Interest Rates and Housing

I started writing this column in November 2008 after witnessing a staggering distortion of the recent historical record regarding the cause of the financial crisis.

The left was blaming Wall Street, bankers, derivatives, and capitalism in general for the crisis when it was a gross exaggeration at best and an outright lie at worst. Instead, one needed to look at key economic factors that led to the crisis, with the housing bubble being the central problem - and the Federal Reserve's low interest rate policy and the government's promotion of housing, particularly subprime borrowers through "rolling the dice" (Barney Frank's words) with Fannie Mae and Freddie Mac.

Recent history is an interesting thing to discuss, since everyone lived through it - unlike debating historical events from decades or centuries ago. But clearly many people don't, or didn't, appreciate the government's role in creating the financial crisis, so it is useful to observe now a new housing bubble potentially being created - in Canada.

The Wall Street Journal reports on the explosive growth in housing prices in Canada recently despite a drop in personal income. Canada's housing prices grew more slowly than America's during the 2000-2006 boom, but it has continued to grow and its cumulative increase is now up 90% since 2000 as compared to less than 50% in America.

And what is fueling the boom? Naturally, the low interest rates that Canada's central bank implemented to address the economic slow down.

Housing prices are, and always have been, extremely sensitive to interest rates. It is true today in Canada as it was in America in the 2000s.

Let's hope Canada's boom doesn't get out of control and create large losses in its banking sector. And if it does happen, it will demonstrate that even well understood bubbles and looming credit losses are difficult for regulators to stop or prevent.