Ready To Pop

Looks like the housing bubble in OZ is coming to an end. Mish has a good piece here.

THE $130 million collapse of subprime lender Provident Capital has highlighted the emerging problems in the nation’s low-doc and no-doc lending markets, which flourished during the years of the last property boom.

Sound familiar?

The Canadian bubble is cracking, but hasn’t popped yet. Look for major problems with CMHC which will be ground zero of the blow-up and severely test the complacency of the Canadian government about its (generally much better than the US) financial management.

Recent housing studies by the Bank of Canada indicate that house prices are significantly higher than what economic fundamentals suggest, including today’s low interest rates. We think the missing piece to the housing puzzle is “animal spirits,” the term that John Maynard Keynes used to describe emotions which influence economic behaviour.

In short, human greed creates the conditions of rapidly rising house prices. When greed ceases to motivate buyers, then house prices begin to decline. Once this begins to happen, the fear of falling house prices turns more potential buyers away. We think that there is a high chance of this narrative playing out in Canada, which would obviously create the conditions for a housing slump and a self-perpetuating decline in house prices.

The bottom line is that housing bubbles can last for several years, but, eventually, time reveals that it was too good to be true. Trying to predict the exact timing of housing corrections, though, is beyond the scope of economic forecasting models.

Canada’s most overvalued housing market, Vancouver, seems to have already cracked. Some other large markets may soon follow. Looking ahead to the next few years, though, we seriously doubt that household incomes will catch up to high house prices. The more plausible scenario is likely to be moderate growth in income and outright declines in house prices. To put a number on it, we expect house prices to decline by 25 per cent over three years.

Not mentioned in either case is the role of the global commodity bubble, now deflating, in supporting household incomes in both of these major commodity exporters. Falling commodity prices will deflate incomes and stress both economies, resulting in housing collapses more like that in Spain than the relatively mild depreciation in the US.

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