Thursday, September 25, 2008

Canada’s housing market looks good to me: Merrill is too pessimistic

Canada could face housing woes, Merrill warns is what the Globe and Mail reports. Merrill Lynch produced an outlier report, suggesting that Canadian households are overly indebted and that eventually the housing markets and credit markets will tumble.

Merrill Lynch is known for its pessimism. David Rosenberg, an Economist for Merrill in New York, has predicted U.S. recession so many times that somebody should really sit him down and read the fable about the boy who cried wolf. I haven’t read the report, but I agree with the consensus, that the Canadian housing market is quite stable.

According to Action Economics, second quarter (Q2) household and business net worth rose 2.8%, up from the 0.5% rate in Q1. If net worth is rising, that means assets are rising relative to liabilities, and on the margin, households are putting themselves in a better position financially without reducing their debt liabilities. As net worth rises, consumption increases and consumers are better able to afford a down-payment on a home; both factors bode well for Canada’s housing and spending markets.

Further, if the U.S. Treasury’s Troubled Asset Relief Program (TARP) passes, the Bank of Canada (BoC) will feel less restricted in its policy options. Canada’s credit markets have remained quite resilient to the U.S. financial storm so far, but a possible spillover into the Canadian economy has remained on the BoC’s radar. If the TARP program passes and it works, the BoC will have more wiggle room to ease its target overnight rate that has been stuck at 3% since April.

According to the article, Prime Minister Stephen Harper assuages readers: “I think our housing market is in strong position [and] consumer markets, as well, are stronger in Canada than the U.S. and the position taken by our financial institutions.”

I can assure you that Canada’s housing and consumer markets are infinitely stronger than in the U.S. Let’s look at the housing market.

The chart lists housing starts in North America that are average in Canada and pathetic in the U.S. The latest report showed 211,100 starts in Canada, which is consistent with its longer-term average spanning 2002-2008, 224,680. However, the latest U.S. report showed 895,000 new homes started, which is just over half of the 2002-2008 average, 1.73 million.

The chart above lists the annual percentage change in existing home values in Canada and the U.S. The data are not exactly comparable, but the trend is overwhelming. The U.S. is experiencing record reductions in home values, which is pulling down U.S. net worth. In contrast, Canada’s home values have descended since 2006, but are still positive. In quarter 2, home values in Canada appreciated 4.5%, which is admittedly below the 2002-2008 average of 7.8%, but above the 3.5% record annual inflation rate. Real home values are declining in the U.S. and rising in Canada.

The U.S. housing market is crippled, and precipitously declining housing starts is just a small part of the whole story, but the Canadian housing market can only be described as weaker than average. Further, it is more likely that the the BoC will cut its interest rate target if the U.S. TARP bill passes; this should lower mortgage rates and stimulate the housing market.

Rebecca Wilder


  1. In the last chart, the deviation in the Canadian home values is so much less than in the US and trending higher. Isn't that what one wants in an investment? US values are all over the map, showing the gambling that took place.

  2. One would think.

    Part of the reason that we got in this mess is because home prices in the U.S. have not fallen, on an annual basis, since the Great Depression. People bought homes, highly leveraged against their income, and assumed that this was a safe investment! Well, I guess that we were all wrong.

    Good catch on the stability of Canadian home values in the 2000s. One would think that if a home was appreciating 20% or more a year (like in parts of California), the market would eventually crack. Canada has different mortgage tax laws as well. They do not allow households to write off their mortgage interest as a credit against earnings. That also provides a bit of stability, as that added incentive to own is not there.

    Hi to Jackie, R

  3. Didn't even think about the high leverage over time. Very true. Now you've opened the can of worms called tax reform! Would LOVE to see simplification. aj

    Jackie say "Hi" and is still thinking about January. aj


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