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Canadians are
in the midst of a mortgage binge, taking out home loans at a pace that's nearly
8 per cent faster than a year ago. The point of a record-low borrowing rate and
new fiscal incentives, such as allowing first-time home buyers to use a bigger
chunk of their registered retirement savings plans as down payments, was to
stir the animal spirits of consumers spooked by the financial crisis. But now,
as the recession eases, officials in Ottawa
and the analysts who advise large institutional investors on where to put their
money are suddenly paying closer attention to the effect of all this stimulus
on the longer-term prospects of Canadian consumers.
The concern is
that people are taking on too much debt on the assumption that interest rates
will stay low for a very long time, making Canadian consumers far more
sensitive to the effects of housing and other asset-price bubbles. There is a
growing consensus among leading economists and policy makers that the financial
crisis might have been less severe had they not bought into former Federal
Reserve Board chairman Alan Greenspan's assertions that nothing can be done
about bubbles.
In Canada,
economists are worried about consumers' willingness to pile on debt so soon
after an economic catastrophe that was triggered by Americans' willingness to
do the very same thing. “We know that cheap money in the past caused some
problems. This is a time to be prudent,” says Benjamin Tal, an economist at
Canadian Imperial Bank of Commerce in Toronto.
That attitude
is lifting house prices faster than many economists expected, given the
severity of the recession. Higher prices are creating wealth for the sellers,
loosening the recession's grip on the economy and helping to explain why the
Bank of Canada estimates that Canada's
first recession since 1992 ended in the third quarter. In the fight against the
worst global economic downturn since the Second World War, policy makers have
effectively drafted Canadians en masse. It's working, but at a price.
Middle-age
mortgagors
Canadian
consumer debt loads were already heading in a worrisome direction before the
crisis. The trend is now accelerating, driven by a large increase in mortgage
balances among middle-aged people.
U.S. consumers, chastened
by the destruction wrought by their profligacy, have lifted their savings rates
to levels above 3 per cent, up from zero ahead of the crisis.
Canadians are
going in the other direction. Household debt rose 3.4 per cent in the first
half of the year, as personal disposable income fell 0.2 per cent, according to
Mr. Tal. The debt-to-income ratio has risen to 140 per cent from 131 per cent
in the past year.
Much of the
new borrowing is mortgages, which have grown even as Canada's broader economy was
contracting. Adjusted for inflation, mortgage growth in the recessions of 1991
and 2001 was virtually non-existent. It currently tops 7 per cent, adjusted for
inflation. Thanks to Mr. Flaherty's January budget, many first-time buyers can
now take as much as $25,000 from their RRSPs to use as a down payment, compared
with $20,000 previously. Novice buyers are jumping into surging real estate
markets in Vancouver, Calgary
and Toronto
with little understanding that the value of the asset they covet can
disintegrate.
Housing prices
don't typically survive recessions. In April, 1989, the value of an average
existing home in Toronto
was $261,650. This was the peak of the 1980's boom, with prices 267 per cent
higher than at the beginning of decade. The bust that followed was nearly as
dramatic: The trough didn't come until August, 1993, when the average price
sunk to $189,620. The average price didn't top the 1980's peak until January
2002. Whether they're first-time buyers or trading up, consumers are using low
rates to take on a bigger loan than they would in normal times.
But the
decision to take on bigger mortgages isn't the result of bigger paycheques. In
2004, mortgage credit amounted to about 74 per cent of personal disposable
income. Now it's 96 per cent.
The hurt of
higher rates
The crux of
the concern in Ottawa
and on Bay Street
is the impact that rising rates will eventually have on highly leveraged
homeowners.
“We know that
interest rates will rise – the only question is when,” Mr. Tal says. “Even if
you lock in a five-year mortgage rate, you have to realize that five years from
now, they will be significantly higher than they are now. Clearly people have
to be much more prudent in this kind of environment.”
Bank of Canada Governor
Mark Carney reiterated this week that his overnight target likely will remain
at 0.25 per cent until next June. But central banks in Israel, Australia and
Norway have begun reversing their extraordinary easing cycles amid signs of
incipient inflation and some concern that asset prices, including real estate,
are getting a little too hot.
Central
bankers in the U.S.
and elsewhere have also indicated in recent months that once they decide it's
time to begin raising interest rates, they may do so at a faster pace than
consumers and investors are used to.
While heftier
debt loads obviously make all borrowers more vulnerable to higher interest
rates, consumers' increased exposure to real estate also means that they have
become more susceptible to changes in the housing market.
Consumers with
fixed-rate mortgages might feel secure. But with many mortgages now having a
35-year amortization, they are bound to feel the pinch of higher interest rates
at some point.
“Consumers
have to think very carefully about what they're going to do in five years when
interest rates are higher,” says Peter Aceto, the CEO of ING Direct Canada. The
financial crisis crimped property markets around the world, but Canada's
eight-month housing correction is now a distant memory.
‘Irrational
behaviour'
Sales of
existing homes slumped in October, 2008, but by May, they had returned to
pre-recession heights.
Home purchases
are now back up to the “lofty” volumes of 2007, according to economists at
Toronto-Dominion Bank, even though the country's gross domestic product
contracted in August, according to report by Statistics Canada yesterday.
The pace of
price increases in September was almost the fastest it's been in 20 years,
according to Bank of Montreal economist Douglas Porter. Prices have gone up in
20 of the 25 largest cities in the past year, and in all 10 provinces.
Mr. Carney
doused talk of a house-price bubble during parliamentary and senate testimony
this week, saying much of the current increase in home buying and prices is the
work of buyers who put their plans on hold during the worst of the recession.
Mr. Carney, who expects the real estate market to cool off by 2011, also
pointed out that construction of new homes remains below year-ago levels,
suggesting that purchases of existing homes in superhot markets such as
Vancouver and Toronto is skewing the national picture.
All things
being equal, higher prices should encourage more people to put their houses up
for sale, which in turn should lower prices by increasing supply.
The problem is
it's difficult to spot a bubble for sure until it bursts. “That was the point
that Greenspan used to make about why this is a problem for central banks,”
says Craig Alexander, an economist at Toronto-Dominion Bank.
Mr.
Greenspan's approach was to let bubbles burst, then attend to the damage by
lowering interest rates. The Bank of Canada, like many of its counterparts,
doesn't have the luxury of simply resorting to manipulating interest rates. If
Mr. Carney became worried about a housing bubble, the economy remains too
fragile to raise interest rates. Doing so would also carry the risk of driving
up the value of the Canadian dollar, which already is at uncomfortable heights
for the country's exporters.
‘Monitoring
the situation'
Canada's housing market is certainly not
stained by the sort of excesses that characterized the U.S. market
before the crash. Subprime lending in Canada
is estimated to represent less than 5 per cent of the market, compared with
more than 20 per cent in the U.S.
prior to the crisis.
But an ironic
scenario could still unfold. In an effort to combat a recession that had its
origins in a U.S. housing bubble, Canadian policy makers have responded with
low rates that might create a bubble here, giving the mortgage market too much
of a kick-start through low interest rates and a program of buying billions in
mortgages from the banks.
Federal
Finance Minister Jim Flaherty says he is confident he has a handle on it. He
noted that in 2008, the government decided it would no longer insure mortgages
with 40-year amortization periods, reducing the maximum acceptable term to 35
years. It also boosted the minimum down payment to 5 per cent. Both Mr.
Flaherty and Mr. Carney said measures of that type could be taken again if
Canadians get in over their heads in the mortgage market.
“We're
monitoring that situation,” Mr. Flaherty told reporters in Toronto yesterday. “Interest rates are very
low, and that is no doubt contributing to some additional activity in the real
estate market. We'll watch, and what we've done before we can do again if we
need to.”
The Bank of
Canada is paying special attention to household debt, and it will include an
analysis of the debt burden of all income classes when it releases its biannual
review of the financial system in December.
For now, Mr.
Carney says the situation is under control because the cost of paying for that
growing debt is much lower than its historic average. While total household
debt rose by $44-billion during the first six months of the year, interest
payments on debt actually fell by $3-billion, according to economists at CIBC.
Still, Mr.
Carney reminded members of Parliament and Senators this week that rock-bottom
interest rates can only move in one direction. Accordingly, he encouraged both
borrowers and lenders to act “prudently.”
And even
though he dismissed the idea of an imminent bubble, Mr. Carney still encouraged
discussion of the subject. The reason: The more people talk about bubbles, the
less chance they form. A key ingredient in the U.S. subprime mortgage crisis was
the lack of attention that was being paid to the problem as it brewed.
“We welcome
the discussion of this issue because it is anticipatory,” Mr. Carney told the
Senate banking committee. “People are anticipating a potential vulnerability as
opposed to looking in the rear-view mirror and seeing a vulnerability that is
already here. That is one of the ways that one prevents that.”
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