Maybe we aren’t TOO indebted
Rising household debt in Canada, and the associated risks posed to the housing market and Canadian economy, increasingly is becoming a topic of great debate. Statistics Canada reports that the debt-to-income ratio for all households in Canada has reached some 151%, which may be a concern, say some, as that ratio is now higher than in the U.S. (which peaked at over 160% in 2007, and has since declined), the U.K., and many other OECD countries.
Context, obviously, is important with an issue such as this. The U.S. and U.K. economies have been deleveraging in response to domestic financial conditions in recent years, as did Canada when in a similar situation in the early 1980s.
Demographic trends are also important. Canadians are living longer, working longer, starting families later in life and all of these trends influence an individual household’s decisions around when to accumulate debt and when to pay it off. On aggregate, these trends, combined with the structure of the Canadian population, clearly suggest that a higher debt-to-income ratio in Canada can exist without representing undue risk to the financial system.
Going forward, whether risks emerge will depend on a number of conditions:
1) The future for housing prices. Today, the evidence is clear, the recovery in home prices in many parts of the country that followed the recession has abated, and flatter prices are likely over the medium term as interest rates normalize. This will curtail modestly the growth in new household debt.
2) Interest rate risk. While interest rates are likely to rise slowly, probably after 2013, in the short term, statistics show that very few borrowers are at risk of debt payments beyond a reasonable ability to pay. If rates rise slowly, history shows borrowers will be able to adjust.
3) Income growth. Sluggish labour market conditions, during the recession and since, have created a challenge to Canadian households in terms of income growth, but stronger economic conditions expected beyond 2012 likely will come with a return to stronger household income growth – improving households’ ability to service debt, and addressing the debt-to-income ratio.
What does all this mean for you? If you are a borrower – do so prudently and always do the math. If you are a lender – focus, as you should, on the credit quality of each borrower, rather than broad national aggregates. If you are a policy maker in Canada – be very cautious of undue regulatory responses that may end up having unintended negative consequences.
Peter Norman is chief economist at Altus Group (formerly Clayton Research), independent real estate consulting and advisory services.