Wednesday, February 06, 2008

I'm filled with gibbering terror

Housing prices are insane in Toronto, but while I've been basically pessimistic about the market (these kinds of market obey gravity, inevitably) I wasn't in an outright panic, mostly because a) I don't own a house, and b) don't have the means to buy one for the forseeable future.

But: In the newest issue of Toronto Life, there's an article by Rachel Giese that convinces me that we're fucking doomed. Not because of any pessimism on the writer's part, but because it reads exactly like something written in SoCal about three years ago. We even get this choice bit:
A more likely scenario is that the housing market will plateau.
Right, a "soft landing". We've, uh, heard this before, and recently. While Giese is quick enough to realize that this will hurt people who are borrowing against their home's equity, she doesn't seem to connect the dots with what has just happened in the US. First, the most marginal cases are hurt, and they sell their houses below-market to get their asses out of the sling as quick as possible. This is the start of the snowball -- as the price of homes stops increasing as quickly, the market reverses direction. People who have homes and were thinking about selling, start doing so in greater numbers to get out at the top of the market. This puts a glut of houses on the market, and presto. Dean Baker explained this very basic reality about five and a half years ago (PDF), and was warning people about the housing bubble ever since. This isn't, really, the kind of thing you can solve with better regulation, nor is unscrupulous realtors: the article points out in every example, the realtor recommended an "agressive" overbidding to secure the house, but neglects to mention the realtor gets a percentage of the sale -- the bigger the final sale price, the more the realtor makes. Kind of an obvious point here: the people who are the key players in a pretty opaque market have a direct financial interest in driving prices ever-higher. If you're thinking auditing firms, circa Enron, 2001...

The other problem with the article is that it focuses on people buying houses, when the real bubble in Toronto, the one that has the potential to pop in a really nasty way, is condos. Eventually, people will stop paying semi-detached prices for a two-bedroom shoebox. (Not that I oppose shoeboxery, I intend to be a big fan of condo living some time in the future...)

The Toronto Life article is not online, sadly, but I'd recommend picking it up and glancing at the article, which is actually very good on its own merits -- pointing out the growing class of house-rich, money-poor yuppies in Toronto. Which are, of course, exactly TL's prized demographic. Sympathetic or no, Gliese sums up their predicament nicely. Also, she gets major points for pointing out that no, it does not always and everywhere make sense to own vs. renting. In fact, if you click on the Baker PDF link above, you'll see that for the entirety of the post-war period, it's been cheaper to rent than to own.

7 comments:

Catelli said...

An awful lot of the housing bubble is the fault of the consumer, or homeowner. Most people I know brag how much their home's value has gone up. When I point out that if they sell, they will be buying another over-inflated house in the same market, thus not making a profit, they shrug admit "I know, but still, my home is worth $100,000 more than a year ago!"

We still think of homes as investments, which is a retarded viewpoint IMHO. No one wants to make the sacrifice to realize the profit (move downmarket, smaller home, etc.). Also many people have no problem with negotiating mortgages where they will make payments well past retirement age. That's financial suicide in my opinion again.

Its nice to see an expert opining that renting can be more cost effective than owning. I've been saying that for years.

Course, no one ever believes me, as i'm not an "expert"

André said...

While a Toronto or Canada-wide housing bubble is definitely a concern I'd be curious to see some actual data. How does the increase in prices relate to historical trends?

Also, my (limited) understanding of the U.S. situation is that bad behaviour related to mortgage securitization played a large part in fuelling the bubble.

http://www.econbrowser.com/archives/2008/01/mortgage_securi.html

I had a prof who was a senior adviser on banking regs at Dept. of Finance and if I recall correctly he said this was much less of problem up here.

john said...

The housing bubble, the sub-prime mortgage crisis, and the financial crisis on Wall Street are a knot of three different but closely related things, and I'd argue are best seen that way. Like any bubble, the housing bubble was always going to suck when it deflated. But I'd be shocked indeed if it turned out there was anything like the subprime fiasco north of the border.

And it's also worth pointing out that Toronto is not one of the cities that I generally see concern about with respect to bubbles.

That said, the Toronto Life article did mention that the Canadian banks have been "innovative" in extending loans to lower-income customers. Though the article made this sound like we were mainly taking about longer-term mortgages.

Mike said...

catelli,

There is lots of fault to go around and I don't think the consumer, while somewhat responsible, carries the lion's share of the blame.

Sure they want a big new house, who doesn't. 10 years ago, they would not have been able to even qualify for the loan that they can easily get today (with little or no down payment - something unheard of until a few years ago). Couple that with the fact that many big cities had incredibly tight rental markets (Toronto and Ottawa for instance) where renting was actually more expensive than buying, provided you can even find a place to rent.

Easy credit + cheaper to buy (than rent) = big boom in the housing market and the lending market. Developers, construction, banks etc all get to make big profits for a while out of this. And they have nothing to lose since the individual will be on the hook for the loan and if they default, CMHC and its insurance program is there to bail out the bank.

So, we have people doing what they are incented to do by the system, and banks happily loaning them the money because the risk of doing so has been externalized.

We still think homes are an investment because, historically and in the long run, real estate has been a sound investment.

Until this articifial housing bubble bursts - then we have people losing their homes and tax dollars spent bailing out banks who made loans they should never have made in the first place.

There is lots of blame to go around here.

Chet Scoville said...

We've seen this before, with the tech boom. Hell, we've seen this going all the way back to the tulip craze. You'd think we'd learn. But we never do.

Catelli said...
This comment has been removed by the author.
Catelli said...

Mike,

Not all of the blame is on the consumer, but its a bit of a contradiction to blame lenders and real estate agents for "being greedy" when the consumer is "being greedy" too. Our entire system is designed to encourage greed.

Easy credit is available, because the consumers demanded it. An example, being able to borrow the down payment is something consumers were demanding. They felt it was unfair to require a 15% down payment. CMHC even provides an incentive to make a larger down payment. The consumer is penalized if they take a high risk loan, which is explained to them at the time of purchase. Regardless of all that, consumers still wanted to buy houses they couldn't afford under old rules. So the market changes to accommodate their wishes.

Unless we pass laws or have more government intervention, I don't see how we can do much to de-incentize people from making poor decisions, and borrowing more than they realistically can afford to pay.