HOUSING BUBBLE ... WHAT?

Economic Bubbles.  They set financial markets into a panic, fearing the inevitable burst, and rightly so.  

Nortel – worth more than a third of the Toronto Stock Exchange, then plummeted to penny stock, resulting in bankruptcy.  Not a pretty picture and still fresh in many minds.  Personally, don’t get me started on the 1989 Toronto market crash.  I still cringe at the reminder - I swear, a minute after the expiry of my 10 day cooling off period on my Erin Mills condo, the markets collapsed.  Mark that one off to experience.  Heck, we can even go back in time to the 1600s, Dutch Tulip mania was in full bloom (sorry for the pun) where a popular bulb would cost you the same as a luxury home.

So what about the suggestion that Canadians are approaching a housing bubble with an impending burst.  Is this hype fact or fiction?  Some reports suggest we are currently in a housing bubble.  But what exactly is a housing bubble? 

A housing bubble is created when there is a substantial increase in housing prices fueled by demand and speculation.  Housing bubbles usually start with an increase in demand in the face of limited supply. Speculators enter the market, believing that profits can be made through short-term buying and selling. This further drives demand.  In addition to the speculative and psychological mind set, there is the lending and rapid growth of debt associated.  At some point, demand decreases or becomes stagnate at the same time supply increases which results in a dramatic drop in prices - and voila - the bubble bursts.  Think of the current United States economy. 

The United States decision to keep the Federal Funds rate very low for a long time caused credit to be very loose and helped the public obtain loans and buy homes beyond their capabilities. Laws were passed that encouraged people to buy loans.  As if that wasn’t enough, restrictions were removed on verifying legal income which opened the door to more bad loans!  Banks had no choice but to impose larger interest rates.  Thank goodness the Canadian Government held a more conservative approach. 

In order to protect Canadians, our Government has tightened its mortgage rules in order to restrict financing options for investors, speculators (an ingredient to the housing bubble) and individuals who are refinancing their homes to consolidate debts. 

Most economists do agree that Canadian home prices are inflated in comparison to income, which would be one reflection of being in a housing bubble.  What we are not seeing, I believe, is the mass hysteria involved in a housing bubble.    

With all the various reports circulating, it’s no wonder confusion abounds.  The best we can do is not panic and be conservative in many regards.

Written by:  Maria Evans