Who Will Take Steps to Control Household Debt?

Bank of Canada by Wikimedia Commons
Bank of Canada by Wikimedia Commons

The government and The Bank of Canada have been warning Canadians of the dangers of taking on too much debt, particularly through mortgages, at a time of historically low interest rates and high housing prices. Although the debt-to-income ratio among Canadian households fell in the fourth quarter of last year to 152.9 per cent from 154.2 per cent, the reason wasn’t decreasing debt but income for farms and unincorporated businesses. Leading economist Craig Alexander predicted it is likely to reach the 160 per cent peak experienced in the U.S. and the U.K. before their real estate corrections occurred by late next year. The concern is that when interest rates do return to historically normal levels, about 10 per cent of Canadians who currently have debt would have to devote 40 per cent or more of their income to making their monthly debt payments. And in an economy that has created few new jobs for six months, wage growth could be tepid for years to come.

Bankers’ and Economists’ Prevalent Views

With the Bank of Canada expected to keep interest rates at 1 per cent until at least late 2014 and household debt already at record highs, Mr. Alexander says policy makers need to act soon to lessen the risk of economic damage. “We want to ensure that the imbalance we have doesn’t get any bigger, so the economy over the medium term can weather the inevitable future adjustment in interest rates,” Mr. Alexander said in an interview for The Globe and Mail. “If we incrementally lean against credit growth while we have low rates, it will be a better outcome for the economy.”

However, the government should not attempt to implement all of the changes at once, or even closely spaced, for fear of causing the very economic damage that policy makers are trying to prevent. “We need to be careful that changes in regulation don’t trigger the unwinding that we fear, so you need to be very gentle about it,” he said. Mr. Carney also will need to move very slowly whenever he starts tightening again, said Mr. Alexander. With the current level of consumer debt, “any quarter-point increase in interest rates today will have a much bigger impact on the economy than it had in the past.”

The Government’s Previous Stance

The government has tightened mortgage rules three times since 2008, most recently in January, and Canada’s finance minister Jim Flaherty said that the given signs of overvaluation in Canada’s property market, the government is prepared to tighten mortgage insurance rules again. To the surprise of many, he left them untouched in the federal budget last month.

Calgary by Wikimedia Commons
Calgary by Wikimedia Commons

Three years ago, the federal government was busily encouraging more people to enter the housing market with a tax credit for first-time homebuyers and an increase in the amount they could borrow from their registered retirement-savings plan. It also indirectly encouraged home-equity loans through a tax credit for home renovations. In 2010, when fears of recession were dissipating, Mr. Flaherty said he wanted “to discourage the tendency some people have to use a home as an ATM, or buy three or four condos on speculation.”

At an October news conference, he said Canada as a whole does not face a housing bubble that requires government action. Asked what would constitute evidence of a bubble, Mr. Flaherty said: “If we saw dramatic surges in prices in some part of the country. There’s some demand in Vancouver in particular, particularly from the Asian people coming to Canada who are investing in real estate. So there’s some demand there that is unusual in terms of the entire country, but overall across the country there’s been some moderation, which is good." Given low interest rates, the level of housing demand in Canada is not surprising, the Finance Minister of Canada said in 2011. But he added, “We have seen in the past year some softening in the Canadian housing market, in part due to the tightening of the insured mortgage market rules that we did earlier this year… That’s an appropriate result from that tightening.”

Housing Market Prognosis

According to Royal LePage House Price Survey, Vancouver continued to experience some of Canada’s largest year-over-year price increases, ranging from the standard condominiums rising 10.7 per cent to detached bungalows rising 14.1 per cent. At the end of 2012, average house prices in Vancouver are forecast to be 2.3 per cent higher than 2011.

While 2011 was a very strong year for price growth, over the past five years, including the recessionary period, Canada’s average home prices have grown by only 3.5 per cent compounded annually, well below the long term average rate of appreciation. Canada’s GDP has also grown modestly over the same period and the economy is expected to expand by approximately 2 per cent in 2012. While unemployment remains stubbornly higher than pre-recession levels, sustained employment at today’s levels in a low interest rate environment can be expected to support continued average house price appreciation across the country.

Flaherty’s Conclusion: No Government Intervention for the Time Being

Calgary House by Bill Longstaff
Calgary House by Bill Longstaff

Regardless of these unfavourable trends, Canada’s finance minister said recently that he has seen signs of moderation in the Toronto condominium market and expects to see a similar trend in Vancouver, one of the country’s hottest real estate markets. “Part of that is based on what I’m being told by people who build condominiums, and also what I’m being told by some of our banks about their standards becoming more stringent with respect to their loans for condominium development,” Mr. Flaherty told reporters in Vancouver after making a speech there.

The verdict is clear: He would rather not tighten mortgage rules again to curb high household debt and banks themselves must take on that job by becoming more strict with their lending criteria. “I’ve tightened up the mortgage insurance market three times… I really don’t want to do it again,” he said. “I find it a bit off that some of the bank executives are taking the position that the Minister of Finance or the government somehow should tell them how to run their business,” Jim Flaherty said at a news conference in Stittsville. "It’s their market. It’s not my market. They decide what they want to charge in interest rates. They’re the ones who make the profits out of this business, so I do find it a bit much when some of the bank executives turn to the government, the Minister of Finance, and say, ‘You ought to change the rules and make it tighter.’”

Despite some resemblance to the U.S. housing market prior to the crash, most economists expect a soft landing in Canada.

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