Debt Crunch: A look at Canada’s record level of household debt

Action Canada Task Force releases final report

The Action Canada Task Force on Canadian Household Debt released their final report on Friday.  The report echoes many of the concerns I have expressed on this site, namely that high debt levels have the potential to cause significant and under-appreciated economic hardships when an inflection point is reached.

As I have often said, we are living in a generation unique in Canadian history.  Never has a generation of Canadians displayed such complacency with their consumer debt levels. It’s been a society-wide credit binge that has come to constitute the new norm.  But our collective notion of ‘normal’ is fluid, ebbing and flowing under the influence of numerous factors.  It’s this ebb and flow that concerns me as history has repeatedly shown that marked deviance from a long, stable norm are often followed by a rapid reversion back to an embracing of long-lost principles.

This is not lost on the authors of the report who note that the current level of household indebtedness has the potential to cause a ‘made in Canada’ recession.

On concerns over current debt levels…

Since 2008, Canada has not only weathered the recent financial crisis, but also emerged as a global example of fiscal responsibility. However, while our banks, businesses and government remain strong, Canadian households have continued to accumulate debt at an unprecedented rate.

Not sure I entirely agree.  As I’ve noted before, our financial institutions received what amounted to a back door bailout on the same scale as our southern neighbours.  While our government balance sheets are strong relative to other nations, we nevertheless have historically large deficits which need to be reined in.

With interest rates expected tonrise, Canadian households that have taken on too much debt face a real financial risk. Vulnerability at the household level could easily translate into a larger risk for the economy as a whole.

On underlying weakness in household balance sheets……at the mercy of interest rates

In 2010, 59% of Canadians indicated they would have difficulty making financial ends meet if their paycheque was delayed by only a week.8 In fact, 1 in 10 state they could not handle an unexpected expense of $500.  Perhaps most startling is the fact that 63% feel their debt limits their ability to reach their personal and financial goals such as going back to school or saving for retirement.

According to a stress test scenario by the Bank of Canada, it would take only a 0.5% increase in interest rates for 1.1 million Canadian households to become at risk of defaulting on their consumer credit or mortgage-related debt.  Projected income increases will be  insufficient to offset the increases in debt payments that will occur with even such a small increase in interest rates.

On the impact of consumer debt on the broader economy

…Over-leveraged households will significantly reduce their spending in the general economy. Personal spending on consumer goods and services accounts for 58% of the Canadian gdp and such a reduction in consumer spending could provoke a “home-grown” Canadian recession.

Combined with factors such as decreased government stimulus spending, economic stagnation in the United States, falling exports due to a high dollar, or a reduction in home equity prices, the result could be a severe, negative impact on the Canadian economy.

Well, they nailed this one, though they report consumer spending at 58% of GDP while I’ve shown it to be closer to 65% based on Stats Canada numbers (keep in mind there are several ways to calculate GDP).  Regardless, the portion of our economy reliant on consumer spending is up markedly over the past 2 decades no matter how you cut it.  This raises some concerns as these same consumers are increasingly stretched to afford their current levels of consumption.  It’s a topic I’ve written about many times and is one of the main themes of this blog.

On the need to tighten mortgage requirements

Due to current mortgage insurance policies, which extend amortization periods and allow lower down payments, individuals have been able to qualify for larger mortgages, and accordingly are spending more on home purchases.  The indirect effect of consumers having access to larger mortgages is that the market becomes artificially inflated, and home affordability deteriorates.

The federal government should introduce more stringent standards for mortgage qualification while still allowing for mortgages with long amortizations.

They got it half right here.  More stringent standards….yes.  Continue allowing long amortizations…..why?  I’ve addressed the issue of the need for lowered amortization requirements in a previous post.

At a macro level, this would also prompt a correction against the artificial inflation in the housing market and improve affordability. These measures could be introduced gradually to promote a gentle correction in the market.

The report was quite likely nearly finished when Jim Flaherty announced the new mortgage rule changes, so it’s hard to know if the report sees these new changes as sufficient.

On the need to change the culture of borrowing…

While education alone is often not sufficient to change consumer behaviour, it is an important factor. Increased timely exposure to key messages can heighten mindfulness of good financial practices, and change how consumers manage their credit and savings.

To this end, they have created an interesting video about the consequences of debt:

The video relays the important point, but I’m not sure that a simple awareness campaign is the answer.  The reality is that experience is the best educator.  We live in a society where we try our best to cushion the blow of poor financial decisions.  A look south of the border at the various mortgage modification schemes meant to help home owners by reducing their outstanding mortgage or somehow assist them in their debt repayment simply illustrates this.

Had we dealt head-on with the financial crisis of 2008 rather than sweeping it under the rug and burying it under a mountain of stimulus and mark-to-whatever accounting tricks by the big banks, we wouldn’t be having this discussion about the painful repercussions of debt.  The shift in consumer mentality would have long since taken place and today would at the very least be 3 years closer to true organic growth in Canada and the US.



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10 Responses to Debt Crunch: A look at Canada’s record level of household debt

  1. backwardsevolution says:

    “…it would take only a 0.5% increase in interest rates for 1.1 million Canadian households to become at risk of defaulting on their consumer credit or mortgage-related debt.”

    That’s a very frightening statement.

    What people needed and still do, in the States and in Canada, are homes they can afford. But who made the money because houses were priced so high or were selling so quickly? Realtors with commissions, banks with fees? They got their money up front, long gone when the trouble arises.

    You mention “true organic growth in Canada”. What is that? Perpetual growth? More construction, more Home Depots, more Starbucks? I’m curious.

    • Vince says:

      What about that “off balance sheet” liability of the Canadian government called CMHC? Its been used to juice the economy, and its never mentioned anywhere that the Canadian govt is on the hook for it.

      • backwardsevolution says:

        Vince – you’re so right, but people are kept in the dark about this. Where is our media, the media I remember? Silent and bought off. CMHC is going to be my own personal mission.

  2. backwardsevolution says:

    Watch the following clip showing the acceptance speech from the creators of “Inside Job”. It’s only about ten seconds, but last night they won the Oscar for Best Documentary category. It’s about Wall Street and the financial crisis. Notice his use of the word “fraud”.

  3. rp1 says:

    Maybe if the BoC were to stop its policy of negative real interest rates people wouldn’t be compelled to compensate for declining real wages and the falling value of their savings by speculating on assets with debt.

    Seriously, saving money? I tried that and got burned. Fuck the BoC. This currency is garbage.

    • backwardsevolution says:

      ATP – “In 2009 the International Monetary Fund called for a capital gains tax on owner-occupied housing, arguing the current tax-free position encourages people to borrow too much then pay inflated prices for houses.”

      That would no doubt slow down the people buying merely for speculation; probably a good idea.

  4. ATP says:

    Excellent analysis on the math regarding public pensions and healthcare costs in the US. The principle applies equally well to other countries including Canada.

  5. jesse says:

    “it would take only a 0.5% increase in interest rates for 1.1 million Canadian households to become at risk”

    Not to be nitpicky but there are always risks of defaulting. If there truly is a 0.5% sensitivity to substantial default due to payments alone, I would argue there is already substantial risk in the system: one leaky roof, illness, death, divorce, illness, or unexpected financial outlay will cripple a family’s finances if they are truly only 0.5% away from default. In other words, an increase in rates may not be required to, over time, tip the scales to a real estate bear market; all that’s needed is for time to pass and normally occurring “personal finance black swans” to happen.

  6. Pingback: So much for the ‘conservative’ Canadian consumer: Another look at Canada’s credit bubble | Financial Insights

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