Canada's Housing Bubble

Analysis of the real estate bubble in Canada -- http://CanadaBubble.com

Beware 'the housing wealth effect' Print E-mail

Let’s hope the housing market holds up better than the stock market has.

If not, we really have problems.

Feeling bummed out about how your registered retirement savings plan or investment account is shrinking in value as stocks plunge? Just wait and see what happens if the housing market slumps.

Far more than stocks, a rising housing market makes us feel wealthy and sustains the economy. But the reverse is true, too.

“If you want to knock consumer confidence out from under people, just let their largest asset decline in value,” said Ben Rabidoux, who has been crunching data on Canada’s housing market on his blog, The Economic Analyst.

Consumer spending accounts for about 64 per cent of our economy, which is to say it’s crucial. And, it’s under pressure. The latest quarterly Consumerology report from ad agency Bensimon Byrne says half of Canadians feel worse off about their personal economic situation than they did a year ago, and they expect to feel worse in a year’s time. Overall confidence levels have fallen by levels not seen since the stock market crash of 2008, the survey found.

A reversal of fortune in housing would make things worse. While the risk of a real estate slump shouldn’t be exaggerated, it should be recognized – if only to provide perspective that may help people keep a level head.

Comments made about Canada’s housing market on Wednesday were typical of the lack of consensus on what’s ahead. The International Monetary Fund expressed concern about the hot housing market’s role in the build-up of consumer debt in Canada, while Finance Minister Jim Flaherty said the market has cooled somewhat and shows no clear signs of a bubble in prices.

While reporting average year-over-year price gains of between 5.7 and 7.8 per cent in the third quarter, realtor Royal LePage said the housing market in some parts of the country is softening and a broader slowdown is expected in the months ahead. And, last week, Bank of Montreal issued a forecast for a “soft landing” in which sales and prices remain steady. BMO summed up housing market supply and demand as follows: Low mortgage rates, relatively low unemployment and strong immigration versus high prices, elevated household debt and slowing employment.

Why worry about the possibility that the negatives in the housing market get the upper hand? For answers, let’s consider the wealth effect of a strong housing market.

Mr. Rabidoux, an instructor at Georgian College in Owen Sound, Ont., quotes an academic paper that found every $1 rise in the price of a house has an economic impact equivalent to 6 cents’ worth of increased consumer spending.

“People go out and buy stuff they wouldn’t otherwise buy if they didn’t feel so wealthy and confident,” he said. “People also feel richer, so they don’t feel the need to immediately save.”

Owning a house has been getting progressively more expensive over the years. So how is it that rising house prices feed higher consumer spending?

We can thank lines of credit for that, Mr. Rabidoux said. His data indicate that LOC balances increased 95-fold since 1985 while incomes and economic output have tripled.

Some of the money has gone into investments, he said. “But there’s no doubt that a good chunk of it has gone to support consumption to finance second cars, vacations or whatever.”

In a perverse sort of way, a drop in housing prices might actually be good for the country. Without the housing wealth effect, people might cut back on spending. This in turn would leave more money available for debt reduction and increased saving.

This is what’s happening in the United States right now and it’s seen almost as a detox process after years of consumer excess. But the healing process for household balance sheets has been a major drag on growth. Earlier this week, U.S. Federal Reserve chief Ben Bernanke described the economy as “close to faltering,” which is about as bleak as a central banker is likely to get in public statements.

Mr. Rabidoux thinks it would be a good thing over the long term if the housing wealth effect lessened and Canadians both saved more and spent less. “But my perspective is that you can’t have that shift without exerting some level of pain in the economy.”

Put your own financial security and that of your family ahead of what’s good for the economy. Cut spending and save more as required. If there’s anything left over, do your patriotic duty and buy something.

Follow me on Facebook. I’m at Rob Carrick – Personal Finance.

 

 

 

 
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