Bank of Canada: House price-to-income ratio outstrips norm by 35%

I have noted a number of times in the past that household debt levels in Canada have reached worrying levels. I am not the only one on to this. Canadian central bank head Mark Carney was in the news yesterday sounding the alarm on this as well.

Testifying before the Commons finance committee, Carney told MPs that both debt accumulation and the number of new variable mortgages are declining sharply.

Household debt has kept growing in Canada despite the weak economy, mostly because, as Carney admits, the Bank of Canada has kept interest rates so low they are almost impossible for Canadians to resist.

But in recent months, debt accumulation has slowed to four per cent annual growth, from 10 per cent, and the percentage of new mortgages on short-term variable rates has fallen to the low teens, from as high as 30 per cent.

Carney said he still regards household debt — which currently is at a near-record 151 per cent of disposable income —as the No. 1 domestic risk to the Canadian economy, but he suggested the recent data was encouraging.

–Mark Carney notes household debt levelling, CBC News

As a reference point, I use a 2 standard deviation rule when talking about bubbles which puts an event at levels above 96.4% of all other events in a data series. I am not clear where these numbers lie on that continuum.

Also as a reference point, while household debt levels in the US were lower than Canada’s when the US property bubble popped, levels are significantly higher in Denmark and the Netherlands, which have also seen prodigious rises in house prices (Denmark’s is 310% of GDP while the Netherlands is 249% of GDP).

Mark Carney noted that Canadian household debt is being driven by a rise in house prices that has caused the house price/income ratio to now be 35% above the norm in Canada.

With housing prices to income levels running 35% above historic norms, Mark Carney, governor of the Bank of Canada, had some words of advice to heavily indebted households, telling them Tuesday to use “prudence and caution” because borrowing costs can only go up.

‘Household spending is expected to remain high relative to GDP as households add to their debt burden, which remains the biggest domestic risk’

Speaking to the House of Commons finance committee one week after the central bank again held its key interest rate at a near-record low of 1%, Mr. Carney said “mortgage rates are extremely attractive and that accounts for some of the move-up in [housing] valuation.”

But he added that consumers cannot rely on lending costs “staying there forever.”

Mr. Carney said when it comes to household debt “the message is one of prudence and caution,” adding that the average home price in Canada is about 4.75 times people’s income, while the historic average is closer to 3.5.

–Mark Carney: House price-to-income ratio outstrips norm by 35%, National Post

Again, the way to look at this if you were crunching numbers would be to measure all of these data points on a continuum to see how many standard deviations above norm these numbers are. I see two data points to consider:

1. Household debt above 150% debt to GDP
2. Price to income ratio of 4.75 versus 3.5.

In particular, if the standard deviation on price to income ratio in Canada is less than 0.6, then it looks like you have a bubble. And bubbles always end badly. Since I don’t have these numbers I don’t know. My hope is that Carney is sounding the alarm before things get out of hand. But if he really wants to do something, moral suasion will not be enough. We will need to see regulation of speculative lending, particularly in places like Vancouver and in the Toronto condo market.

P.S. – If anyone does have the data, including local data on Toronto and Vancouver, please let us know.