We Canadians have been rather uppity since the 2008 financial crisis knocked the stuffing out of the American economy.
But it might be time to pull in the boast reflex among us Canucks. Statistics Canada reports that the average personal debt-to-income ratio in 2011 was 161.7%; that’s revised up from 150.6%. And as of 2012’s second quarter, the Canadian debt-to-income figure is 163.4%, closing in on the 170% debt-to-income statistic found in the United States back in 2007 (170%).
Sure, as a number of analysts have pointed out, our personal debt levels are “safer.”
On housing specifically, Canadians have more equity built up in their homes than did Americans at the peak of their housing bubble. Presumably then, Canadians won’t see a wave of homeowners who walk away from their house and mortgage in the event of a minor reduction in the value of their home.
Also, part of the difference between American and Canadian housing markets at their respective peaks is how the U.S. bubble was pumped up by excessive mortgage debt, itself a result of mortgage interest deductibility. Because interest on mortgage is deductible from one’s taxable income, the bizarre U.S. tax incentive “rewards” homeowners if they stay in debt as opposed to paying off their mortgage early.
Still, even in the absence of that twisted tax incentive, Canadians have taken on ever-more personal debt due to low interest rates. That development leads to this Clint Eastwood question: Are you feeling lucky?
Proponents of the notion that Canadian home prices can never fall from their historic highs – that “it’s different this time,” bet against the odds.
After all, consider these two possibilities: suppose the economy again heats up to a point whereby the Bank of Canada thinks it necessary to raise interest rates to their more historic norm (and not their post-2008 and post-2001 levels). In that scenario, plenty of people who took out five-year mortgages and refinance them at some point find themselves pinched. Meanwhile, new buyers take on less mortgage debt. The result: home prices fall.
Or scenario two: the economy doesn’t heat up much any time soon and interest rates stay relatively low. The economy staggers along, zombie-like, for years. Eventually, given the sluggish economy, individual incomes don’t sprint ahead to match the overheated home market that has developed over the past decade. Instead, home prices revert to historic norms more in line with family incomes and the cost of renting versus the cost of buying. In other words, home prices fall at least in real (inflation-adjusted) terms or even in nominal prices.
The latter scenario already appears to be playing out in some Canadian housing markets such as Vancouver and Toronto, where sales have fallen relative to previous years. Note: That has happened in a low-interest rate environment and in cities with plenty of in-migration. If the volume of sales doesn’t recover soon, sellers will readjust their expectations and prices will drop. In other words, the assumption that home prices will never fall because of low interest rates is already on the verge of being proven false in Toronto and Vancouver.
Also, consider a useful international example: Japan has had low interest rates for two decades – and falling real estate prices. Real estate prices in Tokyo today are now back where they were in the mid-1980s.
I grant that America’s housing market at its peak had some critical differences from Canada’s. I also grant that Japan, unlike Canada, has a declining population. But here’s the similarity that matters: in the late 1980s and early 1990s, plenty of people thought a new economic model was in play in Japan.
It was assumed that people and institutions could borrow and buy assets (real estate and stocks) with cheap money forever and that no decline in the appetite for such risky behaviour would ever take place. That notion, the “it’s different this time” hypothesis, was spectacularly wrong.
