Blessed by the Potato

The Star’s Moneyville section had another real estate fluff piece on Friday, aiming yet again to reassure people that a housing correction won’t happen here. I was at first just going to let this one slide — after all, this is going to be my 4th post in a row on real estate, so sorry for those that are interested in other topics. It doesn’t really raise any new points (except for the incorrect one about no downpayment mortgages being “illegal” — they’re only illegal without insurance, but they’re all CMHC insured, so it’s a red herring), and it was quickly dismissed by people in the forums, over at Financial Insights, and even the big dog took a bite out of it over at Greater Fool. Where this takes a turn is that in the comments section of the Greater Fool blog post, Ian Lee comes in to try to clarify his points (see comments #75, 96, and 146). So now there’s some new points to counter. For the most part his arguments apply more to reasons why a housing downturn won’t spiral out of control and take the rest of the banking system out with it (AKA, the “US style” crash), rather than why housing won’t go down in the first place.

It’s a long conversation thread over there, with many people going back and forth, so I’ll just focus on a few keys points here.

Nothing he’s said so far has made me reconsider that buying a house now, in Toronto, would be anything but a terrible idea. Anyway, on to the specifics:

“But you are assuming that because you lose your job, you immediately list your house for sale AND reduce your asking price. A large number of mortgages issued today are issued to two income households which diversifies risk for both the bank and the borrower. Even if you decide to list your house, you list it at what the real estate agent recommends AND if you are clever, you will NOT disclose your unemployed status to the broker, which would reduce your negotiating power”

This all depends on whether two incomes are needed to keep the property, and my understanding is that in the expensive markets (Toronto, Vancouver) they are. If that’s the case, requiring two incomes to afford the house increases risk. When you have two wage earners the odds of either one suffering a job loss is higher than the odds of just one person suffering a job loss: basically, you’ve bought two tickets in the “unemployment lottery.” If only one income is needed to stay afloat, then yes, it adds redundancy… but that is not how it’s working in many cases these days. For many couples that second income is a mandatory component of the household’s income statement, a requirement to keep the household operating. That means systematic risk has been increased by this demographic shift.

“In fact, Canadian home ownership is at the highest level in our history at 67%. AND the mortgage delinquency ratio – which must be reported to Bank of Canada by the banks is less than 1% (compared to the USA where 1 in 4 homes are under water OR in foreclosure)”

I think his numbers are a bit dated — the spike has been tremendous in the last few years and is closing in on 70% now. Either way, that rate of home ownership is several points higher than it ever has been in our history, and the same thing played out in the states: people who perhaps had no business owning homes ended up buying them anyway, because it was trivial to get a mortgage.

Furthermore, you must realize that foreclosures lag prices. The fact that foreclosures are as high as they are in Canada is an extremely troubling point. In many major markets prices have been increasing at a very decent clip for several years now. Even with a zero downpayment, a borrower in trouble should be able to sell their house and come out whole after just 7-10% increase in prices, which is just a year or two of appreciation these days. So if anyone is getting foreclosed on, it’s either due to extremely bad lending (where the homeowner can’t even budget for repayments a year into the future), or because the foreclosure rate is very high in the non-bubbly areas, making the national average rate look “normal”. Remember, in the US the foreclosure rate was also quite low even while trouble was brewing.

“Concerning my comment that the US housing crisis was caused – NOT by market failure or by government failure – but by what I called “Congressional failure”, I can provide the approximately 60 slides of a paper that I presented at a conference called “Financial Armageddon” at Carleton University in 2009. EVERY slide I presented was publicly sourced from the Federal Reserve or the US Treasury or from Fanny or Freddie or HUD or the US Census Bureau or quotes from the Congressional Record of Barney Franks or Chris Dodds. These slides are remarkably illuminating and demonstrate my hypothesis that Congressional policy caused the housing bubble and then the housing collapse. […] In my Financial Armageddon paper, I provided empirical data to show a large influx of new first time buyers into real estate, that upset the equilibrium or balance between supply and demand, causing a bubble to form i.e. excess demand chasing limited supply. It was caused by the US Congress watering down the mortgage eligibility rules e.g. zero down payment, which encouraged large numbers of low income people to buy homes. Then when these low income people realized they could not afford the new home, they walked away (no recourse in the US), turning the bubble into reverse – into a collapse.”

I’m so puzzled by his views… Except for the non-recourse part (which as we’ve seen with recourse states is a small factor), how is this different than the scenario where CMHC allows for low/no downpayment, 35-year mortgages in Canada? We had a large influx of new buyers because of the rule changes. We shot our home ownership rate up 5% in 5 years in the midst of lowering interest rates. We had prices increase far beyond the historical norm for several consecutive years. How can you then conclude that our outcome is going to be so dramatically different than what the US experienced? [Yes, I will concede that it will not be as deep or as fast a correction, but house prices are going down, especially in TO and Van].

“I concluded that, going forward, we will experience what we experienced in the past with housing prices that overshoot. In the early 1980s, house prices went flat line for several years as they did again in the early 1990s.” [… he is then challenged by the fact that there was in fact a fairly substantial crash in Toronto in the early 1990’s …] “again, it depends on which real estate market you are using. Nationally, it was a wash – although yes, TO and VAN declined. No disrespect to anyone – but Toronto (3 million?) and Vancouver (2 million?) are not the totality of Canada’s 34 million residents.”

I’ll be the first to say that real estate is local, and that most of Canada will not be hurt too badly by what’s coming. But, those are huge local markets (their metro areas combined are 1/5th of Canada’s population). For me, I’m looking to move to Toronto, and chose to rent because the local market has gone insane. If you’re being interviewed for the Toronto Star, it’s very disingenuous to say that Canada’s [national average] housing will be ok, but snicker behind your hand at the suckers in Toronto and Vancouver who are going to get wiped out.

[Ok, yes, that’s a bit of hyperbole]