Good morning,
The steep decline of housing markets, not just in Canada, but in advanced economies around the world is starting to raise red flags among economists.
Oxford Economics in a recent report warns that the global risks of housing market crashes spiralling into banking crises are now much higher than historic norms.
Using a banking sector risk tool that measures 35 macroeconomic and financial indicators, Oxford suggests that up to 16 per cent of major economies have an 18 to 20 per cent chance of suffering a housing crisis within the next three to five years, compared to a historic average of just 2 per cent.
Canada, along with Iceland, the Netherlands, Sweden and Denmark, is among the five most vulnerable with a 7 per cent probability of this leading to a banking crises within the next year and 18 to 20 per cent chance in the three to five years.
All of these markets share two things in common. A housing market that overheated during the pandemic when borrowing rates were low and now a steep decline in property prices and credit now that interest rates have climbed, in Canada’s case by as much as 4.25 percentage points.
The risks appear to be highest in advanced economies, said Oxford senior economist Evghenia Sleptsova, as households in emerging economies are less indebted and their housing markets experienced less of the boom and bust.
The housing booms in advanced economies were fuelled by a long period of ultra-low interest rates. Oxford says real housing prices rose by 36 per cent between 2013 and 2021, an increase equal to that seen in the run-up to the great financial crisis.
Nearly half of that increase was in 2020-21 during the pandemic, when prices rose at their fastest pace in 50 years.
As central banks such as the Bank of Canada swiftly raised interest rates to battle soaring inflation housing markets fell into steep downturns.
“Canada’s housing market, after years of overheating, is already in crash territory. Having risen by 47 per cent between March 2020 and March 2022, real house prices fell for nine months in a row up to December and were 19 per cent down from their peak in Q1 2022,” said the report.
“Historically such sharp falls in property prices have been a precursor to housing and wider banking crises,” it said.
In other words, the higher they fly, the harder they fall.
A decline in prices after a period of excessive growth has historically been a key trigger of housing crises, said Oxford. Its analysis finds that most crises are preceded by on average eight quarters of falling real home prices. Once prices start to fall there is the risk of a negative feedback loop in which tightening credit supply exacerbates the housing downturn.
Whether or not this develops into a banking crisis, depends on the health of the banks’ balance sheets, said Sleptsova.
Oxford includes Canada among the countries where a weak housing market may aggravate existing weaknesses in the banking sector. Others are Sweden, the Netherlands, Australia, Ireland, Germany, Russia and Hungary.
On Oxford’s banking sector balance sheet scorecard below (10 is the highest risk) Canada comes in second, with indicators such as household credit as a percentage of GDP registering the highest possible risk score.
