Either the Canadian real estate bubble is now a bubble on a bubble, or old enough it should be in school. The US Federal Reserve (the Fed) released its quarterly exuberance index for Q1 2021. The index, used to determine country-level housing bubbles, shows Canada is well into one. The unusual circumstances make it unclear if it’s a long bubble, or a double bubble. It does show Canadian home prices have been in bubble territory for 6 years without a correction.
Home Price Exuberance and Emotional Home Buyers
The Exuberance Index is a measure of buyer enthusiasm for higher prices. It measures the prices paid in contrast with fundamentals, looking for explosive dynamics. That’s how smart people say, buyers paying irrational amounts of money. Emotional premiums like this are not based on fundamentals. Consequently, the price of these homes is subject to how people feel. Emotions change faster than fundamentals, leaving markets more vulnerable to shock.
The Fed developed the indicator after the US Housing Bubble popped, and wreaked havoc. By looking for a “smoking gun” indicator to call bubbles, they can identify and address them early. This limits the damage that they might do to the economy.
They crunch the numbers, and make it straightforward for researchers to read. Two sets of numbers are given — a critical threshold value, and an exuberance index score. If the score rises above 95% of the critical threshold value, buyers are acting exuberantly. If the market stays in this territory for five or more consecutive quarters, the market is exuberant.
Exuberant markets are better known as bubbles. The Fed argues this will result in a correction at some point, but they obviously can’t pin down when. Policy and credit extensions are often designed to drag out a bubble. This can run for as long as the government can continue to create a larger bubble.
It’s generally not advised though, since bigger bubbles create more dangerous corrections. Extending them too long inevitably slows down the economy, causing its own event. If you think losing home equity is bad, imagine how bad things get when the economy is dependent on the bubble. On that note, let’s see where Canada is.
Canadian Real Estate Prices Are Based On Emotion, Not Reality
Canada just passed another fifth quarter of exuberance, after a microscopic break. Canadian housing once again became exuberant in Q1 2020. In Q4 2019, it took a brief break below the critical threshold value — just 0.01 points below it. Since then, the market has completed five consecutive quarters in the exuberant territory.
Canadian Real Estate Exuberance Index
The US Federal Reserve Exuberance Index for Canada, and critical value threshold. A market that is is above the threshold for 5 consecutive quarters is considered to be exuberant.
Source: US Federal Reserve, Better Dwelling.
The Fed’s exuberance reading for Canada hasn’t been this high since 2017. Back then, it was due to Toronto and Vancouver, and the infamous foreign buyer mini-bubble. This time the whole darn country is actually showing signs of exuberance. Though it’s important to recognize, the current trend follows 15 quarters of exuberance. One quarter isn’t enough to have corrected prices, and it only fell slightly below that value.
Canadian Real Estate Has Been In A 6 Year Bubble… Or It’s A Bubble On A Bubble
There are two ways to look at this, and it’s just a technical labeling issue. Falling just 0.01 points below the threshold is likely within a margin of error. A single quarter isn’t enough for a new trend either. Remember, it takes five quarters for the market to be considered exuberant in the first place. In this case, the bubble would now be 24 quarters old, or about 6 years. Happy 6th birthday, Canadian Real Estate Bubble!
If you accept the break as definitive proof the first bubble was over in 2019, it’s two bubbles. Canada had a 19 quarter-long bubble, which ended in Q4 2019. It was then followed by the current bubble, which started one quarter later. In other words, it’s a bubble on a bubble.
Ultimately a label doesn’t change all that much. The facts are, buyers showed exuberance in 2015. Early signs weren’t tamed in 2016, which would have been the ideal time to address it. So it turned into a full-blown bubble. Since then there’s been no correction in home prices for the past six years.
Policymakers can either let it correct, or delay the correction until later, and hope it’s the next guy’s problem. By doing this, they’re actively creating more risks for Canada’s economy. No one knows when the bubble is going to pop, but we do know one thing for sure. When it happens, whoever’s in charge will say, “no one saw this coming.”
Federal Reserve researchers will try not to snicker, I’m sure.
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