As he points out in today’s Breakfast with Dave: Market Musings & Data Deciphering, Australia has a great deal more exposure to accelerating growth in China. Only 3% of Canadian exports go to China while 24% of Australian exports go there. Furthermore, Canada has much greater exposure to the moribund U.S. consumer: 75% of its exports go to the U.S versus 6% for Australia.

Yet, interestingly, the Aussie dollar lost ground after the central bank’s latest rate hike in a “sell-the-news-buy-the-rumor” kind of move. Bank of Canada Governor Carney no doubt noticed that response and might accordingly be less fearful a rate hike would strengthen the loonie (as happens most of the time due to capital inflows). And no doubt he would love to raise rates to head off the bubble-like conditions fermenting in the housing market – especially if the loonie remains well behaved and doesn’t inflict any more pain on the already hard-hit export sector.

Monthly rises in August were 2.7% in Toronto, 2.0% in Calgary, 1.7% in Vancouver, 1.5% in Ottawa, 1.2% in Montreal and 0.6% in Halifax. “For Toronto it was the fourth consecutive rise of 2% or more, taking the cumulative gain to 9.4% in just four months,” noted the monthly report from Teranet and National Bank.

Montreal, Halifax and Ottawa prices in August are now above their respective peaks attained during the housing boom. August house prices remain below boom-era peaks in Toronto (-3.0%), Vancouver (-7.7%) and Calgary (-12.9%).

This recent leap in house prices is putting housing back into overvalued territory at the national level, going by the IMF model. As for traditional valuation yardsticks (as mentioned in the IMF study) the existing state of overvaluation is becoming more substantial.

The IMF developed an econometric model from economic fundamentals such as disposable incomes, demographic trends, and mortgage credit for the period 1993Q1 to 2009Q2. It then used the model to compute equilibrium prices for housing in the five largest provinces.

The IMF study also looked at traditional valuation measures. At the end of June (before the recent spurt in prices), the house-price-to-income ratio was about 15% above its historical average (U.S. close to its historical average); the house-price-to-rent ratio was about 60% above its historical average (twice the U.S.).

The study mentions several factors that help to support house prices, They include:

• revival in commodity prices
• lenders have full recourse to borrowers which makes escaping loans harder (unlike U.S.)
• loan-to value requirement of 80% for uninsured mortgages
• mortgage-backed securities represent 20% of the market in Canada (third of the U.S.)
• government initiatives such as buying up mortgage-backed securities, expanding the Canada Mortgage Bond program to 10-year maturities, expansion of CMHC programs and a temporary home-renovation tax credit.

From trough to peak during the boom period, new house prices were up 97% in Alberta, 120% in Saskatchewan, and 41% in the rest of Canada. Existing house prices showed similarly huge increases during the run-up phases.

On a year-over-year basis, the national composite was down 5.1% in July. Cities with the biggest declines were: Calgary (-11.1%), Vancouver (-9.3%) and Toronto (-4.6%).

The Ottawa house market is indeed thawing out. FOR SALE signs pop up like weeds on front yards and SOLD stickers appear on them a few days later. I was coming out of a Costco store in Ottawa a few days ago and overhead one of the clerks tell another that he had just bought a second house. The year-over-year price change in Ottawa never really did get below zero (same for Montreal). If you blinked, you missed the downturn. Let’s give credit to the stability of incomes in the Canadian capital, a government town par excellence.

As for elsewhere around the country, I know mortgage rates are low in Canada and might account for the jump in house sales, but then again, unemployment is still high and rising. That leaves one wondering if news reports several months ago of MLS house prices shooting up (based on the flawed average price indexes published by realtors) created the then questionable impression of house prices surging upward. This may have helped, in self-fulfilling fashion, to change the psychology virtually overnight from aversion to panic buying (buy before house prices go up too much more) and anticipatory buying (let’s chase assets that are appreciating).

I don’t know if house prices will continue on a tear but I do worry somewhat that the high-flying loonie is offsetting much of the stimulus originating from the Bank of Canada, federal government and commodity prices. Then there are the housing prognostications of Yale University economist Robert Shiller (who called the housing and dot-com busts). He says he sees five more years of stagnant house prices in the U.S.

Still, it was an improvement in the second derivative. The only problem, says Rosenberg, is that it may have been helped a lot by a measurement error – i.e. shift in foreclosure sales toward high-end homes. “Moreover, the banks are sitting on a record number of foreclosed units that have yet to hit the market (don’t forget that the government-imposed moratorium just terminated). And once these homes flood the market, we may well get another big leg down in the price data,” writes the noted bear from his lair at Gluskin Sheff + Associates Inc.

Other points from Rosenberg:

• there are more than 800,000 to 900,000 vacant residential housing in the U.S., “not a backdrop for anything but lower home prices”

• residential real estate still comprises over 30% of the household balance sheet, which remains high

• the rental vacancy rate is now at a new all-time high so rental accommodation remains competitive with owned accommodation

• the U.S. homeownership rate has another three percentage points to fall before the cycle runs its course

• University of Michigan and Conference Board surveys indicate that home buying intentions are rolling over again

• “when bubbles get expunged, the mean-reversion process means that you” fall below the mean; to erase the insanity of the 2001-2006 housing mania would suggest that home prices could indeed go down another 25% from where they are.

A reader asked: “Is this just a case of CREA trying to shine things up so agents might see a pick up in business?” I wondered the same thing as I wrote the piece. I can’t really say for sure, but I can see how dramatic increases in prices might play to the interests of the real estate industry. Namely, those persons who were holding off buying have a flashing green light to now venture out and do the rounds with real estate agents. Indeed, the magnitude of the reported price increases could potentially generate a buying panic of sorts as prospective buyers feel the pressure to buy before prices go up too much more and/or they miss out on the price gains from owning a home.

In December, we had the opposite situation. CREA indexes appeared to be substantially overstating the decline in prices. The appearance of steep declines could also dovetail with industry interests. As I conjectured back then, it could erode the optimism of owners with houses listed for sale, leading them to cut their asking prices rather than let their properties sit longer on the market in hopes of getting the offer they had hoped for. The end result would be a pick-up in sales.

Flat to moderately trending markets lull buyers and sellers into inaction. Extreme price changes arouse emotions get people off their duffs. Could this be a reason why CREA continues to headline a flawed indicator? Its tendency to overstate price change at turning points can be a tool for altering the buying and selling psychology of the housing market.

Calgary is no longer leading the trend downward. That honour now belongs to Vancouver, which dropped 9.6%. Next came Calgary (−8.4%), Toronto (−6.9%) and Halifax (−0.8%). Just two cities managed to stay in positive territory: Montreal (2.9%) and Ottawa (1.0%).

All cities in the index are down from their peak levels. Calgary, Vancouver and Toronto are off their peaks by more than 10%.  This is beginning to look like a U.S.-style retrenchment — only with a lag of 12 to 18 months. For more detail, see the charts ( from housepriceindex.ca) below.

Much has been made of the resiliency of Canadian banks in the midst of the global financial meltdown. But was it, in part, based on a delayed tumble in house prices? Now that the Canadian market is beginning to resemble the U.S. market, will Canadian banks be able to keep a stiff upper lip?

National level

These readings are from a new index of resale-house price changes, the Teranet–National Bank National Composite House Price Index. It is a less biased measure than changes in average prices because its repeat-sale methodology controls for changes in the mix of houses over time.

On a month-to-month basis, house prices fell -2.0% from January to February. Toronto (-3.1%) dropped the most, followed by Vancouver (-2.0%), Montreal (-1.2%), Calgary (-0.7%), Halifax (-0.5%), and Ottawa (-0.2%).

Since peaking in August, 2008, house prices have fallen -7.4%. Declines for the six cities from their respective peaks were: Calgary (-12.0%), Vancouver (-10.2%), Toronto (-9.0%), Halifax (-4.0%), Ottawa (-3.8%), and Montreal (-1.6%).

It’s a good thing it’s not as easy to walk away from a mortgage as it is in the U.S. Otherwise, Canada’s banks would be in more of drubbing along lines of U.S. banks. Still, as it stands, there is going to be a bit of pain.
 

2. Are we there yet? Two-thirds of investment managers cite stability of the U.S. real estate sector as the No. 1 indicator they watch for signs of a recovery in financial markets. Unfortunately, the decline in house prices has been accelerating, lately.

3. TFSAs are for the Geritol set. A third of Canadians over 65 now have a Tax Free Savings Account. Only a quarter of 55- to 64-year-olds and a sixth of Canadians under the age of 45 have one.

4. Great, just what we need — government contributing to unemployment in midst of recession; Ontario’s 9% increase in minimum wage “will end up hurting the very people it is intended to help.”

5. Minimum wages by province – chart.

6. Hurry, just 3 days left to get a quick answer to that tax question. H&R Block Canada has declared March 30 to April 4 National Tax Advice Week and are offering Canadians the opportunity to have their tax questions answered by a professional.

7. When it comes to taxes, one of the “biggest mistakes people make is thinking they don’t qualify for a credit when actually they do.”

8. Winners of stock market competition get $2,000 scholarship. John Bogle would not approve.

These readings are from a new index of resale-house price changes, the Teranet–National Bank National Composite House Price Index. It is a less biased measure than changes in average prices because its repeat-sale methodology controls for changes in the mix of houses over time.

On a month-to-month basis, house prices fell -1.6% from December to January. Vancouver (-2.6%) dropped the most, followed by Calgary (-2.3%), Toronto (-1.4%), Ottawa (-1.4%), Halifax (-1.0%), and Montreal (0.1%).

Since peaking in August, 2008, house prices have fallen -5.5%. Contributing the most were declines in Calgary (-11.4%), Vancouver (-8.3%), and Toronto (-6.1%), from their respective peaks (August, 2007, June, 2008, and August, 2008). Contributing the least was Montreal, with a decline of -0.4% since its high in September, 2008.

CREA’s headline measure of house-price change is very misleading because it does not control for changes in the mix of houses over time. CREA’s indicator may have, for example, an average dwelling size of 2,500 sq. ft. in the base period and 3,000 sq. ft. in the observation period. It will also likely have changing proportions for other housing characteristics such as number of bedrooms, region, age, etc. This is not comparing apples to apples.

I’ve been harping on this issue for a few months now – see, for example, Dec. 9, Dec. 11, and Dec. 18 posts. A less biased method is the one now widely followed in the United States: the repeat sale price index (RSPI). According to the RSPI produced for Canada by Teranet Inc. and National Bank, resale house prices are only down about 1%.

Cynics may wonder why CREA continues to publish such dodgy data. Could it have something to do with the fact that real estate agents — like churning stockbrokers — want “to make deals and make them fast,” as Freakonomics authors Levitt and Dubner describe? That is, the perception of tumbling house prices likely makes house sellers more susceptible to admonishments from real-estate agents to lower their asking price on, or after, the listing –which reduces the agent’s listing time. If house prices are not tumbling, homeowners are more likely to keep the agent working on getting a better price.

The readings come from a new index of resale-house price changes, the Teranet–National Bank National Composite House Price Index. It is considered a less biased measure than currently used measures because its repeat-sale methodology controls for changes in the mix of houses over time.

An analysis by Worthwhile Canadian Initiative blog may be of interest to those concerned about a U.S.-style meltdown in Canada. The first chart below compares U.S. and Canadian house price trends (measured by the repeat-sale methodology). It shows a less extreme rise for Canada and so far, much less of a correction. The second chart shows the ratio of house prices to gross national income, which reveals Canadian house prices shot up a lot less than U.S. house prices relative to incomes. Thus, the correction in Canada is likely to be much milder.

Another reason for do-it-yourself investing. And a second reason. And a third.

 A clear winner in the RRSP vs. TFSA debate.

Shopping for corporate bonds like going into a candy store.

More love for bonds.

Special report on self-directed investing.

Eliot Spitzer’s thoughts on salary caps for CEOs

Leading the slide were Calgary house prices, which were down 7.7%. Toronto’s year-over-year change was only 0.7%, followed by Vancouver (1%), Ottawa (4.2%), Montreal (5.1%), and Halifax (5.8%).

On a month-to-month basis, national houses prices fell by -1.1% between October and November. Toronto led the drop with a -1.6% change, followed by drops in Vancouver (-1.3%), Ottawa (-1.3%), Calgary (-0.9%), and Montreal (-0.3%). Halifax bucked the trend with a 1.3% gain.

While the situation isn’t as dire as CREA data would have us believe, things are slowing down in the housing market. The year-over-year change in the TNHPI has declined since the start of 2008, when it stood near 10%. Indeed, on a month-to-month basis, the index is down 1.1% between September and October.

Here is a breakout by city. Ottawa is the only city yet to show deceleration. Calgary is the only one with a yearly decline. Vancouver and Toronto are showing faster deceleration and are getting closer to showing zero or negative yearly changes.

So far, the Canadian housing market looks like it’s just going through the typical cyclical downturn where national-level price changes bottom out near zero or slightly below. There is no widespread forced selling due to foreclosures, as exists in the U.S. “Less than one per cent of Canadians are in real trouble with their mortgages,” McGill University economist Tom Velk told CTV News recently.

Of course, it doesn’t help to hear housing doomster Garth Turner (who has another book coming out, in January) say he “expects housing prices will plunge another 30 per cent next year, on top of the 11 per cent drop so far this year,” to quote a recent CP article. The problem with that expectation is that it is based on a faulty premise, i.e. house prices have already fallen 11%. In fact, they are still above year ago levels.

That 10% “decline” represents not a pure price decline but a change in the mix of houses sold. CREA is aware of this and just recently began publishing another estimate of house prices that supposed corrects for this distortion. This measure shows a 4.7% decline, as the Financial Post reports.

Yet, even this is suspect. I just finished doing a few posts on a less distorted method called the Repeat Sale Price Index (RSPI). It indicated house prices were 3.3% higher over the year to October.

The RPSI is not perfect but would seem to be the least biased. It is the method now widely followed by the U.S. media (i.e. the Shiller-Case indexes). And the New House Price Index published by Statistics Canada shows a year-over-year increase in October of 1.5%, closer to the RSPI than CREA.

I think it is a rather huge disservice to the Canadian public to disseminate such misleading statistics. If gives an overly negative picture of the housing market. It may scare house hunters away from the market and lead house sellers to list at a lower price, creating a self-fulfilling prophecy. Lies, damned lies, and statistics, goes the saying.

Anyway, the RSPI likely just needs time to catch on – the index was only announced earlier this month. One thing that could help get the ball rolling is when a financial group announces they have developed futures contracts or other derivatives to trade off the index – as was done for the Case/Shiller house price index in the U.S. market. Such derivatives open the door to hedging house prices, which was a good idea in the U.S. where house prices are now down nearly 20% over the year — see Trading housing futures post of Aug. 30, 2006.

While it appears the RSPI is a better alternative than the average-price measure presently used in Canada, some readers did not seem convinced it had solved all the problems. Paul wrote:

“… if you’re looking at repeat sales, what’s the chance that these houses were bought, renovated and then flipped for a higher price? This would skew prices higher than normal.”

I put this question to the creators of the index and got this response back from Simon Côté, Managing Director of Property Derivatives at National Bank of Canada:

“I will spare you all the detailed methodology (you can download the methodology from our website). Basically, the contribution of each transaction pair to the index value is not equal. The weighting of a given pair depends on how close its annual growth rate is to the average annual growth rate. The price of a house that has been subject to significant renovations will display an annual growth rate that is significantly different from the average, and its contribution to the index value will be significantly down weighted.
Moreover, if an asset property type changes between the first and the second transaction of a pair, the pair is rejected.”

Blogger Michael James on Money wrote about the RSPI that:

“… it does shrink the sample space considerably. Also, any method that looks only at sales can give skewed results. For example, if a period of time has mostly low-end houses sold, then looking at sales gives little information about the change in value of high-end houses. The best metric will be one that attempts to value all houses.”

The reply from National Bank was:

“Sample size: we screen ALL transactions registered. The actual pair count is published on the website (bottom part of the charts). There is more than enough data for the estimation to be statistically robust. A sample too small would result in high short term volatility in the index value. Sales vs. appraisals: we still think actual sales data is more representative than any appraising method (especially in periods of low trading activity). Sometime in the future, we may be able to publish index values for different tiers, high, medium and low price houses, but our first tests show very little difference between the three in terms of annual growth rate.”

But the year-over-year rate is decelerating in all six cities. The Teranet-National Bank website has some interesting graphs of the trends. It wouldn’t be surprising to see the rate of change get close to zero in months ahead given momentum in the series. And economic conditions are still deteriorating.

Calgary and Vancouver have been slowing down since late 2006 when they peaked at 40% and 25% year-over-year gains, respectively. For these cities, late 2006 and 2007 would have been opportune times to sell and switch to renting (or move to another city) — see Rent or buy? (22 Aug., 2006). The other four cities are slowing down from intermediate peaks near 9%, established in early 2008 or so.

Cumulative price gains over past years remain high. As can be seen in Table 2, house prices in Vancouver, Calgary and Montreal are still more than double what they were in June 1999. Ottawa and Halifax are up about 85%. Toronto, which has had the least volatility in prices of the cities, registers a 65% increase.

Table 1: Year-over-year house price changes (Oct. 2007 to Oct. 2008)
Vancouver 4.9%
Calgary -7%
Toronto 5.6%
Ottawa 5%
Montreal 6%
Halifax 5.5%

Table 2: Change in house prices since June, 1999
Vancouver 120%
Calgary 132%
Toronto 65%
Ottawa 86%
Montreal 106%
Halifax 84%

A new price index gets around the apples-to-oranges comparison and shows by how much CREA statistics miss the mark. The repeat-sale price index (RSPI), developed by Teranet Inc. and National Bank, says house prices are still above the level of a year ago (by 3.3%). For more detail on the RSPI, see the website maintained by Teranet Inc. and National Bank (also shows price changes at the city level).

The RSPI approach is what’s used in the U.S. for the S&P/Case-Shiller and the Office of Federal Housing Enterprise Oversight (OFHEO) indexes. And now that Canada has the same approach, comparisons with the U.S. are more valid (the S&P/Case-Shiller index is down almost 20% year-over-year, showing how much worse things are in the U.S. at present).

Why does CREA data show such a big drop in Canada? House sales have dropped off considerably in the high-priced province of B.C. The result is a lower average price for houses. But this is not a price decline: it’s a change in the mix of houses sold. CREA has undertaken to adjust its data, but the RSPI will remain the less biased measure and should be heard from a lot more in the future.

Defaults are scheduled to escalate because about $50 billion (U.S.) in option adjustable-rate mortgages (ARMs) will be resetting at higher rates in 2009 and 2010. Fitch Ratings “estimates payments will rise some 63% on these mortgages – increasing the average borrower’s outgoings by more than $1,000 a month.”

So here is another reason why the Federal Reserve is not likely to raise interest rates to fight inflation — in addition to other possible reasons cited. Rates are already being raised by financial institutions for a major portion of their customers, and by substantial increments. Why should the Fed pour fuel on the fire?

Institutions with big exposure to option ARMs are going to be pressured for some time, notes Cass on the breakingviews.com site. Two cases with high exposure are Wachovia and Washington Mutual.