Canada's Housing Bubble

Dec 13, 2010 Ben Rabidoux financialinsights.wordpress.com

Banks calling for prudence

Last week BMO and TD bosses vocalized support for tougher mortgage rules in the form of lower amortization and/or higher down payment requirements.  Now it appears that the Conservative government is in some pre-budget consultation meetings with these same banks regarding the need to rein in consumer debt levels which, in case you missed it, was reported earlier today at a new high of 148.1% of personal disposable income.

Ottawa, banks discuss measures to rein in Canadians’ personal debt

“Ottawa is talking to the banks about putting new measures to curb the rise in consumer debt into the next federal budget….Several bankers have told him that they would support further federal moves to cool the mortgage market, including cutting the maximum term of mortgages or increasing the minimum down payment.”

“Fairfax Financial CEO Prem Watsa is among the influential voices pointing to the impact of soaring debt on the broader economy. Not only are Canadians overleveraged, primarily with mortgage debt, low interest rates have prompted speculative buying that is artificially inflating housing prices, he said.”

“The risk is that if consumers act relatively quickly to reduce their debt load, that could cause fresh headaches in some parts of the economy, illustrating the conundrum that policy makers face as they balance the economic benefits of consumer spending with the risks.”

This is exactly why the government has been so hesitant to curb debt levels.  As we’ve discussed at length on this blog, credit bubbles are fantastic for an economy in the short term.  When secular shifts take place in consumer perception of debt, if that shift is one towards an embracing of credit and consumerism, it is down right great for economic growth.  Aggregate demand is pulled forward, unemployment drops, consumer sentiment is jovial, easy credit flows into certain asset classes (often real estate), rising assets create additional consumer spending via the wealth effect….rinse, repeat.  Good times!

Alas it is nothing but a mirage as that debt must eventually be repaid, meaning a gap in aggregate demand, reduced demand for credit, falling consumer spending, rising unemployment, etc.  Mean reversals from points of significant historical deviation are often quite nasty.

Meanwhile, the finance minister was quick to confirm that a tightening of mortgage rules has not been ruled out, despite the obvious economic pain it would cause:

“Canadian Finance Minister Jim Flaherty warned on Monday the government could tighten mortgage rules further if needed after a report showed the country’s household debt levels have soared.

“As I’ve said before, if necessary, we will tighten the mortgage rules again. We keep an eye on the level of credit.”

We’ll see about that.  I’d be a bit surprised to see anything drastic without a majority government in place.

Peter Mansbridge interviews Ed Clark

Speaking of those bank CEOs in the news, TD CEO Ed Clark was interviewed by Peter Mansbridge on ‘Mansbridge one-on-one’ this past weekend.  The last 7 minutes are fantastic.  Clark manages to touch on most of the big themes on this blog in a 7 minute sound bite.  The full video is here.

I quickly transcribed a few of Clark’s key quotes.  They may not be perfectly verbatim, but they do capture the point.

On the Chinese economy:

“I’m worried about this world economy where you have China running an export strategy that is not sustainable”

On the US economy:

“The US housing situation looks incurable….the fiscal situation is not sustainable”

On Europe:

“Europe is in a fiscal emergency that we don’t see a resolution to.  It is a deeply troubling economic environment”

On the demographic challenges facing Canada:

“I think the challenge for the next 20 years….if you look at the past 40 or 50 years, you have an extraordinary situation where you’ve had baby boomers entering the workforce and women joining the labour market…..the population of workers to those not working soared.

As a result, per-capita income was artificially raised and per-capita revenue for government was artificially raised.

Politics was defined as saying, “what more can we give to the population with all this money coming in?”  We’re now going into a period where the exact opposite is happening.  Government revenue will grow more slowly while demand increases.

When you look at this world, the question is, “Who’s promise is going to be disappointed?  Who’s going to bear the fact that we can’t deliver what we thought we could deliver?”

Other countries are finding this out as austerity is beginning to bite.  Promises made at a time when demographics were far different and the credit bubble in the Western world was just starting will become increasingly difficult to honour given the current economy and demographics.  More philosophically, should they be honoured?  While the ethics involved in negating a promise certainly don’t make me comfortable, neither does the idea of asking future generations to make massive sacrifices to their own standard of living to sustain promises that up until the last half century would have been looked at as ridiculous.

Yes, the next few decades will look nothing like the last.  For that matter, the next few years should be a wild ride too.

-Ben