You Think Vancouver and Calgary Are Bad for Housing?

The Globe and Mail had this article that I thought was interesting, something Calgary and probably more likely Vancouver (Tdot O as well) could face soon. Link is here:
Real estate agent Andrea Gaus knew the market was out of whack when the price of a typical four-bedroom house near good schools in the leafy Maryland suburbs of Washington shot past the $1-million (U.S.) mark.

“It got to the point where appreciation was so high that it priced people out of the market,” Ms. Gaus said.

But the peak has passed, and the consequences of the deflating bubble are buffeting the housing market, in Washington and across the United States.

What sold in a weekend here last year is taking months to unload. And increasingly nervous home sellers are slashing prices to get rid of properties before their value sinks even further. One buyer recently threatened to walk away from a signed contract on a $1.6-million house unless the seller took $100,000 off the price to reflect the drop in value since the deal was struck. The seller quickly buckled, fearing the house might be worth even less if put back on the market today.

“Look how fast prices were going up. The same thing is happening on the way down,” observed Ms. Gaus, who’s been selling homes in Potomac for 16 years.

“It’s a very tough market.”

The once red-hot housing market has fizzled. And the topic du jour among economists, investors and policy makers is whether the end of the housing boom signals the beginning of the end of a long run for the world’s mightiest economy, and by association, the rest of the planet.

The U.S. housing crash may prove to be the economic equivalent of the canary in the coal mine — a warning of impending danger in an economy that has surged too far, too fast. Many experts are now openly speculating about a possible U.S. recession next year, brought on by consumers reacting to the shrinking value of their nest egg. If they’re right, the fallout could prove to be far nastier than the collapse of the technology bubble at the start of the decade.

The housing market has been a perfect conduit for economic activity, funnelling and leveraging billions of dollars worth of household wealth into consumer spending in recent years. The U.S. savings rate is negative now, but even a relatively modest shift toward savings now could have a dramatic effect on consumption, sending the economy into reverse. Joining a growing number of anxious forecasters, Prof. Morici puts the risk of recession in 2007 at 50-50.

“The wealth effect has been very important in fuelling the recovery,” he said. “It doesn’t appear like that is going to be available any more. Housing prices have finally outrun incomes.”

Runaway real estate prices, which had been growing in double digits throughout much of the country, are now pricing potential homeowners right out of the market. The ability of Americans to afford a home is the worst it’s been in two decades, according to the National Association of Realtors.

The past year has been rough on consumers. First, mortgage rates began to rise. Then, there was the jolt from sharply higher energy prices. And now the apparent end of the long real estate boom is at hand. It’s all combined to make Americans feeling distinctly poorer, and less confident. Mirroring other recent surveys, the U.S. Conference Board reported last week that its consumer confidence index suffered its biggest one-month drop in August since the devastation of hurricane Katrina a year ago.

Think it all doesn’t matter to you? Think again. For nearly a decade now, the United States has been the economic driver for much of the world — Canada included. The United States has been sucking up excess savings and consuming everything in sight, from cars to homes and everything that goes in them.

In the early 1990s, when Ms. Gaus got into the real estate business, investment in residential real estate represented less than 3.5 per cent of the economy. Today, it makes up 6 per cent. Add in all the products and services tied to real estate — furniture, big-screen TVs, home improvements and financing — and the total contribution is much larger.

Housing has also emerged as an increasingly vital economic driver — for consumption, jobs and overall economic activity.

Economist David Rosenberg of Merrill Lynch & Co. Inc. estimated that construction activity, combined with surging home values, accounted for nearly half of U.S. economic growth over the past three years, or 1.5 percentage points of the 3.5-per-cent average annual GDP increase.

Encouraged by low interest rates, innovative mortgages and a tax system that favours maximum leverage, Americans have been using their homes as ATMs. Thanks to generous lines of credit and multiple refinancings, they’ve renovated, furnished their nests and moved up to ever-larger homes.

In the past decade, the percentage of U.S. household wealth tied up in homes has climbed to 48.5 per cent from 38.7 per cent.

Americans have also super-sized their abodes. From 1975 to 2005, the average size of new single-family homes grew by 48 per cent — from 1,645 square feet to 2,434 sq. ft. — even as families shrunk in size, according to new data from the U.S. Census Bureau.

These larger homes come with more bedrooms and more bathrooms, spawning a bevy of retail chains to help homeowners furnish all that space, such as Crate & Barrel, the Pottery Barn and Bed, Bath and Beyond. In 1975, only 4 per cent of homes had more than 1½ baths. Today, nearly half of new homes do.

That has changed the way Americans spend. Nearly 15 per cent of every dollar consumers spend now goes toward housing-related items. That compares with 11.5 per cent in the early 1990s.

So perhaps it’s understandable that some forecasters may be underestimating the potential downside of this housing boom.

“The decline in housing will not be a mere sideshow,” warned Merrill Lynch’s Mr. Rosenberg. “The housing correction has all the markings of a three-ring circus that has the potential to pull consumer spending to the brink.”

He’s predicting that housing prices will fall by 5 per cent by next year, erasing $1-trillion worth of household wealth.

U.S. Federal Reserve Board chairman Ben Bernanke, for his part, has predicted an orderly deflation of the housing bubble, and a soft landing for the rest of the economy. But in the minutes of their Aug. 8 rate-setting meeting, Fed governors acknowledged that housing is “a downside risk” to the economic outlook. Prospects for the sector remain shrouded in “considerable uncertainty,” according to the minutes, released this week.

Part of the problem for economists is that while housing is now clearly in a slump, other parts of the economy are behaving as if nothing is wrong. Manufacturing, for example, continues to fair well, outside of the auto sector. Similarly, corporate profit and business investment are healthy and growing. Even retail sales and consumer spending aren’t yet showing the impact of the slump.

And if there’s a silver lining for Canada it is that we may not be as vulnerable to a U.S.-led recession as much of the rest of the world.

Economist Clement Gignac of National Bank Financial Inc. in Montreal argued that the price boom in oil and other commodities may keep Canada from following the United States into a recession. He said Canada escaped U.S.-driven downturns three times in the 1970s, and this time could be the same. He puts the odds of a U.S. recession at 40 per cent, but just 15 per cent north of the border.

In Potomac, Ms. Gaus lamented that too few people have fully adjusted to the harsh reality that it is now a buyer’s market.

For sellers, that means accepting less, possibly waiting months to sell and being ready to make huge concessions.

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