Housing bubble

Canadian households are nearing the financial tipping point that Americans reached two years ago, which plunged their housing market into the deepest recession since the Great Depression, a senior Bay Street economist warned Wednesday.

It may just be a matter of time before the Canadian housing market tanks like the U.S. market did, Merrill Lynch Canada economist David Wolf said, warning that Canadian households are now nearly as overextended as households in the U.S., and even more so than those in Britain, prior to the bursting of the housing market bubbles in those countries.

"What worries us is that Canadian households have been running a larger financial deficit than households in either the U.S. or the U.K.," Wolf said in a commentary, noting that in 2007 Canadian household net borrowing amounted to 6.3 per cent of disposable income, which was higher than in Britain and not far off the seven per cent peak in the U.S. in 2005, prior to the bursting of that country's housing bubble.

The concern of a deep housing market meltdown in Canada was dismissed as unwarranted by Prime Minister Stephen Harper and as overly pessimistic by another Bay Street analyst and a senior real-estate industry economist.

"We will not see such a situation here as we see in the U.S.," Harper said, stressing that both the housing and consumer markets and financial institutions in Canada are "much stronger" than in the U.S.

Wolf conceded that the fear of a U.S.-style housing meltdown here, challenges the view that Canadian borrowers and lenders have been more conservative than those in the U.S. and that their debt load is somehow more sustainable.

"We fear, however, that it may simply be a matter of time," he said, suggesting that the recent fall in Canadian home prices and the increase in unsold homes on the market are warning signs that are being overlooked because of continued mortgage lending here.

The underlying cause of the U.S. housing market collapse and in turn that country's financial crisis was that U.S. banks lent people too much money, Wolf said.

"It's horribly clear in retrospect how excessive the lending in the U.S. was," he said.

"But it couldn't have been clear while it was happening, because the banks kept doing it, and the market kept accommodating it," he added, suggesting that may explain the continued strong growth in mortgage lending here.

But as is the case here now, there were danger signals there, including the growing household financial deficit, he said.

"From this perspective, the absence of a Canadian credit crunch to date may be cause for concern, not comfort," Wolf said, questioning how can it be a good thing that mortgage debt continues to grow at a double-digit pace as housing prices decline. "We believe that markets remain overly sanguine with respect to the prospects for the Canadian housing market, the financial sector and the overall economy."

The report is not the first to warn that Canada's housing market is not immune to a sharp downturn, but it is one of the most pessimistic to date.

However, BMO economist Douglas Porter said Wednesday a deep and broad-based Canadian housing market meltdown, as happened in the U.S., is unlikely.

"I'm somewhere between the meltdown camp and everything's hunky-dory," Porter said.

The Canadian housing boom was supported more by economic strength coming from the commodity boom than by the loose lending practices that fuelled the U.S. market, Porter said. And mortgage lending practices here were more conservative than in the U.S., with only a few lenders "dipping their toes" into subprime market.

While some further decline in Canadian housing prices is to be expected, a greater threat to the housing market here than over-extended household finances would be a serious recession in the overall U.S. economy, Canada's main export market, Porter said.

"There is a risk that the U.S. economy is going to go through a deeper downturn," he added.

(prepared by Eric Beauchesne/Vancouver Sun)