An apocalyptic real estate bubble is striking fear in the hearts of many economists.
The Four Horsemen of the Apocalypse — better known to their friends and family as Conquest, War, Famine and Death — are among the more colourful characters in the New Testament's Book of Revelations. But should they ever decide to extend their brand in these turbulent times, there's not much doubt who they should sign up as the Fifth Horseman: Bubbles.
But the most terrifying bubbles these days are the ones that continue to rattle and roil the confidence of financial markets. Most recently, economist Nouriel Roubini (aka Dr. Doom) has been warning anyone who will listen that low interest rates and a falling U.S. dollar could puncture an asset bubble that's formed in the aftermath of the financial crisis.
Bubbles come in many varieties (perhaps the best known one in recent memory in Canada was the high tech bubble of 2000), but they are feared to such an extent because they ravage personal capital and leave entire market sectors in rubble.
Currently, the Apocalyptic Bubble that is striking fear in Canada is of the real estate variety. There's concern in many circles that relatively high housing prices will pop mightily when the Bank of Canada moves, as it inevitably will, to increase interest rates.
As asset bubbles go, the housing market sort are especially tricky devils because of their highly political nature. Home ownership, you see, is a very popular thing with voters. And governments, especially minority governments, like to keep voters happy. Furthermore, because of the ripple effect on confidence and spending that go with purchasing a new home, it's all the more desirable to encourage it as a form of economic stimulus.
There's not much question that the performance of the Canadian real estate market in the midst of the recession has been impressive. In August, the Canadian Real Estate Association estimated that national home sales were up 18.5 per cent year over year and prices were 11.3 per cent stronger in the same period. Hmm.
So what's been underpinning that activity and how sturdy are those underpinnings — especially in light of unemployment numbers and the apparently slow path to economic recovery?
Well, direct government involvement in the real estate market is certainly one factor. It may not be a stated federal policy objective, but the recent numbers around Crown corporation Canada Mortgage and Housing Corporation (CMHC) are revealing. This year, there's been a significant increase in the dollar value of the mortgages that the government allows CMHC to backstop — to $600 billion from $450 billion last year.
So, people who've put down five per cent of the value of a house and amortized it over 35 years could be dangerously squeezed when interest rates are "normalized" within the next year or so — especially given the current taste for variable rate financing.
What else is at play?
Obviously rock-bottom interest rates have done a lot to push people into the market, and the chartered banks, most of which came through the storm in relatively good shape, were amenable to lending money — especially since mortgages are insured through CMHC.
Then there's the issue of pent-up demand. No one was buying or selling much during the worst days of the early downturn, and as the smoke cleared, people wanted to make up for lost time.
That raises the question of whether things are going to level off now that demand and supply are back in better balance. There's no question that if this is a temporary phenomenon, the folks at the Bank of Canada will be more than a little relieved.
That's because it's a tough assignment to manage something micro, like the housing sector, with monetary policy — the ultimate macro-economic tool.
Nevertheless, although the central bank has stated that its "sole monetary policy objective is to achieve a two per cent inflation target," it has also hinted that it may "lean" against a housing bubble and let some of the air out of it if it really has to.
What does that mean for those who are looking to move about in the housing market?
Watch valuations more carefully than ever, crunch the numbers using significantly higher interest rates, and consider fixed-rate rather than floating-rate mortgages. After all, no one wants to take a Bubble bath.
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