January 27, 2013
Title: Beer goggles and housing
Subtitle: Is US money printing making Canadian real estate look better?
Canadian housing prices surged ahead again last month, despite declining sales. According to the Canadian Real Estate Association, the national average price for homes sold during December rose an impressive 10.4 percent to $389,119, compared to the same period in 2012. The Greater Toronto and Greater Vancouver regions led the way. If those sales are excluded, average prices in the rest of Canada rose by a still-impressive 4.6 percent (given that we are in a period of weak inflation).
This strong performance roughly tracks that of residential real estate south of the border, where sales and prices continue to strengthen, following a devastating plunge during the 2008 financial crisis and ensuing recession.
Economists generally attribute the strength of both markets to continued low mortgage rates, which drive down borrowing costs, and boost corporate profits. On paper, this should reduce potential layoffs and foster hiring. Ironically the Canadian economy unexpectedly lost 46,000 jobs during December and job creation south of the border slowed significantly as well.
The beer goggle effect
In recent remarks Richard Fisher, president of the Federal Reserve of Dallas, shed light on why asset prices south of the border may be so strong, despite a sluggish underlying economy, comments which may have resonance here in Canada. In particular Fisher attributes strong US stock prices, which rose close to 30 percent last year, to the “beer goggles effect.” In a presentation made at the Brookings Institute Fisher describes this as “The effect alcohol has in rendering a person, who one would ordinarily regard as unattractive as alluring.”
He went on to say that when money available to investors (and by implication home buyers) is close to free and there is a presumption that the central bank will keep it that way indefinitely, stocks move into a bull market. If Fisher is right, this implies that US equities, which are trading at historically high levels, relative to average profits over the past ten years, may be heading into overvalued territory. However Fisher’s logic also suggests that Canadian housing, which is also trading at high levels, relative to both household income and rents, may also be being boosted by the “beer goggle” effect of low interest rates, which is clouding investors’ judgments.
Economists at the large Canadian banks for their part play down bubble-talk. “Our outlook for 2014 calls for a continuation of this very slow rate of increase (in home sales relative to 2013),” says Robert Hogue, an economist at RBC Economics, though he adds a cautionary note. “Recent re-acceleration in home price increases could result in deterioration of affordability if the phenomenon is sustained.”
In short, if you believe RBC and the other big Canadian banks, which have all made similar statements in recent months, home owners here are unlikely to suffer from any “beer goggle” induced hangovers.
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