House prices and debt loads a growing concern, Bank of Canada says

Debt loads tied to overheated Canadian housing markets are making households more vulnerable, but on the whole Canada's economy is resilient enough to withstand any major shocks to the system, the Bank of Canada says.

Canada's central bank released its semi-annual Financial System Review on Thursday, a document which outlines some of the major risks that the Bank of Canada sees on the economic horizon.

As expected, the housing market and debt loads tied to it features prominently in the report.

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Specifically, the bank mentions an increase in uninsured mortgages, and growth in home equity lines of credit, since the last review in December.

"Highly indebted households have less flexibility to deal with sudden changes in their income," said the bank.

"As the number of these households grows, it is more likely that adverse economic shocks to households would significantly affect the economy and the financial system."

Most of the bank's concerns from the housing market stem from activity in the two markets that tend to get a lot of attention: Toronto and Vancouver.

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"Imbalances in the Canadian housing market have also grown since December," the bank said, "mainly due to an acceleration in prices in Toronto and surrounding areas."

Part of the report includes a risk assessment, where the bank calculates what the impact might be if certain shocks to the system were to occur. In the review, the bank chose to simulate a scenario under which there is a "significant regional house price correction in Toronto, Vancouver and their surrounding areas."

The two cities are far and away the most expensive real estate markets in Canada, with prices for detached houses well in excess of $1 million.

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Overall, however, the bank deems a correction in those two markets to be unlikely. Housing market critics often point to the painful correction that happened in the United States, and say something similar could happen in Canada. But in the central bank's estimation, the two scenarios don't have a lot in common.

"The financial system weaknesses and exposures that helped transform a house price correction into a large and persistent rise in unemployment in the United States ... are not present in Canada," the bank said.

Specifically, Canadian mortgage underwriting standards are much higher, and loans are protected by insurance and other government guarantees. Also, Canadian mortgages"are not financed by complex and opaque securitization vehicles," the bank said.

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That's why the bank doesn't expect a similar correction in those two markets. If one should happen, the bank said, the impact would also be more limited than it was in the U.S.

"Strong underlying housing market fundamentals, however, support the idea that a downturn in prices would be limited," the bank said.

Toronto-Dominion Bank economist Brian DePratto said the FSR made it clear the central bank is becoming more and more concerned about housing in pockets. "Acorrection in overheated markets is now seen as enough to trigger a downturn on its own," he said.