Monday, December 21, 2009

Finance Minister to Move on Housing?

Think of Canada’s housing market as a ticking time bomb. Think of Finance Minister Jim Flaherty as the unlucky bomb disposal expert called in to deal with the problem.
Flaherty is moving slowly — oh, so slowly — to snip a wire here and there in an attempt to defuse the mess.
Problem is, the ticking is getting louder by the minute.If the bomb explodes, home prices could plunge. In the worst case, plunging prices could bring on an economic downfall such as the United States, Ireland and Spain suffered after their real estate markets collapsed.
But to make Flaherty’s challenge even more difficult, he still has to convince most people the bomb even exists. At the moment, he’s being cautious in how he describes the problem. He’s being even more cautious in how he deals with it. Perhaps too cautious.
Flaherty told Canwest News Service last week that he’s monitoring the real estate market and is ready to intervene if it reaches “irrational” levels. The Finance Minister says he may require homebuyers to put down higher down payments. He may also force them to amortize their mortgages over shorter periods.No doubt these are excellent ideas. But Flaherty has already tried them.In July 2008, he made his first tentative move to defuse the housing sector by requiring homebuyers to put down at least 5% of the purchase price of a home.
At the same time, Flaherty reduced the maximum amortization period on home mortgages to 35 years from the previous limit of 40 years.
His cautious strategy accomplished absolutely nothing. The Canadian Real Estate Association reported the resale price of an average Canadian home hit $337,231 in November, up a stunning 19% from a year earlier.
If a red-hot real estate market during the brutal recession of the past year doesn’t meet Flaherty’s definition of an “irrational” market, it’s difficult to know what would.
Yes, interest rates are historically low, but any rational homebuyer has to realize interest rates will inevitably rise. When that happens, many homeowners will face much larger mortgage payments.Canadians appear unshaken by the risk of higher rates, perhaps because home prices have doubled over the past decade and many buyers assume more gains lie ahead.It is difficult, though, to come up with a rational explanation of why home prices should climb from here.
Canada’s population growth has been nothing extraordinary. Wage increases have crawled. The supply of new homes has surged and the level of home ownership stands at a four-decade high. Meanwhile, Canadians are aging, which suggests the pace of household formation should be slowing down.
So why are homes still being bid higher? It seems to come down to the widespread conviction that a house is a great investment.
History suggests this is true only sporadically. Robert Shiller, the Yale economist who warned of both the dot-com bubble and the U.S. housing bubble, has accumulated a mountain of data to demonstrate that the price of a home in the United States over the past century has barely beaten the rate of inflation.
Piet Eichholtz, a professor of real estate finance at Maastricht University in the Netherlands, came to a similar conclusion when he studied real estate prices in an Amsterdam neighbourhood from 1628 to 1973. He found that home prices required 350 years to double in real terms.
If you assume home prices should rise in line with inflation, you come to a dire outlook for Canadian real estate. Taking figures from 1990, 1995 and 2000, and boosting them by inflation during the intervening years, suggests the national average home price should check in around $200,000 — a third less than the current figure.
More sophisticated calculations arrive at similar estimates. David Rosenberg, chief economist at the money manager Gluskin Sheff in Toronto, examined home prices in relation to personal incomes and residential rents. He concluded that prices are between 15% and 35% above levels that are consistent with fundamentals.“If being 15% to 35% overvalued isn’t a bubble, then it’s the next closest thing,” he writes.
So what can Flaherty do? He’s already missed the opportunity to defuse the real estate bomb at an early stage. He’s understandably reluctant to raise interest rates when the recovery is still tentative.
He should follow through on his vows to increase down payment requirements and shorten amortization periods. Most important, though, he should loudly caution Canadians on the dangers of taking on more mortgage debt when home prices seem unsustainably high. After all, when a bomb disposal expert can’t do anything else, he can at least warn people to run for cover.
Financial PostIan McGugan is a freelance business journalist who writes for the Financial Post.

5 comments:

RentingSucks said...

I think he's rattling the saber since if he actually tightens up the requirements it will kill the housing market possibly catastrophically. It's his only in between option. It's pretty obvious in Vancouver that if you want to buy in this market and you don't already own you have to go 35 years and possibly variable. It's the only way the numbers make sense. Not sure where we go from here that's a good place. If inflation arrives to save home prices it's going to drive up borrowing costs. Is limping along for the next 10-20 years better than a quick down and recovery? I'm not sure.

On a side note my job has become a victim of the recession along with all the people in my department. Jobs being moved offshore. So I'm done with the housing market for now until I can re-stabilize in another job. I also have to think seriously about moving somewhere where the median income to median house ratio makes more sense although it seems like it's expensive everywhere just ridiculously expensive in Vancouver.

david said...

I would be surprised if he does anything. Right now all the big wigs are just blowing smoke to try to scare people out of overbidding on a house.

I really dont think it will work, in fact, I think it is doing the oposite. If carney says "rates rise in june" then there is a flood of buyers eager to lock into a 5 year mortgage before then, hoping to "cash in" on the low rates. At best they go 5 years, but they figure by then they will be earning more money, the economy will be back in full force and the price of their home will be higher. If they are right then it all works out. But if they are wrong they are in a heap of trouble.

They need to stop making warnings and just do something. None of this "i am doing X in 2 months" because that just spurs demand for the next 2 months.


RentingSucks,

Sorry to hear about your job. If you are serious about moving the US offers a cost of living that is much better relative to incomes in the short term. I think they will probably be pegged with inflation and higher taxes in the long term, but for the next few years it would make financial sense to live there IF (and this is a big if) you can find a decent paying job there.

Whatever you choose good luck and I hope it works out for you.

jesse said...

RS, more often than not a layoff from a "department" based company is a blessing in disguise.

Increasing required DP on government backed mortgages (i.e. CMHC insurance) sounds like a good way of going, in the absence of removing the government backstop from CMHC altogether (which is unlikely to happen IMO).

casual observer said...

In July 2008, he made his first tentative move to defuse the housing sector by requiring homebuyers to put down at least 5% of the purchase price of a home.


This is completely false. Almost anyone can still buy a home with NO MONEY DOWN through one of the major Canadian Banks. They call it their "Cash Back" Mortgage.

http://www.cibc.com/ca/mortgages/flexible-downpayment-mortg.html

"If you are a first-time home buyer, coming up with your downpayment just became easier. You can purchase the home you want now with as little as 5% down with CIBC's flexible downpayment options. The funds for your 5% downpayment can be borrowed from a variety of sources or taken from a 5% cash back.

The bank will give you the 5% down payment if you take their posted interest rate. CMHC even knows about this and charges a small premium on the mortgage insurance for a "non-standard" down payment. It is reckless on the part of CMHC to allow this to take place.

On top of it all, as Canadians we get to be all smug and say that we don't have any of those zero down mortgages in Canada, so we're OK.

casual observer said...

Another offer from a different Canadian Bank...

http://www.scotiabank.com/cda/content/0,1608,CID10969_LIDen,00.html

Scotia Free Down Payment Mortgage

A helping hand to get started
Coming up with a 5% down payment isn’t always easy, especially when you still have to cover closing costs, moving expenses, renovations, and all the other costs that come with buying a home. Let Scotiabank pay the 5% minimum down payment on your behalf when you take out an affordable insured 5 or 7 year fixed rate mortgage."