Photo: Krystian Olszanski/Flickr
The climbing level of Canadian household debt puts the country’s housing market at risk of a collapse in home prices, Bank of Canada Deputy Governor Lawrence Schembri said Wednesday.
“The buildup of household debt… has increased the vulnerability of the economy and the financial system to adverse shocks to incomes and interest rates,” said Schembri in a speech at the Guelph Chamber of Commerce in Ontario.
“A number of triggers could set off the risk, but the most likely is a severe recession that causes a sharp, widespread rise in unemployment, which reduces the ability of households to service their debt,” Schembri explained.
While there have only been modest increases since 2004 to the aggregate debt level of Canadian households whose debt-to-gross-income ratio is less than 250 per cent, the same is not true for highly indebted households, according to the Bank of Canada.
Over the last 12 years, the amount owed by households with debt-to-income ratios of 250 per cent or above has ballooned by 75 per cent, with a majority of these people aged 44 or younger.
Some 720,000 households in this group have debt-to-income ratios of 350 per cent or great, owing a combined $400 billion, or about 20 per cent of the total amount of Canadian household debt.
A considerable rise in unemployment or interest rates, then, could spell trouble for this group especially, Schembri suggests.
“The rise in household arrears could force some vulnerable homeowners to sell their homes or eventually default on their mortgages and other consumer debt,” he explained.
“If debt defaults rose quickly or if many households were forced to sell their homes, house prices could drop sharply across Canada, particularly in Vancouver and Toronto, which have recently experienced exceptionally strong price growth.”
In a backgrounder, the Bank of Canada explains “a debt-to-income ratio of 160 says that it would take more than one and a half times the annual income of an average household to fully pay off its debt.”
However, Avery Shenfeld, CIBC’s chief economist, noted earlier this week that aggregate debt levels don’t tell the whole story.
“You cannot take the debt-to-income ratio of the entire country and say that we have an over-indebted household sector,” he said Tuesday at CBRE’s Canadian Real Estate Market Update at the Metro Toronto Convention Centre.
“That would be akin to if me and Bill Gates were a country and I told you that we had $200 million in household debt and asked whether our little country was going to have a household debt problem,” he continued.
“If I borrowed it, I’m going to default tomorrow; Bill, he’s probably good for the money, right? So you can’t use these national aggregates,” he concluded.
In light of the major impact the kind of correction Schembri outlines would have on the Canadian economy, the latest assessment from the Bank of Canada’s governing council sets the risk of “elevated,” the deputy governor says.
But Schembri adds that “despite the drop in the price of oil and some non-energy commodities, the probability of this risk being triggered remains low.”
He points out how Canadians are less indebted than their neighbours to the south were during the onset of the US financial crisis.
In 2007, 77 per cent of American households carried debt, while 69.2 per cent of Canadians were indebted between 2012 and 2014.
And low oil prices sending may have sent the energy sector reeling, but Schembri expects strengthening global markets to prop up the Canadian economy as trade partners take advantage of the low Loonie which bolsters their spending power.
“Although the Canadian economy appears to have stalled in the fourth quarter of last year, we expect growth to pick up to 1 per cent in the first quarter and then to move about 2 per cent for the remainder of 2016.”