The Looming Housing Crisis
Jul 30, 2012
The housing bubble in the United States that burst a few years ago has left more than 20 million people unemployed, underemployed or out of the workforce altogether. There are also more than 10 million homeowners that are behind in their mortgages. And tens of millions of Americans approaching retirement have seen most of their life’s savings disappear when plunging house prices eliminated most or all of the equity in their homes.
We seem to be naive enough here in Canada to believe that our housing market can continue to rise unchecked. At the moment, there are housing bubbles here, in the United Kingdom and in Australia that are larger (relative to the size of their economies) than the one that collapsed and wrecked the US economy.
In the case of the U.K., house prices increased more than 115 percent in excess of inflation between 1996 and 2010. In Australia, house prices rose by more than 80 percent between 2002 and 2009. And the Canadian story isn’t much different. The average house price here is more than 70 percent higher than in the United States.
The gap in prices really makes no sense when one realizes that wages are the same or higher in the US than these other countries. Furthermore, the price of rent hasn’t notably outpaced the rate of inflation in any of them, meaning that the price increases are not being driven by the fundamentals of the housing market and supporting the notion that we are in fact in a bubble.
The market cannot sustain itself here. It’s not a question of “if” but of “when.” We are likely to see the same type of house price collapse that has devastated the US economy, whether it be caused by a rise in interest rates or a sharp increase in supply. Either of these would deflate the bubble fairly quickly.
The effect on the economy when this happens is dramatic. Bubbles lead homeowners to believe that they have much more money than is the case, so they spend more and save less than they would normally. This keeps the economy humming. But when the bubble bursts, reality sets in and homeowners realize that they are closing in on retirement with not nearly enough savings put aside. People stop spending and recessions happen.
For these reasons, governments and central banks should be making the prevention of bubbles a key policy objective. But nobody wants to rain on the parade and issue warnings or increase regulatory pressure to limit mortgage issuance. The fact that the Canadian Conservative government tightened mortgage restrictions shows that they realize the market is overheated. But until the public demands that this issue be made a priority, governments and banks will keep their collective heads down and hope for the best.
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