How will the housing market land?

With its overvalued housing market and rising consumer debt, Canada might be in for a shock in coming years.

Last December, the Deutsche Bank created a stir in Canada when it claimed that Canadian housing prices were 60% higher than historical averages. That would make our real estate market the most overvalued on the planet. A few months earlier, the Organization for Economic Co-operation and Development reported that the overvalued Canadian housing market was the most vulnerable to a price correction, along with Norway and New Zealand.

This can only add to the fear of some analysts — including Finance Minister Jim Flaherty — that our housing market will collapse after years of euphoria.

We can always argue over the seriousness of the situation. Some will say that the housing bubble exists mainly in urban markets, such as Vancouver and Toronto, and not necessarily in the entire country. Only time will tell which of the following two camps is right: those who believe the market is headed for a soft landing, or those who predict a painful crash.

Regardless of the prevailing scenario, it's safe to say the Canadian economy will suffer a shock.

The domino effect

The construction industry is unlike any other. Many other sectors (including finance, insurance and, of course, real estate) are linked to construction and depend upon it to varying degrees. In February 2013, Ben Rabidoux, president of market research firm North Cove Advisors, which analyzes the Canadian housing market, among others, wrote that 45% (or nearly half) of Canada's gross domestic product growth since 2000 could be directly attributed to construction and related industries. This is why the possible repercussions of a decline in this sector on the economy as a whole should not be underestimated.

In addition to a likely slowdown in real estate, high consumer debt is also being flagged as a risk to the Canadian economy. Our record-breaking debt has partly fuelled the housing bubble. For a dozen years, real estate prices have soared, far outpacing wage increases posted during the same period. Rising consumer debt is largely to blame for this, reflected in the fact that Canadians continue to set record personal debt levels every quarter.

Moreover, according to the Bank of Canada, the share of consumer credit taken up by home equity lines of credit has risen drastically, making many Canadians vulnerable to an increase in interest rates.

Is the pendulum poised to swing back?

Flaherty is working hard to regulate the housing market. The finance minister has set new rules (such as reducing the maximum amortization period for mortgages, raising down payments, tightening mortgage refinancing, etc.), which should help curb the enthusiasm of new buyers. Also, one hopes that Canadian consumers will one day cease to accumulate debt and begin to set their finances in order.

It's a necessary adjustment, which will be beneficial in the long run. However, in the short and medium term, this new "austerity" among Canadians — if it ever materializes — could dampen consumption and weaken gross domestic product growth, just as housing would be cooling down.

This, of course, would be a nightmare scenario for the finance minister.

That said, we shouldn't underestimate the surprising resilience of our modern economies. Take for example the shale gas "revolution" underway in the United States — it's a relatively unexpected boom that is creating thousands of jobs and contributing to the economic recovery south of the border. Let's hope the upswing continues for our major business partner in the months ahead so our export companies can reap the benefits.

But then again, Canadians have to admit that we have lived high on credit for a long time.

At the very least, we should brace ourselves for a nasty headache in the coming years.