TD gets it. Do you?

One of the things that I can’t stress enough on this blog is the incredibly simple, yet incredibly powerful relationship between house prices, consumer spending (you can lump these first two under debt creation), consumer confidence, and job growth.  I’ve tried to explain this connection in one of my primers.  I hope it makes sense.  If you get it, then you understand in part why the past decade has been such a prosperous time here in Canada, while the next few years promises to be anything but.

Now I’m not saying that all job creation and wealth are the result of a debt pyramid set to topple, but I am saying that we have enjoyed an artificially high unemployment rate, house price increases, and a generally positive economic climate that has all floated on a sea of ever-expanding debt.

TD agrees.  In a report released today, they note that household debt is a significant concern.  But beyond the debt, which we all recognize is on an unsustainable trajectory, they also make the following statements:

“At 146% of average after-tax personal income, Canadian household debt has become excessive. Looking ahead, there are a number of influences that are likely to restrain growth in credit to well below its recent rate – a simmering down in the still-overheated housing market chief among them.”

“Nowhere was the impact of lower borrowing costs and greater household confidence more clearly observed than in the housing market, where ownership rates increased steadily over the past two decades. A self-perpetuating cycle occurred. Strong increases in demand bid up housing prices, which together with equity market gains prior to the 2008/2009 recession, raised net wealth. This positive wealth effect encouraged households to increase their rate of investment and consumption, further driving up borrowing and debt levels.

There it is again!  I can’t stress enough that the fallout from a contraction in credit caused by a loss of consumer confidence, a falling housing market, or both, will be particularly painful as the process that sustained high employment and an illusion of wealth and prosperity works just as efficiently in reverse.

With consumers carrying that much debt, just how at risk is Canadian consumer?

“Based on the new figures, a slightly higher 6.5% of households are currently financially vulnerable (or have a debt-service ratio of 40% or above). More striking, the share of those on the verge of becoming vulnerable (those with a debt-service ratio of 30-40%) had risen from 7.2% in 2009 to 9.3% – up almost two percentage points. Given the change in the distribution of debt, we have estimated that as much as 10-11% of households may become financially vulnerable if the overnight rate rose to 3.5%

So if the overnight rate at the BofC rises to 3.5% from its current 1%, over 10% of all households would be diverting over 40% of their pay to debt servicing.  Research shows that at this level of indebtedness, the risk of default goes parabolic.  How does any of this bode well for our consumer spending driven economy?

The report spends a great deal of time suggesting that we are not facing a debt hangover like the one the U.S. is facing.  I agree.  It frustrates me that people look at perhaps the greatest example of the destruction of wealth at the societal level, shrug their shoulders, and say, “at least we’re not them”.  It may be something to be thankful for, but let’s not gloss over the fact that we have structural issues in the way we have generated growth over the past decade.  The drivers of growth are now fading.  The housing market is gasping.  Consumers are drowning.  Exports are sagging.  The dollar is rising.  Recession is coming!

As a final thought to all this, consider this article today in the Star:

Canada had a miserable quarter, Bank of Canada says

Six months ago this was on virtually no ones radar.

“The latest monetary policy review shows the diminishing of expectations are more dramatic for Canada, partly because the bank once held a more rosy view of how the country’s economy was performing.”

Glad they held such a rosy view.  I never did. Back to the article:

If there were a sudden weakening in the Canadian housing sector, it could have sizable spillover effects on other areas of the economy, such as consumption, given the high debt loads of some Canadian households

The article then states that they don’t see that ‘weakening of the Canadian housing sector’ as a serious threat.  Lest that help you sleep better tonight, recall that they never saw this slowdown coming either.

The Globe ran the same story, with some equally noteworthy lines:

“As consumers retrench to trim their debt loads and the rebound in the country’s main export market seems trapped in a straitjacket”

Pushing on a sting, baby!  When consumers are maxed out and no one wants or is able to borrow, it doesn’t matter how low you cut the overnight rate….just ask Ben Bernanke.

And all of this is exactly why I hold to my view that we will once again see record low overnight rates before a serious round of rate hikes takes place.  Which is why I’m still holding my long dated bonds, long dated strips, corporate bonds, fixed rate preferreds, etc.  Anything that is interest rate sensitive should still have legs for a while.

Looks like I’m no longer the lone voice either:

Could the Bank of Canada be forced to cut rates again?

Should the global recovery slow further than currently anticipated, the bank may have to ease policy again using both conventional and unconventional measures – first by renewed cuts in the policy rate, presumably all the way back down to near-zero, and then by entertaining forms of quantitative easing (QE).

Well said!  Now for the housing bulls out there, let me ask you this:  Has there ever been a time that real estate has prospered during a time where a central bank has cut interest rates to zero and held them there?  I’d be curious to know.  Off the top of my head, I can’t think of one.  Central banks only cut rates to these ridiculously low levels when they recognize that credit demand is so low that it will invoke deflationary pressures.  That’s our future!  Get it?


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One Response to TD gets it. Do you?

  1. R. Willis says:


    Alot of got this a long time ago.
    Apparently the banks didn’t……or did they?
    Canadian household debt is insanely excessive – we all agree on that.
    Question is how did they get there?
    Who extended all this risky personal debt/credit to them.
    Who issued the credit cards?
    Who advanced personal lines of credit and personal loans in exchange for security of home equity?
    Who enjoyed transferring the risk of the weakest home mortgagors to CMHC and the taxpayer?
    What we should all be concerned about is how CMHC and the banks are going to deal with all this unsupported debt when it all hits the fan?

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