No debt problem here!

I want to start this post with the following quote:

“Recent developments in consumer finances are characterized by an unusual combination of hopeful and worrisome trends. Consumers remain the primary source of strength for the economy, but rising consumer indebtedness is a source of concern. The reasons for increased indebtedness and the types of debt being accumulated, however, make consumer obligations somewhat less worrisome than aggregate statistics might suggest. Notably, strong income growth and a robust housing market have supported borrowing.”

I’ll get to the source of that quote in a moment, but first let’s consider the musings of one Hulmut Pastrick, chief economist of Central 1 Credit Union, a credit union with offices across the country but largely concentrated in British Columbia:

Credit unions say household debt no big deal

In spite of the warnings issued by the chiefs of Canada’s big banks, Mr. Pastrick has a decidedly different take on house prices and debt levels in Canada.

“I don’t see a price bubble and I don’t see that we need the mortgage criteria tightened as is suggested in some quarters”

In reference to the mortgage rule changes initiated by Jim Flaherty earlier this year, Pastrick had this to say:

“I didn’t think [the market] needed it at that time…the market was already in adjustment phase, housing sales were moving down…. So there was no bubble developing at that time, nor is there one developing now….(real estate) will continue to hold its value — unless of course the government decides to tinker

So there’s no bubble in Canadian real estate.  But just don’t ‘tinker’ with rule changes and re-institute the 25 or 30 year amortization that had been maximum allowable amortization CMHC would insure for the 60+ years prior to 2006, or the whole thing will pop.  But it’s not a bubble.

As noted before, I find it amusing that any time the government loosens mortgage standards, it’s a good thing and is a sign of the free market, but when they tighten them (or ‘tinker’) in an effort to return to more prudent standards in order to protect taxpayers, it’s a bad thing.  Go figure.

To his credit, Mr. Pastrick does seem to fully understand the great feedback mechanism that exists between home prices, credit demand, consumer spending, and the broader economy.  It’s a topic I discuss quite a bit on this blog.

“If you slow down the housing market that in turn slows down the economy,” he said. “Housing is an important sector. It generates a considerable number of jobs, particularly in housing construction, and [to a lesser extend] in sales. And certainly as sales go, so go housing starts and housing construction.

“Most forecasters are saying it’s going to be the domestic economy that’s going to carry the day [over the next year], so if we begin to tighten on the housing front that too will begin to diminish the growth rates we see on the domestic side.”

He certainly gets it.  I question whether or not he gets the unsustainability of the growth dynamic he just described.

“Mr. Pastrick argues that comparison (between Canada and the US) doesn’t work because the U.S. mortgage industry is fundamentally different from Canada’s. For instance, there is no significant subprime sector in this country, nor did Canadian mortgages get securitized to the degree they did in the United States.

First of all, mortgages ARE being securitized at a GREATER degree than in the US.  The latest mortgage credit figures from Stats Canada indicate that the growth in mortgage credit is over 100% driven by the MBS market.  Yes, you read that right!   Securitization consumes more than 100% of new mortgages.

Note that the total mortgages outstanding increased by $65.4 billion in 2009, yet the total MBS market grew by $84.6 billion!!!!  This is only possible since the big banks actually reduced their mortgage exposure  (go figure).  It absolutely demolishes the notion that somehow our mortgage system is not dependent on securitization.

As for the fundamental differences between our mortgage markets, read here.  We’ve discussed this too many times to repeat.

Finally, Mr. Pastrick notes the following:

“Even if consumers are borrowing more than ever before, that shouldn’t be seen as a problem because it’s mainly backed by real estate, which will continue to hold its value …”

The axiom that real estate is stable and safe holds true until all of a sudden it doesn’t.  The notion that borrowers can leverage themselves in perpetuity as long as it is backed by real estate holdings which at best are at high valuation levels is simply ridiculous.  Ask the US…or Ireland,  Italy, Greece, Spain, etc.  It’s a weak argument that assumes that the immediate future will mirror the past.  I have my doubts.

Remember that quote at the beginning of this post?  It was from the Federal Deposit Insurance Corporation in the US.  It was made in 2003.  Will we ever learn?


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16 Responses to No debt problem here!

  1. Sam says:

    Ben. Nice breakdown of mtg market. From the half trillion sitting on banks books, do we know what % is cmhc backed? Ltv?

    • John in Ottawa says:

      According to the Royal Bank’s 2009 Annual Report, all retained mortgage backed securities are 100% Canadian mortgages and government guaranteed.

      Average credit card balance at the end of 2009 was $12,000. I find this number a bit shocking. If I was carrying $12,000 on a credit card at 18% I would be distressed.

      • Sam says:

        interesting, so shorting cad banks is not the right tool if one believed that Canadian housing was going lower. In fact, it makes sense that they want carney to warn people and they won’t stop flowing credit as they are getting the free put from taxpayers.

        never let debt numbers shock you John. People are allowed to have as much CC/MTG/AUTO/HELOC they want. As long as they make those monthly payments, the banks and BOC will not care. Debt numbers have always looked out tilt since the start, you can look at any year in history and we were breaking records #’s. Focus on employment, job creation (yes, ben housing creates jobs), if that breaks, I would get concerned.

      • Grrr says:

        Debt levels should be worrisome. Once the rate of debt growth slows, that in turn affects someones elses revenue. Deleveraging has an even greater impact. As revenues fall, job losses follow, which can force more people to delever which reduces revenue, which leads to job losses and so on.

        Check out deflationary spiral (better called contractionary spiral IMHO). Debt is a critical element.

      • Lumpen says:

        If you’re using the RBC annual report for CC balances, I believe you’re reading the aggregate exposure, not per capita balance. Page 16, table 13 of 2010 AR has Avg CC balance of CAD 12,500 million, or $12.5bn, over “over 6 mm CC accounts” – so ~$2000 balance per card. And, to me, nothing indicates that these are delinquent, just the point-in-time balance.

        So, yes, just one bank. And people can have CC debt across multiple issuers. But the level doesn’t seem all that bad to me.

        I’d focus more on their delinquency rates, and their CRE portfolio.

  2. TS says:

    Flaherty should just do it with CMHC loans. Let the credit unions and Banks knock themselves out. It would be an interesting experience to see how the financial institutions would react. Let us see prudence in action. Or would that be market share? They just might be a little confused having to accept risk to make a home loan. My guess is that prudence may just follow if our Canadian banking system is so admirable. Or we may just see some get rich quick reckless loans to earn a bonus.

  3. jesse says:

    What do you make of the bank stress tests recently announced? Line it up with Carney’s recent speech. Coincidence…

    What else was Carney stating as his lines of defence?
    1. Let the markets figure it out. They didn’t.
    2. Oversee the banks in an effort to curb systemic risk. That’s about to happen. Will it help?
    3. Change capital requirements to revalue assets based more on underlying fundamentals and less on market rates. Not yet on the radar but will likely be put in place within a couple of years. In the interim the government may resort to reducing amortization lengths which they are probably convinced needs to happen at some point anyways.

    It has begun; I would never underestimate the will of the Bank of Canada and a Conservative government to impose austerity on everyone.

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  5. “Debt numbers have always looked out tilt since the start, you can look at any year in history and we were breaking records #’s. Focus on employment, job creation (yes, ben housing creates jobs), if that breaks, I would get concerned.”

    You’re still missing the big picture, Sam. It’s the expanding debt that creates the very illusion of prosperity you reference. But debt cannot expand indefinitely beyond one’s ability to repay it. If the prosperity illusion is debt-dependent and if debt creation cannot continue at its current clip, put two and two together.

    • Sam says:

      Look at governments, japan, etc. you are looking at number that has and will continue to grow. Your arguments have no investable timeframe. when/why will the debt start to stop? you need to look deeper into how life works Ben. the debt machine is a financial beast created by us and will continue. i could flip it around and call Pensions a Ponzi scheme.

      the “financial insight” you need Ben is not to challange the debt growth – it will be here longer than both of us. millions, to Billions, to Trillions, etc. So what?

      Look at a company balance sheet Ben, open up a finance book, watch a student get a loan to go to school, from the start of working life, we need to access modern finance to get into school, buy a home, make purchases, etc. You don’t seem to understand how modern finance works, how bonds and interest rates work. Again, you should expect more absolute debt when rates are lower. I have put it all together and manage my balance sheet as do business owners, companies, etc. don’t be narrow minded

      • Lumpen says:

        Credit growth is fine, sustained credit growth > nominal GDP growth is an issue. Go back and take a look at any country that’s struggling now – whether “austerity” or “stimulus” is the order of the day, credit growth is slow. Countries that are not struggling have strong credit growth.

        Why that is almost doesn’t matter. It’s the transition that matters – getting the frugal to borrow, or the spendthrift to hoard – and determines where the big money is made.

  6. ATP says:

    In a credit driven economy, debt growth does not need to stop to wreck havoc. Australian economist Steve Keen is developing a model to show that all it takes is a decrease in the RATE of growth of debt (i.e. slower acceleration, not even deceleration) for there to be a significant negative impact on the overall economy.

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