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Comments on CIBC's "no US-style crash for Canadian housing" report: Part 3

NOVEMBER 11, 2012

This is the third and final post detailing my thoughts on the much-publicized "No US-style housing crash for Canada" report written by Ben Tal of CIBC.  Please also see part 1 and part 2.  The CIBC report can be read here.

 

Two final areas of disagreement:

1) The degree of potential overbuilding vis-a-vis the US at peak

From Tal's report:

On average, over the past decade, housing starts in Canada exceeded household formation by only 10%—with most of the excess seen in cities such as Toronto and Vancouver. In the US, the gap during the decade leading to the crash was almost 80%.

I'd be curious to see how Tal derived this conclusion.  Once adjusted for population, housing starts in Canada over the past decade have significantly outpaced housing starts in the US in the 10 years leading up to peak.  In fact, if final housing starts come in around 215k this year, in line with their current pace, it will represent a pace of construction comparable to 2004 in the US when the housing bubble was nearing its frothy peak.

Ultimately, household formation rate is determined primarily by population growth, though it can, and virtually always does accelerate beyond what population growth would warrant during boom years when credit is easily accessible and the drive towards homeownership is particularly strong.  Of course the opposite is always true, and is one reason I fully expect housing starts to fall well below the estimated Canadian household formation rate of 185K once housing falls out of favor.

That said, perhaps the easiest way to compare the level of construction in Canada and the US is to simply look at housing starts relative to population change.  When we do this, we find that in spite of a precipitous plunge in Canadian housing starts in 2009 and 2010, the pace of new residential construction in Canada relative to population change over the past decade has nevertheless been greater than the US experienced in the 10 years leading up to their peak.  While the US built one new dwelling for every 1.70 people added to the population from 1997 to 2006, Canada added one new dwelling for every 1.67 new people added to population between 2003 and 2012:

And by the way, this is not simply Canada "catching up" after years of under-building.  In fact, once we again adjust for population, Canada currently has a higher total housing stock (i.e. total number of dwellings) than the US had at peak.

How the report concludes that US homebuilders massively overbuilt relative to Canada is a bit of a mystery to me.

 

2)  Negative equity position??

An interesting quote from the Tal report:

"In Canada, the negative equity position is nil, and only 15-20% of new originations have an equity position of less than 15%."

I think this is a sleight of hand.  Let's not confuse this as saying that only 15-20% of first time buyers make a downpayment of less than 15%.  There's a bit of trickery in the way this is worded.

In Canada, mortgages typically come up for renewal every 5 years, whereas in the US, most mortgages never need to be renewed as the standard mortgage carries a 30-year term.  That being the case, if we include mortgages being renewed after at least one 5 year term in a rising real estate market, of course "NEW" mortgages appear to have substantial equity in Canada.

A far more telling stat would be to compare average first time buyer down payment in Canada vs the US.  While I suspect it would still be higher in Canada at present relative to the US at peak, I doubt the difference would be noteworthy.

 

Final thoughts:

1)  The real housing story in Canada lies in the degree to which our economy has been driven and sustained by this current boom

Residential construction and the FIRE industries (finance, insurance, real estate services), which collectively serve as a proxy for housing activity in the broader economy, are at by far all-time highs in terms of their contribution to total GDP.

Likewise, their contribution to employment, particularly full-time employment, remains at all-time highs.

And we currently have a $60B annual flow from housing equity into the broader economy, supporting consumption and additional investment in the real estate sector.  This level of home equity withdrawal is on par with levels seen in the US at peak when compared to aggregate disposable income.

How any of these will remain at current levels in the event of a "soft landing" in real estate is an enormous question in my mind.  If the underlying economy and labour market erodes significantly as a result of a soft landing, will it remain a soft landing?  So while a "US-style" crash may be unlikely, a housing correction of even half the magnitude experienced in the US represents an economic shock that will most certainly overwhelm the current ~2% annualized GDP growth rate and plunge us into what would likely be a long, drawn-out recession.

 

2)  Insights into Canadian bank censorship

Finally, and at risk of being accused of character assassination or strawman arguments, I want to reveal some insights into how banks censor some of their analysts.  I should clarify upfront that these comments are not directed at Mr. Tal or his report, which I'll once again say represents one of the more balanced and insightful reports from the big banks in some time. 

In my current role, I've gotten to know a number of excellent analysts and economists who were or currently are employed by Canadian banks and who to varying degrees share my concerns over the housing situation in Canada.  Each one has separately told me of specific incidences in which "bearish" reports they had written received backlash from upper management, or they were forced to remove portions of their reports before they would be circulated.  

Two of these analysts were told in no uncertain terms that they could not discuss their perspective on housing with the media.  Two will only discuss housing-related matters with me via phone and not through their work email.  One relayed an amazing story of a CMHC report they wrote in which they expressed some concerns with current CMHC policy and the pace of growth in their insurance in force.  The day their research note was released, bank execs received a call from a CMHC exec.  The report was pulled and the bank immediately issued an apology.  All of them told me in no uncertain terms that "overly" bearish commentary on housing is simply not permissible for a bank-employed analyst.

All that said, I suspect most bank analysts legitimately do agree with the sentiment expressed in the Tal piece, but don't kid yourself; There are those who strongly disagree....but you'll never hear it.

Canadian bank reports are used as a source in many media articles on important macro issues such as housing.  As with anything else, we'd be wise to consider the source.  As seen below, the chartered banks have balance sheets with significant exposure to mortgage, consumer, and business credit, the performance of which are to varying degrees reliant on the ongoing strength of the housing market and broader economy.  Some banks are far, FAR more exposed than others.  They know full well the balance sheet and earnings risks associated with a housing correction and the economic fallout it would induce.  Don't think for a moment this doesn't colour their perspective on these issues.

I'll be discussing these topics and many more when I visit Vancouver later this month.  You can reserve your complimentary tickets here.

Cheers,

Ben

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Ben Rabidoux
By Ben Rabidoux

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17 Comments

  • damien said:
    • 1 year, 5 months

    Very instructive. Keep up the good work !

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  • Wes said:
    • 1 year, 5 months

    Thanks for sharing your insights Ben

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  • PetrSyk said:
    • 1 year, 5 months

    I particularly enjoyed reading "Insights into Canadian Bank Censorship". Thanks!

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  • Christian said:
    • 1 year, 5 months

    As always, I learn a great deal from your articles. Thanks for all the work you put in to inform us.

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  • Aaron said:
    • 1 year, 5 months

    Good read.

    It would be great to delve into compensation for mortgage underwriters. A topic not much discussed. A guy at Desjardins was telling me about pushing out sizeable loans to get bonuses. He would find ways to make the numbers jive to justify the amount loaned out.

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  • Farmer said:
    • 1 year, 5 months

    As always, a great commentary Ben. I especially appreciated reading your remarks regarding household formation and construction starts as they relate to demographic trends. Mr Tal has surely been one of the more candid bank economists over the past two years but that is never a good reason to not lay down a challenge to his reading of the data. What we do know is that Canada and the US are more similar than dissimilar in how their respective credit and housing situations have evolved and played out. Anyone reasoning that the outcomes will be dramatically different is falling into the trap of it being different this time. It is not different of course as we shall soon see. With a restrictive credit environment now leading the correction in home prices and sales we are able to see more clearly how vulnerable the economy had become to the risks associated with pricing well off historical means. The Canadian Payroll Associations survey of this summer certainly highlighted our vulnerabilites and exposed the vast differences between the publics perceptions of what was realistic for the average Canadian to achieve in the way of savings versus debt management and what they were actually doing. I am sure you have seen it already but it is worth a review anyway. The mere conclusion that almost half the working population would be in trouble if they missed a single paycheque is startling enough. Keeping in mind that this sentiment exists at a time when we are at peak credit and unemployment is relatively low is cause for alarm in my opinion. How can we be expected to fare as construction employment withers and the FIRE economy returns to long term norms? If we are already strapped and tapped out during the good times then how can we expect reasonable outcomes as the economy deteriorates? Without a doubt foreclosures and bankrupcies will mount quickly. Perhaps not as dramatically in the US but this coming period will be stressful as Canadians tough it out and slowly rebuild their household balance sheets. For anyone who did not see the report, incidentally, I will put the PDF link up for review. Decide for yourself how the future might unfold based on the survey.

    http://www.payroll.ca/forms/tmp/NPW2012Media_Package.pdf

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  • Rajiv said:
    • 1 year, 5 months

    Very insightful. I have lived for years on both sides of the border and watched things closely. I have noticed that Canadian banks and real estate industry are less open than in the US. Bank censorship, guarding of data and the lack of transparency seems to be pervade both the Banking industry and the Real Estate industry. Very sad for the end consumer.

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  • Joe  said:
    • 1 year, 5 months

    wow most insightful, unbiased and honest report I have ever seen on Canadian housing market. Keep up the good work. Thk u.

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  • Dimitri said:
    • 1 year, 5 months

    This is great. Thank you.

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  • jesse said:
    • 1 year, 5 months

    Some interesting comments, Ben, on the completeness of bank reports who are advising their clients on what to buy. I would think some of the buy-side shops would release more honest representations. That is something of concern for those relying upon banks to provide them with advice free of conflict of interest.

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  • jesse said:
    • 1 year, 5 months

    "his is not simply Canada "catching up" after years of under-building"

    It indeed cannot; after all, everyone (save a handful) has a place to live! Supply must, then always lead population in need of housing. People may share accommodations but that more indicates the inherent oversupply of bedrooms available. On that score, though I haven't done the calculations, it seems there is significant elasticity in accommodations.

    You have been highlighting boomer downsizing as a significant event for the housing market over the coming few decades. I think this is right, but more to the point, perhaps, is how larger houses will be utilised by new buyers. If a 4br house is sold by a couple to a family of four, and the couple buys a 2br condo, no new construction is required to absorb population growth. If larger dwellings are generally underused today, this can reasonably lead to lower construction starts going forward. By how much I don't know but we can back-of-the-envelope it. My guess is it will be about a 1-2% drop in construction starts over the next decade or so, ceteris paribus.

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  • LS said:
    • 1 year, 5 months

    Thanks for addressing the overbuilding issue. The figure of 80% in the US smelled like a mistaken analysis of the numbers to me as well. There is no way that the US overbuilt by 80% for 10 years.

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  • LS said:
    • 1 year, 5 months

    Also I must say I greatly prefer your comments section without the constant trolling and personal insults that we've seen there in the past. That really brought the site down.

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  • AWOL said:
    • 1 year, 5 months

    Funny how our friend Appraiser disappears after he finds out you know who he is. Classic troll.....needs to be anonymous to feel bold enough to say the rude things he did. I'll miss him. But I think the average IQ on this board jumped 50 points when he left

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  • Neil Milton said:
    • 1 year, 5 months

    Relying on bank commentary on housing is like relying on McDonalds for advice on nutrition - so foolish that you don't know whether to laugh or cry. When a conflict of interest is blatantly obvious, skewed publication bias needs no further evidence.

    As always, excellent piece Ben.

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  • RE Lurker said:
    • 1 year, 5 months

    Hey Ben,

    I'm not sure what you mean by "US-Style" crash. I know that term has been tossed around here and other blogs a lot, but I think it might imply different things in different places so a clarification would be nice.

    The "US-style" crash that most people (I know) seem to understand (perhaps wrongfully) has to do with all the strange debt unwinding thanks to CDOs/traunches/repacked mortgages sold off as tripe-A/complicated financial stuff I don't understand that wrecked havoc on the financial system globally and caused much TV viewing as it unraveled (well, it's been a while since 2001...). Actually I don't think most even know what I'm talking about...

    However, despite all the financial mayhem, the housing market in the US was going to crash under its own weight anyway -- thanks to easy credit loosening. Wouldn't most bubbles unwind largely in the same fashion (at least in this case of a single asset type)? I would imagine that Canada would be more similar than different.

    So I'm not quite sure what you're saying here. That it's not possible for RE in Canada to take a 70% dip that may take over a decade to completely unwind? That the automatic transfer of debt ownership from CMHC balance sheets to taxpayers (remember that the bailout for Freddie Mac and Fannie Mae at the very least required Congress approval) is not going to mean very very bad things are going to happen?

    I feel like I must be missing something here, because it seems to me that we're probably worst off than the US. (Higher debt, more leverage, smaller economy, FIRE economy, possible Dutch disease, ...)

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  • Mario said:
    • 1 year, 3 months

    Don't open Bank account with CIBC, They look at you like chaeter an they never trust on you. I forced to close my account twice in this ugly bank.
    Their agents are baiging you to have CIBC's credit card, but again they look at you like thif!! without any consulting with you they play game with your credit card. I have three CIBC, I am going to close all. I have ten others from other banks but non of them is so intrust to their customers.
    NO MORE CIBC

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