Household credit analysis: What the boom looks like before the bust

CIBC released their latest household credit analysiss report yesterday.  It is full of interesting data points.  Though nothing in the report is particularly shocking for anyone who has been reading this blog and is aware of the ongoing credit bubble in Canada, it acts as one more flashing neon warning sign.  Though too early to tell for certain, it also may give us the first look at the slowing credit that precedes monetary deflation.

What is peak credit and are we close to it?

As a country we may well be approaching peak credit, the point at which credit demand peaks due to debt saturation.  People have taken on as much debt as their salaries will allow.  Once a society hits peak credit, the period of deleveraging that follows looks nothing like the ride up.  Where debt buoyed an economy on the way up, it significantly hampers growth on the way down.  While there will always be some credit demand, once the balance of the population decides that it’s wise to pay off debt and actually save (novel idea!), this dynamic overwhelms what credit demand there is and deflation ensues.

Furthermore, debt demand peaks and additional credit becomes difficult if not impossible to force into the system.  When this happens, cheap interest rates don’t matter.  Monetary stimulus has only a fleeting effect on the economy as it is overwhelmed by the contraction in the money supply as deleveraging and collapsing velocity of money overwhelm central bank efforts to ‘stimulate’.  This is often referred to as pushing on a string.

Though we have examples of other countries whose consumer debt levels peaked closer to 180% of personal disposable income (the UK and Australia may both be headed that way), we also have many examples of countries who experienced credit bust cycles when their consumer debt levels were less than 160% (the US and Ireland come to mind).  In Canada, we’re currently pushing 150%.

Can the credit bubble inflate further?  Absolutely!  But keep two things in mind:  1)  The end game is non negotiable.  If debt levels rise another 10% relative to incomes, they’ll just have that much further to fall to realign with their mean.  2)  Recent moves by the government to tighten mortgage rules will put a lid on credit expansion as it is 70% reliant on mortgages.  We may well be staring at the catalyst for credit deleveraging in the form of a squeeze in the buyer pool.  This camel’s looking awfully strained as it is.  Hard to tell exactly what will break its back, but these new rule changes may prove to be one hefty piece of straw.

My feeling is that we are closer to the pinnacle than most realize, but it’s always important to remember Bob Farrel’s 4th rule of investing as it applies to any monetary phenomena:  Exponential rapidly rising or falling (trends) usually go further than you think, but they do not correct by going sideways.

First signs of credit fatigue?  Credit demand weakest in a decade!

CIBCs report indicates that while credit demand is still outpacing wage growth, it has slowed in a pretty major way.  The most recent data was from October 2010:

“…Growth in household credit in the third quarter of 2010 was the slowest in more than 9 years, while the 0.27% increase in credit during October… was the softest monthly reading in more than 15 years.”

Mortgage credit demand back to recession levels…First time buyers hard to find

“Mortgage outstandings are still rising at close to 7% on a year-over-year basis, but the monthly pattern is currently running at a rate seen during the recession. The reduced  demand for mortgage credit is more notable among first time home buyers”

“The arrears rates in the mortgage market is currently at 0.43%—up from 0.24% in early 2006.”

In order for a house prices to rise you need two things:  New buyers and expanding credit demand/availability.  Both of these are now under threat.  Consider that the lack of new buyers and slowing mortgage credit demand was evident even before the new mortgage rules were announced.

Line of credit demand slows even faster than mortgages

“The signs of softening in consumer loans are even more visible than in the mortgage market….Lines of credit are now rising at a monthly clip of 0.3%, the slowest pace since 2007.”

Let’s not forget that line of credit growth, particularly HELOCs, have significantly boosted consumer spending.  CAAMP data suggests that home equity extraction alone has added 9% to the after tax income of the average family’s budget.  When this slows, consumer spending (65% of our economy) slows with it.  The new mortgage rules aimed at limiting home equity withdrawals will certainly act as a catalyst to strengthen this trend.

Credit card debt demand softens

“The credit card market has softened notably during the past year reflecting in part some supply factors as creditors cut limits during the recession.”

“Delinquency rates and bad debt have risen notably over the past year”

As is always the case, consumers default on their unsecured debt first.  This may well have been the big bank’s primary motivation in pushing Ottawa to rein in mortgage insurance.  While the bank’s mortgage portfolios are largely protected from a housing market correction, their other portfolios may not be.

An excellent article on this very topic was just featured in the Financial Post:

Banks in spotlight amid rising housing debt

And I’ve tackled this topic before as well:

Are the big banks really concerned about the consumer or are there ulterior motives?

The full deleveraging is not in the works yet

“During the third quarter of the year, debt continued to outpace income with total credit outstanding rising by 1.3% (q/q) while income fell by 1.5% (q/q). As a result, the debt-to-income ratio rose to a new record high of 146%.”

Hmmm….credit growth slowing, but incomes slowing faster.  Might there be a connection between income, employment, and our current credit-driven economy?

The good news

The expansion in credit, while moderating, is still significant enough to produce some ‘good’ economic data:

“While debt is still rising faster than income, it is no longer rising faster than assets. The net worth position of Canadians has improved in the third quarter in absolute terms and relative to income.”

A stimulus-induced bounce in the housing market and arguably the stock market will do that.

“After rising since early 2008, consumer bankruptcies are in a clear downward trend”

For now.  Interest rates are at historic lows.  Rampant credit expansion via the housing market and wealth effect spending have a great way of buoying the economy in the short term while masking structural issues.  The chicken have yet to come home to roost, but this data may suggest they’re on their way!


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5 Responses to Household credit analysis: What the boom looks like before the bust

  1. Paxtor says:


    About a month ago, your blog became my favorite Canadian financial blog. More recently it has been creeping up my list of favorite blogs, period. Keep up the phenomenal work!

    Now that the flattery is out of the way, I would agree that the big banks are getting a tad nervous. Protection via CMHC financed mortgages might prevent them from going under, but at their current market prices all these banks would need is a major earnings miss to drop substantially in stock price. As you suggested, lost revenue and capital from defaulted unsecured loans would hurt their bottom line. CMHC loan defaults would also hurt them, not in terms of capital, but in terms of revenue.


  2. The General says:

    This reads like an echo to what I have been telling people since the late 1990’s.

    One question I have is this… If our government is borrowing money to stimulate the economy, what happens when their credit is called on when we crash our economy. Will our money, bank accounts, our RRSP’s, life insurance policies etc… still be insured by the federal government up to existing limits?

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  5. Mature Student says:

    Hi Ben,

    Just wanted to let you know I really enjoy your blog. It is not only well-written, but you’ve clearly done your homework on the posts. I truly appreciate the time and effort you put into the research and writing.

    Keep up the great work,

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