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Analysts Debate Housing Crash Potential

Housing prices are unsustainably high in Canada’s major centres, says a report from the Canadian Centre for Policy Alternatives (CCPA).

“The steep rise in house prices in so many cities displays all the hallmarks of an accident waiting to happen,” says the author and researcher, David Macdonald.

Canadian-US-Home-Prices  (Chart courtesy of C.D. Howe Institute. Click to enlarge.)

Macdonald makes some fair points about the overvaluation of real estate in certain markets (here’s his full report).

He feels the catalyst for any large price declines will be mortgage rates. Canadian real estate bubbles “have historically been burst by relatively small increases in interest in mortgage rates,” he told Business in Vancouver.

“All you need is a 1% increase in the mortgage rate above the two-year average in a given month and that’s what popped every single bubble in Canada, two in Vancouver and one in Toronto.” (For the record, inflation, excess supply, and speculative buying also played a big hand in past bubble burstings.)

The solution, Macdonald says, is to:

A)  “Slowly” go back to 25-year amortizations on insured mortgages;

B)  Ensure the Bank of Canada increases rates by no more than approximately 1% over a rolling 24-month period; and,

C)  Encourage banks to forego mortgage profit and refrain from passing along rate increases when the Bank of Canada hikes its overnight rate.

From a practical standpoint, these “solutions” make little sense.

For one, long-term amortizations are already significantly priced into home prices. Tens of thousands of buyers have used 30- to 40-year amortizations. Therefore, home prices have already been bid up with the aid of longer amortizations. Eliminating long-term amortizations at this point may be too late. It could potentially pull the rug out from demand and accelerate the natural price declines that analysts say are coming.

Secondly, the Bank of Canada has one overriding target: inflation control. All else comes secondary. If inflation is approaching the danger zone, the BoC will raise rates—regardless of the critics, home prices, currency rates, etc.

Thirdly, most borrowers with long-term amortizations are well-qualified and able to withstand price declines and payment increases.  Removing financing flexibility from strong borrowers penalizes responsible Canadians and offers little benefit in return. Remember, 35-year amortizations carry only modestly more default risk than 25-year amzs—statistically speaking.

Mortgage-Rates-3As for banks taking a hit by not raising rates in the face of soaring funding costs, this could be the most ludicrous proposal we’ve seen in months, for four reasons:

  1. Banks have a mandate not to lose money;
  2. Bank shareholders would revolt against the resulting compression in interest margins;
  3. Postponing rate increases only delays the inevitable. When mortgage funding costs skyrocket (i.e. when market rates for BAs, bond yields, etc. jump higher) banks must raise their rates at some point.
  4. Big 6 rate fixing would be predatory to non-bank lenders (who don’t have the balance sheets to withstand extended margin compression). Mortgage rate controls would therefore violate free-market pricing and jeopardize smaller lenders.

Macdonald’s unrealistic “solutions” may be the reason critics call his report a left-wing ploy for headlines. Whatever the case, there are no shortage of counter-opinions to refute impending doom in Canadian housing. One is this report from the C.D. Howe Institute, coincidentally released on the same day.

Report author, Jim MacGee, says: “A comparison of housing market policies in Canada versus the US…suggests that there is little likelihood of a US-style surge in foreclosures or a collapse of house prices in Canada.”

Canadian lenders have “avoided the sharp decline in underwriting standards seen in the U.S…and continue to mitigate the risk of a massive wave of defaults in the future.”

MacGee defines the Canadian government’s exposure to “higher-risk loans” as “small.”

All things considered, few would argue that real estate is not richly valued in our major cities. Accordingly, most believe a natural price correction is coming—anywhere from 5% to 15% (more in some areas and less in others). This correction should likely be sufficient to deflate home prices without any further government or bank intervention.


CCPA:  Founded in 1980, the Canadian Centre for Policy Alternatives (CCPA) calls itself “an independent, non-partisan research institute concerned with issues of social, economic environmental justice.” The CCPA is a registered non-profit charity and depends largely on the support of its 12,000+ members. More…

C.D. Howe:  The C.D. Howe Institute is a “national, nonpartisan, nonprofit organization.” C.D. Howe began in 1958 to research and promote educational activities on issues related to public economic and social policy. It is currently chaired by former Bank of Canada governor, David Dodge. More…