Canadian Res Experts Evaluate Bubble Risk

IRVINE, CA-Auction.com released a statement Wednesday in response to a warning from analysts at Fitch Ratings, London and New York, about the ongoing risk of a Canadian housing bubble that would recall the U.S. collapse of 2008. Both assert that there is a real risk.

Fitch's warning was released Tuesday, and Auction.com responded later in the day. Fitch says that Canada's top six banks have reduced the size of denominators in their risk-based capital measures.

This has the effect of lowering the amount of capital banks hold against residential mortgage exposures. The statement went on to say that Canadian home prices are likely “nearing a plateau” and “could exhibit some weakness,” in the near future.

In response, California-based Auction.com, which offers a full-line of online services and conducts extensive research in the real estate field, released a statement from a senior associate economist Chris Muoio addressing those same concerns. Auction.com's assessment is quite similar to to that of Fitch, and it's warning may be even stronger.

“If home prices were to cease appreciating, this would lead to an unwind similar to the one we saw in the U.S., as home equity is knocked out and owners find themselves underwater,” Muoio says in the statement. “Canada's demographics remain steady, with population continuing its steady growth rate of 1.1% per annum, providing no additional demand for housing to support the degree of price run-up that has been taking place.”

Fitch predicts that Canada's banks are in position to survive a major tumble without failing, and Auction.com notes that if the worst occurs, an “unwind probably will not be as devastating as the US housing meltdown.”

Auction.com's complete statement, attributed to senior associate economist Chris Muoio:

“We believe it is official that Canada's housing market is frothy and in danger of a correction.  Home prices when viewed as an index have soared, surpassing the height of the US housing bubble. But high and rapidly rising prices alone does not a bubble make, if income or population were rising rapidly as well, demand would justify those elevated prices.  This is not the case in Canada. Home prices relative to income have surpassed the height of the US bubble and are continuing to outpace income rapidly.  This skew can continue to rise as long as home prices continue to appreciate, but this means that purchasing a home in Canada is more and more a speculative investment, as the hope for future capital gains drives the purchase decision more so than the basic housing cost calculus of mortgage costs versus underlying household income.  If home prices were to cease appreciating, this would lead to an unwind similar to the one we saw in the US, as home equity is knocked out and owners find themselves underwater.  Canada's demographics remain steady, with population continuing its steady growth rate of 1.1% per annum, providing no additional demand for housing to support the degree of price run-up that has been taking place.  Some will say the demand is being sourced by overseas money from Asia, given the large immigration from there that occurred to Canada over the past decade.  However, with China facing its own housing oversupply and a slowing economic backdrop, even if this were true, it appears unsustainable.
Canada housing development has responded to the sharp increase in prices, with housing completions in Canada on par with their 2008 pre-recession peak.  New home starts remain very high, meaning completions will remain high in coming years.  Were home prices to reverse and buyers exit the market in response, Canada will find itself severely oversupplied.  This appears to be a recipe for the same process that occurred in the US that is only now beginning to unwind.  Like the US, this could create an overhang of supply that would weigh on prices and sales for years.
In addition to hard data suggesting unsustainable housing prices, there are anecdotal suggestions that this market is in a bubble.  We have seen reports that potential homeowners are using two mortgages worth 50% each of the home price so as to minimize the appearance of leverage to each lender.  The Canada Mortgage and Housing Corp. announcement that it is limiting its guaranteeing of recent future securities signals concern over what impact the downside for Canada home prices could have on Canada taxpayers.
While the initial stages of the US housing bust pre-dated the recession that followed, the worst fallout followed when the economy hit the skids in 2008.  Whatever the economic trigger may be, when home sales start to decline and employment growth slows the Canadian housing market is set for an unwind.   The unwind probably will not be as devastating as the US housing meltdown, as there is less leverage in the Canadian financial system and we are unsure if these mortgages and their securities have been packed into CDO's and the many other financial product acronyms that served as additional leverage in the US financial system.  However, this market looks to be in danger that home prices have reached an unsustainable level and the Canada housing market is in danger of a reversal.”