Sunday, September 25, 2011

Is this fellow right...

I found this excellent article by an Economist, Alexandre Pestov at the Schulich School of Business (try saying that twenty times fast) in a comment posted On Ben's site . The graphs are excellent, so are the arguments- though I didn't see much mention of HAM or outside money which has had such a significant effect on our prices.

It was written in Feb. 2000 and he makes the usual case for the bubble in Canada, however he also states the things that may make the bubble pop, which he mentioned may all come about in 2011.

Here are some excerpts:

Current housing prices in Toronto, Vancouver, Montreal and Calgary are difficult to rationalize using any combination of fundamental metrics. As history shows, this leads to a price correction. The disparity between gains in income, growth in rental rates and home prices in Canada is quite apparent.

Over the last 13 years, growth in home prices substantially outperformed all other components. From the fundamental price-to-rent perspective, real-estate as an investment no longer represents an attractive asset. In fact, at the current home prices in major Canadian cities, renting an apartment makes more financial sense than owning it. This market state leads to an array of predictable consequences. For instance, renting a property out now requires a substantial subsidy by the home owner, which effectively eliminates renting out as a contingency measure in case of income loss.


The price-to-income ratio in Canada is at a historically high level. In fact, in some cities it is the highest on record. Over the last 13 years home prices have become decoupled from homeowners income, the mean household income has risen by 23 to 32 percent in the four largest Canadian cities.

Over the same period, the average house prices in these cities increased between 100 and 200 percent. Based on the price-to-income ratio, the four major Canadian cities experienced growth comparable to that of the hottest spots of the US housing bubble. Yet, the US bubble burst, but home prices in Canada remained around these tremendously high levels.


Affordability in Canada is approaching historically high levels. In Vancouver, the housing affordability index exceeded the peak of the latest housing bubble of the late 80s. Adjusted for interest rates, the current affordability index in other Canadian cities is at par or above the peak of the late 80s bubble. If interest rates went up to the historical average, average households in Toronto and Vancouver would be paying 100 percent or more of their gross income towards ownership costs.


On the median multiple ratio measurement, Vancouver (9.3), Toronto (5.2), Montreal (4.9), and Calgary (4.6) hover substantially above the “normal” 3.0 level. Based on this valuation, Toronto is considered a “severely unaffordable” city, while Montreal and Calgary lie on the border between being “seriously unaffordable” and “severely unaffordable”. Vancouver prominently stands out even from this crowd: it is not just “severely unaffordable, but it is also the least affordable city in Canada, the US, UK, Ireland, Australia and New Zealand.


There are three main triggers that may help to set off the housing market decline. They are: HST, Olympics and rising rates


The whole piece is worth reading. But basically he says the triggers could be quite minor.

Eg the end of the construction boom linked to Olympics and the public debt problems that come out of it

Or a small rise in rates.

Or the advent of HST which has pulled demand forward (often due to confusion) and left a drop off that follows

He stated that all three were likely events in 2011.

Well I think he has been partially right. Bubbles are impossible to time and the 'trigger' for the burst is usually not what one would have expected.

Eg we have had the post Olympic drop in public spending, but the Government has kept the build-out going. Also the main hang-over (the Olympic Village) seems to have been thrown around the neck of the City of Vancouver and not the Province.

Also rates did start to move up in 2010 and many thought they would go a lot higher (not us here) - but the worldwide economic crisis has stopped the rise dead and a drop may now be on the cards.

However 2011 does indeed seem to have been the top for now. April to May 2011. And new possible 'triggers' have emerged. These include; a slow-down in China, another world-wide economic crisis, changes in Federal policy on mortgage length and CMHC insurance, a drop in commodity prices and higher unemployment. Maybe something else will come along and be 'blamed' for the fall. Whatever it is, it is never due to our own greed or our leaders' complacency. If it wasn't for 'X" we would still be in a boom!

And if you want a clear indictment of the foolish decisions our leaders made in this whole mess, there is no better summary than this. This is THE MOST important paragraph of our BUBBLE. I have re-read it many times.

Well done Mr Pestov for outlining it so clearly:

It is worth reminding ourselves that the bubble in Canada did not burst due to the massive intervention by the Harper government.

The intervention was orchestrated by injecting thousands of new buyers - many of whom cannot afford owning the property they purchased – into the market to prop up the prices.

The scheme worked, and the disaster was temporarily averted. However, the problem was not fully or even partially rectified.

By postponing the bubble deflation, the bubble was inflated further. If a housing market collapse would have caused pain and distress on behalf of a large and overleveraged Canadian population in 2007, the housing crash of 2011 will affect all the same buyers, plus many more of those who were sacrificed to keep the prices going up. More fire sales and more competing properties on the sell side will cause a sharper and a deeper downturn that would have been experienced in 2007.

Furthermore, CMHC, the second largest crown corporation in Canada, would require a bailout due to all the risky sub-prime mortgages it has insured. Every single one of the main sub-prime lenders in the US went out of business or required a massive bailout2. Unlike the US, the Canadian sub-prime lender would not require a bailout. In Canada, the bailout is already embedded in the system. It would simply be passed on to tax payers in the form of a larger national debt, higher taxes or tighter funds for social programs.


That last sentence explain why we are ALL in for a very difficult time when this bubble bursts. The Government has already committed to the bail-out! The only thing that remains to be decided is when and how much we all pay.