September 23, 2011
Title: Are household debt levels getting out of control?
Sub-title: Experts say that current levels are high, but manageable.
One of the most surprising trends stemming from the recent financial crisis and ensuring recession was the reaction of Canadian households. Unlike Americans, who have been busily restructuring and paying down debt, folk here have been borrowing as if there is no tomorrow.
According to a Statistics Canada report released in mid-September, Canadian household debt (which includes mortgages, credit card debt, and other consumer loans) rose to a record 149 percent of personal disposable during the three months ended in June, compared to 147 percent in the first quarter.
Now, at least one major US credit agency is getting worried. “The creditworthiness of Canadian banks depends on the continued health of the Canadian consumer,” says a new report by Moodys Investors Services. “While robust growth in consumer credit has driven strong system-wide earnings year-to-date, this trend will be constrained as households reach borrowing limits at the same time the economy shows few signs of anything beyond tepid growth.”
True, Canada has fared much better than most western countries during the past few years, particularly our residential real estate sector. Furthermore our raw materials remain in considerable demand worldwide. Yet the question remains: are Canadians borrowing too much?
The paradox of thrift
Not at all say several experts. “Both the performance of household credit, in terms of low default rates, and the historically modest share of incomes going to debt service suggest no immediate threat,” argue Avery Shenfeld and Emanuella Enenajor, economists at CIBC WorldMarkets, one of the banks cited by Moody’s as being particularly vulnerable to high household credit levels. “Barely more than 6 percent of all mortgages are held by Canadians facing interest payments in excess of 40 percent of their incomes, a share that is not particularly elevated by historic standards.”
The pair argue that rising debt levels clearly cannot go on forever. However they also say that if the increased borrowing were to halt now, it would make it hard for the Canadian economy as a whole to move to full employment.
The reason boils down to what economists call the “paradox of thrift.” This paradox is that while it often makes sense for individuals to keep spending low and to adopt conservative financial habits, if everyone does this, then overall consumer spending suffers and economies can tailspin into slowdown and even recession.
Personal disposable income calculated differently
Matthieu Arseneau, an economist at National Bank Financial also is not overly concerned. He notes while that the US experience with high debt levels demonstrates the need to remain “vigilant,” Canadian household credit while growing, is doing so at its slowest pace in more than a decade.
Arseneau bases his conclusions on a close look at Canadian household debt levels, which at first glance, appear to be going out whack compared to those of our southern neighbours. In fact during the past two quarters Canadian debt ratios have surpassed US levels. And we know what excess borrowing led to down south: a massive decline in asset prices which pushed the United States into its worst economic mess since the Great Depression.
However Arseneau argues that the household debt to personal disposable income ratios in Canada and the United States are not comparable, since “Americans allocate nearly 20 percent of their PDI to healthcare spending,” - which Canadians get for free.
Another factor mitigating Canadian households’ increasing debt levels relates to the continued rising value of their homes, which comprises’ most families’ largest asset. According to the Canadian Real Estate Association, the average price of homes sold via its Multiple Listing Service rose again last month by 7.7 percent, compared to year-ago levels, to $349,916. This is important because high debt levels are less worrying, if these are also offset by high asset values.
That said, even if Canadian household debt levels are manageable, and even if interest rates are low, the fact remains that those debt burdens are climbing. While that may be good for the economy as a whole, in these uncertain times, individual households would probably be better off not getting carried away.
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