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Harvard economics professors Carmen Reinhart and Kenneth Rogoff rose to prominence as authors of This Time is Different, arguably the most important book written about the U.S. financial crisis of 2007-08. The professors also paired up for a lesser-known academic paper that will be of extreme interest to Canadians who are currently concerned about a potential crash in domestic housing prices.
In "Is the 2007 U.S. Subprime Financial Crisis So Different? An International Historical Comparison," first released in 2008, Profs. Reinhart and Rogoff described the economic precursors for what had been, before the U.S. meltdown, the biggest housing price collapses in modern developed-world history. The so-called Big Five housing disasters include Spain in 1977, Norway 1987, Finland 1991, Sweden 1991 and Japan 1992. If Canada fits the template, then domestic homeowners have more reason to be concerned about what is likely their largest single investment. Fortunately, this doesn't seem the case.
According to the report, the factors that most often precede a housing crisis are rapid growth of inflation-adjusted prices for housing and domestic equities combined with declining per capita GDP and a slowdown in exports.
For the "Big Five" group of housing market collapses, the average runup in inflation-adjusted home prices was 20 per cent in the four years before the correction (the 2003-to-2007 U.S. increase was much larger – 32 per cent). In Canada, home prices have climbed only 13 per cent over the past four years once inflation is taken into account. Thankfully, while it seems Canadian home prices are rocketing skyward, the speed of appreciation is considerably lower than in previous cases of developed-market housing bubbles.
Profs. Reinhart and Rogoff found that a country's equity market had endured multiyear declines before the sharp falls in national home prices. For the Big Five housing corrections, equity markets had declined by 15 per cent, on average, over four years before trouble began for homeowners. Again, Canadian homeowners can rest easier – the S&P/TSX composite remains 23 per cent higher than four years ago after inflation.
The study also uncovered that the four years ahead of housing crises were usually characterized by steady declines in real GDP per capita. In the case of the Big Five, real GDP per capita fell from an average 4.5-per-cent annual growth rate to negative territory just before home prices headed south. The past four years for Canada have been much different – a steady if sluggish improvement from a 2009 – a year that wasn't easy for any country.
Canada's deteriorating international trade balance – the current account – is the one area where we might have a problem. In general terms, the current account measures the amount the country exports minus its imports. For the first decade of the new millennium, resource exports allowed Canada to enjoy healthy current account surpluses. The inflow of global funds was a significant boost to the domestic economy and a portion of this new wealth was used to bid up domestic assets. For example, the Americans bought high-price oil – and home prices in Calgary surged.
The current account surplus turned negative in 2010 and has remained under water – more funds are flowing out of the country than come in. Unfortunately, the pattern over the past few years follows the average progression before a housing crisis, as measured by Profs. Reinhart and Rogoff – almost to a tee.
Even with the deteriorating current account, the only conclusion to be drawn is that the Canadian housing market is not on the verge of a U.S.-style housing apocalypse. Recent domestic housing price appreciation, while notable, is tame relative to the average real estate free-for-all measured by the U.S. study's authors. The Canadian economy, while not what it was pre-2008, has seen enough growth to support housing prices at least close to current levels.
Canada doesn't fit into the economic, pre-housing disaster template but this is not a guarantee that it's clear sailing for homeowners from here on out. It does, however, suggest that memories of 2008 have not receded far and have fuelled overly pessimistic outlooks for the domestic housing market.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights, and follow Scott on Twitter at @SBarlow_ROB.
Scott Barlow