Authorities Want a Housing Bubble

Skyrocketting debt as people spend money on overpriced houses.

One of my favorite quotes is from Upton Sinclair, “it’s difficult to get a man to understand something, when his salary depends on his not understanding it.” I’ve always assumed that the quote was cynical, but more intended to be amusing than an absolute judgement of how the world works.

But, the more time that passes, the more I’m starting to believe this quote actually reflects reality. Look at people’s reactions global warming. It’s a problem that is now likely to have a major negative impact on everyone, costing hundreds of millions of lives. But the paychecks of powerful people depend on not believing in global warming, so in the USA, denial is the official policy.

Something similar is happening in Canada with the housing bubble.

Some history

Look at the chart at the top of this post that compares Canada and USA’s debt to income ratios for consumers. It shows how, relative to their incomes, people took on massive amounts of debt to buy real estate. The USA’s line begins to fall in 2007 as the housing bubble in the USA pops. Essentially, Americans could no longer service the huge debts they took on. The bubble popping led to the Great Recession.

As a result of this speculative fervor over real estate, the financial system nearly collapsed. Banks usually lend money to each other overnight for about 0.1 percentage points more than they’ll lend it to the central bank. During the financial crisis, they demanded 3.65 percentage points more, because they were terrified that the other banks would collapse overnight. We were literally on the edge of the entire financial system locking up, with nobody lending to anyone else.

And what caused America’s housing bubble in the first place? After the tech bubble popped around the turn of the century, the central banks kept extremely low interest rates for too long. People took on too much debt to buy overvalued houses because the financing was so cheap. They gorged themselves on debt and were killed when houses stopped going up.

The Bank of Canada

This narrative is well-established. Stephen Poloz, the head of the Bank of Canada, must know it. But instead of heeding the warning, he’s pretending none of it happened.

After the Great Recession, the Bank of Canada lowered rates to “emergency levels” in an attempt to keep the system liquid. That worked, and the economy recovered.

So, learning from the experience with ultra-low rates in the USA—the growth of the American housing bubble, the huge amounts of debt taken on by consumers, and the subsequent crash—the Bank of Canada normalised rates after the threat had passed, right?

No. Not at all.

Instead, they kept interest rates at “emergency levels” for a decade, always deciding that the economy simply wasn’t strong enough for rates to increase.

And the result is almost identical to the USA in the early years of the 21st century. Housing prices have skyrocketed. Consumer debt is insanely high compared to incomes—even higher than it was in the USA at the height of their bubble.  British Columbia has had negative savings rates (i.e. people in aggregate spending more than they earn) for over fifteen years now.  People are borrowing huge amounts to buy massively expensive houses anticipating that they’ll increase in value forever.

And what’s Poloz’s reaction to this? A couple weeks ago, he said even a rate hike to over 5% wouldn’t cool the hot housing markets.

What’s going on here?

Really? Is he that stupid, believing interest rates don’t have any impact on housing prices and speculation?

No, I think we just have to look to Upton Sinclair for the answer. Poloz is scared of looking like an idiot if he increases interest rates and crashes the housing market. So, he’s closing his eyes to the consequences of his actions.  It doesn’t matter to him if Canadians take on debt they can’t afford or can’t retire because they lost all their money speculating on overpriced houses.

What matters to Poloz is getting through his term without upsetting the boat, the same thing that matters to every politician.

Heck, you see the same thing in the recent changes the Ontario provincial government has enacted in Toronto. They’ve added a foreign buyers tax on houses, but have excluded pretty well everyone from it. Even foreign students can buy without paying the tax (because every student needs to own their own their own multimillion-dollar home). The government’s goal wasn’t to cool off the market, but rather appear to be taking actions to cool off the market.

The bottom line

This housing bubble experience has changed my views on politicians. I used to believe that most politicians are in the job because they want to make a positive difference, and that, despite their poor reputation, politicians care about more than just making money and holding onto power.

But, seeing politicians’ reactions to this housing crisis—seeing them ignore Canadians who risk ruining their financial lives by taking on massive amounts of debt to buy overvalued assets— I’m no longer convinced that’s true.  Because now, politicians’ salaries depend on them not understanding the causes and consequences of this housing bubble, and so that’s the way they’re acting.

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2 thoughts on “Authorities Want a Housing Bubble

  1. On the motivation of politicians. Could it not be that, because politicians have to deal with multiple issues; they just cannot keep up, and, therefore make decisions based on simplistic overviews of any given issue.

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    1. Yeah, I think that’s part of it, but, considering the visibility of this bubble, it is something they should care about (e.g. in a May survey, the cost of housing was the biggest concern BCers had, above even the economy).

      The other housing-specific issue is that almost all the advice politicians would get on housing is from people who benefit from the housing bubble–real estate agents, banks, mortgage insurance providers, builders…. There’s very few people who stand to gain more money from real estate falling in price. So, people’s advice to politicians is almost certainly skewed bullish.

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