Ottawa could soon join the list of trouble spots
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The Bank of Canada doubled down on its concern over the red-hot real estate market, using its latest checkup on the health of the financial system to warn that speculation in some of the biggest cities has made the country more vulnerable to a debt crisis.
The central bank singled out the Greater Toronto Area, Hamilton and Montreal as experiencing worrisome signs of “extrapolative behaviour,” which is the way Governor Tiff Macklem and other policy-makers describe market dynamics that they see as out of line with the fundamentals of supply and demand.
Ottawa could soon join the list of trouble spots, the Bank of Canada said in its latest Financial System Review (FSR) Thursday.
The central bank uses the report to assess vulnerabilities in the banking system that could trigger a financial crisis if exposed to the right shock.
Policy-makers listed six weak points in total: elevated levels of household debt; a frothy housing market; fragilities in the market for corporate debt; a “high potential” that demand for cash and cash-like assets could outstrip supply in the face of a panic; the threat of cyber attacks; and too many assets whose prices fail to reflect their exposure to climate change.
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Vulnerabilities are different from risks in Bank of Canada parlance because officials aren’t saying that a financial crisis is a possibility. Rather, they use the FSR to flag issues that could turn into bigger problems.
Housing is the vulnerability that appears to be generating the most concern. Since the summertime rebound last year in housing activity, the market hasn’t relented despite waves of lockdowns and job losses. Propped up by government support and low interest rates, demand for housing has surged while supply has scarcely caught up.
“While fundamental factors sparked the rapid rise in house prices, a concern for financial stability is that the increase may also have been driven partly by expectations of future price increases,” the central bank wrote in the review.
The expectations of higher prices in the future can become “self-fulfilling” for a time, the bank said, as people pull forward their plans to buy homes for fear they will be priced out if they wait. This behaviour puts upward pressure on demand and can attract investors looking to flip a quick profit, further straining the market, especially when supply is low.
All this can exacerbate extrapolative behaviour and lead to a correction in prices. The bank pointed out that the markets in the GTA, Hamilton and Montreal are alarming, with Ottawa close to the brink. In some cities, multiple offers have made bidding wars commonplace; sellers are reaping fat profits because final sale prices are exceeding listing prices; and buyers continue to expect price growth.
The bank, with a new approach to assessing the market, suggests these markets are “exuberant.”
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