Canada's Housing Bubble

Dec 13, 2010 Ben Rabidoux financialinsights.wordpress.com

Household debt hits new record

Remember back in 2009 when articles like these were so prevalent?

“Perhaps Canadians are inherently more conservative than Americans and that has kept the market steadier…”

“Canadians have less debt than Americans and a better chance of getting personal and business credit from our much-healthier banking system.”

“Canadians are more conservative by nature…”

Oh for the good old days when the ‘conservative Canadian consumer’ mantra was being bandied about as the major reason why Canada’s economy and housing sector will fare well in the coming years.

Today we learn that Canada’s consumer debt levels are now above those of our ‘reckless’ American cousins.  When adjusted for changes in income tax laws, our current debt levels are arguably above those of Americans at the height of their own credit bubble.

Note: I’ve updated the graph from this TD publication to show new debt levels.

While assets and net worth continue to grow also, their values are floating on a sea of credit.  It’s been my position that peak credit is very close at hand. The lee side of that credit mountain looks vastly different from the summit.  Once demand for credit hits a wall, as it now must, credit-dependent assets like real estate crumble.  The broader economy contracts as consumer spending is choked off.  Unemployment rises.

That is unless the Bank of Canada can somehow orchestrate a soft landing in credit demand whereby consumers gradually come to the realization that they’re overextended and demand for credit gradually weakens.  Mass psychology being what it is, it’s very difficult to see that happening.

RBC had this to say:

“The household debt-to-personal disposable income (PDI) ratio, however, rose to a new record high of 149.9% in the third quarter from 145.2% in the second quarter”

(Other sources had the PDI ratio at 148.1%)

“The recovery was largely driven by the strength in asset values (real estate in particular) since the beginning of 2009 that was supported by historically low interest rates. These gains, however, have been accompanied by increases in debt, and as a result, household debt levels are at all-time highs.”

RBC concludes that since assets are rising on aggregate faster than debt levels that somehow this is not particularly troublesome.  I’m not sure how they can argue that.  The trend is clearly not sustainable.

As TD noted in their economic commentary:

“While household net worth continues to improve, it is growing at half the pace experienced in the three years prior to the recession. All the signs are pointing to a continued moderation in the rate at which households can accumulate assets. Unless households cool their pace of debt accumulation significantly in the near-term, the ability to grow their net worth will be constrained by the level of indebtedness.”

“As households have to devote a greater share of their income to their monthly debt
payments, bolstering their asset position through increasing savings will be a bit more of a challenge in the future, and liability growth is likely to continue to outpace asset growth for some time, weighing on net worth growth.”

Carney chimes in

Earlier today Mark Carney delivered a speech to the Economic Club of Canada.  In it, he mused about the current state of the global economy, the impacts of QE2 on Canada, and the implications of extended low interest rate policies on households.

Some key quotes:

“Encouraged in part by low interest rates, Canadian household credit has expanded rapidly during the recession and throughout the recovery. As a consequence, the proportion of households with stretched financial positions has grown significantly.”

“Without a significant change in behaviour, the proportion of households that would be susceptible to serious financial stress from an adverse shock will continue to grow.”

“These are extraordinary times. A massive deleveraging has barely begun across the industrialised world.”

“More broadly, market participants should resist complacency and constantly reassess risks. Low rates today do not necessarily mean low rates tomorrow. Risk reversals when they happen can be fierce: the greater the complacency, the more brutal the reckoning.”

I do think Carney’s hands are tied over the short term.  It’s pretty obvious that the dream scenario for Carney would be to talk down consumer debt levels through this type of banter while still being able to keep interest rates low so businesses can invest and spur on employment growth. Unfortunately it’s not happening.

People will awaken to the fact that their debt levels are setting them up for financial pain in the future.  When they eschew debt, likely en masse, it sets the stage for deflation in credit-sensitive assets.  It also chokes off consumer spending, which currently accounts for 65% of GDP, and causes higher unemployment.  This is our future.  Exactly when people finally return to their senses is the only question.  I can’t help but think that it’s closer that many realize.

-Ben