Household indebtedness at its peak?

We spoke a couple issues back about the dramatic reversal the Canadian dollar has seen against its US namesake over the last couple of months. As was mentioned in this All Eyes are on Canada issue, CAD went from one of the best performing currencies in the G10 in 2016, to trading at near 2 year lows. As was rightfully pointed out, much of this weakness can be attributed to a couple of key factors; notably the NAFTA/trade-war between the two nations, falling energy prices, and general USD strength as market participants expect US interest rates to continue to rise.


On the back of this issue, I wanted to take this opportunity to dig a little deeper into another issue afflicting not only the Canadian economy, but many other developed markets which have found themselves sustaining growth with substantially accommodative monetary policy – a rampant rise in personal debt levels, unsupported by underlying fundamentals. Is this a warning shot, indicating what might be to come? Some seem to think this might be so.



Canadian consumer debt to household income levels have climbed steadily in the post-Lehman era, with current multiples sitting at all-time highs around 1.7x. Canada is not alone in this – Australia is experiencing much the same, and to an even greater extent with consumer debt representing nearly 1.9x household disposable income.


Many in both countries are calling on regulators to put a stop to out of control housing prices – some attribute the rise to wealthy foreign buyers, others to lucrative tax advantages given to owners of multiple properties. Whatever the reason, the wealth effect (a phenomenon coined by economists) attributable to rising house prices causes households to spend more. Coupling this with near zero interest rates (think mortgages, home equity lines of credit, car loans, etc.) only compounds the problem. What is going to happen when residential mortgage rates rise a few percentage points and homeowners can’t make ends meet? Some are starting to see the writing on the wall…


It seems Moody’s is trying to get ahead of this one (they seemingly dropped the ball ahead of the 2008 financial crisis), announcing on Wednesday of last week that it has downgraded its ratings for the Big-Six Canadian banks, citing that “… challenging operating environments… could lead to a deterioration in… the banks’ asset quality, and increase their sensitivity to external shocks.” What does this mean? They’re concerned that over-leveraged households are not going to be able to meet their obligations should tides begin to turn – rates begin to rise, housing prices fall, or worse yet, a recession hits.


This news came on the back of a story we mentioned in our previous issue – that of Home Capital Group, Canada’s largest non-bank mortgage lender, seeking an emergency liquidity facility as it combats a bank-run on its deposits following an ongoing investigation by regulators. That story continues to play-out, with the lender having already drawn ~75% of its $2bn emergency liquidity facility, and its management indicating they are unsure if the business will remain a going concern. Reading in to some of the details concerning its securitization of mortgage loans, while this practice is not nearly as wide-spread in Canada as it is south of the border, I cannot help but be reminded of the US circa 2007.


Whilst historically high consumer indebtedness and rapidly rising housing prices (be it in Canada, Australia, or elsewhere) appear to be generally localized concerns, I would argue that these latest events should serve as a warning sign of what could be to come, particularly in a post-QE world. Low interest rates, inflated asset prices, coupled with historical indebtedness, make for a quite complicated house of cards – one which could unravel on a global scale.

Author: Josh Macdonald


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