Canada’s housing agency is painting a bleak picture of the damage that a severe housing market correction would inflict on the country, pulling back the curtain on its stress tests for the first time.
As with all stress tests, the limits are pushed to provide a worst-case scenario - or something pretty close.
The Canada Mortgage and Housing Corp’s “primary bedrock scenario” for its test is a 30-percent plunge in home prices and 5-percent spike in unemployment.
In a behind-closed doors speech to a Bay Street audience Tuesday, CMHC CEO Evan Siddall noted that’s what happened in the U.S. in 2008 as the housing market imploded.
The fallout for the CMHC would be an eight-fold increase in insurance claims to more than $13 billion over 5 years. The agency’s $7.5-billion profit over that period would swing to $2.8-billion loss.
Let’s stress test the CMHC’s stress test.
First, is Canadian housing bound to suffer the same fate as the United States?
BMO senior economist Sal Guatieri says the problem south of border was the subprime borrower, and that’s not the case in Canada.
In an interview Wednesday on BNN, Gautieri said it would take a big shock to the economy and the job market to push housing into a severe correction. Vancouver and Toronto, he added, are the most vulnerable in an environment of sharply rising interest rates and unemployment.
The CMHC laid out three additional scenarios that would rock the housing market:
- Global economic deflation persisting for 5 years.
- Oil price shock, with crude at US$35 a barrel for 5 years.
- A magnitude 9 earthquake epi-centered in Vancouver, that also results in the failure of a major lender.
Let’s test these three as well.
There is a great deal of concern globally about economic deflation. Famed bond investor Bill Gross of Janus Capital recently said the global economy is “dangerously close to deflationary growth.”
The IMF is also among a chorus of international voices worried about deflation, as investors nervously eye slowing growth in China and fret about money fleeing emerging markets.
So there is definitely a basis for concern on global deflation.
When it comes to an oil shock that keeps crude oil at $35/barrel for 5 years, that does appear to be at the extreme end of forecasts.
The IEA is forecasting it will take another four years before prices reach US$80 a barrel, but does warn there’s a risk it could stay below $60 for years to come.
Canada’s budget watchdog has WTI crude slowly grinding its way higher to $59 a barrel by 2020.
A quick survey of other forecasts suggests oil at $35 a barrel for 5 years is at the extreme end of possibilities.
Then there’s the scenario in which Vancouver is hit with a magnitude 9 earthquake centered in Vancouver that results in the failure of a major lender.
Place your bets on that one. The last big quake to hit B.C. was in 1946 on Vancouver Island. Emergency Management B.C.’s models put the death toll at almost 10,000 and more than 128,000 injuries in a major quake.
There doesn’t appear to be anything in the model about the quake also taking down a major lender.
Siddall also highlighted the risk foreign investment in the housing market poses if prices correct. While the agency lacks firm data, he says foreign money may be “more mobile” and “subject to capital flight.”
That means hot foreign cash would high-tail it out of Canadian real estate if things got grim.
“This would increase volatility in domestic housing markets,” said Siddall, who added it’s very possible that foreign buyers account for “substantial portion” of demand in Toronto and Vancouver’s high-end markets.