Canada's Housing Bubble

Jun 14, 2011 Julian Beltrame The Canadian Press

OTTAWA — The federal government and the Bank of Canada are again sounding the alarm over growing household debt as two new reports suggest the problem is worsening in the face of a weakening economy.

Finance Minister Jim Flaherty tabled a budget implementation bill Tuesday he says will formalize his powers to intervene in Canada's hot housing market to restrain borrowing.

And on Wednesday, Bank of Canada governor Mark Carney is expected to warn Canadians against taking on too heavy a debt burden that they won't be able to afford once interest rates start rising.

He is speaking in Vancouver, Canada's poster child for a housing bubble that could pop with any hikes to interest rates or a downturn in the economy.

"We have very low interest rates in Canada," Flaherty said. "We need to remind Canadians that historically low interest rates will not be there forever, that interest rates really only have one way to go and that’s up," Flaherty said.

"So Canadians in terms of their most important – their largest debts, residential mortgages, need to be aware that their monthly payments are going to go up when interest rates go up over time."

The trouble is that Carney is hand-cuffed in his ability intervene with the only tool he has — interest rates — by a recovery that is slowing.

The TD Bank said Tuesday it is now unlikely Carney will be able to start raising interest rates until early next year, and when he does, they will be more modest than many expect.

"The (central) bank isn't as confident ... that everything will go smoothly and the economy will be at full potential by the middle of next year," said Craig Alexander, TD's chief economist.

"They need to be sensitive to the (fact) the economy is probably more sensitive to interest rate changes than at any point in the past because of the high consumer indebtedness and the housing boom we've had."

Raising interest rates would be doubly effective in slowing the economy in a high indebtedness environment because households would need to devote more scarce resources to interest payments. Higher rates could not only scare consumers off buying homes, but deprive them of resources for other purchases, like cars, TVs, appliances, clothes slowing economic activity.

That already appears to be happening. A survey by the Certified General Accountants Association suggests 58 per cent of indebted respondents are taking on more debt just to pay for daily living expenses like food, housing and transportation.

The report indicated that while the average family of four owes about $176,000, some owed much more, and single-parent families, retired Canadians and those with income of $50,000 or less were seriously struggling.

Canadian household total indebtedness reached a record $1.5 trillion in the first quarter of this year, Statistics Canada has reported, or 147 per cent of disposable income, another record.

"The financial situation of certain groups of households is much worse than average and continues to deteriorate," said Rock Lefebvre, vice president of research for the general accountants group.

"It's important that the dynamics of household indebtedness remain high on the radar of policy-makers."

Flaherty has tightened mortgage requirements three times since 2008, but did not say whether he was considering another turn of the screw.

For now, many analysts believe what Flaherty and Carney are doing — issuing warnings — is likely the best approach, since action might be too strong medicine. Tightening mortgage rules further, or raising rates or both, could result in an overshoot and send the housing market crashing.

On the other side of the issue, however, is that many Canadians could be financially hurt if they proceed on the assumption interest rates and carrying costs, will remain at current levels for years.

TD Economist Alexander said without an accompanying strong recovery, which is looking increasingly unlikely, consumers could find themselves tapped out for some time.

The chartered bank's new forecast is for modest growth as far as the eye can see, with the unemployment rate hovering above seven per cent until after 2013.

What's more, says TD, the downside risk to the economy is far greater than the upside odds.

Alexander says Canada's economy is believed to have already slowed to 1.3 per cent growth during this current quarter that ends at the end of the month, one third the pace of the first quarter's 3.9 per cent gain.

The rest of the year will see growth crawl along between two and 2.5 per cent, the bank says.

The next two years will see more of the same, TD says, with growth rates of 2.4 per cent in 2012 and 2.1 per cent in 2013.

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