Rising Debt and Higher Net Worth portend a Housing Bubble in Canada

Posted by PITHOCRATES - December 15th, 2013

Week in Review

The Canadians like to think of themselves as kinder and gentler than their neighbors south of the border.  For they have a generous welfare state.  Including single-payer health care.  Unlike those Americans who put profits before people.  But it comes at a price.  High taxes.  And they do pay a lot.  But they get a lot.  Those high taxes, though, lower take-home pay.  Giving Canadians less disposable income than their neighbors south of the border.  Which means they have to borrow more to make up for that smaller disposable income (see Personal debt ratio hits record high of 163.7% posted 12/13/2013 on CBC News).

Statistics Canada reported Friday that the level of household credit market debt to disposable income increased to 163.7 per cent in the third quarter from 163.1 per cent in the second quarter.

That means Canadians owe nearly $1.64 for every $1 in disposable income they earn in a year.

Policymakers are fixated on the debt ratio in part because it was at above 160 per cent that households in the United States and Britain ran into trouble about five years ago, contributing to defaults and the financial crisis that triggered the 2008-09 recession…

Indeed, while they are borrowing more, Canadians are also worth more as their assets increase by a similar amount. The national net worth increased to $7.5 trillion in the third quarter, up 2.1 per cent from the previous quarter.

On a per capita basis, that works out to $212,700 for every Canadian. The previous quarter, that figure was $208,300.

Rising net worth and rising debt?  Gee, what could that mean?  Well, most people’s wealth is determined by the price of their home.  As the value of their homes rise so does their net worth.  That is, their net worth rises as the price of their home (if they were to sell) rises.  And as their home price rises so do other home prices.  Which increases mortgage amounts.  As people borrow more to buy these more expensive homes.  And the lower the interest rates the more they will borrow and the bigger the house they will buy.  And this creates a what?  That’s right.  A housing bubble (see Is There a Canadian Housing Bubble? by Carrie Rossenfeld posted 11/13/2013 on GlobeSt.com).

GlobeSt.com: What factors lead experts to think there may be a Canadian housing bubble?

Muoio: For us, the biggest sign there is a housing bubble is how far prices have appreciated without a corresponding rise in income. This means housing affordability is falling rapidly and will eventually reach a tipping point. Additionally, if lenders are underwriting against an expectation of rising prices, this could result in loosening standards and too much leverage in the system.

GlobeSt.com: How similar are these factors to what happened to the US housing market before the recession?

C.M.: Very similar. US home prices kept appreciating while incomes saw only modest growth in the final years before the bubble burst. This led to a situation where eventually housing just became entirely unaffordable and the market’s liquidity completely dried up. With people over-levered due to the loose lending standards (which were enabled by the expectation of rising prices), this led to a massive unwind and foreclosure mess we are still working through. Additionally, Canada, just like us at the time, is building an extreme amount of homes that could lead to oversupply issues.

A rising debt level and higher net worth probably is more bad news than good.  For it is likely a sign of a housing bubble.  Just like these very things were a sign of a housing bubble in the U.S. just before the subprime mortgage crisis.  Or is it a sign that Canadians are just taxed too much leaving them with less disposable income?  Forcing them to borrow more as they cannot save enough for a sizeable down payment to reduce the amount they have to finance?   Or is it both?

It appears the Canadians can’t learn from the Americans.  And when the Canadian bubble bursts the Americans won’t learn anything from the Canadians.  For governments today want to keep interest rates low to encourage home ownership.  Which they do.  Taking us from bubble to bubble.  And from recession to recession.

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