Why David Madani is Wrong

I awoke this morning to the startling news headlines that an economist named David Madani of Capital Economics saying that house prices could (note – he doesn’t say that they will) drop up to 25% if his predictions of a low inflation environment hold true.

According to the article in the Financial Post he is quoted as saying that affordability will deteriorate in a low inflation environment because income growth doesn’t help to offset Canadian’s debt burden.

This implies, as I read it, a number of assumptions on the part of Mr. Madani:

  • The economy will not grow very much in the coming years
  • Inflation will stay low
  • Overall indebtedness is an overwhelming burden
  • Interest rates will not increase
  • Home prices are too high nationally

Just to be clear, Mr. Madani is predicting a 25% drop in home values *even though he is predicting very low increases in interest rates*.

While I certainly have a vested interest in a strong housing market and strong equity levels in people’s homes, I tried my best to be objective when scrutinizing these reports and Mr. Madani’s position. Frankly, I find that his assertions are a stretch at best. In fact, the report almost seems to be as shocking as possible to try to generate some PR awareness for his firm, Capital Economics, than it does about making a realistic prediction. Certainly, if he’s right, he hits a home run and goes on the talk show circuit and writes a book about how he predicted the housing collapse. What’s the risk if he’s wrong? Nobody will remember.

Here are a number of reasons why I think Mr. Madani is wrong:

  • He asserts that the next several years Canadians will experience low wage growth due to low inflation. According to Statistics Canada personal disposable income has increased 3.8% in Q3 of 2010 vs. the same period in 2009. That’s nearly twice his predicted rate of 2% wage growth, and it happened in a low inflation environment. Maybe he’s right, and this won’t continue…
  • He asserts that inflation will remain low. At the same time, we’re witnessing substantially higher oil prices, which leads to more expensive consumer goods and higher inflation. Higher oil prices, in certain parts of the country, like Alberta, also leads to substantial business investment, new jobs, and higher wages as employers try to attract new hires. Statistics Canada’s report indicates that corporate profits are up 14.4% year over year for Q3 2010, corporate investment is up 16.6%, and consumer spending up 3.4%.
  • Canada recently experienced a growth in jobs of 69,200 vs. the forecast of 15,000 for January of 2011. As jobs grow, purchasing power gets stronger, and this pushes up consumer prices and wages.
  • According to the Conference Board of Canada consumer confidence in Canada is rising – now at a level much higher than two years ago during the recessions, and more Canadians are comfortable making a major purchase now than before.
  • Finally, on the affordability front, there is no doubt that some markets are overpriced (I’m looking at you, Vancouver, Toronto, and Montreal) however, to make broad statements about the national housing market is both damaging to good markets and irresponsible. Thankfully, there are good reports out there that do a better job of showing the differences in regional markets, such as the RBC Housing Affordability Report (PDF). Luckily, here in Alberta, we have some of the most affordable real estate in Canada.

To sum up, Mr. Madani’s prediction relies on a whole pile of “what-ifs” that are already proving to be unlikely. We are seeing job growth, increased profitability, higher input costs (oil), higher disposable income, and more confidence in the economy. Another pattern throughout history is that governments tend to inflate their way out of massive deficits by increasing the money supply. Anyone seen any governments around that have a lot of debt at the moment?

There are substantial reasons to believe that markets like Alberta, where we’re expected to lead the country in economic and job growth, where we’re seeing the potential for another oil boom, and where we’ve already seen our real estate market correct from the peak in 2007, that people are not over-leveraged, that our incomes are sufficient to pay our obligations, and that the fundamentals are solid for a good, old fashioned, boring real estate market where reality overcomes emotion and conjecture.

Of course, that’s only if we don’t pay attention to crystal ball gazers like Mr. Madani.


President of First Foundation Residential Mortgages and First Foundation Insurance. Live in Edmonton but cheer for the Riders. I have lots of kids. Follow me on Twitter @gordmccallum

Learn more about Gordon McCallum