OECD frets about Canada’s House Price Bubble
In its economic outlook released today, the Organisation for Economic Cooperation and Development (OECD) is generally gung-ho about the Canadian economy, and practically bubbling over with new enthusiasm for the global economy. It now expects global growth to accelerate from 2.9% this year to 3.3% in 2017 and to 3.6% in 2018. Call it the “Trump effect” gone global.
But for Canada, despite its hunky-dory economy due to the “moderately expansionary policy stance in the 2016 federal budget,” the OECD has a stark warning: “House prices, housing investment and household debt are very high, posing financial stability risks.”
The OECD’s chart shows the house price indices for Vancouver and Toronto, which make up about one-third of the national housing market, versus the index for the rest of Canada. Note the hook at the top of the red line: a feeble sign that house prices in Vancouver might be heading south:
And there is a risk of “a disorderly housing market correction, particularly in the high-price Toronto and Vancouver markets,” the report warns. How far in the future could this be? Last month, I pointed out the divergence now appearing, with Vancouver in turmoil, and Toronto in a price spike [There’s No Plateau in a Housing Bubble, Not Even in Canada].
A “disorderly housing market correction,” as envisioned by the OECD, would reduce residential investment, which has become a key in the Canadian economy. Through the reverse “wealth effects,” private consumption would take a hit, and in the end the banks are on the line, and it “could threaten financial stability.”
[I]nterest rates have fallen to very low levels. This has added further fuel to already overheated housing markets in Vancouver and Toronto and encouraged Canadian households to take on even more debt, the repayment of which might be problematic. Both of these effects have increased financial stability vulnerabilities.
The indebtedness of Canadian households, when measured against disposable income, continues to “edge up from already high levels,” encouraged and enabled by low interest rates:
Of the OECD member states, only six have higher debt-to-disposable income ratios: Ireland, Sweden, Australia, Norway, the Netherlands, and Denmark (the last two with a ratio of over 250%). All of them have majestic government-aided and abetted housing bubbles. For American debt slaves, this measure is just over 100%, below where Canada’s was in 2000!
The “very low borrowing rates have encouraged household credit growth and underpinned rising asset prices, especially for housing,” the report says.
In terms of “financial stability,” the report takes into consideration the banks’ size as a percentage of GDP, nonbanks’ size as a percentage of GDP, housing loans as percentage of total chartered banks’ loans, and liquid assets as a proportion of short-term liabilities.
In a separate note, Peter Jarrett, Head of Division, Country Studies, OECD Economics Department, has a special word about Canada’s housing bubble, the indebtedness of households that it entails, and the risks to the system:
Local housing markets are presently highly disparate in Canada. While in most smaller localities real estate prices are fairly stable and not out of line with the fundamentals (incomes and rents), 10 of the 15 large Census Metropolitan Areas monitored by the Canada Mortgage and Housing Corporation (CMHC) show signs of overvaluation, and seven show moderate or strong evidence of overbuilding.
Emphasis added. Overbuilding leads to a glut. And gluts entail the very “disorderly” housing market correction the OECD is warning about.
[H]ouse prices in Toronto and especially Vancouver, which together make up one third of the national housing market, are such that, in tandem with high household debt (which nationally reached 167.6% of disposable income at end-2015, near the top of the OECD country range), they represent a significant financial vulnerability.
A sharp fall in house prices triggered by a shock that results in a large increase in unemployment could weaken households’ ability to service their debts, resulting in a rise in mortgage defaults that could endanger financial stability.
One factor driving market strength in Vancouver and Toronto is foreign buying [emphasis added]. Unfortunately, limited data are available on such purchases, but the federal government has allocated some funding for Statistics Canada to begin to gather such data.
British Columbia has begun to address the price distortions caused by foreign buying. It imposed a transfer tax applicable to non-resident investors and other policies. And they’re hitting Vancouver’s housing market hard.
And then there’s the classic risk associated with house price bubbles: construction booms and what they do to the economy and banks when they crater:
[T]he share of residential investment in Canada’s GDP is currently the OECD’s highest…. Strong residential investment may in principle reflect robust demographic growth, but Canada’s outcome appears stronger than what can be justified by underlying population increases. And the larger the share, the further it could fall if the boom ends with a bang.
And there’s one more thing. Soaring house prices are not only a risk to the economy when they come down, and to the banks when mortgages curdle and construction loans implode, but they’re already “squeezing middle-class families in these high-priced markets.”
“Squeezing middle-class families” can’t be all that great for the economy.
One of the ironic aspects of the OECD’s handwringing about the Canadian housing market, household debt, and the banks? The report names the culprit repeatedly – low interest rates – but all the solutions it proposes for the “authorities” are focused on macro-prudential measures, of the type Canada has already implemented. But it fails to point out the solution that has been obvious for years in the face of rampant asset bubbles: higher interest rates.
Higher interest rates are now happening in the US. Read… How (Slightly) Higher Mortgage Rates Maul Housing Bubble 2, Affordability, and the Rest of the Universe