Canada's Housing Bubble

Dec 14, 2010 Jay Bryan The Gazette

On the face of it, the situation is grim. New statistics out yesterday reveal that Canadian households are deeper in debt than they've ever been before; deeper, in fact, than even those spendthrift Americans.

Just to drive home the gravity of our situation, the governor of the Bank of Canada, Mark Carney, has just issued yet another in a string of warnings to Canadians. He told a Toronto business group yesterday that with household debts still rising faster than incomes, the proportion of families vulnerable to any economic shock is growing.

Indeed, said Carney, a central bank simulation shows if the unemployment rate were to rise by three percentage points, the proportion of personal loans in arrears would double.

All this is true, but is it to be taken seriously? Only up to a point.

There's little doubt that Canadians are deep in debt these days and what's more, this debt did help to finance a housing boom that became overheated early this year.

Clearly, Canada's cheap-money psychology needs to be reined in. But actually, this already seems to be happening.

Just witness the recent screeching halt in home-price gains.

And let's remember why we did all that borrowing: it was because that nice Mr. Carney slashed the cost of money to nearly nothing back when he saw that a serious recession was on the way.

He did so in the hope that Canadians would react exactly as they did: borrowing and spending enough to offset the worst of the downturn.

And it worked. Canadian home sales and prices bounced back smartly after having briefly cratered, consumer spending in general held up pretty well and the job market is healing much more quickly than in the U.S.

It's true that the price of this quick start toward recovery has been a level of debt that's very high. But let's not get hysterical about the imminence of a debt crisis.

Let's start with Carney's unemployment simulation. The recession we've just been through was quite serious, yet the unemployment rate actually rose by a bit less than the three percentage points in Carney's scenario. Does he really think an even bigger recession looms? Probably not.

Still, it's okay for Carney to have chosen an extreme example, believes Pascal Gauthier, senior economist at the Toronto-Dominion Bank, since such financial stress tests are supposed to envision shocks far worse than we expect.

But to come back to the real world, "there's really no obvious sign of stress on Canadians' finances," said Douglas Porter, deputy chief economist at BMO Capital Markets. Default rates on loans actually aren't worrisome.

Another point Carney continues to make is that if interest rates were to rise more rapidly than people expect, debts that are manageable now could become hard to carry.

That's fair, but it's equally fair to point out, as Porter does, that if interest rates were to rise rapidly, the cause would be a rate of economic and income growth that would also be rising more rapidly than we now expect. This would help offset any stress on debtors.

As well, Porter notes, there are many measures of indebtedness, and some show Canadians to be in a pretty good situation.

For example, he says, you can add up all the financial assets of Canadians -he leaves out the value of homes in order to be conservative - and then subtract all their debts to get their financial net worth.

This exercise shows the average Canadian household is worth $80,000, or a total of $2.7 trillion. That's 80 per cent more than our total debts of $1.5 trillion.

If you add in the value of real estate and other nonfinancial assets, we're collectively worth $6.1 trillion. That's an all-time high -and an amount about five times as big as all our debts.

This does not mean that our debt level is unimportant, but it does show that when you compare our debts against our assets, we're comfortably in the black. It would take quite a meltdown in real estate or stock prices to put a serious dent in this.

Nevertheless, debts do matter because they must eventually be paid off. And sometimes, asset values really can melt down, so it's not wise to assume that a nice pile of assets makes us invulnerable.

So let's hope that Canadians take Carney's warnings to heart -but not so much to heart that they lose a lot of sleep.

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