All things being equal, higher prices should encourage more people to put their houses up for sale, which in turn should lower prices by increasing supply.
The problem is it's difficult to spot a bubble for sure until it bursts. “That was the point that Greenspan used to make about why this is a problem for central banks,” says Craig Alexander, an economist at Toronto-Dominion Bank.
Mr. Greenspan's approach was to let bubbles burst, then attend to the damage by lowering interest rates. The Bank of Canada, like many of its counterparts, doesn't have the luxury of simply resorting to manipulating interest rates. If Mr. Carney became worried about a housing bubble, the economy remains too fragile to raise interest rates. Doing so would also carry the risk of driving up the value of the Canadian dollar, which already is at uncomfortable heights for the country's exporters.
‘Monitoring the situation'
Canada's housing market is certainly not stained by the sort of excesses that characterized the U.S. market before the crash. Subprime lending in Canada is estimated to represent less than 5 per cent of the market, compared with more than 20 per cent in the U.S. prior to the crisis.
But an ironic scenario could still unfold. In an effort to combat a recession that had its origins in a U.S. housing bubble, Canadian policy makers have responded with low rates that might create a bubble here, giving the mortgage market too much of a kick-start through low interest rates and a program of buying billions in mortgages from the banks.
Federal Finance Minister Jim Flaherty says he is confident he has a handle it. He noted that in 2008, the government decided it would no longer insure mortgages with 40-year amortization periods, reducing the maximum acceptable term to 35 years. It also boosted the minimum down payment to 5 per cent. Both Mr. Flaherty and Mr. Carney said measures of that type could be taken again if Canadians get in over their heads in the mortgage market.
“We're monitoring that situation,” Mr. Flaherty told reporters in Toronto yesterday. “Interest rates are very low, and that is no doubt contributing to some additional activity in the real estate market. We'll watch, and what we've done before we can do again if we need to.”
The Bank of Canada is paying special attention to household debt, and it will include an analysis of the debt burden of all income classes when it releases its biannual review of the financial system in December.
For now, Mr. Carney says the situation is under control because the cost of paying for that growing debt is much lower than its historic average. While total household debt rose by $44-billion during the first six months of the year, interest payments on debt actually fell by $3-billion, according to economists at CIBC.
Still, Mr. Carney reminded members of Parliament and Senators this week that rock-bottom interest rates can only move in one direction. Accordingly, he encouraged both borrowers and lenders to act “prudently.”
And even though he dismissed the idea of an imminent bubble, Mr. Carney still encouraged discussion of the subject. The reason: The more people talk about bubbles, the less chance they form. A key ingredient in the U.S. subprime mortgage crisis was the lack of attention that was being paid to the problem as it brewed.
“We welcome the discussion of this issue because it is anticipatory,” Mr. Carney told the Senate banking committee. “People are anticipating a potential vulnerability as opposed to looking in the rear-view mirror and seeing a vulnerability that is already here. That is one of the ways that one prevents that.”
