Betting against the house

A new report from consultants at Environics Canada suggests that Canadian households are wealthier than ever, despite a continuing slow rise in indebtedness. Nationwide, net household wealth averages just above C$400,000.  Just as important, given the touchiness of many Canadians about their neighbour to the south, Canadian household wealth has been above the equivalent figure for the US for five straight years.

Sounds good, right? As ever, though, there is quite a lot of devil in the details. Much of the growth in household wealth in recent years has been the result of the slow but steady growth in house prices, rather than accumulation of liquid assets.  Canadians haven't been saving assiduously: it's just that all the (house)boats have risen with the tide.  The outperformance of the local housing market is also the entire explanation for the fact that average Canadian household wealth currently exceeds that of the United States.

Because the "wealth" is so housing-dependent, the Environics findings are not as positive a piece of news as they seem on the surface.  As economists have been quick to point out (see Doug Porter of BMO's comments in the linked article), things could go into reverse quite sharply when interest rates start to go up -- which may not be imminent, but is inevitable at some point.  When that happens a lot of indebted households will quickly find their disposable income getting squeezed, and as that starts to happens across the economy, house prices are likely to stagnate or go into reverse, putting a crimp on household wealth.

There's also a bigger question of whether housing wealth is really wealth at all, when you aggregate it across an economy.  A leading proponent of the view that it isn't is former Bank of England economist Willem Buiter, who made the case in this paper.*  (Advice: ignore the abstract, which is quite technical, and read the introduction instead).  Rising house prices are good for current homeowners but bad for tenants and would-be buyers.  To quote Buiter, "On average, the inhabitants of a country own the houses they live in; on average,  every tenant is his/her own landlord and vice versa. So in a representative agent model, there is no net housing wealth effect".

The apparent rise in household wealth reported by Environics has come about purely because Canada's banks are in better shape than those of the US and have been able to continue lending.  It in no way reflects any increase in the productive capacity of the economy, which in the long term is the only source of real wealth.  Over the past three years and more, US households have been slowly but steadily paying down debt and now, house prices there are starting to perk up quite nicely.  There's not much doubt about which country's consumers will be in better shape once interest rates start to move higher.

* Interestingly, Buiter reveals that this way of looking at housing was first suggested to him by Mervyn King, his boss at the BoE.