Posted by: Daryl & Wendy Ashby | December 16, 2010


This is how things look for Bank of Canada governor Mark Carney and other Canadian policymakers: The economy isn’t showing any serious vigour, suggesting they should be stoking it by keeping interest rates low. But the 25 million or so of us with active credit profiles are borrowing money like it’s Boom Time USA.

A lengthy period of low-interest rates has prompted Canadians to rack up debt faster than their disposable income is growing. For the first time in 12 years, Canadian households now have a higher debt-to-income ratio than those in the United States. It hit a record 148% in the third quarter, new Statistics Canada data show.

“Cheap money is not a long-term growth strategy,” Mr. Carney said in his loudest warning yet against the dangers of cheap credit. “Low rates today do not necessarily mean low rates tomorrow. Risk reversals when they happen can be fierce: The greater the complacency, the more brutal the reckoning.”

Trouble is, Mr. Carney has been warning about the situation for months without anyone doing anything about it. And it doesn’t look like that’s about to change anytime soon.

The Bank of Canada has some possible complicity in this: It has maintained low-interest rates to propel the country out of the recession. That has spurred consumers to borrow more because it costs less to borrow. And banks, afraid to cede market share and profits, have been willing lenders.

Consumer debt has ballooned, testing the limits of many Canadians’ ability to repay what they owe. But everyone seems to think this is someone else’s problem to fix.

Politicians from Quebec and elsewhere argue the banks should tighten lending practices. Bank chief executives from Toronto-Dominion and Bank of Montreal say the federal finance department should implement tighter mortgage rules, for example by lowering the maximum amortization period from the current 35 years. Surveys suggest consumers are aware of their current debt loads, but will continue borrowing as long as they think they can afford it.

Debt reckoning looms, FP1 Gary Clement cartoon, A18

“I’m scared. I’m really worried about this,” said Queen’s University finance professor Louis Gagnon, noting that every financial crisis has been preceded by a period of low-interest rates. “We’re dealing with a huge elastic band. It’s been stretched and stretched and stretched. And there will be a point where it’s going to break.”

Mr. Gagnon argues that there is a point beyond which banks should stop lending and a point beyond which Canadians should stop borrowing. He says individual responsibility now has to take centre stage because policy makers are dithering.

Not everyone agrees that Canadian consumers should be the ones scolded for their behaviour.

Interest rates dropped to their lowest levels ever and Canadian consumers reacted as you would expect them to, argues Michael Gregory, senior economist at BMO Financial Group. While it’s true that we’re at the point now where individuals have to make sure they’re living within their means, no one can argue they shouldn’t have borrowed, he says.

“It’s like saying you shouldn’t get married because maybe the marriage will fail,” Mr. Gregory. “Well to be honest what’s wrong with buying a house? What’s wrong with having a mortgage and making mortgage payments? Yes, it’s true that if you lose your job, you’ve now got a financial commitment that you may not have had otherwise. But that’s not necessarily a bad thing.”

Where is this all leading? To more business and personal bankruptcies if Canadians are pushed past their payback limits. Lose your job and you lose your income.

The lesson learned from the U.S. housing crisis was that when you get rising interest rates and declining asset values, namely real estate prices, it can cause a painful implosion of household finances.

“There is absolutely no question that Canadian household balance sheets eerily resemble their U.S. counterparts of roughly three to four years ago,” said David Rosenberg, chief economist at Gluskin Sheff & Associates. “Who’s fault is it? It’s easy to point fingers at this politician or this central banker when we should probably all just grow up and behave like adults. It comes down to prudent decision-making on the part of the lender and the borrower.”

But are we at a panic level? Not yet, says federal finance minister Jim Flaherty.

“I hope Canadians will be conscious of the level of credit that they have, that they will make sure they can manage it and they will assume interest rates will go up,” he said Monday, adding the government is ready to alter mortgage rules if necessary.

TransUnion, one of the two credit rating agencies in Canada, says each Canadian consumer who is actively borrowing had average debt of $25,163 in the third quarter, excluding their mortgage. That’s up 4.3% from last year.

Speaking in Toronto Monday, Mr. Carney used his starkest language to date to warn Canadians against over-extending themselves. His tone and comments led analysts to speculate he is setting the stage for an interest rate hike as soon as economic conditions warrant. He also signalled he is ready to take matters into his own hands and create monetary policy that goes beyond targeting specific inflation levels.

If the federal government gives him permission to do that, to raise rates to counter other systemic risks like personal debt, the Bank of Canada will have done what Bay Street banks and consumers themselves have so far been unwilling to do: Bring an end to the cheap credit party.


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