House rules

By and large, Canadians are not quite as obsessive about house prices as the Brits are -- but they're still fixated on the issue, as these two articles, which took up an entire page in today's Toronto Star,  illustrate.  Much of the analysis in the articles is lifted from a new report from Canada Mortgage and Housing Corporation (CMHC), the government-owned mortgage insurer, that attempts to "detect the presence of problematic conditions" in Canada's housing markets.  CMHC concludes, and the journalists are happy to concur, that the risks of a major correction in Canadian house prices, even in the small number of urban centres where prices have been advancing most strongly, is relatively limited.  It expresses some concern about overbuilding in Montreal and Toronto, but deems other urban centres to be "low risk".

Helpfully, the CMHC report includes an overview of the agency's internal methodology for analysis of market conditions.  This focuses on four inter-related indicators: overheating, price acceleration, overvaluation and overbuilding.  Looking at how CMHC evaluates these indicators, one surprising fact quickly emerges: although the level of interest rates is taken into account, it does not appear to play an explicit role in the final assessment.

Considering the concern that central bankers and others have expressed about the potentially dangerous impact of the long period of ultra-low interest rates we are living through -- or rather, about what happens when rates finally start to rise -- and keeping in mind that Canadian household debt levels remain near all-time highs in relation to incomes, this is remarkable. It becomes even more so if you look at some of the current numbers that CMHC seems so relaxed about.  For example:

"At the national level, Canada’s resale market has been balanced since 2010, thus indicating that (house) price growth should be generally in line with overall inflation.  However, national annual (house) price growth has exceeded growth in the overall consumer price index (CPI) almost every year since 2010. Through the first nine months of 2014, the average (house) price for Canada was up 6.9 per cent compared to the 1.9 per cent increase in the CPI." 

Can this really be considered sustainable?  After all, at a 6.9 percent annual pace, house prices double in just over a decade. Moreover, given weak underlying inflationary pressures and sluggish growth in employment, can there really be any doubt that the degree to which house prices are outpacing the general price level is almost entirely due to the torrent of cheap money provided by the Bank of Canada?

In effect, CMHC's conclusion seems to be only that current house prices are sustainable as long as nothing untoward happens on the interest rate front.  That's not a very robust conclusion from the standpoint of policymakers. Nor, perhaps, from the standpoint of prospective homebuyers. In the first of the two linked articles, personal finance guru Adam Mayers opines that for people in the Toronto area, there's not much reason to delay getting into the market, what with five-year fixed rate money available at rates well below 3%.  Recognizing the risk of higher rates down the road, however, Mayers counsels buyers to apply the money they save, thanks to ultra-low rates, to paying down the mortgage principal as quickly as possible.

That's great advice, but as the persistence of high household debt levels clearly shows, it's not advice that most people care to take.  As and when interest rates start to rise, caveat emptor.