Castles made of sand
Are property values the next victim of the markets?
Where has all the money gone? Long time passing. Where have all the stocks gone? Long time ago. Where have all the options gone? The CEOs have picked them every one.
Apologies to Pete Seeger, but he would get a good chuckle over the fine pickle capitalism finds itself in in the new millennium. Without an opponent in sight, capitalism is eating itself.
The gnashing of teeth that has accompanied the year-long throes of the stock markets is grabbing all the headlines, but a far greater threat to capitalism is waiting to drop its Damocles sword on our collective wealthy nation heads. The pressure created by the loss of over 40 per cent of the value of U.S. and Canadian stocks has the potential of doing what even a recession could not – exposing the shams of building an economy on consumer debt and inflated property values.
If our stock markets were made of bubbles, our castles are made of sand. The recent movement of large-scale money from the faltering markets into the safe haven of property may hide the underlying weakness of our real estate markets for now. But eventually, like stocks, property values will crash if too many people try to sell at the same time. Increasing interest rates and the erosion in property value caused by the general decline in wealth could trigger a property sell-off and a resulting price slump.
Too much money in search of too much profit created the bubble that is now deflating all over the average stock investor’s portfolio. This sudden reduction in wealth should leave more than a few folks scratching for cash and looking to sell property. Even if they decide to hang on in the short-term, low inflation and increasing interest rates will suck the value out of their investment and further harm the perilous consumer asset-to-debt ratio that has driven our economy for the past 20 years.
The growth in property values throughout the Western world has been a critical link in the both the remarkable economic growth of the ’90s and the minor recession we experienced earlier in this decade. Nothing gives a person more economic confidence than the belief the ground and pre-fab they call home is growing more valuable each day.
That confidence was a factor in the growth from 1993 to 2000 that gave both Ralph Klein and Jean Chretien such fat heads. It was overshadowed by the success of the stock markets, but even the average person’s confidence in investing, which played such an important role in the stock market ramp-up, was due in part to the appeal of property. Low interest rates made property affordable and its value only went up. In the last two years, that confidence has played an even more important role in avoiding an overdue economic correction.
Sure, our personal debt increased during the boom times, that is normal, but it kept growing even after the economy stopped. That is not normal and it is not healthy. A critical element of the economic cycle is people reducing the risk of debt during economic downturns. That did not happen in the past two years. Instead, Americans and Canadians heeded their politician’s pleas – the call of accumulation and the lure of cheap and accessible consumer debt – and continued their buying spree.
By 2001, Canadians owed $200 billion in consumer debt, not including mortgages. That is roughly 20 per cent of our annual economic output, and it continues to grow. Until the last few months, those who cautioned against the growing debt and declining spending habits could be dismissed because the ratio of Canadians’ debt to assets was in fact declining. The recent vanishing of equity assets has changed that.
The problem with the debt-to-asset ratio is that debt is stable, especially during periods of low inflation, but the value of assets – as we now know – depends on people not blinking. If everyone tries to sell at the same time, the prices crash. The same holds true for real estate.
Property values – except in post-boom Calgary – generally do rise, but that is dependent on the economic value of inflation. Inflation makes your property more valuable by reducing the value of your debt over time. Thanks to the remarkable inflation-fighting actions of our central bank, the value of this annual price discount on property has declined significantly.
In the short-term, the money moving out of the stock markets may move into real estate and continue the unprecedented growth in property values that low interest rates and wealth creation have fostered. In the long-term, however, can property values hold up when the conditions that created them falter? |
