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Another week, another check mark in the game of Canada’s slow-motion housing crash bingo.
Let’s recap the sequence of events that led up to the US housing crash and let’s see how many of them we’ve hit so far.
Step 1: Households Take on Massive Mortgage Debt
This is the first step of any housing crash where average families take on stupid amounts of debt, borrowing excessively under the assumption that any amount of debt is OK because housing always goes up. Right before the American housing market collapsed, Americans borrowed 147% of their household disposable income. And in Canada? Right now we’re sitting at 171%, according to the Toronto Star.
We’re #1! We’re #1! In…debt! Yay?
Step 2: Sudden Increase In Mortgage Payments
The catalyzing moment for the US housing crash was when those stupid sub-prime loans with artificially low teaser rates reset, doubling people’s payments overnight. Mortgages that were comfortable all of a sudden became stretched, and mortgages that were already stretched became catastrophically untenable.
And as I wrote about last week, thanks to the B20 rules that now require everyone to qualify at the posted mortgage rate plus two percent, mortgage rates just doubled here in Canada. The resulting effect was a drop in the amounts buyers were qualifying for, and as a result a drop in home prices. People who bought right before Christmas immediately saw their downpayment evaporate. Some are already underwater.
Step 3: A Sudden Shock to the Labour Markets
When you’re this indebted, with all your life savings gone, and a giant mortgage hanging over your head, you’d better not lose your fucking job or the entire house of cards comes crashing down.
Canada shed a net 88,000 jobs during the month, a sharp stop to a recent stellar performance that saw 2017 produce the biggest increase in jobs since 2002.
What happened? Well, apparently while I was off traveling and not paying attention to Canadian politics, our lefty government decided to hike Ontario’s minimum wage from $11.60 to $14, an overnight increase of over 20%. I actually noticed something different the last time I was back in Canada. I was walking around the shopping centres in the downtown area, and I noticed that all the tellers were gone. Every store, it seemed, had been busy replacing their checkout lines with automated touchscreen kiosks, and I was like “That’s weird. I wonder why they’re all doing it at the same time?”
Turns out, this is why.
After all, why pay some annoying high school student $14 an hour when you can just replace them with a machine? And as a result, bye-bye jobs.
Step 4: Wave of Foreclosures
So the next step for the US housing market was a wave of foreclosures, brought about by mortgage payments suddenly jumping to unaffordable levels and people losing their jobs. I remember being in Fort Lauderdale at the time and driving around the city with my cousin. Back then, there were foreclosure signs everywhere. Entire neighborhoods were abandoned, seemingly overnight. It wasn’t pretty.
We haven’t gotten to that point yet. And hopefully we won’t. As annoyed as I get by stupid people buying overpriced houses and then bragging about it, I don’t actually want them to lose their home. That would be bad for everyone.
There’s actually a few things that are different in Canada that may provide a backstop and prevent this step from happening. First of all, in the US, they had non-recourse defaults, in which people could just stop paying their mortgages, hand the keys back to the bank and walk. That relative lack of consequences caused people to default as soon as things started getting hairy. We don’t have that here in Canada. If you default, the bank will take your house, and also come after you for any amount you still owe. So defaulting isn’t nearly as easy or painless up here as it was in the US.
Secondly, the doubling of interest rates doesn’t effect everyone. Existing borrowers who are on fixed interest mortgages don’t actually see their payments double like the Americans did. Only new borrowers see that. This will have the effect of everyone’s house going down in value since there’s now less money available to borrow if you move, and it may take a chunk out of lots of people’s net worth, but will it force homeowners into cash-flow-negative territory overnight? I don’t think it will.
And thirdly, the job losses that happened in January were predominately part-time jobs.
The drop reflected a record loss of 137,000 part-time jobs, and a 49,000 gain in full-time work.
So a lot of minimum-wage-earning cashiers lost their jobs, but were those the kinds of people who owned a lot of real estate? Probably not. So while the job losses were bad, I’m not convinced that will have the contagion effect into the housing market that the US saw. Yet. If we start shedding more full-time white-collar jobs, all bets are off.
Step 5: Banks Start Failing
And finally, the wave of foreclosures caused banks to start failing, sparking off the Great Financial Crisis. We haven’t seen anything like that yet, and in fact, Canadian banks have been posting record profits lately.
The reason for this is while Canadian homeowners have seemingly learned nothing from the American housing crash, Canadian banks have. RBC and Scotiabank have been aggressively expanding into Latin American countries, and banks like TD have now become pretty firmly established in the US. The last time I was in the States I was surprised to find TD Bank branches all over the place and TD Ameritrade commercials running on TV.
So while Canadian Home Boners have been concentrating all their net worth into a single asset, the Canadian banks have been quietly diversifying out of Canada. Smart.
A Tale of Two Crashes
As I’ve written before, there are two ways a Canadian housing crash can unfold. In the first scenario, house prices drop and cause homeowners all sorts of misery. They get trapped in their underwater houses, and become permanently tethered to their jobs. They’ll be forced to work in debt slavery for decades, never getting ahead, never able to save any money, and their lives will be miserable and stressful.
That’s the best case scenario.
In the other, much worse scenario, the housing crash causes a contagion effect that takes down the banks, and the entire Canadian economy along with it. Everyone suffers, even those people who never bought a house to begin with.
Will The Defenses Hold?
You can’t trust people with debt. Every Bank of Canada governor warns the public at every press conference not to binge on mortgage debt, only to watch everyone ignore their advice and do it anyway. Smart people trying to lecture stupid people about how to manage their money responsibly never works, because stupid people will always find a way to shoot themselves in the foot.
The only thing that smart people can do is build a wall around those stupid people and make sure that when they blow themselves up, everyone else doesn’t get dragged down with them. Right now, we’re at a crossroads where banks, governments, and financial regulators have been quietly building those walls and preparing for the day when our housing market screeches to a halt. The B20 regulations, after all, were designed to trigger a housing crash-like situation in a slow, somewhat controlled burn rather than have it blow up in a messy forest fire.
The Home Boners can’t be saved. It’s too late for them. But do you think the crash can be successfully contained, or will it burn out of control like in the US?
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