Inevitable crash and economic turmoil predicted

Commentary

Bank of Montreal economists Doug Porter and Robert Kavcic, in an article titled “Catch-’23: Canada’s affordable conundrum”, elaborate on a difficult issue that has been a concern for many years, especially in urban and suburban areas.

Despite politicians’ assurances, there seems to be no easy way out. Single family homes in Canada are simply too expensive relative to the income of the majority of residents. Recent interest rate hikes have further exacerbated this problem into an economic and social crisis. Porter and Kavcic point to the naivety of the common explanation that this is just a supply problem.

The left’s simple solution is to just build cheap, government-funded, high-density condominiums with even more debt. They dream of the mythical ‘city of 15 minutes’. In reality, they will end up with 1970s American-style housing projects that are miserable and unlivable. The right, in turn, believes in allowing the private sector to work its magic. End restrictive regulations and, in the case of Toronto, the Green Belt, and entrepreneurs will create supply and lower prices.

However, both are not feasible. Population growth is too strong in cities like Toronto, Vancouver and others for the achievable supply thanks to immigration and Canadians from other parts of the country looking for opportunities. Although prices have come down, the cost of carrying a mortgage along with taxes, maintenance and insurance is still high relative to income for nearly 30 years. Only a price correction improves affordability. Homeowners cannot count on rates returning to multi-generational lows, as Bank of Canada Governor Tiff Macklem has indicated. Canadians certainly won’t enjoy a miraculous rise in average income anytime soon. Even if that were to happen, speculation could push prices even further.

Note that income growth has slowed in recent decades, but house prices have risen. The Canadian situation has been fueled by artificially low interest rates, supply suppression (usually due to misplaced environmental concerns), and high demand due to government-induced but unsustainable population growth.

As a result of rising mortgage payments, homeowners have opted to extend the term of their debt rather than paying much higher monthly payments or selling their home. While understandable, this is a silly message. It’s reminiscent of Japan in the 1980s, where the idea of ​​100-year mortgages was floated, and we all know how that turned out. This strategy increases interest payments and thereby reduces the homeowner’s disposable income. This happens while the underlying asset is about to fall in value. Essentially, this is an inverse wealth effect: equity and disposable income fall at the same time.

Canadian single-family home prices are too high. These are higher than those in the United States, despite the fact that the average household income in America at the end of 2021 was about 37 percent higher than in Canada. According to data from BMO, home prices in Canada have outperformed the United States by about 90 percent. It seems that Canada’s greater population growth more than compensates for the fact that our economy lags behind that of our neighbor to the south. To put this situation in context, the average home price to income ratio is 6.2 in the United States and 10.5 in Canada. That’s why Canadian home prices are nearly 70 percent higher than those in the United States by income.

Politicians, economists and pundits can talk all they want about demand, but ‘demand’ in economics is different from desires and wishes. There is a “demand” for four-bedroom homes in developing countries, but the people there simply don’t have the economic resources to make that dream a reality. Also for many young Canadians, owning a real home, which was the norm for previous generations, is currently unlikely.

However, relief is coming. As economist Thomas Sowell said, “There are no solutions, only compromises.” Sooner or later there will be a housing crisis in Canada and prices will become more affordable, although times will be very tough for homeowners with large mortgages and stagnant incomes. All bubbles eventually burst.

The views expressed in this article are the views of the author and do not necessarily reflect the views of The Epoch Times.