Canada’s Great Housing Recession — and How to Prevent it
The Canadian economy is on a crash course like nothing seen before since the Great Depression. Those who claim the impending recession will be ‘mild’ — such as the Royal Bank of Canada — are reassuring the public with at best tactical dishonesty, and at worst optimistic stupidity. In any case, Canada is in trouble.
The 2008 financial crisis failed to break the Canadian financial establishment, leading to a common belief in its resilience. The economy was left mostly unscathed and Canadians had one more thing to feel self-righteous about compared to the USA. Former Prime Minister Stephen Harper is often credited for masterfully navigating Canada through the recession. As good as all this makes the people in charge look — it's not what actually happened.
In the real world, the Bank of Canada, the Crown's Canada Mortgage and Housing Corporation, and the U.S. Federal Reserve spent $114-billion on direct financial assistance and unsecured loans to keep Canada's big banks afloat. This was touted as 'liquidity support' and was covered up by the Bank of Canada, despite numerous issued and ignored information requests. Scotiabank, CIBC and BMO received more stimulus than their respective values at the time, which questions any claim that they could have survived otherwise.
The consequences of this charade are not only still being felt today, but the 2008 bailout is the direct precedent that has led us to the current housing crisis. Without any recourse from the recession, debt remained Canada's opium. The Bank of Canada soon after dropped interest rates to a record low of 0.25% - 0.50% for six years — creating conditions for low interest lending by financial institutions. The move, they hoped, would incentivise consumer spending to carry an economic rebound. It was a major success, mostly for the real estate sector.
Armed with cheap credit, illusions of an invincible market, and desperation not to miss out on equity; Canadians stormed housing. The election of Prime Minister Justin Trudeau in 2015 exacerbated the issue. Though interest rates were slightly increased, the new government ramped up spending — but also dramatically expanded the scope of immigration and foreign temporary worker admittance.
Housing markets, particularly in the migrant hot-spots such as Toronto and Vancouver, exploded with demand. Meanwhile urban flight to suburbs and small towns carried with it disposable capital, cheap mortgages and higher home prices. COVID abetted this invasion by introducing a work from home dynamic, which allowed urban dwellers to relocate to cheaper small-town locations. Reality set in after it was too late: Canadian housing was locked in a gargantuan bubble.
As of now Canada's total mortgage debt is about $2 trillion, or 114% of Canada's total GDP. Comparatively, in the United States during the 2008 crash the mortgage debt to GDP ratio only climbed to around 73%. This is reason for Canadians to be incredibly alarmed.
COVID mandates came with more consequences: the castration of the domestic economy, weakened supply chains, ridiculous levels of stimulus spending, and a great deal of personal financial debt and insecurity. Immigration was temporarily put on hold while interest rates were dropped to near-zero levels once again. Housing went parabolic amid mass hysteria, by which the public again rushed the market to avoid running the risk of being priced out.
In 2022, over half (55%) of all mortgages are financed with a variable interest rate — compared to the historically popular fixed rate, which cost borrowers marginally more. The trade-off is that a fixed rate isn't adjusted at the mercy of banks, who may raise rates in search of capital to finance their lending. For reference, variable rates accounted for less than a third (24.7%) of mortgages in early 2021 — only a year prior. In short, masses of people opted for irresponsible and volatile housing loans than ever before. What many, however, didn't anticipate was record inflation in the following months.
Caused by a combination of a decade of high spending during the pandemic, and for the first time ever quantitative easing by the Bank of Canada (buying government debt from banks to lower interest on loans); along with too much subprime mortgage lending from the banks, residual and present supply chain disruptions from COVID lockdows, and the war in Ukraine (including Russian sanctions) — inflation has ripped through Canada and is now officially reported at 8%. There is only one tangible way to fight runaway inflation, and that’s increasing interest on lending.
This is all up to the Bank of Canada, but not entirely. It is important to note that although the central bank is supposed to make independent monetary decisions, it is still a crown corporation owned by the federal government. Political pressure during the pandemic motivated the Bank of Canada to lower interest rates so that the federal government could borrow more and spend accordingly. That same level of commitment could be utilized for raising rates — so the federal government should still be held accountable.
Either way, as inflation spiked the Bank of Canada promptly raised interest rates from 0.25% to 2.5% in the first quarter of 2022. This isn't nearly enough, but how high the Bank of Canada is willing to go depends on how many Canadians they are willing to subject to homelessness. In theory. Public spending is being reigned in, but private lending may not for long.
Contrary to popular belief, private banks aren't bound by the Bank of Canada's interest rate recommendation. They make their own loans, and set their own rates — effectively these private banks print the majority of Canada's money supply out of thin air. When banks distribute loans they spend first, and pay out later. They are allowed to do this due to a convention called fractional reserve banking, whereby banks are only required to hold a fraction (8%) of the capital they lend to consumers.
For now, the private banks are cooperating with the Bank of Canada — but as inflation persists and likely rises, there is bound to be an impasse between them.
What will soon happen is what I like to call financial deadlock. While the Bank of Canada may be eager to restrain lending to fight inflation, banks hold way too much liability in housing to stop lending. A housing crash could bankrupt every Schedule I in the country. Canada's big banks hold 73% of residential mortgage debt. Therefore, they are eager to keep the market stimulated with more credit — and the cycle continues.
Those paying down their property on a variable rate are now seeing their mortgage payments rise beyond expectations — and as far as they know higher rates are coming. A cursory look at wage stagnation reveals why people can't afford higher rates. Insolvency, foreclosure, and for many bankruptcy, will be the only option for these borrowers. That's a lot of liability to lose.
The banks holding on to all that bad debt will be caught in a bind. Repossessing expensive homes, and desperately trying to get them back on the market at value, will be far too costly. Very few will be able to afford them either way. On the other hand, refinancing people's mortgages with lower subprime interest rates invites risk against collecting liability from borrowers. There is no winning for the banks right now — and when banks lose, their investment assets are pulled as collateral.
Canada's big banks occupy about 3.8% of the country's GDP in assets. They not only own shares with one another, but they have a strong hand with every industry leader in the country. For example, Canada's big-five banks own a combined share of over 15% in Enbridge, the country's premier energy corporation. Telecom giant Bell has the banks as over 18% of its shareholders. This doesn't include shares these banks own in smaller companies, which also own shares of their own. But that's not half of the problem.
'Real estate and rental and leasing' (not including construction) is Canada's largest industry. It now accounts for roughly 10-13% of Canada's GDP, down from 14-15% in 2020. Needless to say, if the housing market crashes, the banks will fail, thus driving the entire economy into ruin. So the banks simply must not fail, even though they probably should.
What would typically happen, if the deadlock can't be reconciled and a crash strikes, is another bank bailout. However, with roaring inflation and mortgage debt unlike anything in 2008, the federal government is in a unique position where it may not even be able to afford to save the banks. Or at the very least, not all of them. Either way, the federal government has already signalled that it doesn't plan on any bail-outs. Instead, something much worse is on the horizon.
In 2016 Prime Minister Trudeau's very first budget detailed under Chapter 8 – Tax Fairness and a Strong Financial Sector, "To protect Canadian taxpayers in the unlikely event of a large bank failure, the Government is proposing to implement a bail-in regime that would reinforce that bank shareholders and creditors are responsible for the bank’s risks—not taxpayers." This was implemented with Bill C-15. What it means is that banks are able to seize uninsured depositor's money to keep themselves financially afloat. The CDIC protects up to $100,000 per financial institution, but any more is up for grabs. After all, those savings don't actually belong to depositors — they were invested in the bank.
If there's any way to eradicate public trust in the financial system, it will be through the mass confusion and losses caused by a bank-wide bail-in. The backlash will be overwhelming, and recovery will be difficult to navigate. Perhaps many will conclude that this entire crisis was planned all along — a narrative that already has growing salience.
Canada needs major financial reforms, as painful as they may come for the flexibility of the economy. Although abolishing the fractional reserve banking regime is necessary, it isn't a wise move until after the housing crisis is stabilized. Smaller, more actionable, steps need to be taken before giant leaps are possible. After all, inadvertently causing the crash by dramatically cutting credit flows is the last thing anyone wants. The housing bubble needs to be deflated first. Some say the bubble is a supply issue, but that isn't true.
Any push for greater residential construction could never hope to keep up with the market. Canada already has the average per capita supply of housing, and builds at the average rate, compared to other OECD countries. The United States, for example, doesn't have a comparable housing bubble. Canada would need to go from building 100,000 new houses a year — to over 600,000 a year by 2030 to make the market near affordable. Achieving half of that target is not feasible. As a matter of fact, developers may not even want to build until housing prices begin to rise again and interest rates fall.
Another common proposal is banning foreign buyers from purchasing real estate in Canada. Though probably more feasible than mass development, foreign owned property constitutes a small proportion of real estate stock. For example, foreign ownership of residential real estate is only 3.4% in Toronto and 4.8% in Vancouver. The federal government has already placed a temporary ban on foreign buyers, which came into effect in January 2022. It was never a significant factor. Granted, in the event of a housing crash a foreign buyer ban would be necessary to prevent multinational speculators from sweeping up cheap real estate.
The only real solution to overcome the financial deadlock, aside from banks cutting back on lending, is to incrementally cut immigration and foreign worker inflows. Doing so, over time, would reduce demand on real estate without jeopardising an outright crash. It would allow the price of housing and rent to depreciate in a controlled manner by the federal government, without much complexity involved.
Gradually reducing migration will most likely cause significant worker shortages, and likely more short-term inflation. That being said, it will also make the labour market more competitive and lead to increased wages for existing residents. With more disposable income people will be able to pay off their mortgages, and first-time buyers will eventually have the means to buy repossessed houses from the banks. Even those who remain priced out will have more opportunities to rent at an affordable rate.
If the government doesn’t act soon, disaffection with living in Canada could become the norm — both for citizens and foreigners. Given enough time and with enough unrestrained immigration, demand pressures will push renting out of reach for those same immigrants entering the country — not to mention native citizens. A sudden spike in emigration or a drop in immigration, or both, could cut through housing demand almost immediately — assuredly leading to a crash. As many as 30% of recent immigrants aged 18-34 already plan to leave the country in the next two years.
Speaking as a young native-born Canadian with no significant assets, and basically nothing to lose, I can tell you that most people in my milieu are enthusiastic about the crash — and a total reset of the economy. It's naive, but they certainly didn't sign-up to be priced out of home ownership for the rest of their lives. They also aren't the ones who have incurred copious amounts of mortgage debt.
Unfortunately for these prospective first-time home buyers hoping for a crash, they’d still need high wages to buy cheap real estate. They certainly won’t be relying on low interest mortgages in the future.