Monday, February 08, 2010

Canada’s Rebound from Financial Crisis Too Good Too Soon?

Sources: Canada's housing bubble could soon burst: Merrill Lynch; Housing Rebound in Canada Spurs Talk of a New Bubble.

Analysts have been watching Canada’s housing market closely for the last few months, alarmed by its similarities to the failed U.S. housing market of late 2008. February 4, 2010 a housing-price index that measured six of Canada’s biggest cities showed a gain for the seventh month in a row. Numbers have reportedly reached pre-recession highs.

Why is this dangerous?
Only two years ago, the housing market in the United States was booming at all time highs. This unusually lucrative time in the U.S. housing market is now referred to as the housing bubble. The housing bubble occurred when market prices for houses in various U.S. markets grew exponentially in a short amount of time. This dramatic value increase created a false sense of security and interest rates plummeted, allowing people from all income levels to believe they could finance any type of home. Like every bubble, however, this euphoria did not last. The housing bubble burst in September of 2008, igniting a global financial meltdown.

How has this happened?
Canada’s economy is based in substantial part on exports to the U.S. When the U.S. economy was devastated by the financial crisis, Canada’s economy was dramatically affected. As a stimulus, the government has focused on keeping interest rates extremely low. This decision has fostered low mortgage rates in addition to various financial and tax incentives. The product of the stimulus has been a 70 percent increase in home sales.

Lurking dangers for Canada in coming years
While home sales have risen, so has the unemployment rate. Worse, the average income for Canadian residents has fallen one percent over the same time period. The synchronicity of these statistics is problematic. When the market fails to mimic reality for a period of time, a false sense of security can set in. While Canadian banks, in general, engage in conservative lending practices, adjustable mortgage rates in the country are set to increase steadily. If Canadian residents are buying now with low teaser rates while their income is decreasing, a few years could be all it takes for a housing crash to mimic that of the U.S. in 2008.

While Canada’s housing boom has no immediate dangers, the danger has been identified. The benefit of hindsight is the ability to monitor like situations. Canada is surely taking steps to make sure history does not repeat itself.

Discussion Questions:
1) What can be done to prevent another housing bubble from bursting? Is it as simple as raising interest rates?

2) The winter Olympics are coming to Vancouver later this month. What effect, if any will the games have on Canada’s economy? If the effects are positive, do you think it would be wise for Canada to discontinue heavy regulation of the housing market?

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