Canada's Housing Bubble

Jonathan Tonge Sep 23, 2009 www.americacanada.blogspot.com

An inquiring reporter came to me to ask "what's the risk?":

The risk is that the government is socializing risk in an attempt to prop up the real estate market and the economy as a whole I answered.

Perhaps this will be a better story for you when you see real estate collapse. With long line ups outside of builders sales offices in Canada, you'd think a real estate bear would be nuts right now. Perhaps a doomsday scenario. But real estate's fate is written into the cards. 35 years, 5% down, record low interest rates, generous banks thanks to government insurance, and obsessive consumer attitudes towards real estate is all that is driving it. It's not sustainable.

When consumer attitudes change towards real estate, it will collapse. Consumer attitudes can change within weeks without notice. They will turn much faster than what you could sell your house in. I can't tell you when but I can tell you they will soon. In 2008, when real estate prices started to decline, consumer attitudes hadn't changed. Affordability had collapsed - Canadians wanted real estate but a tiny increase in mortgage rates sent prices down 10%. They simply couldn't afford it.

When the economic crisis came it brought a small population of house-starved Canadians that much closer to a home. Today these remaining greaterfools are maxing out debt at 3%. The entire home market has been fueled by debt. This debt bubble is thirty years strong and at most has a couple years left in it in Canada. In the US it has already collapsed.

What started off with Bernanke and Paulson saying was a moral hazard, and letting Lehman fail, became a hypocritical and politically charged focus of cause and effect. Lehman's did not cause the market to seize. Even after AIG was bailed out, and TARP was created, the credit markets were still frozen. The credit markets in the US had been freezing up since 2007. This was the natural breathing process of an economy that was overburdened in debt trying to struggle out of it.

The banks needed to default. The borrowers need to default. This debt can not be paid back. But instead of admitting that, the government hopped in with a 2 trillion dollar deficit to attempt to keep the economy inflated. They offered 8K to home buyers, cash for clunkers, home renovation tax credits, propped up banks, propped up failing companies. Debt repayments started to result in deflation, making the debt burden even greater. So the solution Bernanke, Carney and Flaherty came up with was to socialize risk. Apparently Bernanke studied the Great Depression and knew the follies. So the answer is to socialize risk and indebt the country further.

Wait a minute, isn't it debt, huge corporations and an absence of properly calculated risk that caused this mess? What's the exit plan? Are these great minds in Ottawa and Washington going to put together a great way to make this debt disappear? No there isn't a way. The only way to avoid the negative repercussions of a debt bubble is to not cause one in the first place. If debt is a problem today then what will 20% more debt next year mean? Didn't anyone learn from Greenspan when he created the housing bubble in response to what was going to be the greatest stock market crash of all time (tech bubble represented the most inflated stock market ever)? The truth is the government will try, but can't spend forever. Their solution won't work because it only makes the problem worse.

And Japan is evidence that this process doesn't work. Japan's economy has barely grown in 20 years, and 20 years after their real estate market collapsed and prices are down over 50% and the stock market 75%, the Japanese consumers as measured as a percentage of GDP are more indebted than ever. When the Japanese bubble popped, Japan owed 260% of GDP. Today it is 500%. The government alone now owes 200% of GDP. Furthermore, after years of saving hard to prepare for retirement, the Japanese this year became net borrowers from the world. The Japanese baby boomer population attempted to save hard through the 90s to replace their losses after the crash, but they have now completely run out of funds. They are borrowing to fund their retirements.

Japan did exactly what the US did. Lowered interest rates and stimulated their economy to death. They built roads into nowhere. A couple years after the crash the people pressured their government to reduce stimulus and balance the books, and the economy immediately sank again. Economists point to the idea that the Japanese were too aggressive, and the stimulus should have been kept in place. But what these Keynesians don't get is that Japan's economy will always need stimulus so long as this much debt is in place. 20 years later and its still there. It's the debt that is the problem.

So why would you want to stimulate and stop people from defaulting on that debt? Why would you want the government to continuously steal resources from the private sector in what they refer to as stimulating? Japan will sink year after year for decades until the entire country defaults. Only after the ensuing great depression will Japan emerge once again ready to grow and take on the world. But that's Keynesian economics - shift the buck onto our children, let another politician deal with it. If only Japan had defaulted on the debt twenty years ago, their economy would be growing now and 65 year olds wouldn't still be suffering paying off their $600,000 mortgage on their condos that are now worth $400,000.

It was the debt that these big banks lent that are crushing America. This debt became true not because of the free markets and the independent choice of risk that so many blame, but because of the opposite - the government's hand. It was the government, US's, China's, Canada's, the Fed and Greenspan, lowering interest rates after the tech crash, increasing bank multipliers creating fictious money to lend, Asias big hand dumping savings on the West, Fannie, Freddie, CMHC insuring mortgages, and government programs stimulating more debt.

Canadians are more indebted today then he history of their country and they are not investing any of that money. Therefore their will be no way to pay off that debt. Even if Canada sold all their natural resources, they'd be lucky to net more than $400 billion. They are broke.

The spin offs from debt are completely absorbed within 6 months of the creation of that debt. As the debt grows, and debt repayments increase, the reality of its burden will become apparent. This isn't doomsday. It's just common sense.

We can't keep growing debt at a compounded rate of 13% a year to prop up real estate. Next year we will need to grow debt at 14%. The year after 16%. The year after 18%. Take a look at the graph on this link. Look at the compounded growth rate of mortgage debt in Canada. What do you notice? To keep housing prices rising, it takes a higher growth rate each year on that debt. That's how debt fueled asset price increases work. They are not real. Note: The 2009 estimation in the graph was when the market was cooling earlier this year. It will actually grow 12+% this year.

So using my quick and dirty calculation, to keep home prices rising at 4-5% per year, it will take a 56% rise in mortgage debt from January 2010 to December 31, 2012. That would put us at over 1.5 trillion mortgage debt or about 50% more indebted than Americans on a per capita basis (and they're private debt is now shrinking). To keep real estate growing at this rate until 2015, mortgage debt will have to double that figure, at 3 trillion. In the year after that it will rise almost 1 trillion in just one year (about nine times the rate of borrowing today) . It turns into a ridiculous amount of money and it is a mathematical impossibility. It's not going to happen. And people aren't going to borrow even at the current velocity if house prices are falling. They never do. That's a debt fueled market - we've reached a point where we simply can't grow debt at a rate that sustains the momentum of the underlying asset prices.

Free markets work identically to nature - identical. There is absolutely no difference between a free market full of business, consumers and investors than a free population of animals. It's the combination of chaos and rational choices that drives the best results. Sure there are negatives, but survival of the fittest allows for independent choice. Independent choice when multiplied by the entire population provides a much better solution than the decisions of just a few who are by all means, biased and politically charged. The choices of just a few rarely if ever benefit all.

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