A recent parade of articles discusses the prospects of a pending Canadian housing bust. For example, The Globe and Mail reports Bank CEOs ‘should be worried’ about real estate.
Ed Clark, Toronto-Dominion Bank’s outspoken chief executive officer, is playing the contrarian card one more time, publicly arguing that he and his fellow bank CEOs should be cautious about the country’s heated real estate market.
While he isn’t worried about a full-blown bust, Mr. Clark believes chief executives simply can’t ignore warning signs in the market – particularly the sudden run up in prices for real estate of all stripes. “If you run a bank, you should be worried about it,” he told the audience at a bank conference in Toronto.
The only thing I am confused about is why Ed Clark isn’t concerned about a “full-blown bust”.
Pater Tenebrarum at the Acting Man blog notes Carney’s Legacy: Canada’s Credit and Housing Bubble.
Tenebrarum quickly asks “How Long Before it Bursts?”
Over the course of the past five years, every time I thought a major Canadian housing correction was coming, none did.
Canadian housing has been like the “Energizer Bunny”, going and going and going. Nonetheless the housing bust calls keep on coming.
The Financial Times reports Canada housing: On short notice.
In the past five years, while other big developed economies have been suffering through the financial crisis, the average Canadian home price has risen 38 per cent to C$389,119 (US$355,000), according to data from the Canadian Real Estate Association. This has been driven in part by Toronto, where a condominium boom has driven prices to record highs.
At the same time, Canadian households have been on a debt binge fuelled by easy bank lending, low interest rates and government-insured mortgages. The household debt-to-income ratio rose to a record 163.7 per cent in the third quarter, close to the US peak of about 165 per cent on an adjusted basis.
Many of the investors and economists sounding the alarm about Canada’s housing market are veterans of the US subprime crisis. They include Mr Hanson, the analyst, Steve Eisman, an investor, and Nouriel Roubini and Robert Shiller, the economists. Whether they will be right a second time is the source of a heated debate on both sides of the border.
While some of the bigger hedge funds are choosing to stay on the sidelines, Canada, and to a greater extent Australia, are top of the watch list.
“Once you start to see [Canadian] banks showing credit deterioration they’ll all pile in,” says Mr Eisman, founder of Emrys Partners and noted for his role in forecasting the US subprime crisis in Michael Lewis’s book The Big Short.
The Canadian government is playing an important role in the mortgage boom. The government encourages banks to insure mortgages with more than an 80 per cent loan-to-value ratio with the national housing agency, meaning that mortgages with 20 per cent deposits and under are counted as close to sovereign risk.
“The vast majority of the mortgage book is insured by the government. This naturally protects the banking system but it does create a big taxpayer liability,” says Craig Alexander, chief economist at TD Bank, the country’s second-biggest bank.
“If you had large-scale losses and that insurance came into effect it would end up with the Canadian taxpayer.”
Banks have piled into housing, racking up hundreds of billions of dollars in mortgage loans, a large portion of which are backed by the government through the Canada Mortgage and Housing Corporation. Consumer lending helped the banks to report record earnings in 2013.
The federal government is also guaranteeing up to 90 per cent on claims in the case of insolvency of private insurers in an effort to level the playing field between the private sector and the national housing agency.
This year, Canada imposed a “risk fee” on mortgage insurance provided by the country’s housing agency, to compensate taxpayers for potential losses.
Despite the government’s measures, Toronto’s cranes and surging skyline tell a different story. But even those in the hedge fund industry know that betting on a Canadian housing collapse is not a sure thing.
“For every Eisman or [John] Paulson, there’s someone that went out of business for shorting subprime too early,” says Mr Daniels.
Rule of Predictions
No one knows for sure precisely when any bubble will burst. I got the US housing bubble correct but missed Canada by a mile.
I got the 2007 stock market bubble on the nose, but on this go around called a top on February 3, 2013: Extreme Sentiment: Barron’s Cover “Get Ready for Record Dow – We Told You So”; Top Call.
Here is the cardinal rule of predictions: Make enough calls and sooner or later you are going to look ridiculous. Even those who get things correct often look ridiculous at intermediate stages.
I discussed a prime example of getting the call perfect but looking ridiculous along the way in Bubble Valuation Blues; GMO 7-Year Outlook for U.S. Stocks is Negative.
Leverage Works Both Ways
Make a play on major macro calls too early with leverage and you are wiped out. Had Paulson been a year early, he would have been fried to a crisp and we probably would never have heard about him.
In general, you only hear about the successes, never the failures.
The safest thing to do with bubbles is avoid investing in them at all, either way. There is no rule that says “one has to play the game”.
Mike “Mish” Shedlock