Cognitive Dissonance and Canada's Real Estate Boom

Yesterday, on Victoria's housing blog, House Hunt Victoria, a real estate agent said:

Wrote 4 unconditional offers over the weekend ranging from 30k to 110k over asking and none accepted. It is brutal out there ...

Phew — as the last patches of snow from last week's storm melt away, the real estate market is so crazy in the capital of British Columbia that an agent not only needs offers above asking, they need offers much, much above asking.

Million-dollar Vancouver home. Image source.

The median house price in Victoria, Vancouver and Toronto is now something like ten times the median household income.

That's tough for young folks wanting a home of their own before starting a family, especially as they mostly earn less than the older generations that own most of the real estate available for sale.

How tough is suggested by a comparison with say forty years ago when houses in Canada's largest urban centers mostly cost only a couple of times median family income. True, interest rates were much higher then, but when prices were so low, a mortgage was often not even necessary, whereas, today, young couples are committing much of their life-time earnings to owning a home, and that probably, a home near the bottom of the spectrum of desirability in location, size and elegance.

Which raises two questions:

What's driving prices so high, and why are people still buying?

The answer to the first question is simple or complex depending on how deeply you want to delve.

Million-dollar Toronto home. Image source

Real estate is a desirable commodity and thus people tend to pay whatever it takes to own it, which means that, in a competitive market with a limited supply, people pay as much as they can afford, which in turn means that they pay as much as they can afford to borrow, an amount determined by the rate of interest and various government-imposed rules concerning minimum mortgage down-payments, and mortgage insurance.

So real estate prices are high now because (a) the Bank of Canada lending rate is stuck at a mere half percent above zero, which is half a percent above the point at which borrowing rises to infinity, and (b) the Government of Canada shored up Canada's banks by taking billions of risky mortgages off their hands following the 2008 financial crash.

Beyond that, one could discuss why the Bank of Canada and the Government of Canada have combined their efforts to insure dirt cheap mortgage lending.

Of the chief factors, one is the foolish action of the Harper Government in backing endless expansion of tar sands oil projects. The result was to make Canada the world's fifth largest oil exporter, after Saudi, Russia, Iraq and the United Arab Emirates. It also drove the Loonie to parity with the US dollar, which killed much of Canada's manufacturing sector, already weakened  as a consequence of the Mulroney Government's Free Trade Agreement.

Thus as the Western world exulted at the pain suffered by the Russians following the 2015 oil price collapse, Canada also suffered, our oil exports per person far exceeding Russia's. As a result, the Government of Canada has necessarily focused on preventing economic implosion.

The Russians accommodated the oil price crash with a 50% ruble devaluation and an an import replacement drive. Canada has accommodated the oil price crash with a 25% currency devaluation and a housing boom.

Canada is weathering the storm on the backs of its young adults, reinforcing the Trudeau-Liberal Party policy of driving down the fertility of the Canadian population and making up the deficit with people from elsewhere.

Which leads to the second question:

Why don't young people just leave Canada's great urban centers and head for a small town on the prairies, or emigrate to Africa or India or somewhere where the cost of a conventional life-style is less insane?

The answer: cognitive dissonance reduction.

Cognitive dissonance reduction is just a fancy term for the process whereby a person who finds they hold beliefs that contradict one another, tends to abandon one belief or the other — which is only sensible. In the case of young Canadian adults wishing to have a house and raise a family, the conflicting beliefs with which many must deal are:

(1) With house prices so high, only a fool would buy now; and

(2) Everybody buys a house and raises a family, so it cannot be crazy to commit most of one's life-time earnings to owning a more or less crappy stick-frame box of minimal intrinsic value on a handkerchief-sized lot.

Because the reproductive impulse is a potent force even in the decadent and dying state of Western civilization, Belief No. 2, wins out, and Belief No. 1 is either abandoned, or it is made compatible with Belief No. 2 by the adoption of Belief No. 3, for example, that house prices always rise and therefore however much one pays for a house now, it will prove in the years ahead to be an excellent investment.

Belief 3, may indeed prove true, although a major rise in interest rates any time in the next decade or two, could devastate the financial fortunes of those who embrace it.

Related: 

Garth Turner: The House Tax

Garth Turner: More on Taxing Houses