Canada's Housing Bubble

Jun 24, 2011 Michael Babad theglobeandmail.com

Risks of debt bubble

Consumers may be starting to tame their borrowing habits, but the lengthy period of rock-bottom interest rates risks fuelling a debt bubble, BMO Nesbitt Burns warns.

"With overnight rates unchanged since last September, household credit market debt has climbed to a fresh all-time high of $1.524-trillion in [the first quarter], or a record 147.3 per cent of disposable income," economists Douglas Porter and Sal Guatieri said in a report today.

"Canadian debt ratios are now leaving their U.S. counterparts in the rearview mirror ...despite the repeated exhortations by domestic policy makers to rein in borrowing. It seems that (interest rate) actions speak louder than words. Although household debt growth has cooled notably in recent months - April’s 5.5 per cent year over year was the slowest pace since early 2002 - the plain fact remains that it continues to outstrip income growth."

Bank of Canada Governor Mark Carney has held his key overnight rate at 1 per cent for some time now, and is expected to continue to do so at least into the fall, and possibly longer. Indeed, he told The Wall Street Journal that he may need to hold rates down for a while longer given the economic uncertainties in the world.

Mr. Carney has been vocal on the need for Canadians to cut their hefty debts - as recently as this week - as the central bank fears the impact of a financial shock on overburdened consumers.

The BMO economists also cited higher debt service costs and lower equity among homeowners. Interest payments now take up 7.6 per cent of disposable income, just a shade more than the 10-year mean of 7.4 per cent, and it would be higher but for low interest rates.

That will change when rates inevitably, Mr. Porter and Mr. Guatieri said. And while homeowners have a "nice equity cushion" should house prices slump, that cushion is "losing some padding even in the face of rising house prices (as was the case before the U.S. boom turned to bust."

The BMO economists did note that there are "solid assets" among households, because of higher house prices and stronger stock markets in the first quarter. As well, a steady climb in debt ratios has eased recently.

Still, they're worried that Canadians could continue to borrow faster than their incomes rise, leading to an unsustainable debt burden among households.

"While we maintain that a singular focus on debt to gauge the strength of household finances is not entirely appropriate, the prolonged period of ultra-low interest rates runs the risk of pumping a debt/housing bubble," they said in their report.

"We are encouraged by the recent slowing in consumer debt growth, though some further cooling, especially on the mortgage side, will be required to stabilize household debt ratios. This should occur when (or if) interest rates climb moderately in the year ahead."