The head of Canada’s bank regulator called the country’s housing market what it is — a speculative frenzy. Office of the Superintendent of Financial Institutions (OSFI) superintendent Peter Routledge gave his take on housing this week. Speaking on the Herle Burley podcast, the regulator explained he sees real estate market exuberance. In his opinion, it will taper as interest rates rise, and prices can see a substantial correction. A correction wouldn’t spill over into a financial event, though. Canada’s banks are prepared for volatility events like a housing crash.
Canadian Real Estate Is In A Speculative Fever, Prices To Drop
Canadian real estate is in the later stage of a “speculative fever,” said the country’s bank regulator. He called it herd mentality, with investors leveraging equity to increase housing exposure. “… [it’s] a herd mentality around the speculative sector, where folks say, Well, you know, I can get a quick loan if I have equity built up from my savings or maybe from my first house,” said Routledge.
The pin for the bubble is expected to be higher interest rates, which will reduce credit liquidity. As interest rates fall, borrowers receive more credit to bid up home prices, allowing faster growth. Canada’s central bank realizes this is the case, despite leadership expressing alternative facts.
As interest rates rise, the exact opposite occurs. Rising rates will reduce the liquidity, and this usually brings home prices lower. As long as the government doesn’t increase credit capacity in other ways, such as down payment assistance. “… my expectation is that as rates go up, assuming they do some of that, [the] fever’s going to abate a little, and you’ll see a slowdown in prices,” he said.
Falling home prices can occur in markets that have seen substantial increases. “In some markets, where you had really rapid increases in prices, you could see a fall of 10 percent, 20 percent,” he said.
That’s pretty much all markets that have seen rapid increases. It would barely make a dent in affordability at this point, but interesting to hear a regulator explain this.
Canada’s Banks Can Handle A Real Estate Price Crash
Don’t expect a Lehman-type even if home prices fall sharply, Canada’s banks are prepared for such an event. If Canada’s notoriously low delinquency rates climb, banks have safety buffers to use. Those buffers are even larger at financial institutions considered essential to the economy. Most advanced economies agreed to do this after the Great Recession.
“That [capital buffers] in turn then means that when things do go bad, when we do have hard times in the economy more broadly, the system has buffers to absorb the shock of a downturn in housing or an increase in unemployment or both simultaneously,” he explained.
In addition to the regulator’s point, end housing users aren’t impacted much by a crash. In the US, the narrative is poor people using subprime lenders took on too much debt and defaulted. It has since been debunked by researchers. Subprime users didn’t actually default at higher rates. Investors with prime or better credit scores looking for leverage at subprime lenders were the increase. Millions of subprime borrowers continued to pay right through negative equity. It’s not as easy to blame investors, though.
Canadian Housing Fully Valued, Smart Investors Will “Think Twice”
Canadian real estate investment has been absorbing significant capital from other economic segments. After all, a whole generation has seen real estate do nothing but rise in Canada. Many adults have never seen a crash, and some mentally blocked them out. The result is people are putting a disproportionate amount of capital into housing.
Since capital is finite, this diverts money from other areas of the economy. Real estate now outpaces investment in businesses for the first-time ever in Canada. Self-employed people are also on the decline, likely since many see homeownership as a better opportunity. Are you really going to work for years to build a six figure job, when a house is adding $40k per month? Probably not. The regulatory head sees this as a temporary issue.
Routledge was asked if housing is diverting capital from other investment areas. He replied, “Maybe a little bit over the last few years? Probably not going forward, to be honest, with rates going up with general recognition that boy housing is pretty fully valued.”
Adding, “a smart investor would think twice [about housing] and look at other outlets.”
That last point probably isn’t going to make him many friends in Canada, but that’s kind of what the country needs. There is an adult in the room who doesn’t need to appease private industry due to politics.