With recovery will come yet another bubble
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With recovery will come yet another bubble

The economy is showing some signs of recovery – although the most important element, employment, remains problematic – but will we learn anything from market meltdown? The changes we’ve seen aren’t likely to include a move against speculation. While other jurisdictions have made noises about bans or restrictions on speculation in stocks, currencies and oil futures, for instance, such thinking is beyond the pale in North America.

Speculation, of course, is another word for gambling. When you buy stocks, you’re betting they’ll go up in price (or down, if you’re shorting). Other than securities, there are a host of speculative investments for those willing to take the risk. Speculation also extends to the housing market. This applies not only to people who buy homes to flip them, or farmland in the hope of a future subdivision, but to many who’ve entered the housing market in recent years.

As the bubble grew and prices rose, many buyers overextended themselves, believing prices would just keep rising. In much of the U.S., the bubble has long since burst, leaving many holding mortgages on homes now worth considerably less than what they owe the bank. Foreclosures followed, and some banks collapsed under the weight of ill-advised mortgages. The intricate house of cards that was built precipitated the financial crisis we see today.

While Canada’s housing market has not taken the same kind of hit, sales and prices did drop a bit before recovering. The Canadian Real Estate Association’s market survey saw national home sales decreasing by 12 per cent to 461,200 units in 2008, with a further decrease of three per cent in 2009. The number of new listings is forecast to decline further from the peak reached in the second quarter of 2008, with levels by the end of 2009 on par with levels in 2007.

Anyone who thought the bubble would continue to expand has neglected history, and the market optimism has proven unfounded.

“It’s a simple lesson. Housing prices do not always go up,” says William Strange, a professor of real estate and urban economics at the Rotman School of Management, University of Toronto.

“Prices are down already, and indications are they’ll go down even more.”

That said, prices are simply down relative to the big increases we’ve seen in recent years. The small drops are really only a correction from what was an overheated market fueled by unrealistic expectations.

Even a five-per-cent drop, while noticeable, is minor; we never saw the kind of freefalls that have occurred in the U.S.

“We’re not in that territory yet, and there are reasons to believe we won’t get into that territory,” he says.

That’s because Canadian banks are more prudent, stable and regulated. We don’t have the kind of mortgage issues undermining the U.S. market right now.

Still, we ought not to get too cocky. No one knows where the slide is going to end.

“We don’t know yet how far down our prices will go,” says Strange.

Given our attachment to the American economy, the major drop in new home construction there translates into fewer sales of building materials here. The slowdown domestically will also have an impact on the economy, leading to job losses, in turn adding to the economic malaise.

Where previous corrections in the housing market, most notably in the early 1990s, saw prices flatten, falling relative to the rate of inflation, this time around we can expect real drops. Those who jumped into the market at the peak with wild expectations of ever-growing prices were making “bad budgeting decisions,” says Strange.

Price drops could help those looking to get into the market down the road, but that upside could be offset by the fact credit is harder to come by. Lenders are hanging on to their money, and tightening requirements when they do part with it.

Easy-to-get loans? “Those days are gone.”

Strange predicts some systemic changes will come from the meltdown, particularly in the States. He’s not overly optimistic, however, that many of us will have learned a lesson from all of this. We have pretty short memories, and the complexities of markets and financial instruments means we’re happy to have others do the thinking for us. When the economy picks up, as it has done after other recessions, there will be plenty of people happy to jump on the next bubble that comes along.

“Eventually, there will be good times again … and some people will forget about the [bad] times.”

If there is a take-away lesson to be learned when it comes to real estate, don’t take any undue risks, he suggests. Don’t bet money you can’t afford to lose, the same as any other form of gambling.

“People shouldn’t buy homes based on appreciation of prices, but based on where they want to live for the next 10 years.”

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