Here we go again. For what feels like the umpteenth time, someone with clout is calling for a big drop in Canadian house prices.
This week the culprit is Pimco, speculating that domestic house prices will drop 10 to 20 per cent in real terms over the next three to five years. The more heavyweights that join the chorus, the more international news organizations pile on, with the Financial Times the latest to report on the worries.
You can't blame them. The arguments often make so much sense, and the Canadian media – including the Globe and Mail – has reported them endlessly. National house prices are on a wild run, rising roughly 7 per cent each year in the decade from 2002 to 2012, according to Toronto-Dominion Bank, and Canadian households are so massively indebted that they can't reasonably be expected to borrow more money.
Yet we keep tripping up on a crucial piece of the puzzle. When it comes to housing, it's all about underlying rates. Nearly everyone – the banks, the central bank, the media – have predicted that a central bank rate hike or a spike in government bond yields is coming, and so far, they've been wrong. Until it happens, all bets of a housing correction are off.
Even in the face of mind-blowing data demonstrating an explosion in household debt levels, Canadians continue to borrow. Even after so many calls speculating bank profits would cool because mortgage growth was bound to slow, the country's largest lenders charge ahead.
And even with all the worries about excessive condo development in major Canadian cities, new projects still sell out in a matter of days.
The common theme? Rates haven't budged.
Former Bank of Nova Scotia chief executive officer Rick Waugh was on to something. Right before he retired, he spoke at a press conference in Toronto and made it very clear that if the Bank of Canada really wants to cool the housing market, its best option was to raise rates.
By no means was Mr. Waugh demanding that they do so. He wasn't worried about a bubble. But his message to policymakers was clear: You can beat around the bush, or you can cut right to the chase.
The trouble, of course, is that a rate hike is a blunt tool, and the Canadian economy is rather fragile. Our glory years seem to be over. The U.S. has stolen the spotlight because its economic engine is roaring back to life.
Luckily for Bank of Canada governor Stephen Poloz, he hasn't had to make the tough choice yet because he's had some help from his friends.
Finance minister Jim Flaherty moved to tighten mortgage rules four times in as many years, most recently in July of 2012, and now even the banks are acting without any influence from Ottawa. Although their cost of borrowing is falling, meaning they could lower their mortgage rates if they wanted to, they've decided to stand pat for now. In private, they stress the need for personal lending and housing to cool because they're worried about the bigger picture.
But until underlying rates – both the Bank of Canada's overnight rate and the five–year bond yield that mortgages are based on – budge, Canadians are still going to borrow. Some good friends of mine are real estate agents, and their clients rarely ask questions about the broad market. To them, it's all rather simple: Housing prices keep going up, and if they can afford to get in the game, they might as well.
Remember, the 20-and-30-somethings who are scooping up condos and buying their first family homes haven't known anything but a bull market in housing. They see that their parents' homes are worth many multiples of what they bought them for in the '70s and '80s, and they think they can replicate that success. Until they simply can't afford the monthly mortgage payments to do so, they're going to want to buy, and that could lead to a macro disaster. Give the average person too much rope, and they'll hang the whole market.
Yes, there are signs of a slowdown in personal lending. The banks just reported their quarterly earnings and mortgage volumes are now growing roughly 1-to-1.5 per cent every three months. That's a far cry from the double-digit quarterly growth the banks saw not so long ago. But as one bank executive told me, if the banks could lock in four to six per cent annual mortgage growth in perpetuity, they'd take it in a heartbeat.
By any normal standards, Canada still has a hot housing market. That won't change until rates do.