Bank of Canada sounds alarm bell

Bank of Canada sounds the alarm bell

The Bank of Canada released their latest Financial System Review today.  While they speak at length of the risks of European contagion, a weak global economy, low interest rates, and global imbalances, it is the section on household finances that caught my eye:

“In Canada, with the growth rate of debt outpacing that of disposable income in recent years, the proportion of households with stretched financial positions that leave them vulnerable to an adverse shock has grown significantly.”

Pretty sure I just talked about this a couple days ago

“The risk is that a shock to economic conditions could be transmitted to the broader financial system through a deterioration in the credit quality of loans to households, which would prompt a tightening of credit conditions that could trigger a mutually reinforcing deterioration of real activity and financial stability. Developments since the June FSR suggest that the vulnerability of the Canadian household sector has increased.”

“The Bank judges that, overall, the risk of a system-wide disturbance arising from financial stress in the household sector is elevated and has edged higher since June. This vulnerability is unlikely to decline quickly, given projections of subdued growth in income.”

Under the ‘Policy Actions’ section they have this to say:

“In Canada, the deteriorating financial position of the household sector requires vigilance. When taking on debt, households bear ultimate responsibility for ensuring that they will be able to service it in the future.”

So if I read this correctly, the ‘Policy Action’ is one of passing the buck.

I’m just being a bit of a jerk here.  I actually completely agree with the statement, but it doesn’t let the bank off the hook entirely.  I often wonder if guys like Carney and Bernanke sit up at night and wonder how history will judge them.  They have to know that an entire generation is set to reap the whirlwind that they helped sow.  I wonder if statements like this aren’t meant to soothe their own conscience.


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8 Responses to Bank of Canada sounds alarm bell

  1. jesse says:

    No offense to the Bank of Canada but they have a “conundrum” on their hands. Sternly worded treatises espousing the dangers of too much debt don’t seem to be working.

  2. jesse says:

    Here is an post put forward by CalculatedRisk earlier this year. He argues that rational homeowners should be using long-term historical financing rates when valuing house prices. It’s particularly interesting how his thesis was shot down in the comments by his regular readers. When his normally “rational” readers are disagreeing with him on what is a commonly forwarded by economists as a “rational” argument (now reiterated by the BoC), it gives me pause.

    That said, the US is in a more favourable position on this front because long-term mortgage financing is readily available. But I believe the thesis is still correct in that current business cases using current financing conditions, even if one plans on holding forever, must still consider liquidation in a finite time frame, often in unanticipated circumstances. Canada’s households, by comparison, are at the mercy of future interest rates due to the 5 year term limit on government underwritten mortgages so CalculatedRisk’s arguments are more valid north of the line.

    The biggest question is what will be done about it? Barking the troops back into line is right out of the BoC’s playbook. When that doesn’t work (let’s face it, it probably won’t) it’s fun to speculate what the next steps for the government and the Bank will be. Further CMHC policy changes, or the more drastic act of shuddering the de facto government guarantee on CMHC-cleared MBSs? The creativity emerging from Ottawa on how to handle this will undoubtedly surprise me, hopefully in a positive way.

  3. Sam says:

    Unemployment is going down. I would say he is doing fine with low rates. Keep people working. Now he can only warn people about spending and debt. We can’t blame him for the person who chooses to become a slave to debt. Even if rates are zero and bags of money on arrive on your door step with an i o u . Individuals need to exercise caution.

    Another problem is deep cultural beliefs about owning. The human race is obsessed with home ownership? A rabbi once told me always keep a third of your worth in real estate. Chinese cannot marry without a home. Renting brings shame. Latinos perceive it as family safety – we cannot be evicted. What culture promotes renting? Is canada just doing what it’s people who make it up believe in?

    Everyone hears the story of the guy with a house and no couch. Porsche and no money for gas. Has society become so obsessed with home owning that we will deny ourselves life? I believe these are the next big steps we will see take place before debt is reduced.
    This is what people need to be prepared for in the upcoming years

    Bridle path 1989. Meals on wheels was a regular sighting. Can it happen again?

  4. Potato says:

    Jesse: there’s an interesting political dilemma there. The BoC can’t raise rates just for homeowners, and still keep them low to stimulate the rest of the economy. All Mark Carney can do it try to talk the housing bubble down and the rest of the economy up. Ideally, the loosening interest rates would have been accompanied by tightening at CMHC… but the CMHC is under the control of Harper & Flaherty, and they have expressed basically no interest in letting the air out of the bubble. Indeed, they’re largely responsible for bringing the bubble to Canada, and though they had the CMHC take a few token measures earlier in the year, for the most part they’ve just been stoking the fires…

    • jesse says:

      I think it a mistake to underestimate the influence Carney has at the PMO. Remember CMHC policy has been tightened this year already. This opinion from the BoC indicates more should be done and I doubt the contents of this recent report come as a surprise to anyone formulating policy.

      I don’t think it outside the realm of possibility the overnight rate be raised late Q1 2011 with commensurate business incentives to offset.

    • John in Ottawa says:

      You bring up some really good points, but Harper is walking the same thin line that Carney is. If he takes the punch bowl away from the sheeple, he will burst the bubble as surely as raising interest rates. I do agree that Harper should have taken a tougher stance earlier.

      I can’t see how this can end well unless there is a very strong pickup in the economy that translates into higher wages. There are some signs of life south of the border, but with so much debt overhang, it looks awfully weak.

      BTW, I’ve come to understand over the past few weeks who the Republicans are going to select for the 2012 Presidential ticket. Obama!

  5. reasonfirst says:

    Somewhere along the way I came up with a number that Canadians are adding ~$9 to $10B of household debt a month (sorry no links). When this peaks, and it has to even without any major interest rate rise or other “adverse shock” (meaning households will generally be able to hold the line in the short term), what will happen to GDP growth and all the effects of that on jobs etc? $10B a month no longer hitting the streets…hmmm.

  6. Pingback: Canadian bankers fret over mortgage amortization lengths; China moves to quell inflation…will it squash the commodity rally in the process? | Financial Insights

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