Watching for signs of a deflating Canadian debt/real estate bubble

One of the favourite pastimes of those who acknowledge the existence of a credit bubble in Canada (self included) is predicting what will cause its demise and what might give us an early indicator of debt fatigue.

What will cause the credit bubble to pop?

Contrary to popular opinion, I don’t believe that higher interest rates are necessary to deflate a credit bubble.  One need to only look at the extreme Japanese example to see this is true.  Even our neighbours to the south have experienced a household deleveraging amid a period of historically low interest rates.

While a rapid rise in interest rates would certainly kill the bubble in a hurry, I’ve always maintained that it’s not necessary to force a consumer deleveraging.

Bubble are strange.  They are the product of mass psychology and are often accompanied by some form of government elixir to intoxicate the masses.  In the case of the US and Canada, the sweet elixir was the loosening of mortgage requirements which dragged demand forward by luring dewy-eyed property virgins and those previously priced out into the market.  This led to the massive propagation of mortgage debt and a spike in home prices…..followed by the ‘my house is an ATM’ mentality and rampant HELOC growth…..which goosed consumer spending, lowered unemployment, raised consumer perceptions of the strength of the economy, and the process repeated itself.

The ‘elixir’ may have had a different flavour and was undoubtedly served in a more potent form in the US, but make no mistake….we’re drinking the same stuff.  It’s just taken us a bit longer to get tipsy.

But now the room’s starting to spin and consumers are starting to dry heave.  Consumer debt is at a record percentage of personal disposable income.  It currently sits above the level of debt racked up by those ‘imprudent’ American consumers whose ‘foolish’ ways brought about their own fiscal ruin.  Gone are the days when the media held up our prudent banks and conservative consumers as a stark contrast to the irrational behaviour seen south of our border.

While our debt to PDI ratio could conceivably follow the experience of the UK consumer and hit a peak in the 160% range, let’s not lose sight of the ultimate end of a credit bubble.  My great concern is that this whole process I described above is set to work in reverse as it is in the US, leading to anemic growth over which the government and central bank have little control amid a wholesale repudiation of debt.

Mean reversions and monetary deflation

In economics, marked variance from a long-term mean tends to do two things:  1) Create the illusion of a new paradigm in which people believe that their current experience constitutes a new and stable norm;  2)  Greatly disappoint those who stake their financial future on an illusory trend, as they are overwhelmingly often followed by a mean reversal.

In this case, I believe several great mean reversals are set to occur at some point in the near future:

1)  Consumer spending will return to its long-term mean somewhere closer to 55% GDP, though certainly under 60%.  It currently accounts for ~65%.

2)  Consumer debt levels will revert back to a more stable level.  I have no idea exactly how far it will fall from the current level of 150% PDI, but I would suggest that we’ll see it push 120% PDI over the next decade, with a significant chance of it pushing double digits.

3)  Savings rates will rise to their long-term means.  The realization that too much debt and no cash cushion is a recipe for financial hardship will dawn on many Canadians far too late.  I’d expect savings rates to double over the next 5 years to at least the 8-9% range.

Anyone who sees these trends coming will also recognize that the combined impact will exert strong monetary deflation on the Canadian economy.  Demand for debt will dwindle, existing debt will be retired, and the velocity of money will fall significantly.  Deflation will pull strongest on leveraged assets priced in local currency…..namely real estate.  As I’ve explained before, commodities could move higher in such an environment as they are priced on international markets.  This is the worst case scenario as deflation would likely pull at wage growth making debt loads more burdensome while at the same time rising commodity prices would eat into remaining incomes.  For the time being, I’m not entirely convinced the recent boom in commodity prices is anything more than rampant speculation, fear of future inflation, and a China growth story that is missing some key chapters.  Nevertheless, it’s worth acknowledging the increasing possibility that this dynamic of debt deflation in Canada could occur simultaneously with a global commodity boom.

A debt/credit bubble or a housing bubble:  The chicken or the egg?

It’s extremely difficult to determine where our Canadian debt/credit bubble ends and our real estate bubble begins.  They are joined at the hip.  Mortgage credit alone accounts for 70% of the outstanding debt in Canada.

In addition, real estate is responsible for indirect credit creation via HELOC grow, the rate of which has dwarfed even the brisk pace of mortgage growth.

In total, HELOCs and mortgages account for 80% of the total outstanding consumer debt.  This is not unusual, but again the pace at which this debt has been accumulated that is problematic as it has greatly outpaced income growth and inflation, particularly in the past 5 years.

The question then becomes, which comes first:  A retrenching consumer which causes weakness in the economy and a house price decline by extension, or house price declines which cause a retrenching consumer and a weaker economy?

I looked at this exact question back in October.  The bottom line is that it is really an academic argument as either one exerts significant pressure on the other.  It’s the Great Connection in reverse.

Looking for signs

Let me suggest a few things that might precede either a retrenching in consumer spending or a declining real estate market:

1)  Falling home sales.  As prices overshoot the ability of buyers to access adequate mortgage financing, sales fall.  There are two things that could certainly exasperate this:  1) Rising 5 year government of Canada bond yields, upon which all mortgages (even variable) much be approved.  Bloomberg tracks bond yields here.   Keep an eye on this.  2)  Upcoming mortgage rule changes which may or may not affect maximum amortization and minimum downpayment.

As an aside, the most recent realtor board stats showed significant cooling in home sales across the country, particularly in Vancouver and Toronto.

2)  Falling housing starts.  Developers typically have a pretty good sense for current and future demand.  When housing starts drop off significantly, it’s often an early indication of dwindling demand for new homes.  While the month-to-month numbers can be notoriously volatile, watch for a general trend lower.  With housing starts having averaged nearly 200K over the past few years (outpacing net household formation by 25K per annum), I’d be very surprised to see housing starts much above 150-160K this year.  October and November housing start data has told two VERY different stories.  Watch these numbers closely.

3)  Falling consumer confidence.  Consumers whose view sours on the economy and their own prospects tend to hold their dollars a bit tighter.  Consumer confidence readings are also notoriously volatile but have shown a clear downward trend over the past few months.

4)  Rising defaults on unsecured debt. As debt burdens become increasingly onerous, consumers will begin to default on unsecured debt first.  Watch for an increase in credit card delinquencies (check out this story!) and rising delinquencies in unsecured lines of credit.

Keep your ear to the ground and your eyes wide open.  I believe we’re in the early stages of a period of recognition and enlightenment where consumers will begin to grasp the sad and dangerous state of their household finances.  The media is certainly trumpeting this story.  I think the great Canadian debt/credit/real estate bubble will be THE story of the next half decade.

Happy bubble watching!


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37 Responses to Watching for signs of a deflating Canadian debt/real estate bubble

  1. Sam says:

    Ben, when you say

    “Consumer debt is at a record percentage of personal disposable income” and you have a graph from 1990, any point on the graph in the last 21 years has been a RECORD high, it has been going the same way, so every single point with time is higher. It doesn’t mean anything, you could have been doing this blog for 21 years pointing to that same graph with moments in time. You have recycled this point too many times, let it go. 21 year trend, who can say when and if it ever breaks??????

    • Of course it has since interest rates have consistently declined since the 80s. What exactly is your point, Sam? Can debt to PDI rise forever? Can it hit 175%….200%….500% in an environment of rising interest rates?

      • Sam says:

        The point I am making is exactly that, sure some fella said the same thing in the 90’s..can it go 50, 60, 160??? Yes we are here today, and it will grow higher or the revenues will bring it down and chip it away, it’s not a line to say “a ha”

        If you said to me Ben

        Sam, people have zero income and are funding homes at 0% teaser rates and the job picture looks bleek and the economy doesn’t look as it will have any job creation soon, then I would say something can break. Simply watching people spend and take on debt is not a “Watching signs…”

        This is my point.

  2. Sam says:

    “In addition, real estate is responsible for indirect credit creation via HELOC grow, the rate of which has dwarfed even the brisk pace of mortgage growth.”

    This gray line that has been growing is secured HELOC from homes, it means that equity levels in homes are high enough that it doesn’t trigger CMHC charges (25%) and the bank let’s you take money out. This is not increasing LTV from 75% to 95% but rather taking LTV from 55%-65%. Otherwise, these loans would be pushed back to CMHC via HELOC, which would mean that homes and lines of credit are being all underwritten by the government. I don’t believe that is the case Ben

    I buy a home for 100k, put down 25K, homes goes to 200K and I take out 50K, etc…
    If this was not the case, then basically you are saying banks are then pushing loans on the government’s balance sheet and increasing CMHC LTV ratios. That is not possible because you would need that in your bond holder prospectus.

    • You’re stretching pretty hard to find fault. I didn’t remotely suggest that HELOCs are being underwritten by the government. Nice try.

      • Sam says:

        i am simply saying that line should reflect along with the prices of homes, homes prices explode, so will that grey line.

        It is like showing a graph of home prices, nothing more.

  3. Sam says:

    Looking for signs

    All 4 points you have given are again Ben only looking at the debt side of the balance sheet, I know you know that revenue side is strong, improving with the economic recovery and people are getting better shape to handle the 160% ratio you point out. For a “bubble” to crack, you need something to pop, break – IT HAS TO COME FROM PEOPLE NOT BEING ABLE TO PAY THOSE MONTHLY PAYMENTS, the revenue side…you know this, everyone from the BOC to my local mortgage broker knows this.

    Why do you not focus on this at all Ben, it’s a simple balance sheet. Can’t only look at one side…. I respect and go through your points on the debt side, why don’t you look at the revenue side?????

  4. don says:


    • Sam says:

      construction is not everyone job’s – if that is case and I accept your point as ture, then has it always not been the case then? That is how an economy works.

      • In the past 20 years consumer spending has increased from 55% GDP to 65% GDP while consumer debt to PDI has nearly doubled. Where do you think that money has been spent. How might a return to the mean affect the revenue side of the equation? Connect the dots Sam.

      • Sam says:

        rates are lower, normalize and you connect the dots. You continue to ignore the revenue side of Canada because you can’t find holes in it. Find some and then we can talk. The last I checked, the BC Ferries CEO was making a MILLION bucks. Look up this in google

        Ontario 100k – the clerk for aborginal affairs makes 165k? Those are all government jobs..private sector job creation is ok also, i believe someone pointed out that it’s also been ok during the recovery

        Make me happy Ben, for one week, take your amazing talent to dig into the debt side and use it on the revenue side. PLEASE

  5. Kevin says:


    “Consumer debt levels will revert back to a more stable level. I have no idea exactly how far it will fall from the current level of 150% PDI, but I would suggest that we’ll see it push 120% PDI over the next decade, with a significant chance of it pushing double digits.”

    do you have any info on how the debt to income for households in Japan has changed throughout the last 20 years?
    Not only does the US experience give us some hints on what may happen here, so does Japan, but I have not followed Japan much.

  6. John in Ottawa says:

    I have a mortgage and a small HELOC. I know that my bank, in determining just how large my HELOC could be, used the rule: Mortgage + HELOC <= 80%LTV. I don't know if they have a program to break that rule.

    The key chart in Ben's post is the savings rate chart. Currently, it shows that the Canadian savings rate is about 5%. It has never gone negative. Notice the US savings rate went negative and credit peaked in 2005. The savings rate is the SUM of money invested (whether under the pillow or in stocks, bonds, etc) and debt repayed. As long as the savings rate remains positive, the credit bubble will not pop.

    So the key indicator to watch for is a sustained drop in the Canadian savings rate. If it goes negative, it's all over. The primary risk to the savings rate is interest rates.

    • Sam says:

      This point inverted to Ben

      Ben, what ratio leverage do you need to feel ok? 25% down, 50% down??? Lets hunt for the average LTV in a CANHOU Bond? The last I checked with a bond desk they were implied to be 55% LTV in the loans. Prove me wrong. At least know the sensitivity of the CMHC to changes in home prices – THIS IS KEY ON THE DEBT side, not all these graphs. That would be the first breaking point.

    • Grrr says:

      “So the key indicator to watch for is a sustained drop in the Canadian savings rate. If it goes negative, it’s all over.”

      It doesn’t necessarily have to go negative; it depends on the variance. As a simple example:
      25% of the population is saving 20%
      25% of the population is saving 10%
      25% of the population doesn’t save
      25% of the population has a negative savings rate of 15%

      This gives an average savings rate of 3.75%, meanwhile a quarter of the population is going to ruin and another quarter is on the cusp. The only way low average saving rates are safe is if we’re all average.

  7. jesse says:

    “So the key indicator to watch for is a sustained drop in the Canadian savings rate.”

    This is an interesting point but Japan had a hugely positive household savings rate and their housing bubble burst nonetheless. There is some interesting research on how bubbles implode and as Ben has pointed out, it can happen without rising interest rates, and without negative savings rates.

    All’s that’s needed is to run out of Greater Fools, pardon the innuendo…

    I type sitting in BC and I can tell you parts of the province have close to 1.5 years of inventory, parts of the province with steady net in-migration. What? How is this possible with positive savings rates, low interest rates, access to credit, and population growth?

    • John in Ottawa says:

      Let’s not start mixing apples and oranges, Jesse. I wasn’t talking about a housing bubble burst, just a credit bubble burst. As long as debt can be serviced it isn’t going to bust. A positive savings rate, in aggregate, means that the debt can be serviced.

      It is pointless to bring into the discussion specific geographic regions unless we can also get stats relevant to the discussion for the region. Canada is a huge country with a small, sparse population. Regional mileage is always going to vary.

      WRT to Japan, Japan was a heck of a lot more than a housing bubble burst. In fact, any burst in house prices in Japan was only a side effect of the currency crisis that infected most of the orient. Japan has had two lost decades now and the only thing that has saved it at all is the, as you say, huge savings rate. Until just recently, Japan has been able to fund its stimulus programs from within. That’s changing as we write.

      To properly comprehend what is happening right now in the US requires a good comprehension of what happened in Japan. In particular, it is useful to understand what steps Japan took to rescue themselves, unsuccessfully so far, from deflation. Bernanke is trying his best to save the US from deflation, yet he is doing almost exactly what Japan did. Just more so.

  8. Norm says:

    Thank you for this blog Ben. There is not enough canadian economic info on the internet.

    In 1980 when I bought my house, I paid twice my annual salary. I still own the house and it would need roughly 6-7 times the annual salary of a young person to buy it now.

    Obviously, the interest rate was much higher then, but I was getting 10-15% annual increases because of the high level of inflation. The mortgage (gage à la mort) was paid in 12 years. Try to do that today!

  9. mac says:

    Now we’re waiting FIVE YEARS for The Great Canadian Debt/Credit/Real Estate bubble to pop? A prognostication cheered on by well known Vancouver Bubble Blog posters from Vancouvercondoinfo, Realestatetalks, etc congratulating Ben on his analysis because it has been their analysis for the last 10 YEARS.

    So the advice now is wait for the next FIVE years and watch the bubble implode? Consumers heads are spinning and they’re starting to dry heave. Where? Not here. When? Now? No way. Waiting another 5 years is going to be one expensive call for any potential home buyer in Vancouver if this blog is wrong.

    The “evil” G&M this weekend took apart the Vancouver real estate market. 2010, that disastrous year for sales, the year of the greatest Spring run up in inventory in human history (which turned South as the year went on). 2010 has turned out 20% increases for SFHs in some west side areas. Lemme guess. Numbers are skewed by low volumes? And volumes will stay low forever, right? No spring market because consumers are tapped out, heaving and sweating?

    Interest rates will skyrocket to unmanageable rates bankrupting many (yeah, right!) If the gov’t won’t do it bond vigilantes will. It’s just like Ireland and Spain over here, despite the current relative strength in our housing market, economy, stock and commodities market. We’re going to collapse just like Australian has(n’t) since interest rates have climbed there. China will pop any minute and then we’ll be sorry!

    I like this blog but boy does it confuse the present tense with the future tense.

    • Welcome back, Mac. The comment section was getting cold without all your hot air. You seem tense. A bit concerned are we?

      • Sam says:

        Why would Mac be concerned, he is pointing out some real facts -this reminds me almost when that lame-o Rosenberg says
        “its been a 5 year bear market rally” BUT it’s still a rally and money is being made? A rally is rally.

  10. mac says:

    I’m happy to oblige. Somebody has to look out for the best interests of newbie bears who think this type of analysis = fact, rather than prognostication. Again, readers should be aware of taking free financial advice off the internet.

    I especially like your graph of Japan’s 20 year real estate collapse. Interest rates there went down and down you say and prices never recovered? Fancy that. You know what would be interesting? Showing that graph with the matching 20-yr Japanese immigration policy. That might do some ‘splainin’.

    • And that quote tells my readers just how seriously they should take your critique. Just what graph exactly are you refering to? Did you actually read this post?

      • Sam says:

        I believe the problem might be that posts now are not fresh, the same information is being recycled over and over and is really not going anywhere. Hopefully you can use your talent Ben to breakdown the jobs, wages, incomes, etc side…

  11. “I believe the problem might be that posts now are not fresh, the same information is being recycled over and over”

    …and yet you linger….and are by far the most frequent commenter. I’d understand it if you sought out the greener pastures of a more intellectually stimulating blog. Good riddance my friend.

  12. mac says:

    Wow. Nasty.

    (Sam’s right. I skim read unless it’s something new… a cursory glance made me think you had posted the Japanese house price graph.) I always consider your point of view but I’ve gotta call you out when you get too arrogant. Like now.

    Sam offers a nice counterpoint to your arguments whereas you behave terribly by comparison. And have done ever since the appearance of the first poster who disagrees with you–me.

    Sam gives you more of what you want in a rebuttal but he too is rewarded with personal attacks and a very Canadian invitation to leave this blog. You do know a blog isn’t a house of worship, aye?

    • You didn’t call me out on anything, Mac. It was obvious from your comments that you hadn’t read my post as you seem to think I’ve put off my forecast for 5 years. Read it again. Slowly. Sound out the words.

      The fact that you made reference to a non existent graph only confirms that you attack first and read later.

      I’ve had many people disagree with my point of view. It doesn’t bother me. It does bother me when people try to twist what I’ve said to fit it into their own narrative. That would be you Mac.

    • ATP says:

      A blog isn’t a house of worship. A blog is a blogger’s HOME, where he or she volunteers to host an open house. As a ‘homeowner’, the blogger reserves the right to suggest the guest to leave without even needing to give a reason.

  13. Cam Fitzgerald says:

    That was a terrific article Ben. I just wanted to tell you I really enjoyed reading it and noticed that many of your estimates of the trends are similar to my own. My favorite line from your article though had to be the following few words…….

    “But now the room’s starting to spin and consumers are starting to dry heave”.

    Too funny Ben!

  14. Pingback: Value of building permits plunges in November; Bank of Canada talks tough | Financial Insights

  15. Saul says:

    Good riddance to Sam!…if only he took Mac with him!

  16. Hey Ben
    I really enjoyed reading your article. I’m going to tweet it.
    We have certainly seen the falling home starts and falling Real Estate statistics and just about all the Real Estate warnings I can imagine!

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