Another Bursting Bubble: The Housing Crisis in Canada

Canada, having navigated the 2008 financial crisis, now faces a housing bubble, especially in cities like Vancouver and Toronto, with warnings from the IMF on high personal debt. As rising interest rates pose concerns, the government must delicately balance addressing inflation while preventing potential disruptions in the housing market, emphasizing the need for a multifaceted approach and collaboration among stakeholders for a sustainable housing market.

As it is widely recognized, the 2008 housing market collapse and financial crisis gave way to a devastating recession that shook global economies to their core. Originating in the United States, the crisis was fueled by the collapse of the housing markets and the subsequent failures of multiple banks. As a leader in the financial world, the setbacks faced by the United States ultimately resulted in severe domino effects for global finance. Canada, although implicated by the 2008 crisis, managed to weather the storm due to strong and stable banking practices. 

Now, in 2023, the Canadian economy is seeing echoes of a housing bubble that was reminiscent of the downfall witnessed during the 2008 financial crisis. Exploring the rising real estate prices in Canada and reflecting on the intricacies of the past financial crisis highlights the interconnectedness of the market prices and a potential warning sign. 

The 2008 financial crisis was ultimately driven by subprime mortgages and a housing bubble, seemingly undetected by major institutions. In economics, a ‘bubble’ refers to the rapid increases in the prices of an asset based on speculation or unsustainable practices that do not reflect the fundamental value of that asset. For instance, a housing bubble occurs when property prices inflate past levels justified by underlying economic factors such as income growth, employment rate, economic growth, or the increased cost of constructing houses. The term ‘bubble’ implies that this unsustainable increase in the prices will not last, and when it bursts, the value will rapidly decline, sending shocks through the market and resulting in losses for many of the stakeholders. 

Behind the housing bubble in the early 2000s was the proliferation of subprime mortgages. These loans were offered to riskier borrowers, with less favorable terms, such as higher interest rates compared to prime mortgages. As these borrowers defaulted on the loans, and housing started falling apart, the entire financial system collapsed due to the interconnectedness of all the players. Many institutions including banks, life insurance companies, and even pension funds, purchased mortgage-backed securities (MBS) under the impression that they were safe investments. The subsequent failures of banks caused panic, worsening the entire situation. These lessons from the past highlight the relevance of understanding the historical context to interpret the current housing bubble in Canada. 

Housing prices in Canada, specifically in big cities such as Vancouver and Toronto have dramatically risen in the last 15 years. According to the Real Estate Board of Greater Vancouver, “single detached homes in Vancouver have risen from approximately $400K CAD to $1.75 million CAD since 2002”, which is a 337% increase in 15 years. Taxes, interest rates, and inflation are also increasing, while protections such as caps on rental rates are surprisingly low. The effects of such conditions make individuals very vulnerable to shocks and price changes. In fact, the IMF warned Canada and a handful of other countries that their populations are facing high personal debt-service ratios. The debt-service ratio is a measure of the proportion of disposable income that goes towards servicing debt, including mortgage payments and other debt obligations. It reflects the financial burden on individuals or households in meeting their debt obligations relative to their income.. The private sector debt-to-GDP is now 218% in Canada. Another concerning consideration has to do with ‘shorting’ the housing market. “Many U.S. hedge funds have looked for various ways to short the Canadian housing trade”. To short the housing market is to bet against the value of real estate. If individuals and companies are trying to short the market that implies that there are concerns about the sustainability and stability of the current real estate prices in Canada. 

Canada’s central bank, The Bank of Canada, said that “high levels of mortgage debt are of particular concern as interest rates rise and more borrowers are strained to pay bills”. Canada is also struggling with high inflation, and the increasing interest rates aim to combat that, however, this also results in Bloomberg saying that “The housing market in Canada has turned so fast some buyers are losing money on their properties before the sales even close”. Partner Phillip Colmar at Global Strategist MRB Partners told Bloomberg that he believes the bubble will inevitably burst. The government and central bank face the intricate challenge of delicately balancing the need to address inflationary concerns while simultaneously averting potential disruptions in the housing market, all with the goal of preventing their delicate house of cards from collapsing. 

In addressing the housing crisis, Canada’s government needs to carefully monitor different rates and general economic indicators to assess the overall stability of the economy. A multifaceted approach is required by policymakers who need to consider the affordability of housing to protect the interests of the public and weigh the effects of economic growth and maintaining low and stable inflation. An important measure that can be implemented is improving financial literacy programs and supporting mortgage payers by helping them understand their options and making sure they make informed financial decisions. Mortgage and debt management accumulate throughout the economy, and default on a larger scandal can be detrimental as seen through the 2008 crisis. Policies that encourage collaboration between the government, financial institutions, and real estate stakeholders are crucial in creating a sustainable and resilient housing market.

Written by Anvita Dattatreya