The Canadian housing bubble revisited

Confusion reigns among Canadians regarding the housing bubble. Some “analysts” point to recent price gains in Vancouver and Toronto as proof that prices will continue to rise forever. Stories are passed around that attempt to explain why the housing industry is exempt from basic economics. On the other hand, people in Calgary, Edmonton, Saskatoon, Regina and elsewhere are becoming acutely aware of what’s really happening.

When I’m talking to the media to discuss the housing bubble, interviewers press hard to learn the one factor that would burst the bubble. But bubble deflation doesn’t need a single factor as a catalyst. It’s just another cycle of boom and bust that has happened repeatedly throughout history.

Professor Robert Shiller has a description of the common factors in bubbles.  From Shiller’s November 2013 interview, cited on page 26 of my book, “When the Bubble Bursts”:

“It’s like a mental illness. Symptom one: Rapidly increasing prices. Symptom two: People tell each other stories that purport to justify the bubble. Symptom three: People feel envy and regret that they haven’t participated. And I would add one more — the news media are involved,” Shiller said.

It is clear that Canada’s housing bubble, which started around 2000, meets and exceeds all of those requirements that Shiller, a Nobel Prize winner, laid out.

Shiller studied bubbles to try to understand how they appear and why they burst. Shiller’s work proved that bubbles cannot be predicted by current economic theory.

Jeremy Grantham, of GMO, a Boston-based money management firm, reminds us that all bubbles burst. His staff studied 28 different bubbles, from stocks to real estate, and found that, without exception, all bubbles underwent “reversion to the mean.”

Grantham said, “all 28 major bubbles … eventually retreated all the way back to the original trend, the trend that had existed prior to each bubble, a very tough standard indeed.” GMO Quarterly Letter April 2014, quoted on page 25 of “When the Bubble Bursts”, and GMO’s homepage.

So if all bubbles revert back their original trend and Canada’s housing market fits the criteria for the definition of a bubble, there’s no escape for Canada’s housing market. It must go through a nasty correction.

But why does the bubble have to burst? Couldn’t prices just level off and then gradually correct, in a process that many call a “soft landing”?

Grantham’s assertion that all prices revert back to the trend line, as happened in the U.S. from 2006 to 2010, means a price drop of 40% or more in Canada would be comparatively worse than the U.S. correction because Canada’s bubble is bigger. But the second reason, an excess of debt, is even more compelling:

Sources: Teranet-National Bank National Composite House Price (11 city) IndexTM, Statistics Canada,, The MacBeth Group

We can see clearly that rapid house price gains generated an associated bubble in household debt. And that debt has to be repaid in one of three ways:

  1. The house is sold and the owner moves to rental housing or a cheaper home
  2. The lender forecloses and the debt is cancelled, often leading to personal bankruptcy
  3. The homeowner repays the mortgage and HELOC debt over decades

Option 1 is rarely used, although I recommend it in “When the Bubble Bursts.” Regarding Option 3, given the mountain of household debt for many people it will take too long to repay their loans, especially given periodic recessions like Alberta’s current slump. Unemployed people don’t meet their monthly payments for long.

So that leaves Option 2, foreclosure, as the most likely way out of the debt trap for many Canadian families. This happened in many countries in 2009, like the U.S. and Ireland, and the Canadian experience will be similar, unfortunately. Conservatives will say “it’s their own fault for borrowing so much” and the Liberals will propose government programs to mitigate the impact. But in the end, the boom/bust cycle will prevail.


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Hilliard, The MacBeth Group team and their clients may trade in securities mentioned in this blog.




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