Canada's Housing Bubble

Sep 10, 2011 Andrea Hopkins theprovince.com

With fresh signs from the Bank of Canada that interest rates will stay lower for longer, Canada's still-hot housing market has many of the hallmarks of the U.S. situation just a few years ago.

House prices dipped during the recession, but bounced straight back and have kept climbing since. And homebuyers are taking on record debt to buy houses at historically high prices.

When interest rates eventually rise, some forecasters warn the result isn't going to be pretty. "Our view is that we are in a housing bubble, that housing prices have risen very sharply over the last 10 years, and that there is a big disconnect between housing prices and fundamentals, including interest rates," said David Madani, an economist at Capital Economics in Toronto.

"It really does look like a housing bubble that will have a very unhappy ending."

He predicted a 25-per-cent drop in house prices, adding Canadian homeowners would end up with negative equity.

Few economists are as willing to use the word "bubble" to describe Canadian real estate, even though the central bank noted in June that house prices are up 31 per cent from an early 2009 trough and are 13 per cent above their previous peak from before the global credit crisis.

Household debt is certainly soaring. Bank of Canada Governor Mark Carney recently warned Canadians were "as indebted as the Americans and the British."

But faced with a stumbling global economy and European and U.S. debt woes, the central bank opted on Wednesday to keep rates steady, with many economists now expecting easy money until the second half of 2012.

"In order to crash you need two preconditions: a huge increase in rates as in 1991, which is unlikely, and a subprime type situation, namely very low-quality mortgages," said Benjamin Tal, senior economist at CIBC World Markets. "That is not the situation in Canada.

"So although I see prices going down over next two to three years, I don't see a crash, I see a moderate gradual softening."

The government, fretting about high debt levels, is working to engineer that soft landing with tighter rules for government-backed insured mortgages that took effect in March. The changes cap mortgage terms at 30 years rather than 35 and cut the amount homeowners could borrow against their homes to 85 per cent from 90 per cent.

Canada's national banks are more conservative lenders than America's fractured regional banks were, and there is virtually no sub-prime market, where riskier borrowers end up paying higher rates. Mortgage interest is not tax-deductible, so the incentive to buy a home is less. And a large slice of the mortgage market is insured by the government.