After decades of the Canadian real estate bubble inflating steadily, the market is finally cooling down. Buying a home is increasingly becoming an unattainable dream for most working class Canadians, especially for young people. The recent rise in interest rates has thrown a bucket of ice water on the overheated market and has led to a drop in home prices and a slowdown in sales. However, this is not good news for the working class.
On Jul. 13, the Bank of Canada raised its benchmark interest rate by one per cent to reach a total 2.5 per cent. This was the largest increase since 1998 and the fourth since March.
Faced with runaway inflation, which stood at 8.1 per cent in Canada in June, central banks around the world have responded by raising interest rates. But this heavy-handed remedy is having dangerous side effects.
For years, historically low interest rates have fueled the Canadian real estate market, driving down the cost of mortgages and encouraging investors to buy on borrowed money. The economic crisis of 2008 and the period of anemic growth in the years that followed pushed investors away from the real economy and into speculative investment vehicles. This speculative boom has caused Canada’s real estate bubble to swell to the point where it ranks second in the world.
Recent data from the Bank of Canada shows that Canadian housing is at its lowest level of affordability in 30 years. For example, in Vancouver, the price of a home increased by 337 per cent between 2002 and 2018. And the already frenetic pace of price increases accelerated even further during the pandemic.
The question of when this bubble would burst has been debated for a long time. Many have wrongly predicted it. But this may just be it this time. The Royal Bank of Canada expects the real estate market to experience a “historic correction“, the worst in 40 years.
The housing market is already in a steep decline. As it becomes more expensive to take out a mortgage, buyers are thinking twice, or are simply unable to afford it. As a result, sales have slowed significantly. A Royal Bank of Canada report states that in Toronto and Vancouver, “the decline in activity is quickly becoming one of the deepest of the past half a century”. In Toronto, sales are at their lowest pace in 13 years. July marked the fifth consecutive month of declining residential property sales. Sales were down 5.3 per cent compared to June, and down 29.3 per cent from the same period last year.
As it becomes more difficult to find buyers, sellers must lower their prices. In Toronto, the average selling price has dropped by 14.1 per cent from its February peak. Desjardins expects a 25 per cent drop in prices across the country by the end of the year.
This drop in prices in turn puts downward pressure on the pace of sales by discouraging speculative investors.
The consequences could be significant. Normally, an increase in interest rates would not have an immediate large-scale effect on mortgages, as the vast majority of mortgages in Canada are fixed rate. A fixed rate means that the increase in the key interest rate is not reflected until several years later, when the mortgage is renewed, which is usually after five years.
However, variable rate mortgages have expanded at an historic level since the pandemic. More than half of all mortgages taken out in the second half of 2021 and the first two months of 2022 were variable rate, according to the Canada Mortgage and Housing Corporation (CMHC). This compares to only seven per cent of new mortgages that were variable rate before the pandemic.
This type of mortgage is very vulnerable to changes in interest rates. For example, a first-time buyer who took out a mortgage in May could suddenly see the interest on their loan double in one month and find themselves with a monthly payment hundreds of dollars higher than they budgeted. This is while the cash value of their home is declining. Not to mention that the Bank of Canada is expected to raise its key interest rate by at least another 0.5 per cent in September.
And let’s not forget the fixed rate mortgages that are coming up for renewal, which will also create many unpleasant surprises.
Thus, we could find ourselves in a situation where many mortgage holders, unable to make their payments because of higher interest rates, would have to sell their houses, but in a context of declining house prices. Depending on the depth of the crash and where prices bottom out, some could end up getting back less in the sale of their home than the amount of their mortgage. Not only would all these mortgage holders find themselves with a gaping hole in their finances, but this would further depress house prices, with all these houses being put on the market and no one to buy them, in a downward spiral.
So far, we have not seen a wave of bankruptcies. The mortgage delinquency rate (i.e., the proportion of borrowers who are more than 90 days behind on their payments) remains very low. However, it’s important to understand that people tend to exhaust all their options before missing a mortgage payment. Tania Bourassa-Ochoa, Senior Economist at CMHC, tells CP24, “I think in the next couple of months, in the next couple of quarters, it’s going to be interesting to look at delinquencies on other credit products, like credit cards, auto loans, personal loans.”
There might be a delay in terms of a wave of defaults, but soon many working Canadians will have to tighten their belts. Already, stories are emerging of mortgage holders who fear they will have to cut back on groceries, according to Toronto mortgage broker Ron Butler.
The impact is also being felt by renters. The increased cost of mortgages is causing more people to abandon the idea of buying a home and choosing to rent instead. The transfer of demand from the housing market to the rental market is pushing up rent prices. The average cost of renting in Canada rose 9.5 per cent on an annual basis in June, reaching $1,885.
Meanwhile, big investors are sniffing out a golden opportunity. According to Christopher Alexander, president of ReMax Canada, falling home prices could attract institutional investors, who are not dependent on credit and therefore not affected by rising interest rates. As a result, we are likely to see a concentration of housing in fewer, bigger hands. In fact, it has already been reported that Blackstone, an investment management company, has amassed $50 billion to purchase real estate at bargain prices during the downturn, some of which will certainly be invested in Canada.
Already, the share of housing owned by large investors has increased from zero per cent in 1996 to 10 per cent in 2020. These investors see housing as nothing more than a cash cow from which to milk more and more rent. These parasites will contribute all the more to making housing unaffordable for workers.
In a context where the warning lights are flashing around the world about the risk of recession, the decline of the Canadian housing sector presents a particularly significant risk. Canada’s seemingly never-ending housing bubble has led the country’s economy to become unhealthily dependent on this sector.
This is particularly evident in the ratio of residential investment to GDP, which stood at 8 per cent in the first quarter of 2022. As Better Dwelling explains: “During the US housing bubble, experts warned residential investment had become too large. Households were diverting money from everything else, and just putting it into housing. At its worst in 2006, residential investment represented a whopping… 6.7 per cent of GDP. It’s a huge number that had experts ringing alarms. Canada’s economic output is about 20 per cent more dependent on housing than the US at peak bubble.”
According to the Financial Post, the consequences of the decline in the residential market will be “carnage”. Several sectors such as construction and insurance are partially dependent on the residential sector and could fall like dominoes.
Already, the pace of residential construction appears to be showing early signs of slowing, although it remains strong. Real estate consultancy Urbanation estimates that 10,000 homes will be delayed or cancelled this year in the Greater Toronto Area. June saw the first decline in residential construction investment in nine months.
For example, the Financial Post predicts that, at best, a cooling of the residential sector to the mean would result in a 1.4 per cent decline in real GDP and a 1.4 per cent increase in unemployment. The danger of the residential sector dragging the rest of the Canadian economy into a recession is very real. CMHC considers it likely that Canada will experience negative growth for the first two quarters of next year. And as in any economic crisis, the capitalists and their governments will put the burden of this crisis on the shoulders of workers through layoffs, wage cuts and cuts to social services.
In the Communist Manifesto, Marx and Engels point out that the ruling class can only overcome capitalist crises “by paving the way for more extensive and more destructive crises, and by diminishing the means whereby crises are prevented.” The rise in interest rates and its repercussions are a good example of this phenomenon.
Since the 2008 crash, the capitalist system has been stumbling from one crisis to the next, each time picking itself up while creating more problems down the line. It became addicted to cheap money in the form of extremely low interest rates and printing money, so-called “quantitative easing”. This cheap credit fueled a speculative bubble on the housing market, as explained. A large part of the Canadian economy has been living on borrowed money. Canadian household and government debts are both at historic highs.
This money frenzy reached its peak in 2020-2021 with the COVID crisis, when governments around the world injected colossal amounts of cash into the economy to prevent an economic collapse.
The resulting dramatic increase in the money supply was not accompanied by a proportional increase in economic activity. In other words, for every dollar created, there was not a dollar of goods created at the other end. The result was that each dollar corresponded to a lower value—each dollar was worth less. The chosen solution succeeded in preventing an economic collapse, but created a different problem: inflation.
The ruling class is thus faced with a new problem, as rapidly rising prices make business more unstable and unpredictable for the capitalists. According to bourgeois economic orthodoxy, inflation is a problem of “overheating” in the economy, which pushes up prices. Higher interest rates “cool” the economy by encouraging savings and discouraging consumption, which should theoretically lower demand and thus reduce price pressure.
It remains to be seen if and when the interest rates hike will actually reduce inflation. But for now, it is creating other problems, as we have explained, and it could act like a match thrown into the powder keg that is the Canadian economy, with its high levels of indebtedness, stagnant incomes, rapidly rising costs of living and housing bubble. Some even fear that it will trigger a nightmare scenario of stagflation, if it fails to cut down inflation but succeeds in slowing down economic activity.
But for the ruling class, the danger is not simply economic—it is above all political. The whole situation hangs by a thread. The failure to solve the problems of inflation, a slowdown in the housing market or worse, the bursting of the housing bubble, could all trigger a wave of mass political struggle against the capitalists and their system. We have already seen how inflation is pushing workers into struggle in one country after another, such as the U.K. with a wave of strikes, or Sri Lanka, where the government was ousted by a mass uprising.
The Canadian ruling class is certainly trembling at these developments and wondering when its time will come. Each development in the growing economic crisis brings the coming political crisis closer. As revolutionaries, this means we need to prepare ourselves for the battles that are surely to come.