 3 per cent of Canadian households make a first-time home purchase,” Will Dunning, chief economist said. “Our data shows that only a small percentage of them are pushing-the-envelope – about 4,000 households which amounts to a tiny fraction of the 13.25 million homeowners in Canada.”

    I need to examine the report carefully, but isn’t the 4,000 households out of the survey of 40,000, not out of the 13.25 million homeowners total? That would mean 10% of new loans in 2009 were risky.


    Edit: You can read the entire release here.

    From the report:

    It is true that some home buyers are pushing-the-envelope of their affordability. But, it should be recalled that the households in this dataset, representing primarily first-time home buyers, represent about 2.5% to 3% of Canadian households. If up to 15% of this group of households is pushing-the-envelope, they represent less than one-half of a percent of all Canadian households.

    My reading comprehension skills are not up to par this morning. Does that mean 15% of new loans (“in this dataset” assuming the survey of 40,000) are risky, but are saying it pales in comparison to the total of all Canadian households?

    Virtually every Canadian who is in a position to buy a home and qualify for a mortgage is well-educated and capable of assessing what is in their best interests, of looking forward, and of anticipating threats to their financial well-being.

    I assume “virtually every Canadian” means everyone except the 15% of 2009 buyers that are “pushing the envelope.”

    The Canadian mortgage lending industry is amply incentivized to avoid making bad loans and to optimize risk exposures.

    According to Table 1, those with GDS/TDS ratios higher than the limit somehow were still approved for mortgages.

    As this study has attempted to illustrate, very few Canadians are at risk of unaffordable increases in mortgage payments.

    Ah. The report had an editorial slant from the beginning and did not just intend to report the facts 😉

  10. Yeah I saw that article too. Not sure about the 15% thing…starts getting a bit convoluted when they start talking about a % of a % of a %. Would be nice if they just said how many of the 40,000 fall into each of these categories.

    However one thing ‘seemed’ cut-and-dry and that is that 10% (4,000 of 40,000) are at the economic limit and very risky considering interest rates can only move in one direction over the next 5 years. That seems like a pretty high number.

    The report also indicates mortgage debt has been increasing more than 10% a year (60% over 5 years), far outpacing income growth. Not sure where you’re working Ed, but where I work (at one of Calgary’s largest O&G companies) we are looking at the second straight year of no raises and are expecting less than average bonuses this Feb as well. I would love to see my salary increase by 25-30% to help keep pace with these house prices but not really seeing that yet….I think people will have to stop losing their jobs first, and no strong signs of that occuring in Calgary or Alberta very soon.


    Mike Fotiou says: In the CAAMP report, future risk assessments were calculated assuming a 2.5% annual wage increase. Reason being:

    This is a conservative assumption, as most of these recent borrowers are early in their careers and can expect raises due to promotions, in addition to cost of living adjustments.

  11. From the same CAAMP report as above:

    A separate cause of mortgage default, which is considerably less significant in Canada, is “over-extension” – debt levels were reasonable at the time of getting the mortgage (as evidenced by GDS/TDS ratios), but credit was added after the fact, such as lines of credit, credit cards, and buy-now-pay-later retail offerings.

    There is no reason to believe that over extension is becoming more prevalent, especially based on the caution shown by the vast majority of mortgage borrowers.

    However, if you go back to CAAMP’s November report you’ll find the following statistics:

    -18% of mortgage holders took out equity from their homes or increased the amount of the mortgage principal within the past year

    -The average amount taken out was about $41,000

    -52% indicated that the money would be used for debt consolidation or repayment.

  12. Just thinking about that 10% thing again. I don’t want to pull numbers out of the air, but don’t have time to look them up for 100% accuracy…Mike you might be able to help clarify this.

    Let’s assume Calgary adheres to the 10% risky mortgage average as pointed out by the CAAMP.

    In 2009, ~ 14,000 SFH changed hands and ~10,000 condos changed hands. That’s roughly 24,000. In 2008 those numbers were ~13,000 and ~6,000 for a total of roughly 19,000.

    Generally speaking that is 43,000 sales. If 10% are high risk, that is 4,300 homes at risk and only includes the last 2 years. Over 5 years it is likely closer to 10,000 (keeping the math really simple…4300*5/2).

    If rates increase and these individuals cannot adjust accordingly, there is a chance that many of these homes would be forced to sell. If it occured for 50% in the same year, then 5,000 properties could hit the market. I think that would be about a 25% of the yearly listing average (looks like it was around 25,000 in 2009) and would cause a very swift shift from a demand based market to a supply based one.

    Basic economics dictacts what happens in that situation…

    Anyone have thoughts on this….am I out to lunch or what?

  13. sorry…meant 20% (5,000 of 25,000).

  14. TT, it would be difficult to make any assumptions specifically on the Calgary market for a couple reasons:

    The survey represents 1/6th of the mortgages funded in 2009 ($10B out of the $60B) and we aren’t given the breakdown for individual provinces.

    We don’t know the percentage of those 15% who are “pushing the envelope” that are on fixed-rates (and for how many years) or on a variable rate. This would stagger the timing of any forced listings.

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