The Chain of Events 2007-2012

This is my big picture view of how this housing crash might play out. I am in the housing bear category as I believe that the massive increase in prices since the mid 90s would likely burst on their own. Add to the mix a global credit crunch and a Canadian recession and things could get real ugly real fast.

1. Housing Affordability declines (2007) as prices and interest rates rise. In the early part of this decade, rising prices were completely offset by generational lows in interest rates. Also, housing in Canada suffered through some lean years for much of the early 90s as the 1989 housing bubble popped and Canada suffered through a brutal recession (remember Kim Campbell saying that inflation would not drop below 10% in the 90s?). In the past few years, prices have continued to rise, while interest rates have gradually increased. Housing affordability is now at its highest since the 89/90 bubble years.

2. As affordability declines, house sales slow down, price growth slows, inventory builds. (Early 2008) As affordability declines, buyers either buy smaller, pay too much, rent or stay in their current homes. House sales slow, while inventory build due to continued new home construction and lower sales. Prices continue to rise but the momentum of the increases slow down. Financing has become increasingly dubious as 40 year amortizations are all the rage. This allows buyers to take on more debt and lower payments.

3a As inventory continues to build, certain markets begin to slow dramatically and prices actually fall. (Mid 2008?) Inventory building allows balance to return to the market and buyers have more selection. Some of the hottest market reverse as prices rise to unfathomable levels (Calgary & Edmonton?). Lenders begin to tighten their financing as they worry about some of their boom time lending practices (no down payments, low rates)

3b Making the situation worse, a global credit crunch causes most or all of the 6 main Canadian banks to cut the financing available. (Mid 2008?) 3 of the 6 main banks are already having problems (NatB, CIBC, BMO). I would be surprised if at least 1 or 2 more don't have similar problems in the upcoming months. Due to the credit crunch and an economy either near or in recession, bank mortgage lending dries up. Already mortgage rates have creeped up (despite the BoC cuts and drop in bond market yields). In addition, 3a causes banks will begin to ask for higher down payments.

3c The slowing economy leads to higher unemployment and salary freezes. (Mid 2008?) With a slowing economy, companies begin to lay off and institute hiring freezes. Bonuses are not paid. Salary increases are lowered. Consultants and other self-employed individuals lose business. These factors cause people to cut back their housing needs and in some cases sell their houses.

4 A vicious cycle ensues (Late 2008 into 2012?). 3a, 3b and 3c coincide at the same time to pop the bubble. Demand for housing is cut by high house prices, lower affordability, lower mortgage lending, tight access to credit, unemployment and declining incomes. Supply of housing increases as inventories build due to the drop in buyers. Also, new listings can increase (and thus supply) due to unemployment and foreclosures as well as sellers who want to sell before prices fall.

Prices begin to fall precipitously due to lower demand and higher supply. Once prices begin to fall, buyers tend to wait. Houses take a long time to sell as sellers are reluctant to drop prices (remembering bubble prices/not willing to take a loss). Inventories continue to build....

5 Eventually, prices bottom (2012?). Eventually, prices drop to such a low level and inventories fall as the low prices attract enough buyers. As time goes on, a new generation of house buyers enter the market. I have chosen 2012 but it could be a year or two sooner or later. These things take time. Nominal prices finally begin to creep up. However, it could take a decade or more for homes to regain their real (not nominal) prices of 2008.