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Canada's Housing Bubble rises to $74k in March ... USA has over-corrected by $14k

click to enlarge ... more macro economic charts at our website
click to enlarge ... more macro economic charts at our website

 Canada's Housing Bubble Rises to $74,000 in March ... Canadian Homes 2 x's USA

April 25th ~ March sales figures reveal the average Home Price in Canada is double the similar price of a home in the USA for the second month in a row:  $335k vs $167k.  The 2010 Canadian Housing Bubble has gained ground ($15k) over the past three months, setting a new record of $74,000.  The avg Home Price is now 3.4 x's two-earner Family Income compared to the long time trend factor of 2.7.  The Year-to-Date $335k Home Price for 2010 is 28% higher than the trend-indicated $261k.

TrendLines Research first drew attention to the topic of Canadian Housing Bubbles in 1989.  Although that particular Bubble was only $53k, it was actually a more severe event as the average price of the time was an unprecedented 55% above the trend metric ... double the current episode.  Families were paying an astonishing 4.2 x's their Income.  At its peak in 2005, the USA Housing Bubble was 30% ($65k) above the P/I ratio trend.

Rather than the recent rapid four year correction (-22%) witnessed in the USA, it took ten long years for the Canadian average price to surpass the 1989 high.  Avg Home Price fell a mere 6% over the first five years.  Considering the momentum in play within the present economic Recovery, it is not unreasonable to expect a repeat of the long-term sideways correction ... with perhaps an absence of new highs 'til 2017.  It would be prudent for CMHC to temporarily increase its down-payment requirements for high-ratio insured mortgages to 10% (from 5%) until the downside risk dissipates.

This recommended action may be difficult in an environment where economists for four of Canada's largest banks have been unequivocal in recent weeks that "there is no real estate bubble in Canada".  They join the Gov't of Canada and the Bank of Canada (see our Wall of Shame below).  We heard their same chorus of rationalizations in 1989 & from their counterparts south of the 49th in 2005!  Both events posed an assault on the Disposable Income of consumers, and wealth effect ramifications resulted in imminent Recessions within twenty-four months.  As elaborated in our Canadian Recession Meter, failure by the Bank of Canada & CMHC to address a winding down of the Housing Bubble could easily turn the expected 2012 economic downturn into a full fledged Recession.

 USA Housing Bubble has over-corrected by $14,000

Prices peaked for both New Homes & Existing Homes in 2007Q1, and the completed correction in 2009 exhibits a classic "return to the mean".  The irrational exuberance commenced in 2002 and culminated in a break from the median Existing Home Price norm (2.0) to 2.8 x's 2-earner Family Income.  Similarly, median New Home Price drifted from its long term metric (2.5) to an unsustainable 3.1 x's Income.

In May 2008, TrendLines Research published guidance that the correction of the USA Housing Bubble would not be as drastic as forecasts painted by self-appointed pundits.  Our scenarios predicted the collapse would only be as severe as needed to return the USA Existing & New Home Median Prices to their Price/2-earner Family Income ratio trend ... far less than the silly 40% prediction (2008/11/18) by McDoomer Nouriel Roubini.  By the end of its fourth year in correction (2009), the annual Existing Home Price was down 22% and within $1,988 of our target!  New Homes were down 13% from their annual high and within $2,505 of our target for 2009.

Looking ahead to 2010, March sales stats reveal the YTD median Existing Home Price has over-corrected and is $14k less than our 2.0 P/I ratio trend target of $180k.  The New Home Price is $9k less than the 2.5 P/I ratio trend target of $227k.

The Existing Home Price monthly median dropped 28%, from $229,000 (June 2007) to $164,700 in January 2009.  This is far less than the 40% forecast (2008/11/18) by McDoomer Nouriel Roubini.  As the economic Recovery took hold, Price rebounded 10% within 20 weeks.  After a relapse to a low of $164,600 in February 2010, March saw a 4% ($6k) rebound.  March sales were 18% above the January 2009 low.

The median monthly New Home Price decreased 22%, falling from $262,600 (March 2007) to $205,100 in March 2009.  By December 2009, Price had rebounded 9% ($18k).  Unit sales rose 27% from the January low by July;  but also suffered a relapse dropping 27% to a new low in February.  March sales were 27% above the February low.

As shown by trajectory in the chart, it is probable that new highs for New Home Price will not be set 'til 2013.  Existing Home Price records should be stalled 'til 2016.

"There is No Real Estate Bubble in Canada"  ~  Wall of Shame

As mentioned above, there exists in Canada an extraordinary denial of the housing bubble.  We have seen these rationalizations of unsustainably high prices in North America before:  1989 Canada with its 55% ($53k) episode & the USA's 30% ($65k) event in 2005.

Here are some of the more current members of our Wall of Shame:

- Bank of Canada (Paul Jenkins, Senior Deputy Governor - 2010/2/22)  "I would certainly not say we are looking at a housing bubble" - Global Business Leaders Day panel discussion sponsored by Govt of Canada & Financial Times, via Vancouver Sun

- BMO Capital Markets (Michael Gregory - 2010/2/15)  "He also concludes that there's no bubble and, furthermore, that there is very little chance one will appear.  His prediction:  talk of a housing bubble, which has become bit of a bubble itself, should deflate by summer" - Vancouver Sun

- Bank of Canada (Timothy Lane, Deputy Governor - 2010/1/11)  "It is premature to talk about a bubble in Canadian housing markets" - Financial Post

- Gov't of Canada (Jim Flaherty, Federal Finance Minister - 2009/12/21)  "We always watch the housing market to make sure that we do not see the development of an asset bubble.  Record Canadian home prices partly reflect a stabilizing economy and don't constitute a bubble right now" - Bloomberg

- Gov't of Canada (Jim Flaherty, Federal Finance Minister - 2009/7/16)  "There is no bubble in the Canadian housing sector.  That has not been our concern" - Calgary Chamber of Commerce speech, via Reuters

Backgrounder ~ (rev 2010/4/25) Back in May 2008, we went public with our concern that some media pundits were openly rationalizing the USA housing market was not in a bubble, whilst others, like McDoomer Nouriel Roubini 2008/11/18, were predicting a massive 40% collapse.  It was Roubini who also forecasted (Nov/2008) that 1,400 banks would "go bust in 2009".  He was out by 1,250 on that call.  A growingly tabloid-style mainstream media seemed obsessed with extreme positions.

Following a long time commitment to Home Price/Family Income ratios to measure real estate bubbles, our first publicly available effort illustrated that Existing Homes were inflated by $65,000 (30%) at the 2005 crest.  Based on the Canadian Real Estate Bubble of the 90's, we speculated that it would take at least nine years to correct and set new highs.  But to our amazement, the classic "return to the mean" did not even come close to mirroring the Canada event, and the correction was basically complete by January 2009.  It was by no accident the economic Recovery commenced the following month ... long before any fiscal stimulus cheques.

While waiting for the realty sector (and general economy) to correct (recover) completely, we had been awaiting four bottoms.  The first two were Existing Home transactions/month & Existing Home Median Prices.  Done ... January & January (2009) respectively.  The remaining pair were New Home monthly sales & Prices.  Done ... January & March (2009) respectively.  An increase in monthly transactions was important to the Economy 'cuz it brings on increased revenues via purchases of furnishings, appliances, landscaping/gardening,  With respect to New Homes, rising sales also mean "jobs".  The passing of the bottom of Prices for both categories is important 'cuz the subsequent apparent increase in "wealth effect" affects consumer demand and durable good sales.

A return to the mean is both natural and necessary for economic stability.  In the early 80's & 90's, we twice saw the Fed raise rates to embattle the Inflation cycle.  An upward effect on mortgage rates left less Disposable Income for consumers to spend on holidays, clothing, durable goods, etc ... and Recessions ensued.  The purpose was to quell overheating Economies.  And it worked.

Due to winterization costs, Canadians spend an average 2.7 x's 2-earner Family Income for their residences, compared to a 2.0 factor in the USA.  Analysis reveals avg Home Price in both nations detached from the home price/family income ratio trend line in 2002 (see charts) along with avg New Home Price.  Lower interest rates made upgrade purchases almost painless.  Then irrational exuberance set in...

In 2001 the Fed lowered interest rates to draw the Economy out of its Technical Recession.  Many consumers, recently burned by the Dotcom fiasco, began to invest heavily in Real Estate rather than the volatile, collapsing Stock Market.  Low interest rates enabled the purchase of more expensive homes for the same monthly servicing cost, even w/o an increase in Family Income ... and housing inflated.  At the same time, new sub-prime mortgages flourishedk, compounded by rampant fraud by buyers, mtg brokers, appraisers, lawyers, lenders, mtg aggregators, investment banks and bond rating agencies.  Artificial Demand was greater than Supply, and the Realty Bubble was under way.  As Existing Home Prices attained levels of 2.8 x's Median Family Income, it was all to clear that irrational exuberance was fuelling the frenzy.

The USA norm for Median Existing Home Price is only 2.0 x's the  median of 2-earner Family Income.  With extraordinarily higher prices, many families were drawing from their Disposable Income to pay higher monthly mortgage payments.  This left less funds for family budget spending on holidays, clothing, durable goods, vehicles, etc.  Coming out of the Recession, mortgage interest rates began to rise.  Add to the fray the higher energy costs for transportation and heating fuel that was in play, and we had the recipe for a Severe Recession.  The Fed recognized this scenario unfolding and attempted a succession of lower Interest Rates to keep the Economy humming ... but alas, could not avert negative GDP growth rates.

The realty correction plunge was unexpectedly swift ... much faster than originally forecast, and resulted in a return to the trend line in January 2009.  It is no accident that the Severe Recession came to an abrupt end in July ... prior to delivery of the first fiscal policy stimulus cheques.  Nasty real estate & mortgage practices caused the economic contraction, and the return to norms also helped in getting out of the downturn by restoring Confidence.

Disclosure: no positions