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What Housing Prices Do to the Canadian Psyche

08/06/2013 12:14 EDT | Updated 10/06/2013 05:12 EDT
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The global forecasting firm Capital Economics released an interesting projection on July 31 for the Canadian economy and housing market. Predicting an outright correction in house prices on the horizon (versus a "soft landing"), the firm stated it believes Canada will experience much slower economic growth over the next few years than others' have suggested.

The report is worth reading due not only to the contrarian economic perspective it offers, but for the questions it raises about how Canadians will respond if their projections prove to be accurate. At the very least, it identifies how basing our debt and financial management upon assumptions, generated from the last decade of steady house price increases, could be worthy of second thought.

While the Bank of Canada and other economists have forecasted that Canada will enjoy accelerated growth in the economy in the latter part of 2013, which they believe will continue into the subsequent two years, Capital Economics have predicted quite the opposite.

The firm's Chief Economist sees meager growth for the remainder of 2013 and 2014 that only increases to a more noteworthy level starting in 2015. The contrarian economic view is based predominantly upon Canada's housing market and what the firm sees as a correction coming in house prices.

Acknowledging that others have predicted a "soft landing" to the country's overheated housing market, the Chief Economist indicated that he thinks "people are really under-estimating the risks to the housing market" and pondered rhetorically "is no one worried about this?" Some may be, as the Bank of Canada itself has identified a significant drop in house prices as the number one domestic risk to the country's economic growth.

Whether or not Canadians see a "soft landing" or an outright correction in house prices, the more high level consideration many should be pondering is that everyone is in agreement that house prices will not continue their exaggerated growth of the last decade. While Euro Pacific Capital reported in August, 2012 that Canadian house prices increased almost 100 per cent since the year 2000, a TD Economics study released in March 2013 indicates that this boom is over and house price increases over the next decade will match inflation and produce little real return.

This radical deceleration in house prices could have a comparable impact upon people's psyches, let alone their finances. After years of unbridled appreciation in the value of their primary asset (i.e. their home), many have developed an ardent confidence based upon the expectation of a continuance of this trend.

They have extended this confidence to their interpretation of their finances. As personal debt loads in Canada have soared to record high levels, their overall financial confidence has remained steadfast due to the offsetting spike in the value of their homes year over year. Their balance sheets, if you will, have more than held their own. Indeed, many have also used their home as an "ATM machine", pulling out the growing equity to fund more spending, often due to an expectation that the house would continue to rise in value.

So when reading the forecasts of various economists about what type of correction we'll see in house prices over the next few years, the question for this debt help professional is not so much about whether or not it will be "soft" or serious, but "how" people will respond. If the entrenched confidence that has resulted for many after a 100 per cent spike in the value of their home is not tempered with changes to their debt and financial plans, what will occur?

Many may wish to view the end to the housing boom as an end, or alteration, to the spending patterns they have come to accept as their norm. This point becomes all the more true when interest rates, eventually, start to rise and servicing increasing debt loads becomes more onerous. If Capital Economics is correct, and we see a significant correction in house prices, then this point takes on a life of its own.

Most Expensive Houses For Sale In Canada - June 2013