Household debt likely won’t hit ‘crisis’ level
Threat is lower than feared as Ottawa has headed off a crunch for several years
“The biggest vulnerability to the Canadian economy is coming from household indebtedness,” Carolyn Wilkins, senior deputy governor of the Bank of Canada, said last week on the sidelines of a G7 symposium.
“High household indebtedness,” the bank’s second-in-command added for emphasis.
Canadian household debt is a concern, at a record high of $1.71 of debt for every $1 of disposable income. So, it’s worth asking if we’re facing a widespread insolvency crisis among everyday Canadians.
That threat, after all, has long been a preoccupation of government policymakers and the financial markets.
But that same preoccupation is also why an insolvency crisis among Canadians is probably an overstated threat.
Ottawa has been working with lenders to head off such a crisis at least since stricter lending standards were first imposed on Canadian banks several years ago by the late Jim Flaherty when he was the federal finance minister.
The love affair that many Canadians have with debt has required Ottawa and the provinces ever since to keep warning that costlier credit is on the horizon.
That moment has arrived, with the willingness of central bankers to raise rates after a remarkably long period of “easy money” as a recovery measure dating from the Great Recession.
But perspective helps. During the last Canadian crisis in personal insolvency, in the early 1980s, interest rates peaked at a nosebleed 24 per cent or so.
By contrast, after several Bank of Canada rate hikes, the bank’s current key lending rate is a mere 1.25 per cent.
Soaring housing costs alone required the central bank to raise rates to curb inflation before it becomes ruinous.
And the plan is working. At 1.5 per cent, inflation is well below the bank’s target of 2 per cent.
So is the feds’ most recent initiative to bring sanity to the housing market.
Its demand for the strictest-ever standards in residential mortgage lending has culminated in a “stresstest” regimen for home-mortgage applicants effective Jan. 1.
That new measure has already yielded an estimated 20-per-cent jump in rejected mortgage applications.
In turning away so many borrowers, the new regime is preventing a lot of Canadians from getting in over their heads.
Indeed, it’s teaching a generation of would-be borrowers to focus instead on accumulating savings, and deferring purchases of homes and other big-ticket items if the only way to make them is with credit.
If we’re fortunate, today’s higher interest rates will mark a welcome return to what economists term “future preference,” and what the rest of us call “delayed gratification.”
Rising interest rates will also bring higher returns for Canadians reliant on fixed-income investments.
Obviously, many Canadians are in a debt trap. And higher rates for mortgages, credit-card borrowing and lines of credit will bring acute distress for some and discomfort for many.
The higher rates coincide, however, with a 42-year-low in Canadian unemployment. And with strong 2.9-per-cent wage gains in 2017.
And with one of the biggest pay hikes in history, as measured by the millions of Canadians affected, which is the overdue increase in minimum wages across the country.
Unmanageable consumer debt skews to low-income households. The minimum-wage increases will relieve some of their distress.
It’s also encouraging that among the 35 member countries of the Organization for Economic Cooperation and Development (OECD), Canada ranks second in stable, higher-paying, full-time jobs as a percentage of all new-job creation.
And one doesn’t want to exaggerate the indebtedness phenomenon.
Roughly half of Canadians report not having a dime in consumer debt. The vast majority of credit-card users pay what they owe in full each month.
And online shoppers, ever-growing in number and ever smarter in their comparison shopping, report lower consumer debt than the estimated national household average of $8,500, excluding mortgage costs.
It’s also worth noting that the two Canadian groups with the least consumer debt are Quebecers and millennials, people aged 18 to 34.
Those two groups are the Canadians least likely to own a home, preferring instead to rent. Lifetime renters are unencumbered by property taxes, insurance, repairs and other fixed costs that come with home ownership.
Millennials are also the group probably most attuned to the repeated warnings of the Bank of Canada and others, dating roughly from 2013, that credit won’t stay cheap forever.
And so their average household debt is $5,600.
By contrast, Gen-Xers, the nextyoungest generation, aged 35 to 54, report average debt in excess of $10,000.
It may seem counterintuitive, but by modestly raising borrowing costs now, and thereby discouraging imprudent personal borrowing, the new regime has put a ceiling on how high interest rates will need to go to contain inflation and keep the economy sustainably healthy.
On the housing front — the biggest driver of inflationary pressure, requiring higher interest rates to curb it — the higher-interest-rate regime has been succeeding.
In the third quarter of 2017, the latest period for which we have data, Canadian real home prices, adjusting for inflation, fell 3.8 per cent. That’s the biggest quarterly drop in 27 years. And that was before the feds’ strict new lending standards kicked in.
To put that drop in context, the second-largest decline in that period worldwide, in Italy, was just under 0.4 per cent.
“The ratio of household debt to disposable income in Canada is relatively conservative,” economists Stefane Marion and Mattieu Arseneau of National Bank Financial wrote in a recent report.
“This probably reflects the cumulative effect of all actions taken to date to mitigate the vulnerability of the financial system to household indebtedness.”
As noted, the Canadian debt-toincome ratio is 171. Seven OECD member countries have higher ratios, including two that exceed 250.
But no one is bracing for a personal insolvency crisis in those countries, which include Switzerland, Denmark and Norway, which boasts one of the highest per capita incomes in the industrialized world.
Finally, the economic fundamentals work against a personal insolvency crisis, by which is meant hundreds of thousands of Canadians filing for personal bankruptcy.
That prospect simply isn’t in the cards, due to continued strong job growth; significant personal income growth; an above-average rate of higher education graduates in the workforce; a robust social welfare system; and a highly selective immigration system that finds almost two-thirds of the non-Canadianborn population equipped with a post-secondary education.
The only issue with the 300,000 new Canadians each year is that, in the course of economically establishing themselves here — Ottawa’s top criterion in determining who gets in — many are going to buy homes and launch businesses, putting upward pressure on house prices and wages.
Which means our economic stewards will have to keep striving to prevent a strengthening Canadian economy from overheating.
And that’s a most agreeable challenge to have. dolive@thestar.ca
Roughly half of Canadians report not having a dime in consumer debt