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Housing Market: Bank Of Canada Outlines Scenario For How Home Sales Slump Could Drag Down Economy

BoC Explains How Housing Slump Could Take Down Entire Economy

Don’t hit the panic button yet, but the Bank of Canada just outlined how a housing market slowdown could drag down the entire economy with it.

Canadian households are vulnerable to two interrelated shocks: a significant decline in house prices and a sharp deterioration in labour market conditions,” the bank said in its latest financial system review. “The vulnerabilities will increase the longer imbalances persist (or grow) in the housing market and the more household indebtedness rises.”

The BoC report singles out the condo market, and especially Toronto’s condo market, as the tinder box where a housing collapse could begin (and maybe already is beginning).

“In the current context, a specific concern is that the total number of housing units under construction has been increasing and is now well above its historical average relative to the population. This development is entirely accounted for by multiple-unit dwellings (which include condominium units), especially in major metropolitan areas,” the report says.

The BoC describes a sort of spiralling domino effect that could hit Canada’s economy, with housing pushing down the broader economy, and the broader economy further pushing down housing.

Price corrections in particular segments of the housing market may put downward pressure on house prices more generally. This would likely lead to a decline in housing activity, adversely affecting household incomes and employment, as well as confidence and household net worth, which would in turn reduce household spending.

As the declines in incomes and employment impair households’ ability to service their debt, loan losses at financial institutions would likely rise. These effects may be amplified by tighter borrowing conditions as lenders come under increased stress. These interrelated factors would further dampen economic activity and add to the strains on household and bank balance sheets. They may also cause house prices to fall below the level required to correct any initial overvaluation.

This is, of course, a hypothetical scenario, but note that the BoC predicts house prices could fall below reasonable, corrected values if the economy goes into tailspin.

And note, also, the bank’s prediction that a housing slump could cause a spike in unemployment. Canada is currently more dependent on construction jobs than the U.S. was at the peak of its housing bubble half a decade ago.

Construction jobs amounted to more than 7.4 per cent of all employment in Canada this spring, compared to 6 per cent in the U.S at the height of its housing bubble (the U.S. rate has since fallen to 4.2 per cent).

But so far, the BoC’s warning about bank earnings coming under pressure from housing hasn’t come to pass. CIBC, RBC and TD have all reported earnings in the past week, and they have been stellar.


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