If Mark Carney doesn’t want to be Alan Greenspan, the dude knows what to do.

That was the word this week from some notables, including the New York-based chief economist for Societe Generale, Stephen Gallagher. The reason, adds C.D.Howe Institute economist and former Bank of Canada advisor David Laidler, is simple – a puffy housing bubble.

Of course, perfect hindsight tells us it was rock-bottom mortgage rates following Nine Eleven that led more or less directly to the American housing love-in. Then Fed boss Alan Greenspan was trying to do what Carney is now – keep recession at bay, goose demand and stoke the fires of inflation. Of course, the US real estate market overheated, spewed lava over the entire world, incinerating trillions of dollars and fried the American middle class.

The dangers of Carneynomics have been pointed out here often. And this blog has presented all the evidence little central bankers should need to know the people are smitten once again. Multiple offers. Condo madness. Surging prices and sales. No-condition offers. Two per cent mortgages. 5/35 euphoria. Vancouver princesses. The works.

Carney is the only central banker on the planet with the stones (or the lack of them) to tell people how long interest rates will stay in the dirt. That has fuelled a buying boom as folks scramble to purchase homes they could never afford otherwise. The fact they’ll probably not afford them in the future seems moot. The bubble grows.

So, here’s the news: Economist Gallagher estimates Carney has no choice but to raise rates in 2010. By 1.25%.

What does that mean?

Let’s take the average Toronto home now selling at its Carneynomics price of $450,000. With a 5% down payment ($22,500), plus mortgage insurance, the debt would be $437,500. At the current VRM rate of 2.25%, it would take an income of $68,500 to carry the monthly of $1,905. At a VRM of 3.5%, the income needed jumps to $79,200, as the payment rises $300 a month.

With a 5-year closed loan now at 5.59%, the income needed to carry the monthly of $2,700 is $97,200, and with a five-year mortgage at 6.84%, the required income rises to $108,765 as the payment increases, also by $300.

That may be worrisome to some buyers on the edge, but not a disaster to most. However, that’s just next year’s increase. You should assume there’ll be another 1% a year added to the prime for the next two or three, which will get us back to a ‘normal’ rate of about 8% or so by 2014 – renewal time. At 8%, that same house will need a family income of $122,400 with monthly payments of $3,400. Plus taxes and utilities, of course.

This is the danger of keeping interest rates too low for too long. People who don’t have enough money tend to buy things only because financing costs are so damn cheap.  So, somebody snapping the average T.O. home in 2009 with an income of $70,000 or so might find in 2014 he or she needs to be making $120,000. The odds of that happening given what lies ahead – higher rates, higher taxes, government cutbacks, persistent unemployment, the HST – are nil.

But, that’s not the biggest concern. Instead, it’s what relentlessly rising interest rates over the course of a few years will do to the real estate market. Obviously given the above, as rates go up, fewer people can afford to buy homes, eating into demand. This will happen (as I have explained a tiresome number of times) as the Boomers start turning 65 in 2011 and think about cashing in their chips so they can take up bowling and early-bird dinners, as well as buy new electric wheelchairs, oxygen canisters and Rolling Stones downloads. In other words, the demand-supply overload we have experienced will turn into a supply-demand tidal wave.

So, what happens if the real estate market tweaks down a little in 2010? Say, 10%?

Well, the average $450,000 Toronto house bought with 5% down ($22,500) would then be worth just $405,000. That’s negative equity, since the mortgage on the place would be $437,500 – or $30,000 more than the property was actually worth. Worse, the poor owner would have also coughed up $12,000 for mortgage insurance plus $10,200 for land transfer tax, meaning at least $46,500 went into the deal. The true loss in that case – with just a 10% market correction – would be well over $75,000, or 17% of the asset value. Isn’t leverage fun?

And if the equityless owner decided not to feed a mortgage (even at its low emergency rate) bigger than the value of the house, and bailed, it gets worse. After real estate commission of 5%, a three-month mortgage penalty, and paying off the principal, the owner would need to cut a cheque for $58,750 to get out on closing day. Add the cash put into the deal, and the loss on this house is $105,300 – or 24% of its value.

This is how bubbles hurt average people.

And why you’d swear a smart guy from Goldman Sachs would know that.

In the news: He does it again.