Since the beginning of this blog, we here at Running of the Bulls have spent considerable time detailing the wackiness of the Canadian Housing Bubble, which you can read here, here, here, here, here,and here.  The Running of the Bulls thesis for why the Canadian Housing Bubble has not popped in a similar manner as the American Housing Bubble is here.

Alexandre Pestov has written an excellent paper entitled The Elusive Canadian Housing Bubble.  Pestov is an MBA candidate at the Schulich School of Business at York University. (Toronto's second best MBA program!)  The following are exerts from Pestov's paper.  (HT to Zero Hedge.)

First, Canadian mortgage rates are at six-decade lows.

Those arguing that home prices are not a bubble say that housing is not particularly unaffordable.

The problem with this argument, as Pestov rightly points out, is that interest rates are at multi-generational lows.  In Canada, all mortgages are fixed only for a specific period of time, i.e. 5 years.  Interest rates reset thereafter.  When interest rates normalize, homes will become even more unaffordable.

Citing a report on the Canadian housing market by RBC, the paper notes

• An average Vancouver household (that is a family of usually two income earners, not a single person) spends over 70 cents of every pre-tax dollar they earn on house ownership costs. Deduct unavoidable taxes, and this amount would rise to nearly 100 percent of an average household income in Vancouver
• An average Toronto and Montreal household spends over 57 and 47 of their pre-tax income on house ownership costs, or nearly 80 and 70 percent of their after-tax income respectively

Home price increases have far outstripped rising incomes.

Over the last 13 years, house prices in Toronto, Montreal, Vancouver and Calgary rose 5-10 times quicker than incomes in these cities. Incomes simply did not keep up with the rising home prices. Housing affordability (or un-affordability would be a better term in case of Canada) is significantly above its long-term average now. While it is lower than that at the peak-bubble in 1990, it is expected to skyrocket into the stratosphere once the bank rates rise and the mortgage rates follow. Despite the historically low mortgage rates, housing affordability in Vancouver is close to being the worst on record (the actual record was set less than two years ago). Once bank and mortgage rates gravitate towards their long-term average, housing affordability in Vancouver will approach 100 percent. In other words, an income-earning family in Vancouver would have to spend every penny they earn on housing costs. This is in addition to learning tax evasion methods, as this 100 percent would be of their pre-tax income. While not as dire as it is in Vancouver, housing affordability of Toronto, Calgary and Montreal will deteriorate and likely exceed levels seen during the last real-estate bubble.

 By international comparisons, home prices in Canada are very high.

The annual Demographia International Housing Affordability Survey reveals surprising results. Predictably, during the peak of the US housing boom the affordability measurement in cities including Los Angeles, San Diego, Honolulu, and San Francisco reached double-digit levels. In retrospect, it is hard to comprehend the rational and thinking process of buyers snatching houses they wouldn't be able to pay off during their lifetime. Vancouver didn't trail far behind, staying solidly in the “severely unaffordable” category and surpassing both London, UK and New York, NY by mid-2006. During that time, Calgary and Montreal gradually rose from “moderately unaffordable” levels to “seriously unaffordable”. Toronto, being excessively pricey already, stayed within the “seriously unaffordable” band.

Once the bubble burst and home prices plunged, the affordability improved in the most overpriced cities in the US and UK. But not in Canada. Instead, the housing affordability average in Canada moved closer to the upper boundary of the “moderately unaffordable” band. Instead, the mean house price in Canada became less affordable than that of the US. During the crisis, Montreal and Calgary edged dangerously close to crossing the “severely unaffordable” line, while in 2009 Toronto finally managed to turn itself into a “severely unaffordable” city. And Vancouver outshined them all.

In 2009, Vancouver became the most unaffordable city among 272 markets. Presently, Vancouver is less affordable than London, UK, Los Angeles, CA, Miami, FL, New York, NY, Sydney, AU or any other city in Australia, Canada, Ireland, New Zealand, the United Kingdom and the United States. ...

On the median multiple ratio measurement, Vancouver (9.3), Toronto (5.2), Montreal (4.9), and Calgary (4.6) hover substantially above the “normal” 3.0 level. Based on this valuation, Toronto is considered a “severely unaffordable” city, while Montreal and Calgary lie on the border between being “seriously unaffordable” and “severely unaffordable”.

By other valuation measures, such as price-to-rent and price-to-income, homes in Canada  are expensive.

Since the financial crisis began, mortgage credit in Canada has expanded primarily through the government.  CMHC MBS securities have doubled since 2007 whereas private credit has barely budged.

Nearly 90 of mortgages issued between 2007 and 2009 were securitised. By the end of 2007, there were $138 billion in MBS that is guaranteed by CMHC, which covers approximately 17 per cent of all outstanding mortgages. By July 2009, that figure rose to $290 billion. CMHC's stated goal was to guarantee $340 billion by the end of this year and is on track to reach $500 billion by the end of 2010, which would be would be equal to 1/3 of the Canadian GDP. In fact, between 2008 and 2010 CMHC‟s issuance of MBSs will likely exceed the combined total issued by CMHC in its 62-year long history prior to 2008.

The volume of home sales has exploded.  This is typical of highly speculative activity.

Furthermore, the data series shows that sales more than doubled from 1980 to 1997, and then nearly doubled again by 2007. At the same time, the population of Metro Toronto increased just 13 percent from 1980 to 1997, and approximately 20 percent between 1980 and 2007 (Statistics Canada; Toronto.ca). In 1980 home sales stood at 12.8 per 1,000 citizens of Toronto. In 1996 this number increased to 25.0, and by 2007 they reached 37.6.

Debt held by Canadians is at an all-time high.

Including, predictability, mortgage debt.

Mortgage debt has fueled an explosion in residential construction.

The Canadian Housing Bubble can go on for awhile.  As long as interest rates are low, the yield curve is steep, China's stimulus is working its way through commodity markets, and the world avoids a serious sovereign debt crisis, the Canadian economy should be okay.

But the laws of economics have not been suspended for Canada, no matter how wonderful the country may be.  The Canadian Housing Bubble will end no differently than past housing bubbles.