There's a line from Tolstoy's "Anna Karenina" that says, "Happy families are all alike; every unhappy family is unhappy in its own way." I'm inclined to say that that's also broadly true of bubbles. Apart from some superficial differences that may convince participants that it's somehow different this time, bubbles seem to follow some familiar patterns. With that in mind, Canadians may want to take a closer look at their own housing market, lest it go through the same spasms that have knocked the wind out of the U.S. housing market and the broader economy.
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Is a Bubble in Place?
Although there is some truth to the oft-repeated idea that Canada regulates its banking industry more conservatively, there is more than just circumstantial evidence that the generally conservative outlook has not prevented a housing bubble from forming.
Housing prices have doubled across Canada over the last 10 years, despite broadly-flat wages. While higher prices in markets such as Calgary, Edmonton or Fort McMurray could, perhaps, be explained by an influx of workers tied to the energy industry (and a shortage of housing in place), it's harder to explain why housing prices in Toronto and Vancouver should be about three and four times higher than average prices in the United States and more than double their historical average price ratios.
It's not just high housing prices that lead to bubbles or to bubbles bursting. Household debt plays a major role and that too is where there are some worrisome signs in Canada. Debt to income has grown from about 75% in 1990 to 150% recently, above the 125% or so that represented the peak in the U.S.
Expressed differently, Canadians now carry an average of $26,211 in non-mortgage debt, and it's very much appropriate to ask what will happen when rates lift off of these historical bottoms. Even if rates rise into just the 4 or 5% range (a level that would still be low by long-term historical averages), a large percentage of Canadians would suddenly find themselves unable to meet their debt and mortgage obligations. Then the country could easily see a similar sort of disruptive mass deleveraging as happened in the U.S.
But Canada's Government Is on the Job!
As I mentioned earlier, there is a widely-held belief that the Canadian government is different, that it has been much more conservative with respect to regulating the banks and that this conservatism will see the country through to a soft(er) landing.
Perhaps. Canada certainly does not have the same sort of rampant sub-prime lending that caused so much trouble in the U.S. What's more, while the U.S. not only has a much larger number of banks, savings and loans, thrifts and credit unions, the U.S. housing bubble also saw the rise of mortgage brokers, private mortgage insurers and a flood of Wall Street money into U.S. housing. By contrast, a much larger percentage of Canada's lending market is controlled by the Big Five (Royal Bank of Canada (NYSE:RY), Toronto-Dominion Bank (NYSE:TD), Bank of Nova Scotia (NYSE:BNS), Bank of Montreal (NYSE:BMO) and CIBC (NYSE:CM)).
It's also true that things are legitimately different in Canada in many ways. Lending standards are broadly tighter and more strictly enforced. What's more, the government (via the Canadian Mortgage Housing Corp (CMHC)) insures mortgages.
But for all the differences, there are many similarities and vulnerabilities. Home equity lending (HELOC) has soared and, just as happened in the U.S., Canadian government officials and leading Canadian banks are quick to ensure that there is no bubble. Also worrisome is the size and make-up of the CMHC; it is now larger (on a relative basis) than Fannie Mae at the U.S. peak, and five of the 10 governors have ties to the housing industry.
That said the Canadian government is actively trying to slow down the market. The government has tightened the rules, with steps like shortening the maximum loan length from 30 years to 25 years and reducing the maximum loan to value ratio to 65% from 80%. It looks like these steps may be having some impact; August sales were down almost 6%, while prices were up 4%.
What Happens from Here?
If Canadians are very lucky, there will be a gradual slowdown in housing prices, an increase in wages and a gradual country-wide deleveraging that reduces the interest rate sensitivity of Canadian citizens, prior to general rises in interests and without devastating the retail and housing sectors.
What's more, a bad outcome in Canada is going to look different than it did in the U.S. It seems hard to imagine that there will be a repeat of issues like robo-signing or that the CMHC will look to put back bad loans to Canadian banks. Nevertheless, it would still represent quite a lot of bad debt going on to the Canadian government's books, a pronounced slowdown in lending for banks and a lot of downward pressure on Canadian consumer spending, as that debt binge winds down.
It's also worth noting that Canada's economy is different from that of the United States. While many Canadians are employed in the domestic service sector, Canada as a whole gets a substantial portion of its national GDP from exports, particularly natural resources and high-value manufactured goods, like autos and airplanes. As such, there's a possibility that Canada can export its way out of trouble, provided the economies in major markets like the U.S. and China improve.
The Bottom Line
A housing bubble is a real threat to the Canadian economy. Housing bubbles have created problems for a number of countries, including the U.S., United Kingdom, Australia and Japan, and it seems safe to say that while not every housing bubble necessarily devastates the economy for years, it can create a lot of trouble. Consequently, Canadians may be at a point where they have a serious decision to make: start deleveraging now (and have some control over the pace) or be forced to do so later and in much more painful circumstances.