Is there a bubble in real estate? Canadians have been arguing about this for years. We'll keep arguing, because asset bubbles are hard to identify until they've deflated, and this one hasn't. Besides, it depends on which of Canada's many real estate markets you're looking at. In Saint John, New Brunswick, where a detached home can be had for a monthly payment of $750, or Calgary, where prices have levelled off and the typical house sits on the market for six weeks, there's no sign of trouble. But if you're in Vancouver and must sign up for 25 years of financial servitude for the privilege of owning a small glass box in the sky, prices look very dangerous indeed.
So the bubble question is complicated, but a few points are not in dispute. On average, owning a home is now more expensive, compared to renting, than it has been in generations. Prices are growing faster than incomes; in Vancouver, the mortgage payments on an average home would consume more than half of the typical household's wages, says TD Bank's economics department. Buyers respond to high prices by borrowing heaps of money. Three years ago, just one out of every nine mortgage-holders borrowed more than 80% of the value of their homes. Today, it's one in six.
These are verifiable facts; whether they add up to a bubble, I can't say. But given the data and the terrible consequences of real estate bubbles (see: United States of America), the Harper government could—at the very least—stop pumping air into the property market. And that means reining in the Canada Mortgage and Housing Corp., the vehicle through which you, dear taxpayer, have assumed the risks for these urban bidding wars and the jumbo mortgages they create.
The Tories, and Finance Minister Jim Flaherty in particular, are given a lot of credit for steering the country through the worst of the financial crisis, and some of it's deserved. When investors became reluctant to lend money to banks during the Black Autumn of 2008, the government, via CMHC, bought tens of billions of dollars worth of mortgages from financial institutions. That was clever. The program gave the banks fresh cash with which to make loans and improved public confidence in them. Later, when it became clear that homebuyers were beginning to take stupid risks, Flaherty essentially eliminated the 40-year mortgage, then the 35-year. He also tightened the borrowing rules for investment properties.
These were good moves, but they left intact the basic structure of the home-financing market in Canada: Ottawa backs virtually all of the riskiest residential mortgages. CMHC provides default insurance on loans for which borrowers put down less than 20% (remember, that's one in six mortgages). It makes it possible for a person of modest income and little savings to buy that $500,000 townhouse. It is the official insurance company of the House Poor.
CMHC insurance creates a terrific one-way deal for the banks. If Ms. $500,000 Townhouse makes her mortgage payments, the bank makes money; if she defaults, CMHC pays for any loss. So the bank gives her the loan. What business doesn't want risk-free profit? In part because of this sweet arrangement, home buying in Canada has soared. The home ownership rate, long stuck just above 60%, is now about 70%.
By definition, the new entrants are marginal buyers—the people who, in different circumstances, would still be renters, many of whom probably should be renters. By international standards, 70% is quite high. Fewer than half of German households own the place they live in; same with the Swiss. The last time we looked, Germany and Switzerland were modern, orderly, prosperous nations, busting the idea that a country needs a substantial majority of homeowners to enjoy social stability.
That's certainly what Americans believed. Through government-sponsored financing entities such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corp. (Freddie Mac), the U.S. also raised its home ownership rate to almost 70%—until the foreclosure crisis. The two mortgage giants then became sinkholes for public money, and Washington placed them into conservatorship in 2008. The U.S. home ownership rate is now 66% and declining fast.
Just as the U.S. bubble probably couldn't have happened without an implicit public subsidy from Fannie and Freddie, the Great Canadian Home-Price Inflation couldn't have occurred without CMHC. In just six years, its insurance business has doubled, and it now backs more than $500 billion worth of mortgages. Most of these are fine. But about $45 billion is with the riskiest group—buyers with less than 10% equity. These people could be wiped out if there's a sharp correction.
The banks won't lose. Only Ottawa will. It's too late to do anything about those insurance policies now—we're on the hook. But it's not too late for Mr. Flaherty to show up at the CMHC board with a new set of orders: Shrink it.
Derek DeCloet