Updated: Aug 31, 2021
“Is the Canadian housing market in a bubble?”
“Is the Canadian housing market going to crash?”
“When will this happen?”
As an economist, sometimes I’m consulted on independent financial and market advice. No matter the question, I always begin my answer the same: “Don’t spend what you do not have.”
This answer is especially relevant because our society loves “things.” An abundance of resource, capitalism, and industrious work-ethic, has afforded our people the ability to own goods that the rest of the world classifies as ultra-luxurious. Homes, sports cars, PS5’s, shoes, and chocolate bars, are just a few of the everyday items we enjoy that countless billions can only dream of. Never in human history has a society acquired such levels of comfort and ease of living.
The problem is that in our endeavour to build more “civilized” lifestyles, we have violated the rule, “don’t spend what you do not have.” We have ignorantly excused this axiom of budgeting and replaced it with a fantasy that we can spend forever without incurring any negative consequence. But as the housing market is going to dreadfully reveal, that’s wrong.
We cannot blame Canadian homeowners for this crisis. Granted, I think it’s foolish for a man to bite off more than he can chew, but seductively low-interest rates appeal to the palate of potential home buyers. If a man walks into a bank, he is presented a platter of economic appetizers that tease what his life could be. Variable rates on mortgages are astonishingly low, the market is hot, and the economy is rebounding (or so our government says)…Why not buy a beautiful home?
“Why not,” thinks the father, “buy a nice house for my wife and children? Why not give them an ample backyard to play in? Especially since lockdowns, masks, and isolation seem to be coming back into vogue.”
Or what about the fiancé? “Why not,” he thinks, “buy my fiancée a spacious home as our happy lives commence?”
People capitulate, sign a mortgage, and think everything is just about perfect. Low rates mean they can afford it, and a bubbled housing market means they should be able to sell their home for more than they paid for it.
It’s all a fantasy; it’s a charade. A dream. All of these promises seem too good to be true; they are. They’re not true at all. They’re lies, and a housing crash is imminent.
Here is a graph detailing residential investment in Canada.* It’s the highest level it’s been in decades, climbing far above its historical trend and natural level. This tells us that for whatever reason, there is a housing bubble. More and more houses are being built, and people are buying them.
Complimenting this intense investment is, as we have all felt, a spike in price. Below is a graph that details this increase over the last ten years. As we can see, housing prices have jumped substantially.
“Well, what’s wrong with that? What’s wrong with higher housing prices?”
The question is welcome. There might be nothing wrong with these prices. Granted, a 24%*` increase from a year ago is astounding, but it might be a necessary response to maintain a steady equilibrium of supply and demand.
Yet there is a stubborn wrench in all of this. Look below at the change in the price of rent. It’s dropped 8.5% last year alone.**
That is not normal. If people are really searching for places to live, why isn’t rent increasing parallel with the price of a house? Whether apartment or house, both can be classified as a home, so why has rent dropped while housing prices have risen?
The answer is plain. Extraordinarily low interest rates have induced regular renters to become homeowners. Young bachelors, young couples, part-time workers, or those on welfare assistance have taken the low-interest bait trolled by government and banks and are purchasing homes they cannot afford. Their finances are of no consequence. Sub-prime buyers are enjoying prime mortgage rates. The market is out of equilibrium. People head to the bank, refinance their homes to “extract equity,” and use their “new” funds to spend extravagantly. It seems like we’ve beaten the market!
But be warned. We haven’t beaten the market; it’s impossible to do so. Ask Moody’s or Bear Stearns in 2008. Because the laws of economics always prevail, the BOC will have to tighten up interest rates sooner rather than later. And with it, catastrophe.
Just whose fault is this? Why are mortgage rates too low, interest rates are too low, and the housing market has bubbled? Trudeau said, according to the CBC,
“…the real estate market is afflicted by "instability" and "uncertainty" and a COVID-fuelled spike has led to soaring prices, bidding wars, rampant speculation and too many vacant properties. He said the situation demands government intervention to help more people acquire their own homes.”*``
Government, the Federal Government in particular, is to blame. They created this mess by setting interest rates too low, and now they want to clean it up (or do they?) It’s their fault because only the BOC has the power to raise interest rates. Even the “Big 5” are servants to the BOC, and let’s not be fooled; the banks are not politically neutral.
So should we let government solve this problem? Absolutely not.
Suppose I were the foreman of a farm. On this farm, there were two combines, and it was my job to maintain the efficient production of grain during the harvest. But then suppose that I was proven to be terrible at my job. The combines were always dirty, broken, running out of diesel, and I didn’t set them right. As a result, the farmer lost substantial crop, time, and money.
Is the correct recourse to allow me control of five combines instead of two? Of course not! The argument that “I will do better if I have more to watch over and control” is ludicrous. If I manage two combines poorly, why should it be expected that I would handle five any better? On the contrary, presumably, I would perform much worse!
The correct course of action would be to fire me. I have proven incapable of organizing two combines, so it's impossible that I will effectively manage five.
And yet, this is precisely what our Federal Government is trying to do! They have perpetrated this housing crisis, and now they promise to solve it. Trudeau’s guarantee of new homes, easier ownership, and higher supply isn’t the answer. It’s easy to own a home as it is, it’s easy to go to the bank and get a mortgage, and contractors are always willing to build. The problem is that invasive bureaucrats have messed with the market, and now it's going to fail.
“Well, why would the banks lend out such suspect mortgages?”
That again is a welcome question. The answer is clear—the bank (especially the “Big 5”) assumes little to no risk. Let’s suppose the housing market crashes and banks begin to fail. Do we believe the government will let them die? Not at all! Billions and billions of dollars will be doled out, paid by you and me, to bail out the banks. They know this, we know this, and the government knows this. So why not serve more loans? More loans mean more money, and even if they sour, the government—which in theory cannot fail—has cosigned.
But there is another thorn government will have to navigate when they bail out the banks: inflation. Right now, the housing market is a veil that hides the horrible face of inflation. But not for long.
When we calculate inflation, we use the “Consumer Price Index” (CPI). The CPI shops for a “cart” of goods, like tires, speakers, oil, etc., and places them in a “cart.” Then, we checkout. Each year, we purchase the same “cart” of goods, and if the total at checkout increases from one year to the next, we say there is inflation. If the cost decreases, there’s deflation. Right now, the BOC claims our inflation rate is 3.7%.
But did you know that housing prices aren’t included in the CPI? We use the “owned accommodation” index in our CPI, and it includes six “essential” components:*`*
Mortgage interest cost
Homeowners’ home and mortgage insurance
Homeowners’ maintenance and repairs
Other owned accommodation expenses
“The basic principle is to treat homeowners as if they were renting their own dwelling. Any expenses that a landlord would normally incur are included (even imputed expenses such as the replacement cost). However, the capital gain and the opportunity cost associated with capital invested in the dwelling are excluded, since they are considered as investment rather than consumption.”
The price of homes, now rising at 30% annually, is not included in the index and therefore is not included in the CPI…can you imagine if it were? There’d be panic! The CPI would skyrocket, and inflation’s terror would scare.
This is government’s fault. Why haven’t rates tightened up yet? I don’t know. This fantasy is being protracted. But play tough with the banks, promise them they wouldn’t be bailed out in the event of a crash, and we’ll see how long they keep handing out mortgages like this.
We must ask one last question. What if, perhaps, this is what the government’s wanted all along? What if all this is by grand design? What if the economy must crash, but in a way makes the government seem innocent and shifts the fatal blow to “Capitalism and Covid?” That way, powerful bureaucrats could legitimize the powerful illusion that they are here to save us. They could restructure the economy, and the society, in the image of themselves, all because they have tricked unsuspecting victims into violating the rule, “Do not spend what you do not have.”
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