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Is Canada on the Verge of its Own Housing Bust?

August 29, 2008
Michael Burt
Director
Canadian Industrial Outlook
New home prices have been flat for several months and existing home prices are now falling on a month over month basis. When coupled with the recent drop in housing starts and existing home sales one might be tempted to think that we are headed for a U.S. style housing collapse. You would be wrong if you did.

There is no doubt that the Canadian housing market has weakened significantly over the course of this year. Weak prices and a steady fall in the sales to new listings ratio indicate that supply has outstripped demand and that we are moving into a buyer’s market. The important thing to remember as we now undergo this overdue correction is that home construction and sales activity is returning to a more normal pace. Housing starts in Canada have exceeded 200,000 units for six consecutive years, a boom of this magnitude has not been experienced since the 1970s. Sooner or later the party was going to end, and that time is now.

The reason why the Canadian housing market is not headed for a collapse like that in the United States is that housing markets are inherently local. It is no mean feat to move a house a few kilometers down the road, let alone across the country. As such, the housing market of every metro area in the country is an island onto itself. Needless to say, market conditions in the United States have little to do with what is going on in Canada. The only tenuous link between housing markets within Canada, and with those in the United States is financing. And the differences in the lending environment between Canada and the U.S. are considerable.

Factors such as rampant speculation on home price appreciation and large increases in the use of exotic mortgages (examples include interest only mortgages, mortgages where interest rates “ballooned” after a year or two, and mortgages issued to people with no income or assets) were major factors in the U.S. housing market collapse. Also important was the securitization of mortgages; the bundling and reselling of the cash flows associated with a group of mortgages. This activity transferred the risk of ownership from those who issued the mortgages to anyone willing to buy the cash flows, reducing the incentives for lenders to conduct due diligence on the loans they were issuing.

Lending practices in Canada have been much more conservative. Lenders here have begun to experiment with mortgages that have longer amortization periods or no money down, but the excesses that occurred in the U.S. have not occurred here. Further, the federal government recently announced that it will only insure mortgages with a maximum amortization period of 35 years, a minimum 5 per cent down payment and a minimum credit score. Lenders are taking note and have begun to adjust the products they are offering as a result of these regulatory changes. These changes will likely contribute to the slowing housing market this year, but they will also reduce the likelihood of a future bust in Canada.

The reality is that the Canadian housing market is undergoing an orderly and timely correction. Most major markets in central and eastern Canada have already witnessed a peak in construction activity, for some of them it was several years ago. The current downturn is the result of the booming housing markets in Western Canada now finally returning to earth. Some individual markets may experience oversupply conditions over the next 12 to 18 months, but this is not the start of national meltdown in housing markets.

 


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