Housing markets at risk

As home prices finally stop rising, the vulnerability of the housing market and overleveraged households could make Canada vulnerable to a U.S.-style crash, according to one of the more bearish economists on Bay Street.

Canadian households are now running larger deficits than those in the U.S. and the U.K., which are amongst the world's hardest-hit housing markets, Merrill Lynch & Co. economist David Wolf cautioned in a report yesterday.

Increasing leverage, combined with recent turmoil in U.S. financial markets and weaker-than-expected data on the domestic housing market, have increased his sense of worry in the last month, Mr. Wolf said in an interview.

"When house prices stop going up is when the problem is revealed. We've seen it in the U.S. ... [and] this is just now starting to happen in Canada."

Bank stocks in Canada have held up better than their counterparts in many other countries. This suggests the markets "remain overly sanguine" about the prospects for the housing market, financial sector and overall economy in Canada, Mr. Wolf said.

Mr. Wolf has been influenced not just by prices of late, but weakness in building permits, housing starts and sales of existing homes.

In response to questions about the report, Prime Minister Stephen Harper said he believes Canada's housing and construction markets remain much stronger than those in the U.S. "We don't have the same situation here with mortgages as was the case in the United States with the subprime mortgages there. And so, therefore, I think our market is in a much stronger position," Mr. Harper told reporters during a campaign stop in Vancouver.

Canada's housing market is in better shape than that of the U.S., where prices are down by 20 per cent from their peak in 2006. All told, they could plunge more sharply than the 30-per-cent drop experienced in the 1930s, according to Yale University economist Robert Shiller.

In Canada, new home price gains were nearly flat in July and resale home prices dropped by 5.1 per cent last month. Some markets are holding up better than others, with the decline in existing home prices in August mainly due to a slump in Vancouver, the priciest housing market.

Canada's more conservative lending practices and stronger economy should help keep the housing market here from deteriorating to the extent it has in the U.S, said Douglas Porter, deputy chief economist at BMO Nesbitt Burns Inc.

"The most important factor is what happens to the broader underlying economy. I think it is possible the housing market could take it on the chin here if the U.S. goes into a deep recession," Mr. Porter said.

The nature of the decline in Canada is much different than that of the U.S., said Benjamin Tal, senior economist at CIBC World Markets Inc.

"You need a trigger for a crash in the housing market. In 1989 to 1990, the trigger was double-digit interest rates that killed affordability in Canada. In the U.S., the trigger was subprime, and a huge increase in default rates when people who were not supposed to be in the business of owning a house did, and that created artificial demand," he said. "Unless Canada goes into a major economic recession ... I'm missing that trigger."

One of the first places serious cracks in the market are likely to show is in the alternative lending sector, which caters to customers who can't qualify for bank mortgages.

Thus far, his company has seen few signs of customer distress, said Gerald Soloway, head of alternative lender Home Trust Co. "We've seen no appreciable increase in losses, arrears or other problems, and I believe we would be a leading indicator for this."

(prepared by Lori McLeod/Globe & Mail)