Yes, It Is Time to Panic Over Canada’s Housing Bubble

And no, this bubble won’t be any different.

Yesterday Macleans asked the pertinent question of whether or not it’s due time to start fretting over Canada’s looming housing bubble.

Here in Canada, we patted our backs for not falling into the same trap, and basked in the spotlight as the world’s new beacon for financial stewardship. It’s a compelling narrative that has been promoted by the federal government and the Bank of Canada as they encouraged Canadians to spend their way through global economic turmoil.

But pry through the pocketbooks and bank accounts of the average Canadian and the country looks remarkably like the America of 2005—or even worse by some measures—complete with record house prices and unprecedented debt. “One of the really terrible narratives we’ve allowed to develop in the minds of Canadians is that somehow we are better than the U.S. and so that means we have nothing to be concerned about,” says Ben Rabidoux, who runs The Economic Analyst website and parlayed his obsession with watching the housing market into a job with a Wall Street firm that advises institutional investors on how not to get caught up in the Canadian miracle/disaster.

What Rabidoux and others have seen is just how much Canada’s economy has come to rely on the country’s housing boom—and how much consumers have been digging themselves into debt just to keep it going.

While the housing bubble burst in the United States literally brought the world economy to its knees, the suspicion over its true cause has sparked a renewed interest in the Austrian school as many considered to be within the “mainstream” of financial commentating actually had their fingers pointed at the Federal Reserve for keeping interest rates too low for too long.  Thanks to the 2008 presidential campaign of Texas Congressman and Austrian disciple Ron Paul, the Fed has faced a degree of scrutiny unseen in its nearly century long existence.  The public is becoming more enlightened to the fact that interest rate manipulation may yield short term gains but the cost will ultimately be paid for with recession and/or depression.  Ludwig von Mises figured this out back in 1912 with the publication of The Theory of Money and Credit.  Thanks to the ineptness of former Fed chairman Alan Greenspan and his fetish with printing dollars to prop up asset prices, more are catching on to Mises’ business cycle theory.

Macleans is thankfully no different in regard to Canada:

Banks themselves can only be blamed so much for offering consumers mortgages for next to nothing. The Bank of Canada has held its key interest rate at one per cent since September 2010, and most economists expect the bank to keep it there until well into next year.

It’s a dangerous game. Low interest rates might sound great for anyone looking to take out a loan, but they can have a perverse effect on an economy when they stay low for years.

Low interest rates had as much to do with the U.S. housing bubble as subprime mortgages, even working to make such lending more popular, says Stanford University economist John Taylor. He argues there never would have been a housing boom or a bust at all if the U.S. Federal Reserve and its chairman, Alan Greenspan, hadn’t slashed interest rates in the wake of the 2000 dot-com bust and then held them low until 2005. Not only did low rates encourage Americans to take on larger mortgages, but they pushed banks to make more aggressive loans in search of profits and increased demand for higher-yielding—and therefore riskier—debt.

Being that human action is unpredictable and the amount of variables involved within complex market economies are vast in number, isolated case studies based off methodological positivism and empirical evidence alone are impossible to conduct and apply universally within the science of economics (thymology is the appropriate term for making predictions based on axiomatic truths- as demonstrated by this post in particular).  This doesn’t stop one from observing “after the fact” data and deducing logical interpretations.  Up until this point, the correlation of the Bank of Canada’s low interest rate policies with the growth in household debt and home prices has been uncanny.

In a recent post at his highly popular financial blog Mish’s Global Economic Trend Analysis, Mike Shedlock provides some astounding examples of the housing bubble in what looks like the ground zero of rising prices otherwise known as Vancouver.

2119 East 3rd Ave, Vancouver
MLS® Number V934050
Listing Price: $899,500

2564 East Pender Street, Vancouver
MLS® Number V930595
Listing Price: $899,000

And here is my favorite

1016 East 7th Ave, Vancouver
MLS® Number V930461
Listing Price: $899,000 (notice the boarded up windows!)

As I have written previously, Bank of Canada head Mark Carney has acknowledged the run up in household debt but has been reluctant to admit that the housing industry is experiencing bubble like activity.  Like an alcoholic addicted to the slosh, Carney admitting his reliance on cheap credit to keep certain sectors of the Canadian economy afloat at the expense of an eventual asset bubble bust would start raising questions over his competence and would necessarily strike a serious blow to his legacy.  Carney, like Alan Greenspan before him, is playing with fiat fire which will leave his, and the rest of Canada’s, hands burnt after the housing market corrects itself.  His only hope will be resigning in time to pass the buck on to a hapless Ben Bernanke-type to pick up the pieces; thereby exacerbating the true cause of the business cycle when money printing is used as another band aid.  And Mises’ important lesson will continue fall onto the deaf ears of central bankers believing themselves endowed with enough intelligence to dictate the prevailing borrowing interest rate for millions.

True, governments can reduce the rate of interest in the short run. They can issue additional paper money. They can open the way to credit expansion by the banks. They can thus create an artificial boom and the appearance of prosperity. But such a boom is bound to collapse soon or late and to bring about a depression.

- Ludwig von Mises writing in Omnipotent Government

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13 Responses to “Yes, It Is Time to Panic Over Canada’s Housing Bubble”

  1. Mark Pascoal says:

    Great post!

  2. Jeremy says:

    @Appraiser
    Market psychology pure and simple – things don't matter until they do. Until it dawns on enough people that the problems overrun the positives nothing will change. As ridiculous as it seems now, at some point in the 1600's you could buy a couple of houses in Holland for a few tulip bubbles. Rational markets are a complete misnomer, you would do well to remember that.

    Trading these 'events' becomes difficult because you need to keep your radar well tuned to changes in sentiment. Again, many times the 'facts' don't matter until they do.

  3. Andre Lalonde says:

    It's been some time since I read it, but If I recall correctly, in Tom Woods' book Meltdown, the small prick that ultimately burst the gigantic bubble in the USA was a very small uptick in interests rates. Where many who had financing based on (temporarily) lower, variable interest rates, got caught with their pants down and couldn't afford their payments under the new terms.

  4. Appraiser says:

    We've been hearing about an impending housing crash in Canada for at least 5 years now. It seems like all of the bears are simply going to keep dancing until it rains. Hardly an intellectually defensible position.

    • Appraiser,

      As you remember (or very well should), many Austrian minded folks were warning of the housing bubble in the U.S. five years prior to its crash as well. Not to say it takes 5 years for inflation driven bubbles to pop, but I would reckon to say that it was not those who were calling for a bubble that took an intellectually defensible position.

      Care to pull and Irvin Fisher and declare housing prices have reached a new plateau so we have you on record?

  5. Rob says:

    The Economic Analyst website has a ton of charts on our housing market, showing things like house prices to income ratios and so on. Very eye opening!

    You know we're in trouble when even Macleans has clued in to our over valued real estate market. Its amazing how many people are in denial about this, even after having front row seats to the collapse in the US. "Oh, its different here…" Yeah, sure it is!

  6. Aikham says:

    @ JC00065. Do you know what the exchange rate of the CND/US currencies is currently at or has been at for nearly a year?… They are trading at or close to par.. Those prices are arguably the same.

  7. Sidera says:

    Great post. This bubble is going to catch the ordinary person by surprise. They will be calling for flaherty, carney, and harpers head. The most interesting info from the macleans article was that the cmhc up until 2003 would only insure mortgages up to 300k and only in Toronto or Vancouver. It's only a matter of time before the cmhc is bailed out just like Freddie and Fannie. It will be interesting to see how the banks will fair. Not a good time to be holding canadian bank stocks.

  8. Aikham says:

    @ JC00065. Do you know what the exchange rate of the CND/US currencies is currently at or has been at for nearly a year?… They are trading at or close to par.. Those prices are arguably the same.

  9. JC00065 says:

    Are those prices in US dollars or Canadian?

  10. Dean says:

    Your posts are excellent James. Please keep them coming!

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