Brace yourself for housing slump

Weaker sales are likely to drag down Canada’s economy

Ifyou’re very worried about a Canadian housing slump, here’s something new to keep you awake at night. A stellar group of U.S. housing economists, who once believed that rising home prices boosted the economy but falling prices did little harm, now have a new view. It isn’t encouraging.

The latest work by Karl Case of Wellesley College, John Quigley of the University of California, Berkeley and Robert Shiller of Yale University adds lots of new data from the last decade’s housing boom and crash in the United States, allowing them to conclude that each dollar of lost housing value likely slashed another 10 cents from consumer spending, a heavy hit.

That cost the U.S. about $350 billion in annual consumer spending, helping to explain why its recovery was so agonizingly slow.

What might worry Canadians, of course, is our housing slump isn’t behind us, it’s just beginning. And while few think it will resemble the U.S. crash, economists in Canada are still concerned.

That’s because even moderately weaker home sales, along with falling home construction, are likely to be major drags on our prosperity for the next couple of years.

So far, concern is focused mostly on home construction, which provides wellpaid jobs and boosts other kinds of activity, from lumber production to mortgage finance. That’s great when housing starts are rising, but it’s unpleasant when they fall.

At Capital Economics, economist David Madani estimates that residential investment accounted for a beefy one-fifth of all economic growth in Canada last year — 0.4 per cent out of two per cent total growth.

But this growth machine is already lurching into reverse.

Madani thinks falling home construction will subtract about 0.2 per cent from growth this year, helping drag the total to a mere 1.2 per cent, with another negative hit coming in 2014.

Douglas Porter, deputy chief economist at BMO Capital Markets, sees the same pattern, with homebuilding subtracting from our growth while a resurgent U.S. sector boosts that country’s economy. Largely as a result, Canada’s ability to sustain faster growth and job creation during most of the past decade has ended. We’ll trail behind the U.S. for a year or so.

The real pain, though, will come if home prices fall precipitously rather than gliding down gently. Any big drop will bring distress all by itself — for example a far bigger drop in homebuilding and construction employment is now expected. But now we must also wonder if any large drop in home values could also help to torpedo consumer spending in general, which we count on for about two-thirds of the country’s economic activity.

Admittedly, the U.S. numbers can’t be applied blindly to Canada’s situation. But the two economies have more similarities than differences, Porter notes, so it makes sense for Canadians to give this new information some thought. In his opinion, the idea that falling home values could be a big drag on consumption sounds right. Not only do lower prices really make people poorer, but the shock of seeing prices fall after years of generally rising values might add to the anxiety.

So how much might prices fall? Some analysts expect nothing dramatic. At the Royal Bank, economist Robert Hogue estimates they’ll dip by about 3.5 per cent over the coming two years, with lesser drops outside the high-priced Vancouver market.

At the other end of the spectrum, Madani thinks prices will plunge 25 per cent over this period, propelled by the collapse of speculative hysteria in Vancouver and the Toronto condo market — a factor he thinks other analysts might be underestimating.

Porter sees a significant, but not catastrophic, decline of five to seven per cent, while economist Benjamin Tal at CIBC World Markets acknowledges that he “would not be surprised if we see 10 or 15 per cent.”

In general, analysts think Vancouver and Toronto would suffer the most, with lesser impacts in cities like Montreal that show little evidence of speculation.