This is not 2008, a blog posting, got a lot more attention than I expected after I posted a link on social media. In it, Ritholtz Wealth Management’s Michael Batnick shows how different and safer the U.S. housing market has become over the past 14 years. The same, unfortunately, is not the case for the domestic real estate market.
There are numerous reasons to believe that the Canadian residential market shows more signs of a 2008-style bubble than the U.S. market. For one, domestic home prices have increased by 420 per cent since 2000 while U.S. home prices are up about half of that, at 209 per cent.
The financial crisis included a correction not only in U.S. home prices but also in household debt. The U.S. household debt-to-GDP ratio was 100 per cent just before the financial crisis and now it’s 80 per cent. The Canadian debt-to-GDP ratio did not correct during the financial crisis. As high as 113 per cent at the end of 2020, the ratio now stands near the U.S. peak at 97 per cent.
Debt levels are high but a domestic financial crisis is highly unlikely. Ebrahim Poonawala, a bank analyst at BofA Securities, researched company filings for all the major banks in Canada regarding their mortgage exposure. He found few if any concerns on this front, even with rapidly rising interest rates.
Royal Bank management noted that higher rates would trigger higher payments or longer amortizations for 80,000 mortgages. However, they also noted that well below 0.5 per cent of customers would even require a phone call for support.
Bank of Montreal executives emphasized the large proportion of mortgages insured by Canada Mortgage and Housing Corp. Many borrowers would see significant increases in monthly payments when they renew their mortgages, but “renewals are spread out over time, and only 10 per cent of uninsured installment [mortgages] are up for renewal in the next 12 months, giving borrowers time to adjust.”
Perhaps the biggest difference between the United States before the housing crisis and Canada now is the lack of derivatives domestically. In 2007, U.S. underwriters were shovelling low quality mortgage-based debt instruments out the door but they believed they had insured themselves against potential losses with credit default swaps. Once it became clear that this insurance was no good, the entire financial system froze – no institution knew how solvent their potential counterparties were.
A correction in the domestic housing market is likely to be painful. Mr. Poonawala noted that housing prices would have to fall 42 per cent on average just to retrace pandemic period gains. There will no doubt be personal debt defaults and corporate bankruptcies among lower-quality lenders. Given the strength of the banking system, however, combined with the lack of derivative exposure, a domestic financial crisis remains unlikely. Bank investors should take note.
-- Scott Barlow, Globe and Mail market strategist
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