Canada's Housing Bubble

Sep 30, 2010 Tavia Grant Globe and Mail

Mark Carney wants to ensure that consumers don’t add to already swollen debt levels in an era of still-low interest rates and an unusually uncertain outlook.

The Bank of Canada Governor’s harshest warning to date indicates policy makers are concerned that consumers who haven’t yet got the message will continue piling on debt if the central bank holds rates steady, after three increases, amid a sluggish recovery.

The Bank of Canada is cautious in its outlook for borrowing costs, and has hinted it could hold its benchmark rate steady, at 1 per cent, at its next meeting Oct. 19.

Mr. Carney used a speech in Windsor, Ont., Thursday to express concerns over the levels of debt built up during the era of rock-bottom interest rates. Too many households are becoming too stretched for comfort and the dynamic is already proving to be unsustainable, adding to the forces causing growth to slow as some Canadians’ ability to spend seems to have tapped out.

“This cannot continue,’’ Mr. Carney said. “While asset prices can rise or fall, debt endures.’’

His tone was significant because throughout the recession, the central bank frequently expressed surprise at the pace of credit growth, without ringing alarm bells in such stark terms. Policy makers are now in a difficult spot: An already slower economy will stay tepid as overextended borrowers pull back, making it that much harder to raise rates. But with rates still low, they want Canadians to understand that at some point it’s going to cost more to service their debts.

Even with a relatively buoyant housing market, Mr. Carney noted, Canadians’ debt-to-assets ratio has risen to its highest level in more than two decades, and the amount they are putting into financing their homes has dwarfed their total savings for more than nine years.

“What we’ve urged Canadians, and I think Canadians are starting to heed this message – of their own accord, not because we’re saying it – to think about the debt that they’re taking on over a longer term, and what’s a normal interest rate, and am I comfortable paying a normal interest rate with the type of debt I have?’’ Mr. Carney said after the speech. “Our expectation is that behaviour will become increasingly common, given the level of debt. If that happens, that’s consistent with a continued modest recovery.’’

His comments come at a troubling time. The recovery is sputtering and the outlook is muddied. A report from Statistics Canada earlier Thursday showed the economy contracted in July for the first time since August, 2009, slipping 0.1 per cent.

Canada is now sinking into an economic malaise that will force governments and businesses to rethink strategy just as borrowers, as Mr. Carney hopes, hunker down.

The shift to slower growth will have profound effects on everything from public finances to the prospects for companies ranging from home builders to exporters. The flailing U.S. economy is already having an impact on Canadian consumers, with confidence falling to its lowest level in a year.

“The soft patch in the U.S. doesn’t look like it’s getting any worse, but the bad news is it doesn’t look like it’s getting any better,’’ Geoffrey Somes, vice-president and senior economist at State Street Global Advisors, said in an interview from Boston. As a result, he said, ``there’s a bit of an erosion of confidence occurring across the globe, including in Canada.’’

The slowdown in Canada’s recovery is pronounced enough that government forecasts could fall well short next year, CIBC World Markets chief economist Avery Shenfeld said. He expects nominal growth of little more than 3.5 per cent next year – “well below the 5-per-cent gain envisaged in 2010 budgets.”

Businesses, too, are having to retool strategy.

“It isn’t panic stations, but there’s definitely less momentum relative to what we saw in the back half of 2009 and first part of 2010,” said Chuck Phillips, chief executive officer of Armtec Infrastructure Income Fund, a Guelph, Ont., maker of noise barriers and construction products.

Mr. Phillips is adjusting his plans to focus more on Western Canada, where demand is stronger. He’s also beefing up customer service to better compete in a market where some competitors, that previously supplied the U.S. market, are now focusing more on Canada.

Other firms, such as Chilliwack, B.C.-based IMW Industries Ltd., are shifting operations overseas to cope with slumping U.S. demand and a strong dollar. Exports to China and Latin America are still strong, but infrastructure spending is fading in Canada, while oil and gas activity has not returned to pre-recession levels, said Brad Miller, president of the industrial equipment maker.

With files from Kevin Carmichael