After years of lecturing America about loose lending, Canada now must confront a bubble of its own
Feb 4th 2012 | TORONTO
IN FEW corners of the world would a car park squeezed between two
arms of an elevated highway be seen as prime real estate. In Toronto,
however, a 75-storey condominium is planned for such an awkward site,
near the waterfront. The car park next door will become a pair of
70-storey towers too. In total, 173 sky-scrapers are being built in
Toronto, the most in North America. New York is second with 96.
When the United States saw a vast housing bubble inflate and burst
during the 2000s, many Canadians felt smug about the purported prudence
of their financial and property markets. During the crash, Canadian
house prices fell by just 8%, compared with more than 30% in America.
They hit new record highs by 2010. “Canada was not a part of the
problem,” Stephen Harper, the prime minister, boasted in 2010.
Today the consensus is growing on Bay Street, Toronto’s answer to
Wall Street, that Mr Harper may have to eat his words. In response to
America’s slow economic recovery and uncertainty in Europe, the Bank of
Canada has kept interest rates at record lows. Five-year fixed-rate
mortgages now charge interest of just 2.99%. In response, Canadians have
sought ever-bigger loans for ever-costlier homes. The country’s house
prices have doubled since 2002.
Speculators are pouring into the property markets in Toronto and
Vancouver. “We have foreign investors who are purchasing two, three,
four, five properties,” says Michael Thompson, who heads Toronto’s
economic-development committee. Last month a modest Toronto home put on
the market for C$380,000 ($381,500) sold for C$570,000, following a
bidding war among 31 prospective buyers. According to Demographia, a
consultancy, Vancouver’s ratio of home prices to incomes is the highest
in the English-speaking world.
Bankers are becoming alarmed. Mark Carney, the governor of the
central bank, has been warning for years that Canadians are consuming
beyond their means. The bosses of banks with big mortgage businesses,
including CIBC, Royal Bank of Canada and the Bank of Montreal, have all
said the housing market is at or near its peak. Canada’s ratio of
household debt to disposable income has risen by 40% in the past decade,
recently surpassing America’s (see chart). And its ratio of house
prices to income is now 30% above its historical average—less than, say,
Ireland’s excesses (which reached 70%), but high enough to expect a
drop. A recent report from Bank of America said Canada was “showing many
of the signs of a classic bubble”.
The consequences of such a bubble bursting are hard to predict. On
the one hand, high demand for Canada’s commodity exports could cushion
the blow from a housing bust. And since banks have recourse to all of a
borrower’s assets, and Canadian lending standards are stricter than
America’s were, a decline in house prices would probably not wreck the
banks as it did in the United States.
However, the Canadian economy is still dependent on the consumer.
Fears about the global economy have slowed business investment, and all
levels of government are bent on austerity. The Conservative
government’s next budget is expected to put forward a plan to close the
federal deficit, now 2% of GDP, by 2015—modest austerity compared to
Europe’s, but still a drag on the economy. Few new jobs are being
created. Assuming there is no setback in Europe’s debt crunch, slowdown
in America or drop in commodity prices, GDP is forecast to grow by a
meagre 2% this year. If consumers start feeling less well off, Canada
could slip back into recession.
The inevitable landing will probably be soft. Increases in house
prices and sales volumes are slowing, and the 2015 Pan American Games in
Toronto should prop up builders. “The national housing market is more
like a balloon than a bubble,” says a report by the Bank of Montreal.
“While bubbles always burst, a balloon often deflates slowly in the
absence of a ‘pin’.”
Moreover, the government is trying to cool the market. The banking
regulator is increasing its scrutiny of housing in response to concerns
about speculators. The Canada Mortgage and Housing Corporation, a
government mortgage-insurance agency, says it will have to start
reducing its new coverage because of legal limits. And the finance
ministry has cut the maximum term of publicly insured mortgages from 35
years to 30. Some bank managers are calling for it to be reduced to 25,
the historical norm. Canada’s reputation for financial sobriety is not
entirely unwarranted.
However, the state has refused to use its most powerful tool. To
protect business investment, the central bank has made clear that it
plans to keep interest rates low. As long as money stays cheap, the
balloon could get bigger—perhaps big enough to become a fully fledged
bubble after all.
from the print edition | The Americas
