October 8, 2008

Residential Construction

U.S.-style housing crisis possible in Canada, Merrill Lynch Canada report finds

RICHARD GILBERT

staff writer

An economic forecast predicts a U.S.-style housing meltdown, even though Canada has more stable credit markets.

The U.S. financial crisis reached new depths last month with the collapse, bailout or acquisition of several major American banks, including Merrill Lynch.

In the midst of the financial turmoil, Merrill Lynch Canada released a report that predicts a major downturn in this country.

“What worries us is that Canadian households have been running a larger financial deficit than households in either the U.S. or the U.K.,” said the Merrill Lynch report. “After forty years of net saving, Canadian households moved into sustained deficit in 2002. In 2007, household net borrowing amounted to 6.3 per cent of disposable income, a wider deficit than in the UK, and not far off the peak U.S. shortfall seen in 2005.”

The report by David Wolf and Carolyn Kwan challenges the prevailing view that household debt is more sustainable in Canada.

It also challenges the notion that our housing and credit markets are more stable than their U.S. counterparts.

“We fear that it may only be a matter of time,” said the report.

“The clear tipping point in the U.S. was the emergence of falling house prices in the summer of 2006, kicking off the vicious circles that have brought the financial system and the wider economy to the brink.”

The Canadian Real Estate Association recently announced that unit sales and prices for the housing market declined in August.

The group reported that sales were down on a month-to-month basis in all the 25 markets profiled except Edmonton, Calgary and Regina.

On a year-to-year basis, sales were down in all five of the country’s most expensive markets, Vancouver, Victoria, Calgary, Toronto and Edmonton.

According to the Merrill Lynch report, the decline in Canada will be driven by the double-digit growth of mortgage debt and the deflation of housing prices.

A quarterly economic forecast released by TD Economics is nowhere near as pessimistic.

“Notably, the Canadian housing sector has come off the boil, with prices moderating across Canada and the pace of new home construction returning to an average pace, but is not crashing American style,” said TD economists Don Drummond and Beata Caranci.

The CIBC released a World Markets report, which notes that while housing prices in Canada are cooling, there is little worry of a U.S.-style meltdown.

“U.S. housing prices have been falling for two years with a cumulative decline of 18 per cent to date-on their way to an eventual correction of 25 per cent,” said CIBC economist Benjamin Tal.

The Merrill Lynch study reports that at the peak of the cycle, subprime and Alt-A mortgages accounted for at least 33 per cent of U.S. mortgages.

At its peak, non-conforming mortgages reached 5.4 per cent of the market in Canada.

The CIBC report concludes that the percentage of subprime mortgages led to the drop in U.S. housing prices and that the same situation does not exist in Canada.

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