Canada has been receiving attention as of late for its overheated housing markets. I recently read, with interest, Don Pittis’ latest editorial entitled, “Why a housing bubble is good (but may be bad for you).” Pittis argues that when viewed in ‘the long term’ through ‘rose-colored glasses’ housing bubbles are good because when they pop the economy, in its most general terms, benefits. As Pittis explains:
During bubbles, a country grows its housing stock, over-investing in the construction of new properties so that the supply is more than sufficient, allowing prices to fall relative to income. At the end of a bubble, finally and for quite a while afterwards, there is enough to go around.
Essentially, Pittis understands a ‘housing bubble’ as “just a rising market driven by rising demand.” In his estimation it is the undersupply of housing that causes price increases which in turn spur building frenzies that eventually result in oversupply which at a certain point cause the bubble to pop resulting in a significant, downward correction in housing prices. Pittis suggests that in this scenario the individual pain suffered by some is outweighed by the societal benefits of an adequately stocked housing system. A simplified, utilitarian argument.
I think the significance of this editorial lies not in the actual argument as in the story it tells (or does not tell) about housing bubbles, housing systems, and Canadian political decisions leading up to and in the wake of the U.S. housing crisis. In his over-simplistic portrayal of housing bubbles as ‘demand driven’ and in his utilitarian logic the real causes and social consequences are completely overlooked by Pittis.
The editorial reminded me of the important work of Alan Walks, a geographer at the University of Toronto. In a paper entitled, “Canada’s housing bubble story: Mortgage securitization, the state, and the global financial crisis” Walks offers a deeper analysis of the Canadian case. He traces the growth of Canada’s housing bubble to the securitization of mortgages in Canada and the accessible, cheap mortgage credit this securitization engendered.
In Walks’ analysis the demand creating Canada’s housing bubbles has been made possible by the availability, for buyers and banks, of state guaranteed credit. In other words, the central character in the whole story is the state, but not for the reasons generally repeated in the mainstream media. Walks’ analysis shatters many commonly held myths, not only about housing bubbles in general but also myths about the soundness of Canada’s banking sector and the prudence of recent government policies.
Walks shows how Canada is in many respects more similar to the United States then portrayals of Canadian exceptionalism might have us believe. First, in the early 1980s the Government of Canada began building a secondary mortgage market similar to the United States. This began with the Mortgage-Backed Securities program which allowed government-insured mortgages to be packaged together and traded on the open market by financial institutions. Later, in 2001, the Government of Canada started the Canada Mortgage Bond program in an effort to stimulate the growth of this secondary mortgage market. They used the money acquired through selling these bonds to buy Mortgage-Backed Securities from Canadian banks. Now that banks no longer had these Mortgaged-Backed Securities on their books they were free to provide more mortgages to buyers. Moreover, they could package these mortgages and sell them back to the Government of Canada.
Second, in the years immediately prior to the U.S. financial crisis the Government of Canada was doing its best to emulate the U.S. mortgage market. In 2006, the National Housing Act was changed to allow foreign firms into Canada’s mortgage insurance market (prior to 2006, only the Canadian Housing and Mortgage Corporation and private insurer Genworth operated in Canada). The Government of Canada offered a 90% state guarantee of mortgages to private insurers willing to come to Canada. The Government of Canada also extended mortgage terms to 40 years, reduced the minimum downpayment eligible for Federal insurance from 5% to 0%, and began insuring interest-only mortgages.
In this context of expanding, easy credit housing prices ballooned, household indebtedness increased, and the Government of Canada’s liability in terms of its insured mortgages and securities exploded. Moreover, as Walks (2012, 10) explains:
the financial institutions now had even less of an incentive to worry about borrowers’ ability to pay back loans, since they were not planning on holding the notes. With the federal government providing guarantees of both principal and interest, the lenders that originated new mortgages and packaged them into NHA mortgage-backed securities were able to secure guaranteed cash flows, risk free, from the Canadian state, merely by signing up new homebuyers.
Walks provides the following numbers. From the end of 2005 until the beginning of 2008 outstanding mortgage credit grew by roughly 33% from $628 billion to $838 billion. Record bank profits were made and house prices shot skyward. And then the U.S. housing bubble burst.
This is where Walks’ story gets interesting and Pittis’ story falls apart. Contrary to popular belief Canada’s banks were as precarious as U.S. banks. Furthermore, the Government of Canada did, like the U.S., bail out its banks. Walks reports the ratio of tangible assets held by banks to their tangible common equity (where a higher ratio indicates greater exposure to changes in asset values). According to this measure, Walks finds that the top 5 Canadian banks, with ratios of 32:1 in 2007, 37:1 in 2008, and 31:1 in 2008 were more highly leveraged than the top 10 U.S. banks (26:1 in 2007, 35:1 in 2008, 20:1 in 2009). Thus the drop in Canadian house prices during the global financial crises significantly impacted the tangible assets of Canadian banks and the lax lending standards introduced in 2006 raised concerns about the quality of their mortgage assets.
To avoid a credit crunch the Bank of Canada responded by sending over $44 billion dollars to the banks. In addition, the Canadian Pension Plan purchased $4 billion worth of mortgages from Canadian banks. As the U.S. crisis intensified in 2008, the Canadian Mortgage and Housing Corporation was authorized to purchase $137.55 billion worth of mortgages from Canadian banks. This corporate welfare continued in spurts over the following two years. As Walks (2012, 16) details:
All told, approximately $510 billion of liquidity, stimulus, bailouts and guarantees had been summoned up for potential injection into Canada’s banking system by the end of 2009 representing roughly 33% of Canada’s annual GDP (with about $280 billion eventually drawn upon). Even at its most restricted definition (excluding the US Fed TAF loans, and the CMB program, and funds not drawn upon), the minimum total Canadian ’emergency’ bailout comes to $179 billion, or 11.6% of Canada’s 2009 GDP, not dissimilar to the combined costs of the direct federal bailout/stimulus programs in the US.
This contradicts the widely held perception that Canadian banks were resilient going into the crisis and were able to weather the storm on their own. In fact, if it were not for government intervention the Canadian banking system could have crumbled.
Setting the political consequences aside for a moment, it is also important, as Walks explains, to consider the social consequences of Canada’s housing and mortgage markets. State orchestrated mortgage markets enticed new, young buyers into the housing market garnering enormous profits for banks in the run-up to the global financial crisis. This buying frenzy had social consequences – wealth inequality. Rising house prices place enormous burdens on the middle class. Walks cites evidence showing that young families and immigrant families have the highest debt levels and household debt is disproportionately concentrated among low-income families. Thus housing bubbles are accompanied by massive growth in household indebtedness, a point Pittis ignores. Moreover, as Canadian society ages, ‘boomers’ retire and the age-dependency ratio shifts the burden on younger generations will only increase. Walks rightly points out that in the wake of these bubbles we should expect generational conflicts at a time when solidarity and resilience is needed.
Returning to the political consequences, one of the most poignant facets of Walks’ story is that the securitization of mortgage markets in Canada and the bailout of Canadian banks has shifted the private risks and liabilities of banks onto the shoulders of ordinary Canadian citizens, all while bank profits and executive bonuses reach record levels. In addition, the costs of the bailout to government balance sheets has yet to be addressed. Given the aversion to tax increases among conservative governments the austerity agenda – cuts to government services – becomes the vehicle for balancing the books. To make matters worse, as Walks explains, bubbles have the perverse effect of shifting capital away from productive investments into the speculative housing market hampering long term economic growth. Housing bubbles, therefore, have deleterious effects to everyone insofar as they thrive upon moral hazard, incur the socialization of private risk, intensify government austerity, and misdirect investment capital.
Pittis cites Stanley Kubrick’s film “Dr. Strangelove (how I learned to stop worrying and love the bomb)” as inspiration for his editorial. Perhaps he has forgotten that Kubrick’s film is not only a cutting satire of cold war politics but a tragedy. In the end everyone gets blown up.
Walks, A. 2012. ‘Canada’s Housing Bubble Story: Mortgage Securitization, the State, and the Global Financial Crisis.’ International Journal of Urban and Regional Research. 1-30. DOI 10.1111/j.1468-2427.2012.01184.x
I have two questions, Josh. First, who is the artist behind these very apt accompaniments to your posts?
Second, what is happening to rental housing as this story unfolds?
Pittis mentions in passing that Germany has had low rental prices since 2008, following its own bubble burst. From what I understand about the local housing market (in S. Ontario), while plenty of new houses have been built for sale, very little new rental housing has been created. So regardless of prices, there are just no vacancies. Is that situation a product of the housing bubble?
Pittis sounds very casual about qualifiers like “So long as you don’t care about the exact moment of a peak or trough…” and “While you may suffer personally when the price of your house falls, and while the wider economy may suffer a contraction when homeowners suddenly feel poor…” But if someone who owes more on their mortgage than their house is worth loses their job and needs to sell, and then there’s no rental vacancies to keep them housed while they sort out this giant debt, wouldn’t it just not matter if there’s plenty of owned houses to go around? I guess that’s the debt you’re talking about, too, but I’m just having trouble wrapping my head around how Pittis counts adequate owned housing supply as a correction at all, when the bubble popping changes the nature of housing demand.
The Socialist Myth of Economic Bubbles