Time to keep eye on debt, no time to panic, say economists

OTTAWA — Canadians are already saddled with the highest level of debt in history — and it’s rising — but the problem may be exaggerated, some prominent economists say.

OTTAWA — Canadians are already saddled with the highest level of debt in history — and it’s rising — but the problem may be exaggerated, some prominent economists say.

Alarms went off again this week after the Bank of Canada warned household debt will likely climb this year from its already all-time high perch of 153 per cent of annual after-tax income, a worrying development since governor Mark Carney started flagging debt when it was approaching 140 per cent.

By the central bank’s own projections, Canadian households are inching ever so close to the 160 per cent ceiling hit by American households before the roof caved in on the U.S. economy in 2008.

Carney and Finance Minister Jim Flaherty voiced their concerns, although they held off committing to doing anything about it.

Some analysts have expressed skepticism in the past about the central bank’s furrowed brow over household debt, particularly CIBC’s Benjamin Tal, who has written often that Canadian homeowners are responsible borrowers and can afford to service their borrowing.

Now two more — TD Bank chief economist Craig Alexander and Derek Holt, vice president of economics for Scotiabank — are raising their voices to try and debunk the theory put forward by Carney and Flaherty.

Yes, Canadians should be careful not to take on too much debt during the current period of low borrowing costs, but the situation has not reached alarming levels, they argue.

The myth of too much debt, they say, is that the data often cited — debt to annual disposable income — is one of the “worst” of available measures for assessing household finances, says Holt.

That’s because it is comparing a liability that needs to be paid off over a lifetime to a single year’s income, a bit like comparing apples and orange groves.

A better comparison, adds Alexander, would be to pit debt against assets, such a person’s home equity, stock investments and other savings. If income is to be the measure, then the important criteria is the cost of servicing the debt annually, not the total debt itself.

“What truly matters is the quality of the assets acquired with the debt and even more importantly the ability of the household to meet their financial commitments,” Alexander said.

He gives the example of a couple that takes out a $160,000 mortgage with a combined income of $100,000 a year. The ratio is the scary 160 per cent, but, “It is not evident that household is exposed to major financial risk,” he said.

On more relevant metrics, Canadian households are well positioned.

Canadian assets relative to income is at an all-time, they have greater equity in their homes than their American cousins, and their net worth is near the pre-recession peak even though their stock portfolios are not nearly as rich. Home affordability ratios — annual cost of service debt to annual income — are also within historic levels, partly because of low interest rates.

Holt said the litmus test of the financial health of Canadian households is what happens during a shock.

Consider Toronto’s 27 per cent house price slide between 1989 and 1996, or the 10 per cent drop in 2008-09. Also the 20 per cent hit in Vancouver home values between 1995 and 1999. In none of those shocks did the delinquency rate for mortgage payments approach one per cent.

By contrast, the U.S. delinquency rate hit as high as nine per cent during the current crisis.

Holt said Canadians may be more vulnerable now, but not by much.

“We have to worry about the sustainability of house price gains, we also have to worry about how much longer housing and consumer spending can contribute to economic growth, what we have less to worry about is that … we would face a U.S.-style set of problems,” said Holt.

“That’s where the difference between Canada and the U.S. is night and day.”

Alexander estimates a two per cent hike in interest rates would push about 10 per cent of households with debt into uncomfortable territory, where mortgage payments would eat more than 40 per cent of after-tax income.

That’s something that should keep vulnerable household’s eye on their personal debt curve, he said, but it does not suggest a U.S.-style meltdown is in the offing.

Analysts, including the Bank of Canada, also point out that Canadians are already starting to temper their credit appetite, since the rate of debt accumulation has slowed significantly in the past year. Part of the current climb in debt-to-income ratio is due not to taking on more debt, but to slowing income growth.

Get local stories you won't find anywhere else right to your inbox.
Sign up here

Just Posted

Health Minister Tyler Shandro and Dr. Deena Hinshaw, the chief medical officer of health, receive flu shot. Photo via Government of Alberta
COVID cases climb in central zone, Red Deer

The total number of active COVID-19 cases in the province reached 3,138… Continue reading

Many rural municipalities were concerned about a proposed reduction to their industrial revenues, but Alberta’s municipal affairs minister has come up with an alternative solution. (Photo contributed)
Energy industry support won’t injure municipalities

Creating new wells or pipelines would result in a three year ‘tax holiday’

Conservative Leader Erin O’Toole and Premier Jason Kenney participated in a livestream on Oct. 17, 2020. (File photo by THE CANADIAN PRESS)
UCP members pass resolution at AGM calling for privately funded health care option

EDMONTON — Members of Alberta’s governing United Conservative Party have narrowly endorsed… Continue reading

“We weren’t sure what to expect with just doing the 50/50. We have been positively surprised with sales so far,” says Craig Fleming, co-chair of the Red Deer Kinsmen Club’s raffle. (Photo by SUSAN ZIELINSKI/Advocate staff)
Non-profits put their money on 50/50 draws

COVID impacts fundraising events

Student taking a math test. (Pixabay photo)
David Marsden: Students need more testing, not less

Testing has been central to Alberta’s response to the COVID-19 pandemic. It’s… Continue reading

Gillian Robertson celebrates her win over Sarah Frota during UFC 240, in Edmonton, Saturday, July 27, 2019. Robertson used her superior grappling skills to dominate Brazil's Poliano Botelho en route to a unanimous decision win Saturday night on a UFC Fight Night card. THE CANADIAN PRESS/Jason Franson
Canadian Gillian (The Savage) Robertson dominates in UFC decision win in Abu Dhabi

Canadian Gillian (The Savage) Robertson dominates in UFC decision win in Abu Dhabi

Forge FC head coach Bobby Smyrniotis, right, hugs captain Kyle Bekker following their victory in the Canadian Premier League soccer final against Cavalry FC in Calgary, Saturday, Nov. 2, 2019. A month after winning the Island Games in Charlottetown, Hamilton-based Forge FC is back on the move. THE CANADIAN PRESS/Jeff McIntosh
CPL champion Forge FC off to El Salvador for CONCACAF League preliminary-round match

CPL champion Forge FC off to El Salvador for CONCACAF League preliminary-round match

Course workers prepare the landing area at the ski jump venue in Whistler Olympic Park in Whistler, B.C. Friday, Feb. 5, 2010. THE CANADIAN PRESS/Jonathan Hayward
Next generation of Canadian ski talent sets sights on Whistler, B.C., in 2023

Next generation of Canadian ski talent sets sights on Whistler, B.C., in 2023

Mighty Heart is held by groom Siobhan Brown in his stall at trainer Josie Carroll's stable at Woodbine Racetrack, in Toronto, Thursday, Oct. 15, 2020. The one eyed horse, will run in the $400,000 Breeders' Stakes on October 24, attempting to become Canada's first horse to win the Triple Crown since Wando in 2003. THE CANADIAN PRESS/Chris Young
Rain could present big challenge in Mighty Heart’s quest to capture Triple Crown

Rain could present big challenge in Mighty Heart’s quest to capture Triple Crown

Veteran sniper Evgenii Dadonov excited to join Senators: ‘It’s a perfect fit’

Veteran sniper Evgenii Dadonov excited to join Senators: ‘It’s a perfect fit’

Tampa Bay Buccaneers running back Ronald Jones II (27) gets pushed out of bund by Green Bay Packers free safety Darnell Savage (26) during the second half of an NFL football game Sunday, Oct. 18, 2020, in Tampa, Fla. (AP Photo/Mark LoMoglio)
Packers seek to bounce back after embarrassing defeat

Packers seek to bounce back after embarrassing defeat

World junior hockey championship opens on Christmas Day for first time since 2005

World junior hockey championship opens on Christmas Day for first time since 2005

Most Read