April 11, 2017

The Same Exact Mistake As Greenspan

A report from the Business News Network in Canada. “More than half of the country believes home prices will never fall, according to a new poll from CIBC. Despite lofty valuations in the Toronto and Vancouver housing markets, 54 per cent of respondents to the CIBC poll say housing prices will rise indefinitely, while only 40 per cent think prices will decline over the course of the next five years. David Madani, senior Canadian economist at Capital Economics, thinks the unbridled optimism is just one more sign the Toronto housing market is in bubble territory. ‘The fact that the majority of Canadians still think home prices can continue to shoot up is sort of testament to the fact we’re in a full-blown housing bubble,’ he said in an interview with BNN.”

From Global News. “With house prices reaching record highs, the pressure is mounting on homeowners. A news report from RBC said that as home prices continue to climb, fewer homeowners feel they can weather the storm if there was a downturn in the housing market. The report goes on to say that a growing number of homeowners admit they’d be concerned if their mortgage payments went up by 10 per cent or more.”

“The report comes as no surprise to Darrin Surminsky, a bankruptcy trustee in Kelowna. He’s been watching the Kelowna housing market closely and is predicting a spike in foreclosures when interest rates finally begin to climb because some homeowners are already stretched to the limit. To add to the growing pressure on homeowners, Surminsky believes many are on the verge of bankruptcy because they’ve taken out a home equity line of credit — digging themselves deeper into debt with no way out.”

“‘What we’re seeing is people are kind of using their homes like ATM machines,’ he said.”

The Calgary Herald. “Alberta’s boom and bust economy has left Calgary with record numbers of newly built homes and condos that sit vacant as a massive stockpile of housing goes up for sale at the end of a recession. More than 2,000 new housing units were unoccupied in the Calgary area last month, the biggest inventory on record, driven largely by construction of apartment-style condos, according to the Canada Mortgage and Housing Corp.”

“While apartment-style condos account for more than half of the current housing surplus, there are large clusters of new, unsold homes in south Calgary suburbs. Across a swath of 24 southern neighbourhoods, from Evergreen to Legacy and from Douglas Glen to Cranston, there are 400 newly built, unoccupied homes, according to Canada’s housing agency.”

From Bloomberg. “There’s a pretty big housing bubble in Canada. By some measures, such as household debt to disposable income, it’s even bigger than the one in the U.S. a decade ago. People are going to look for someone to blame. Let me help. To put what’s happening in Canada in context, let’s first look at the U.S. Following one of the biggest stock market bubbles ever in the early 2000s, the Federal Reserve led by Chairman Alan Greenspan feared that a crash-induced loss of confidence could lead to a serious recession or even a depression. But the actual recession, in terms of the ‘real economy,’ turned out to be quite mild. Gross domestic product went negative, but not for consecutive quarters, so it didn’t even meet the technical definition of a recession. Then, a strong recovery began.”

“Greenspan engineered an epic monetary policy response to the downturn by cutting interest rates from 6.50 percent at the end of 2000 to 1 percent in 2003 and leaving them there until mid-2004, even though by that point it was clear that the recession was over and the recovery had begun. When the Fed did begin to raise rates, it was only at a pace that was ‘measured,’ which turned out to be a quarter of a percentage point at a time.”

“But too-easy monetary policy allowed a stock market bubble to morph into a housing bubble. In economics it can sometimes be difficult to determine causation. This is easy. Mark Carney was Governor of the Bank of Canada during the financial crisis and cut interest rates early and often leading up to the financial crisis.”

“It has now been almost nine years since the overnight rate was last above 1 percent. You can guess what happened next: a long period of negative real interest rates that led to an enormous misallocation of capital — again in residential real estate. A few years later, huge housing bubble — the same exact mistake as Greenspan.”

“As for Canada, it is still trying to figure out what to do about the exploding housing market. Pressure is starting to build on Stephen Poloz, Carney’s successor, to raise rates. That would help, but it is far too late. Poloz actually cut rates two years ago, partially because of recession fears and partially because he is obsessed with the foreign-exchange rate. Crude oil prices collapsed on his watch, which didn’t help.”

“This mistake happened because Carney had a bias toward easier policy. He was in no hurry to hike, even when it became apparent that Canada had escaped the worst of the crisis. What Group of 10 economies need are central bankers with a bias toward tighter policy. We now know what happens when you leave interest rates too low. Entire civilizations are ripped apart. Are there any consequences to leaving them too high? Why not give it a try?”