Carney Bank of Canada rates in housing boom prompts bubble talk

TORONTO: Bank of Canada Governor Mark Carney’s pledge to freeze record-low borrowing costs through June may be raising the chances of a bubble in home prices even as it helps the economy recover from its first recession in 17 years.

Sales of existing houses rose 74% in October from the January low, with prices up 21% from a year ago to a record C$341,079 (RM1.01 million), partly because of Carney’s promise -- the only date-specific commitment from a Group of 20 central banker. To prevent the economy from overheating, Carney will raise his benchmark rate by 125 basis points to 1.5% in 2010, while Federal Reserve Chairman Ben Bernanke will keep his key rate at 0.25%, said Stephen Gallagher, chief US economist in New York at Paris-based Societe Generale SA.

“The worry has got to be that you might be getting a housing bubble out of this,” said David Laidler, a former visiting economist and special adviser at the Bank of Canada and now a fellow at the C.D. Howe Institute, a Toronto research group. Laidler is a member of the institute’s Monetary Policy Council, which studies central-bank decisions and said in a Dec 3 statement that a “possible unintended effect” of Carney’s commitment is “the buoyancy of mortgage lending, particularly variable-rate mortgages, and the housing market.”

For now, analysts at Toronto investment banks Scotia Capital and RBC Capital Markets are recommending that investors buy shares of companies such as Home Capital Group Inc, even after the Toronto-based mortgage lender has gained 168% to C$42.05 since its 2009 low on Feb 11.

Potential bubbles

“The challenge right now is getting the economy going and dealing with any potential bubbles down the road,” said Ian Nakamoto, director of research at MacDougall MacDougall & MacTier Inc in Toronto, which manages about C$4 billion.

Carney’s situation reflects the conundrum faced by policy makers who must weigh the trade-off between stimulating their economies now with ultra-low rates and dealing later with the fallout from unintended consequences.

“It is time to break the daisy chain of asset and credit bubbles and the global imbalances they spawn,” Morgan Stanley Asia Chairman Stephen Roach told a conference in Vancouver Dec 1. “If we fail, there may not be another chance.”

Carney, 44, has made it clear that stimulus is his priority. Only if the outlook for inflation shifts would the bank break its promise, he has said.

“Rates are exceptionally low, they are exceptionally low for a purpose and we have given pretty clear guidance on how long we expect they will have to remain at these levels in order to achieve the inflation target,” Carney told reporters Oct 22. The bank projects the consumer price index, which rose at a 0.1% annual pace in October, will reach the target of 2% by the second half of 2011.

International investors

The central bank hasn’t talked much about house prices, “to the bafflement of international investors,” said Eric Lascelles, chief economist and rates strategist with TD Securities Inc in Toronto. The bank’s next opportunity comes tomorrow in an interest-rate announcement scheduled for 9am New York time.

“It makes perfect sense that there is a good appetite for the housing market,” Lascelles said. What isn’t clear is “whether this is a bubble in the making or simply a recovery from earlier softness.”

The New York-based Trump Organization, founded by real-estate developer Donald Trump, is building a 60-story Trump International Hotel & Tower in downtown Toronto. The residential condominiums sell for at least C$2 million.

Canada will be “one of the first markets” that “we’ll look at in the upswing,” said Donald Trump Jr, 31, executive vice president of development and acquisitions.

‘Once In a Llfetime’

Canadians are jumping at “what they perceive as a once-in- a-lifetime opportunity,” said Peter Gilgan, 58, founder and chief executive officer of Oakville, Ontario-based Mattamy Homes Ltd, Canada’s biggest homebuilder.

The average five-year mortgage rate was 5.59% last week. In May it was 5.25%, the lowest since 1951, according to Bank of Canada figures.

Sales of existing homes will rise to 492,300 in 2010, up 7% from 460,200 this year, according to the Canadian Real Estate Association, an Ottawa trade group -- the second-highest total on record after 520,747 in 2007.

The booming housing market partly reflects the strength of Canada’s financial system, which was named the soundest in the world for two consecutive years by the Geneva-based World Economic Forum.

No bailouts

No banks collapsed or sought a bailout during the biggest global credit crunch since the Great Depression. In the U.S., the Treasury Department’s Troubled Asset Relief Program provided a total of about $205 billion in capital injections to banks, according to the department’s most recent report on Nov 25.

Lending practices at Canadian banks have been more conservative than those of U.S. financial institutions, said Ivan Wahl, chairman and chief executive officer of mortgage provider Xceed Mortgage Corp. Subprime loans accounted for 5 percent at the peak of Canada’s market in the summer of 2007. Even in that segment, default rates are about 3% compared with 30% in the US, he said.

“We’ve never had the traumatic problems,” said Wahl, whose Toronto-based company targets customers who have trouble getting mortgages with the largest banks. “We have one of the most constructive, positive and stable real-estate markets in the world.”

Shrinking economy

Canada’s economy shrank for three quarters starting at the end of 2008, one period less than in the US. Canada’s unemployment rate was 8.5% last month compared with 10% in the US. The 1.5 percentage-point gap was just under October’s 1.6 point difference, which was the widest since at least 1976.

The state of the housing market reflects “an element of pent-up demand,” Carney told reporters Nov 19. “Rates are exceptionally low, affordability has improved in part because of the low level of interest rates and part because of some former price adjustments, and we are seeing a housing-price response.”

His view is shared by Peter Aceto, chief executive of Toronto-based ING Direct Canada, a unit of financial-services company ING Groep NV in Amsterdam, that has 1.6 million customers including 125,000 mortgage clients and C$33 billion in assets. “I don’t believe that there’s a bubble,” he said. “Most stories I hear are just typical Canadians trying to buy their first home or move up.”

Aceto said he is seeing some unusual signs, particularly in the Toronto market, where houses are getting as many as five offers at a time and prospective buyers are trying to woo sellers with personal notes or gifts.

‘Waiving conditions’

“When Canadians are waiving conditions and paying 10% more than asking for a home, it does give you some pause,” he said.

If policy makers are concerned about a possible bubble, they might look to tools other than interest rates to cool the market, said Brian Johnston, 51, president of Monarch Corp in Toronto, the Canadian division of London-based Taylor Wimpey Plc, the UK’s largest homebuilder by market value.

“They might encourage lenders to be a little more circumspect in their mortgage qualifications; they may look at the amortization periods on mortgages,” he said. “I don’t think they can control housing through fiddling with interest rates.”

Last year, the Department of Finance said Canada Mortgage and Housing Corp. would limit amortizations to 35 years and 95% of the loan value. The government’s housing agency had offered mortgage insurance on loans worth as much as 100% of the home value and amortization periods of as many as 40 years since 2006.

Sector outperform

The strong market will help companies such as Brookfield Real Estate Services Fund, said Rossa O’Reilly, a financial analyst at CIBC World Markets in Toronto. O’Reilly raised his rating on Brookfield, which has about 14,500 brokers and agents under brands such as Royal LePage, to sector outperform in July, and in November raised the share target price to C$12.50. It closed at C$11.48 on Dec 4.

The fund is a subsidiary of Brookfield Asset Management Inc, which, along with Simon Property Group Inc, has purchased part of General Growth Properties Inc’s bank debt and bonds and may make bids for all or part of General Growth, the Wall Street Journal reported last week, citing people familiar with the matter it didn’t identify by name.

Hardware stores

Other industries will also benefit, notably appliance and furnishing manufacturers and retailers including Boucherville, Quebec-based Rona Inc, O’Reilly said. Shares of Canada’s largest home-improvement chain have returned 22% this year, lagging a 31% return for Canada’s benchmark stock index.

Paul Lai, 55, and a dozen other real-estate agents camped out for 10 days along Toronto’s Bloor Street in late November for the chance to buy a home that won’t be completed for four years.

“Where else is the world do you have agents lining up overnight to buy a condominium?” said Lai, with Tradeworld Realty Inc, a firm that has a sales staff of more than 200. He was bidding for a client on a condo costing as much as C$500,000. “We’re making history here,” he said. -- Bloomberg