October 24, 2008

Everyone appears to think that the credit crises that engulf the world trace back to American greed. In this case, though, everyone appears to be wrong.

Did the U.S. compel Iceland's three bankrupt banks (which didn't hold a single subprime mortgage) to guarantee 5.4 per cent on foreigners' deposits? Do we make the U.S. responsible for Europe's absurdly inflated housing prices? Aren't smart, affluent Europeans as responsible for Europe's housing crash as hapless, poor Americans? In 2006, after all, one-bedroom apartments in Dublin sold for $600,000 - as much as $125,000 more than they now forlornly list.

When the International Monetary Fund published its world economic outlook earlier this year, it calculated the top-of-cycle "bubble" component of housing prices, which it defined as "the house price gap," in Canada, the U.S., Japan, Australia and 13 European countries.

Among these 17 countries, the IMF determined that only two had a zero (or better) "house price gap." Canada emerged as one of these, with average house prices 2 per cent less than the fundamental worth.

(The other was Austria, with average house prices 6 per cent less than the fundamental worth.)

The IMF found that the U.S. did, indeed, have a house price gap at the end of 2007 - a bubble factor of 10 per cent that "could not be accounted for by fundamental economic factors." Compared with European house price gaps, though, the U.S. gap indicated only modest excess. The IMF put Ireland's price gap at 30 per cent, meaning that Ireland's housing price bubble is roughly one-third above fundamental value.

As well, the IMF calculated the mortgage debt of various countries as a percentage of GDP. Canada emerged, once again, as a country without inflated property values. Canada's housing debt was equal to 50 per cent of its GDP.

In the Netherlands and Denmark, mortgage debt was equal to 95 per cent of GDP. (Selected other countries: Austria, 80 per cent; Spain, 60 per cent; Ireland, 70 per cent.) U.S. mortgage debt was equal to 78 per cent of GDP, midway between Canada, on the one hand, and the Netherlands and Denmark on the other.

Canada fared well in these (and other) comparisons. But the much-maligned U.S. didn't fare all that badly. (The United States, the IMF report concluded, was among the middle-ranked countries in "vulnerability" to a bubble-busting correction.) Most European countries are decidedly worse off. Some confront the prospect of catastrophic house price crashes; some apparently confront the prospect of bankruptcy. The Baltic countries (Estonia, Latvia and Lithuania) are desperate. Spain is desperate. (Spain built four million houses in the past decade, more than Britain, France and Germany combined - most of them as second homes for affluent Europeans.) Britain, France and Ireland are desperate. House prices are falling in all of these countries - and U.S. subprime mortgages have nothing to do with it. On the far side of every wave, the direction is always down.

Why is this housing cycle so much more destructive than earlier bubbles? In a review of previous housing cycles in 19 countries, the IMF determined that the average "up cycle" in the past took 61/2 years; and that the average price increase in this period was 39.2 per cent. They determined that the average "down cycle" took four years, and that the average price decrease in this period was 20.2 per cent. The IMF also calculated that the "up cycle" that peaked last year had lasted for an extraordinary 15 years, and that the average price increase in this period was an equally extraordinary 116.6 per cent. Assuming that the emergent "down cycle" consumes proportionately as much value and time as past "down cycles," housing in Europe could take a 58-per-cent price hit within the next six years.

The Great Housing Bubble (2000-07) was the first comprehensively global housing bubble. (House prices are also falling in India.) It did much good - extending home ownership to more people than ever before in history, employing millions of people in constructive enterprise and enriching millions of homeowners in the process. But psychology propels house prices as much as economic fundamentals. In the 20th century, as literary critic George Steiner expressed it, all God's creatures moved in herds. Apparently we still do - except, fortuitously in this case, Canadians. But you don't blame the animal at the front of the stampede for the self-inflicted calamity that spooked them all.