Canada's Housing Bubble

Dec 16, 2009  Matt Stiles  examiner.com

Mark Carney, Canada's top central banker, gave a refreshingly colourful and provocative speech to The National Forum in Toronto on Wednesday.  As with recent communiques, Carney focused on issues pertaining to Canadian and American household balance sheets, further suggesting that rising debt levels have superseded currency fluctuations as the Bank's biggest concern.

Carney reiterated, "While the near-term risks from a further sharp deterioration in labour markets have diminished, the Bank believes that overall risks to financial stability arising from the household sector have continued to increase. In particular, the combination of sustained growth of household debt relative to income and a rising interest rate environment could increase the vulnerability of households to an adverse shock."

Carney is attempting to prepare Canadians for a future environment of rising interest rates.  But with mortgage rates near all-time lows, major financial institutions more willing to lend than ever, and hundreds of billions in financial guarantees being undertaken by government entities, the allure of quick capital gains with borrowed money is likely to be too tempting for consumers to resist.  Carney is attempting to introduce market discipline, while the exuberance of borrowers is resulting from non-market forces.  It is a risky strategy.

Carney ended his speech with a warning: "While asset prices can rise and fall, debt endures."  With this, Carney is suggesting that Canadians may be too quick to consider gains from rising stock and real estate prices as "money good."  And if asset prices were to endure another hit, such as the one in 2008, borrowers would still be left with the debt burden used to make their purchases.

He continued, "Ordinary times will eventually return and, with them, more normal interest rates and costs of borrowing. It is the responsibility of households now to ensure that in the future, when the recovery takes hold and extraordinary measures are unwound, they can still service their debts."

These sentiments are in stark contrast with those typically espoused by policymakers south of the border, where asset values are unquestioningly considered to be part of "domestic savings."  Carney also departed from conventional economic theory when he made the statement, "price stability over the medium term could simultaneously build financial stresses over a longer horizon."  Here, he appears to be channeling Hyman Minsky's Financial Instability Hypothesis, where it is suggested that long periods of stability breed excessive risk taking and, eventually, financial crisis.

These deviations from conventional monetary ideology may be early signs of a sea change in the field of economics, the timing of which may or may not be intentional.  US Federal Reserve Chairman Ben Bernanke is expected to be reappointed this week.

But while Carney appears more than willing to talk openly about the dangers of the rapidly rising debt burdens of Canadians, he concedes that his current policy is designed to encourage exactly that, while discouraging Canadians from accumulating "precautionary savings."

He noted, "As the economy begins to grow again and confidence is gradually restored, we expect that some of these precautionary savings will be unwound, and that some consumers will take further advantage of unusually low borrowing rates. Indeed, our current stimulative monetary policy is meant, in part, to encourage such behaviour."

Strong words may not be enough to discourage Canadians from taking advantage of the Bank's loose policies.  If current trends persist, Carney may be forced to act.

Read the entire speech at the Bank of Canada's website, here.