Mark Carney: Housing in Canada
Remarks by Mr Mark Carney, Governor of the Bank of Canada, to the Vancouver Board of
Trade, Vancouver, British Columbia, 15 June 2011.
* * *
Introduction
It is a pleasure to be back in Vancouver, a place often rated as the world's most liveable city.
Less frequently is it viewed as the most affordable. In the past three years, the average
Vancouver house price is up about 30 per cent, making this city an extreme example of
general developments in Canadian housing.
In my remarks, I will discuss the Canadian residential real estate market, consider some of
the lessons from recent international experience and, finally, draw the policy implications.
Importance to Canadians
The single biggest investment most Canadian households will ever make is in their home.
Housing represents almost 40 per cent of the average family's total assets, roughly
equivalent to their investments in the stock market, insurance and pension plans combined.
In recent years, housing has proved a very good investment indeed. The value of residential
real estate holdings in Canada has climbed more than 250 per cent in the past 20 years,
vastly outpacing increases in consumer prices and disposable income over
that period (Chart 1).
However, Canada is arguably no better off because of it. That's because while homeowners
may feel wealthier because of this rise in prices, housing is not net national wealth. Some
Canadians are long housing; others are short. Housing developments can have important
implications for equality both across and between generations. Though some people in this
room may have been enriched, their children and neighbours may have been relatively
impoverished.
Importance to the Bank of Canada
Housing not only meets a fundamental human need, it also has a wider economic
significance. The Bank of Canada cares about the housing market because it can affect both
price and financial stability. Let me address these in turn.
Price stability
The objective of Canadian monetary policy is low, stable and predictable inflation, defined as
a 2 per cent annual rate of increase in the consumer price index (CPI). Housing can
influence inflation in three principal ways.
First, it is a major element of the CPI, accounting for more than a fifth of the basket of goods
and services that makes up the index. The prominence of housing in the Bank's target index
provides an important advantage in that it ensures that the most important asset price in the
economy is directly relevant to monetary policy.
Second, the real estate sector makes a significant, if volatile, call on resources and labour in
our economy, thereby influencing wages and price pressures more generally. While
residential investment has accounted for only 6 per cent of GDP on average over the past
30 years, activity in the sector has been four times more volatile than the overall economy
over that period. Thus developments in housing substantially affect the business cycle and
by extension inflation.
Third, while changes in housing values may not lead to changes in net wealth, they do
influence consumption by affecting households' access to credit. Through this
"financial-accelerator" effect, homeowners can borrow more against increases in home
equity to finance home renovations, the purchase of a second house, or other goods and
services. Such expenditures can accelerate the increase in house prices, reinforcing the
growth in collateral values and access to borrowing, leading to a further rise in household
spending. Of course, this financial accelerator can also work in reverse: a decrease in house
2
prices tends to reduce household borrowing capacity, and amplify the decline in spending.1,
Financial stability
A home purchase triggers the biggest liability most families will ever take on. The value of
housing-related debt in Canada has nearly tripled over the past decade to $1.3 trillion. This
debt is also the single largest exposure for Canadian financial institutions, with real estate
loans making up more than 40 per cent of the assets of Canadian banks, up from about
30 per cent a decade ago (Chart 2).
This unprecedented exposure exists in the context of a Canadian mortgage market that is
subject to more stringent checks and balances than in the United States. For instance,
almost all Canadian mortgages are full recourse, mortgage interest is not tax-deductible, and
high-ratio lending standards are generally prudent. These factors help instil responsibility and
discipline on both homeowners and lenders.
Nonetheless, the central position of housing assets and liabilities on the balance sheets of
both households and financial institutions means that any housing excesses could generate
important vulnerabilities in the financial system.
Housing market developments in Canada and abroad
A review of the recent history is instructive.
A benign global macroeconomic environment and rapid financial innovation contributed to a
global housing market boom through much of the past decade. In some countries, it went too
far. Most prominently, in the United States, a substantial deterioration in underwriting
standards turned boom to bubble and, ultimately, to bust. U.S. housing starts are now down
three-quarters from their peak and prices have fallen by one-third. There have been over
nine million foreclosures initiated since the cycle turned, and almost one in four mortgages is
now in a negative equity position.
While some details differ, most notably in the scale of defaults, recent trends have been
similar in the United Kingdom, Spain and Ireland, where housing markets remain acutely
challenged.
Elsewhere, however, the global financial crisis proved to be only a brief setback, with the
growth of house prices resuming, or even exceeding, its former pace.3
Canada falls into this latter group. Nationally, our house prices have risen 31 per cent from
their trough in early 2009, to stand 13 per cent above their pre-crisis peak (Chart 3).4 Here in
Vancouver, the recovery has been even stronger, with prices up 55 per cent from their trough
to a level 29 per cent above the prior peak. The rebound in housing market transactions and
new construction, both locally and nationally, has been similarly robust.
The performance of Canadian housing during the recent cycle has been unusual. For
example, it took nearly 12 years for real residential investment to regain its level on the eve
of the 1990s recession; this time it took only a year and a half (Chart 4). This rapid recovery
importantly reflects the evolution of monetary policy during the recent recession. In response
to the sharp, synchronous global recession, the Bank lowered its policy rate rapidly to its
lowest possible level, doubled our balance sheet, and provided exceptional guidance on the
likely path of our target rate.
With the initial rapid narrowing of the output gap, the return of employment to a level above
its pre-crisis peak, the highly effective transmission of monetary policy in Canada, and the
sustained momentum in household borrowing, the need for such emergency policies passed
(Chart 5). As a consequence, the conditional commitment was removed, our balance sheet
was normalized, and rates were successively tightened until they reached 1 per cent last
autumn, where they have remained.
These policies provided considerable stimulus to the Canadian economy during a period of
very weak global economic conditions and major downside risks. The housing market, highly
sensitive to interest rates, responded. The rapid bounce-back in housing activity was also
supported by federal government initiatives, notably the Insured Mortgage Purchase Plan
and the Home Renovation Tax Credit. As a result, the recovery in the housing market played
an important role in ensuring that the recession in Canada, while sharp, was also short.
With this renewed vigour building on the decade-long boom that preceded the crisis, the
average level of house prices nationally now stands at nearly four-and-a-half times average
household disposable income. This compares with an average ratio of three-and-a-half over
the past quarter-century (Chart 6). Simple house price-to-rent comparisons also suggest
elevated valuations (Chart 7). While neither of these metrics reflect the impact of low interest
rates, even after adjusting for these effects, valuations look very firm. For example, the ratio
between the all-in monthly costs of owning a home and renting a home, as measured in the
CPI, is close to its highest level since these series were first kept in 1949 (Chart 8).
Financial vulnerabilities have increased as a result. Canadians are now as indebted (relative
to their income) as the Americans and the British (Chart 9). The Bank estimates that the
proportion of Canadian households that would be highly vulnerable to an adverse economic
shock has risen to its highest level in nine years, despite improving economic conditions and
the ongoing low level of interest rates.5 This partly reflects the fact that the increase in
aggregate household debt over the past decade has been driven by households with the
highest debt levels (Chart 10).
There are some offsets. Debt is largely fixed rate and household net worth is at an all-time
high. However, borrowers should remember that a fixed-rate mortgage will reprice a number
of times over the life of the mortgage and, while asset prices can rise and fall, debt endures.
The fact that the "official" personal savings rate in Canada has remained consistently positive
is of limited comfort.6 The personal savings rate has fallen to historically low levels, despite
the fact that the baby-boom generation is entering its highest saving years.7 Adjusting for
housing expenditures, Canadian households have now collectively run a net financial deficit
for 40 consecutive quarters, in effect, demanding funds from the rest of the economy, rather
than providing them, as had been the case through the 1960s, 1970s, 1980s and 1990s
(Chart 11).
How concerned should we be? To answer requires a deeper examination of the fundamental
forces of supply and demand in the Canadian housing market.
The forces of supply and demand
Canada's housing supply is relatively flexible, compared with other countries (Chart 12), and
it appears to have grown at rates broadly consistent with underlying demand forces, the most
important of which is the rate of household formation (Chart 13).8
Some excesses may exist in certain areas and market segments. In particular, the elevated
level of "multiples" inventories (Chart 14), the ample pipeline of developments under way,
and heavy investor demand (much of it foreign) reinforces the possibility of an overshoot in
the condo market in some major cities.
Moreover, looking at the amount being spent on Canadian housing, rather than simply the
number of houses being built, suggests that overall activity has been quite robust.
Residential investment as a whole (including new home construction, renovations and
ownership transfer costs) has consistently exceeded its long-term average share of the
overall economic activity for more than seven years. Residential investment is now at levels
that have previously proved to be peaks in Canada and, on a relative basis, in the United
States (Chart 15). This partly reflects the generally strong performance of Canada's labour
market over the past decade, which has driven solid gains in employment and income.
However, it also reflects historically favourable borrowing conditions, and potentially overly
optimistic assumptions about future developments.
Lower interest rates reduce the cost of financing the purchase or construction of houses and
increase the value of collateral, enabling more borrowing than would otherwise be possible.
While monetary policy rates influence mortgage rates across the yield curve, mortgage rates
are ultimately set in the market, where a broad set of domestic and global forces play a role.
Among these forces, the so-called "global savings glut" has been particularly important in
underpinning the trend decline in long-term borrowing rates over the past decade. Flows of
excess savings from emerging markets into the U.S. Treasury market have restrained the
long-term U.S. interest rates that provide the benchmark for yield curves globally. Rough
calculations suggest that the lower real rates from this phenomenon could justify a
substantial proportion of the increase in house valuations across mature markets.9 The
eventual rebalancing of the global economy from deficit countries, like the United States, to
surplus countries, like China, should dampen this effect.
As in many other countries, cheap credit has been used to bid up the price of Canadian
houses, a non-tradable good, rather than invest in expanding the productive capacity and
export competitiveness of our businesses. For example, over the past decade, housing debt
grew by more than 150 per cent, while business borrowing rose by only 40 per cent. As a
result, the stock of housing-related debt went from less than business debt to almost
two-thirds more.
Domestic demand factors are not the only forces at work. Some Asian wealth is being
invested in selected international housing markets as those investors seek out diversification
and hard assets. This has become a familiar phenomenon in this city. Partly as a
consequence, the average selling price of a home in Vancouver is now nearly 11 times the
average Vancouver family's household income, a multiple similar to those seen in Hong
Kong and Sydney - cities that have also become part of a more globalized real estate
market. Such valuations are extreme in both Canada and globally (Chart 16).
Given such developments, one cannot totally discount the possibility that some pockets of
the Canadian housing market are taking on characteristics of financial asset markets, where
expectations can dominate underlying forces of supply and demand. The risk is that
expectations become extrapolative, prompting the classic market emotions of greed and fear
- greed among speculators and investors - and fear among households that getting a foot
on the property ladder is a now-or-never proposition.
Policy implications
The Bank manages policy for the economy as a whole, rather than any specific region or
sector. In this context, what does the Bank of Canada expect for housing? In a word:
moderation.
In the Bank's view, Canadian housing market developments in recent years have largely
reflected the evolution of supply and demand. While supply of new homes should remain
relatively flexible, many of the supportive demand forces are now increasingly played out.
For example, while measures of housing affordability remain favourable, this is largely
because interest rates are unusually low. Rates will not remain at their current levels forever.
The impact of eventual increases is likely to be greater than in previous cycles, given the
higher stock of debt owed by Canadian households. At a 4 per cent real mortgage interest
rate - equivalent to the average rate since 1995 - affordability falls to its worst level in
16 years (Chart 17).10 As I have observed, some markets are already severely unaffordable
even at current rates.
Since 2008, the federal government has taken a series of prudent and timely measures to
tighten mortgage insurance requirements in order to support the long-term stability of the
Canadian housing market. These will reduce the possibility that prices are further driven up
simply through higher leverage.
The Bank has been expecting moderation in the housing sector as part of a broader
rebalancing of demand in Canada as the expansion progresses. Overall economic growth is
expected to rely less on household and government spending, and more on business
investment and net exports. Household expenditures are expected to converge toward their
historic share of overall demand in Canada (Chart 18), with expenditures growing more in
line with household income. In this context, the Bank anticipates a slowing in both the rate of
household credit growth and the upward trajectory of household debt-to-income ratios.
There are conflicting signals regarding the extent to which this moderation is proceeding
(Chart 19). While growth in consumer spending slowed markedly in the first quarter, housing
investment re-accelerated, as did household borrowing, with mortgage credit growing at a
double-digit annual rate (Chart 20). It is likely that some of this resurgence in borrowing is
transitory, reflecting the lagged effects of the surge in existing home sales in the fourth
quarter of last year, as well as recent changes in mortgage insurance regulations that may
have resulted in some activity being pulled forward into the first quarter. Mortgage credit
growth slowed in April, reinforcing the view that the particularly strong increase in borrowing
in the first quarter was temporary. Nonetheless, at a 5 per cent annual rate, growth in
mortgage credit in April was slower but not slow, particularly given the sustained above-trend
increases of recent years.
As the Bank emphasized in its recent rate announcement, the possibility of greater
momentum in household borrowing and spending in Canada represents an upside risk to
inflation.
Conclusion
In conclusion, historically low policy rates, even if appropriate to achieve the inflation target,
create their own risks.
Canadian authorities will need to remain as vigilant as they have been in the past to the
possibility of financial imbalances developing in an environment of still-low interest rates and
relative price stability. We continue to co-operate closely and monitor the financial situation of
the household sector.
In the short term, economic growth in Canada is expected to slow to modest rates, due to a
number of temporary factors. These include supply chain disruptions that will dampen
automotive production and the drag from adjusting to higher energy prices on consumer
spending in Canada and the United States. Overall, the Bank expects a re-acceleration of
growth in the second half of the year, consistent with a renewed narrowing of the output gap.
While global uncertainties persist, to the extent that the Canadian economic expansion
continues and the current material excess supply in the economy is gradually absorbed,
some of the considerable monetary policy stimulus currently in place will be eventually
withdrawn, consistent with achieving the 2 per cent inflation target. Such reduction would
need to be carefully considered.
With monetary policy continuing to be set to achieve the inflation target, our institutions
should not be lulled into a false sense of security by current low rates. Similarly, households
will need to be prudent in their borrowing, recognising that over the life of a mortgage,
interest rates will often be much higher.
Thank you.
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