Home Capital Group Inc.’s meltdown leaves Canadian economy looking frail

It’s too early for the meltdown at Home Capital Group Inc. to show up in the data — and, with just 1 per cent of the national market, the mortgage lender may be too small to do so anyway.

But it’s already had a big impact on how investors and analysts are weighing the country’s weaknesses against its strengths.

Boom-times in Vancouver and Toronto look more like spillovers from debt-fuelled housing bubbles, the kind that wrought havoc in so many Western countries last decade.

A banking system long considered among the world’s soundest got hit by a Moody’s downgrade this week.

Expectations that Canada will grow faster than developed-world peers this year — as forecast by the Bank of Canada — may be unsustainable, according to Craig Fehr, Canadian investment strategist at moneymanager Edward Jones & Co.

Both home-ownership and consumption are being financed by record levels of household debt. Canada’s traditional remedy for commodity busts involved scraping together enough foreign financing to cushion the initial blow, then depreciating the currency to stoke manufacturing and exports.

There has been plenty of overseas borrowing: External debt was about 60 per cent of GDP a decade ago; now, at $2.3 trillion, it’s larger than the economy.

But much of it has been channelled to households.

As a result, they’re “indebted to a level that is unprecedented,” said Michael Emory, CEO of Allied Properties Real Estate Investment Trust, who describes that as the economy’s biggest concern.

Moody’s Investors Service cited the private-debt burden when it cut ratings on the country’s six biggest banks, expressing concern about asset quality.

That backdrop makes the Home Capital crisis more threatening than it otherwise might have been. A run on deposits, even at a small lender, sparks concern about contagion.

Investors looking for the drama of a full-blown financial crash may be disappointed.

Even while downgrading Canadian banks, Moody’s acknowledged that they “maintain strong buffers in terms of capital and liquidity.” Regulators keep a relatively tight grip on the system.

Canada’s wider financial markets have been lacklustre rather than dismal. So investors aren’t exactly flashing warning signals. Still, they’re finding more things to worry about than was the case a month ago.