How Long Before it Bursts?
Current BoE chairman Mark Carney is widely hailed as some sort of central banking superhero due to the fact that Canada did not sink beneath the waves during his tenure. We say he was nothing but an unmitigated inflationist, whose legacy is one of the biggest housing and consumer credit bubbles in history (global history that is, not just Canada's). The result of this will be a bust of similarly historic proportions, the only question that is open is the timing, which cannot be foreseen with any degree of certainty. What is certain is that this house of cards will eventually implode.
This is not just some wild assertion that cannot be backed up. The proof, as they say, is in the pudding. Of course, Carney was no different from other Canadian central bank governors in that respect, but as can be seen below, money supply growth was significant during his reign (and credit growth along with it). What is not obvious to us is in what respect he was deemed to be 'better' than his predecessors. He simply continued to aid and abet more monetary inflation.
Canada's money supply M2. Similar to the money supply of other countries during the fiat money era, it has exploded into the blue yonder. A significant acceleration in growth took place during Mark Carney's reign (February 2008 to July 2013) – click to enlarge.
A close-up showing the Carney era. During his tenure, the money supply grew from C$1.1 trillion to C$1.55 trillion. Not exactly an inflation of Bernankean dimensions, but roughly comparable to US money supply inflation during the roaring 20s – click to enlarge.
In conjunction with this explosive money supply growth, mortgage credit, housing prices and consumer debt have shot up to never before seen levels, both in absolute terms and relative to various benchmarks such as Canada's economic output and personal incomes. Real estate prices in particular have risen enormously relative to rents, which is always a sure sign that one is looking at a significant bubble. In fact, when measured by this yardstick, Canada's housing bubble is now by far the biggest in the world – click to enlarge.
Housing prices compared to rents, via the Economist. Canada's housing market is the by far most overvalued in the world by this yardstick
The Teranet composite house price index for Canada – click to enlarge.
Teranet house price indexes disaggregated by region since 1999 – click to enlarge.
At least one Canadian banker has become sufficiently alarmed to issue a warning to his colleagues in the banking industry – which was promptly blown off. After all, nothing bad has happened so far, so why should anything bad happen in the future? Everybody knows house prices can only go up!
“Ed Clark, Toronto-Dominion Bank’s outspoken chief executive officer, is playing the contrarian card one more time, publicly arguing that he and his fellow bank CEOs should be cautious about the country’s heated real estate market.
While he isn’t worried about a full-blown bust, Mr. Clark believes chief executives simply can’t ignore warning signs in the market – particularly the sudden run up in prices for real estate of all stripes. “If you run a bank, you should be worried about it,” he told the audience at a bank conference in Toronto.
His opinion contrasts with those of his peers, many of whom argued Tuesday that the data they look at simply does not give them reason to be overly worried. Brian Porter, Bank of Nova Scotia’s CEO, told the crowd that he studied his bank’s retail loan book this past weekend – much of which is tied up in retail mortgages – and he didn’t find much cause for concern. Until now the portfolio has been stable, with loan delinquencies at levels that are barely noticeable.
“I know you’re looking in the rear-view mirror when you do that,” he added, implying that past success doesn’t mean the future won’t be rocky, but he’s confident that the market won’t wreak havoc on the bank’s loan book. Mr. Porter has also met with developers in Toronto and Vancouver to ask in-depth questions, and he’s studied the market dynamics enough to give him comfort. “We would view supply and demand relatively in check across the country,” he said.
National Bank of Canada CEO Louis Vachon echoed similar comments, noting that he reviews many of the same portfolio metrics, such as delinquencies. And being a Quebec-based bank, he studied the data on owners of Montreal condos – which are being built at a rapid clip – and found that the vast majority of those properties are owner-occupied, meaning there isn’t a lot of investor speculation in the market. As for the rush of new condo supply, he remains unfazed. “Is there a massive disequilibrium in the real estate market in Montreal? I don’t think there is,” he said.”
Of course we heard exactly the same arguments during the US housing bubble. 'Bank balance sheets are stronger than ever', was a common refrain. In late 2007, then treasury secretary Hank Paulson, a consummate insider due to having been the CEO of Goldman Sachs, asserted that he had never – never! – seen the US banking system in such ruddy health. About a year later, virtually the entire system was completely bankrupt and had to be bailed out by a mixture of massive money printing, taxpayer support and accounting chicanery. To this day, no-one can be quite sure what skeletons are still hiding out in the opaque balance sheets of major US banks. All we know for sure is that it took four different iterations of 'QE', a huge expansion in the federal debt and a falsification of accounting procedures (the repeal of mark-to-market accounting) to create a semblance of 'stability'. Today it is once again asserted sotto voce by the establishment that the fractionally reserved banks are safe and sound. We think it would be more appropriate to refer to them as zombies – hollowed out carcasses that only appear to be alive.
In Canada, there is currently a lot of misguided optimism about the housing bubble's durability, no doubt due to the fact that it has kept growing with nary an interruption for so long. For instance, right after it was reported that house prices have reached a new record high, the Canadian Real Estate Association confidently predicted “a strong year in 2014”. If 2014 indeed turns out to be a strong year, the same prediction will be made about 2015, and this will continue until the crash.
“Sales of previously owned Canadian homes are turning out slightly than expected overall, and 2014 will be even stronger, according to a new projection from the country’s largest real estate association. The Canadian Real Estate Association’s 2013 sales projections have been increased slightly upward in Ontario and the four western provinces and that prices have been generally firmer than expected.
“Most housing markets are well balanced, including many large urban centres,” said Gregory Klump, CREA’s chief economist.”
We always find it highly amusing when the 'chief economists' of real estate associations refer to gigantic bubble markets as 'well balanced' or otherwise play down the situation.
Does anyone remember former NAR chief economist David Lereah? In 2000 he published a book entitled “The Rules for Growing Rich: Making Money in the New Information Economy”, touting investment in technology stocks. The Nasdaq promptly collapsed by 80% after the book's publication. In 2006, he decided that he once again needed to impart investment advice and published another book, entitled: “Why the Real Estate Boom Will Not Bust—And How You Can Profit from It.”. Home prices peaked four months later. In January 2007 he famously said: “The steady improvement in [home] sales will support price appreciation…[despite] all the wild projections by academics, Wall Street analysts, and others in the media."
In other words, confidence projected by realtors and economists in their employ is not necessarily a good sign. In fact, it is entirely meaningless. 2014 could be another good year and the bubble may well expand further – but at some point the party will end, and then bankers will deeply regret that they have not heeded the warnings (we suspect that taxpayers will have even more reason for regret).
It should also be pointed out that Canadian mortgages are insured by a state-owned corporation, a fact that ensures that the bust will lead to a sizable deterioration in the government's finances, as it will have to bail this insurer out.
A Dangerous Addiction to Debt
Household debt in Canada is moving further and further into the danger zone. An article recently published by McLean's discusses '' to debt.
““Canadians like to see themselves as the Scots of North America,” theatre critic Ronald Bryden wrote back in 1984, “canny, sober, frugal folk of superior education who by quietly terrible Calvinist virtue will inherit the 21st century.”
Sorry, which country was that again? Like looking at a younger picture of yourself and straining to see the resemblance, the Canada Bryden described is barely recognizable today. It’s probably true Canadians were never as frugal as we liked to think we were. But with household debt on the march to $2 trillion, a savings rate a fraction of what it was 30 years ago, and waves of warnings from international banks and Nobel-winning economists about our debt-fuelled housing market, any pretense to prudence has long since been banished. If a scriptwriter were to pen the tale of our transformation into giddy spendthrifts, the working title would surely be: How Canadians stopped worrying and learned to love the debt bomb.
You’ll have heard these warnings before, usually in a scolding tone. But what we are seeing is a fundamental shift in our attitudes toward living on credit, one that’s not really that illogical, given money is essentially free. An era of low rates has desensitized borrowers to the risks inherent in carrying too much debt. A whole generation of young Canadians has come of age in an era when no bungalow, renovated kitchen cabinets or TV is ever truly out of reach.”
For now Canada’s towering household debt load has the appearance of being manageable, a point at which the banking and real estate industries hammer away. The household debt-service ratio, the share of income that goes to debt payments, is just 7.17 per cent, about its lowest level ever. But that’s only because of low rates. In 1990 the ratio was 11.5 per cent, at a time when total household debt was $360 billion. Since then debt levels have soared 370 per cent to $1.7 trillion. At the same time interest paid on household debt has gone up just 60 per cent. But here’s the thing. Central banks have consistently proven themselves incapable of spotting bubbles. It happened in the U.S. It will happen here. And when the consensus among economists, and more importantly, borrowers, is for rates to stay low, it’s a safe bet they’ll be proven wrong.
We would add to that: even if interest rates were to remain at low levels, the debt burden will become unmanageable if there is a major economic bust. However, the worries expressed by the author about to cozy consensus are well founded. It is almost a law of nature that the consensus of mainstream economists and central bankers will be proven wrong. We can confidently assign a probability of 1 to it – i.e., it is an absolute certainty. As noted above, only the timing is open to question.
Moreover, as the chart above shows, the ratio of household debt to disposable income has been boosted enormously by the seeming 'manageability' of growing debt loads due to artificially low interest rates. The stress must be on the term 'artificial', as it is precisely the fact that Canada's central bank has left interest rates at an extremely low level for far too long that is ultimately responsible for this enormous build-up in debt.
There is of course nothing inherently bad about consumer credit, but this enormous increase in outstanding debt will considerably worsen the economic bust when it arrives. The bust may be triggered by rising interest rates, but it could also be triggered by a decline in commodity prices due to Canada's dependence on commodity exports. Regardless though of what trigger event will eventually appear on the scene, there can be no doubt that this debt-fueled bubble escapade will end badly. We wonder if people will then still remember which superhero bureaucrat they have to thank for creating the bubble and its inevitable consequences?
As far as Canada's credit and housing bubble is concerned, the clock is ticking ever louder. Some will leave the party in time, but most won't.
Charts by: St. Louis Fed, Teranet, CNBC, Economist, Haver Analytics
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5 Responses to “Carney’s Legacy: Canada’s Credit and Housing Bubble”
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