Recent reassuring comments about the Canadian housing market remind me of similar blandishments when oil prices began to fall. 

I wouldn't want to overemphasize the parallels between houses and petroleum. Indeed, there are many differences in the two markets, which I will expand upon in a moment.

But first the similarity. It is that, just as with oil, so many of the people we expect to know what is happening refuse to admit that house prices can go through big declines as well as big increases. 

Expert failure

This is the most disturbing lesson from the recent fall in oil prices, that the professionals — the people who have all the historical data on production and demand — seemed as surprised as the rest of us when oil plummeted by half. The second most disturbing lesson is that after the decline had happened, economists at the big international banks acted as though it was an inevitability, sagely predicting further declines.

Where were they this summer when oil was trading at $100 US?

Real Estate Outlook 20141028

Sellers may be unwilling to drop their prices until they really need to sell. (Ryan Remiorz/Canadian Press)

That is why, just as I did with oil, I want to talk through how a sharp decline in house prices could happen once rising U.S. interest rates begin to push mortgage rates higher. The longer we let house prices continue to escalate, the more dangerous it becomes.

Both federal Finance Minister Joe Oliver and the governor of the Bank of Canada, Stephen Poloz, have acknowledged potential dangers. Poloz worried publicly last week that house prices could be overvalued. But when questioned in New York he said a 30-per-cent overvaluation was not a bubble.

 "We don’t think of this as a bubble in any way," he said.

Most journalists covering the property market call any fall in house price expectations an "easing" or a "soft landing." But when interest rates start to rise and prices begin to fall it could be more than that.

As deep as oil?

There have been voices willing to take a possible fall in prices seriously.

Hilliard MacBeth, an experienced investment manager who has seen it happen before, says house prices could fall just as far as oil. A more moderate voice is Ian McGugan, who observes that Poloz's willingness to depart from the "see-no-evil, market-knows-best boilerplate" shows he may be more worried than he lets on.

McGugan mentions something I have called the "sticky downward" effect — that is when owner psychology or unwillingness to sell at homes lower prices, delays price declines.

This is one example of how housing is different from oil. While oil trades on big, well-informed central trading desks by large corporations, housing is a market made of individual, many of whom have only bought and sold a house once in their life. 

Partly because of that, housing is an illiquid market. Unlike stocks or oil, you can't just sell a house at today's price and get out. You have to go through the long process of finding another individual who wants to buy your exact house at a price at which you are willing to sell.

In previous housing downturns that has meant a stock of overpriced houses builds up because buyers are unwilling to pay the price sellers expect.

At that point, prices in the market are set by people who have to sell immediately and will take the price offered. Sudden divorces. A new job across the country. A death in family. People who can't afford to keep up their payments. Overpriced properties waiting for their price actually fall in value while the seller waits.

I have heard people say falling home prices are good because they let young people get into the market. That is true in the long run, but at the moment when house prices actually turn and begin to fall, the buyer's psychology also changes. Who wants to save up a five or 10 per cent down payment and know it could be gone in a matter of months?

13-year wait

I remember visiting friends when we came back to Canada who said their house they were living in had just regained its value from when they had bought it 13 years before. In that way houses are better than oil. Oil can, theoretically, be replaced or become outmoded. But no matter what its dollar value, a house will always be worth a house. It is a place to live.

On Wednesday we may have another hint from U.S. central banker Janet Yellen as to whether they are thinking of raising interest rates sooner or later. However long they wait, the lowest interest rates in history cannot last forever.

People in the real estate business may be unwilling to face that fact. But it is best for us all if we realize the potential effect on the housing market now, rather than being unprepared for worse consequences in the future.