Housing bust looms

The Canadian housing market could face a housing bust similar to the United States', particularly in more bubbly markets like Vancouver and Calgary, said Robert Shiller, the Yale University professor who predicted both the 1990s stock market boom and bust and the U.S. housing slump.

Shiller, co-founder of the S&P Case/Shiller Home Price Index, said psychology is the primary driver of bubbles and it appears that Canada has been just as caught up with home-buying fever as the U.S. and other countries around the world.

Asked whether that meant Canada could face a similar bust Shiller said: "Yes, especially in places that went up a lot like Vancouver and Calgary. I don't think Toronto has been quite as extreme."

Shiller said there was a natural connection between the U.S. and Canada.

"I would be surprised that the bubble that appeared in the United States and elsewhere didn't appear in Canada," he said in an interview. "It's psychology, I think, that drives it.

Shiller, whose book Irrational Exuberance came out in March 2000 just as the tech bubble peaked, said it was essential for the U.S. government to pass a financial bailout, though he believes the U.S. is facing a "severe recession" regardless.

"I'm concerned problems are deeper than can be handled by the bailout, but that doesn't mean the bailout doesn't do some good," he said.

He said the housing crisis was primarily a policy failure by U.S. authorities.

The U.S. government was "totally blind" to it, regulators failed to monitor the mortgage industry properly and the U.S. Federal Reserve had very low interest rates at a time of the greatest housing bubble of all time.

While homeowners should take some personal responsibility for the debacle, they were being goaded into the fervour by an establishment that endlessly pushed an ownership society.

"They were doing what was considered right at the time," Shiller said.

While ups and downs in the market can lead to creative destruction, the current housing crisis has morphed into a system problem.

"The problem is that perfectly good firms are in trouble," he told the Financial Post in an interview at the Ontario Economic Summit.

A bailout may not be palatable, but government assistance is required when the system fails.

The trick is to reduce conditions that fan bubbles.

In his current book, The Subprime Solution, Shiller proposes several measures to reduce bubble conditions in the housing market, including better information for prospective buyers and broader markets that trade risk better, such as the housing futures he has developed on the Chicago Mercantile Exchange.

There should also be new retail products such as "continuous workout mortgages," that go up and down with the value of the home equity and mortgage equity insurance.

Shiller, who would not give a precise forecast on the outlook for U.S. home prices, nevertheless said futures markets are predicting more price declines of 10 per cent or more.

(prepared by Jacqueline Thorpe/Fiancial Post/Vancouver Province)