The CBC in Canada is wondering if using your home equity as an ATM machine is a bad thing. Perhaps they should ask any of the millions of homeowners in the United States who were told (or duped) by banks into thinking that credit is the same as wealth. Credit is NOT wealth. More than that though, while Canadian banks are more heavily regulated, Canadian bankers are sounding a lot like American bankers circa 2007. It’s Déjà vu all over again.
There is no doubt that Canada is in the middle of a debt bubble that tests economists’ predictions of just when that bubble is going to burst. While the U.S. has been deleveraging its household debt since the Great Recession, Canada has been increasing its household leverage exponentially in the same time period. The Canadian household debt-to GDP- ratio looks like this:
Most of that debt is in mortgages. But there are significant differences in the Canadian mortgage market:
- most Canadian mortgages are insured by the government
- the Canadian mortgage debt market has been almost entirely an over-leveraging of consumer credit
- There are no mortgage backed securities in Canada that put banks at risk. Bank risk is mitigated by government sponsored insurance.
The similarities from Canadian Banks are striking though. First, houses are over valued based on no real methodology, just like the U.S. in the early 2000s. Second is that Canadian bankers claim that they are doing their “due diligence” in assessing Canadians’ ability to repay; something American bankers still insist today. The result is that when the bubble bursts, while not impacting much on the global level, there will be some striking similarities to the United States:
- over valued houses will lose their value. Many homes will be underwater.
- The government will be on the hook for the mortgages, increasing sovereign debt, tanking Canadian bonds as interest rates spike. Interest rate spikes in bonds will surely add gasoline to any Canadian recession
- Bankruptcy laws in Canada are much more forgiving than in the U.S., and personal bankruptcies will spike
- Personal credit will freeze.
- Cities, towns and villages will suffer, just like in the U.S.; especially the severely overheated Toronto housing market.
- Canada’s trade partners, who are largely the United States and the Eurozone will take a hit.
To be sure, Canada did not suffer much of a recession in 2009, mostly because of a trade surplus in oil and other commodities. The hit to GDP was on the consumption side. However, Canada has had a tough time recovering its unemployment, wages and inflation numbers, with stagnant GDP, just like the United States. This may be a cause for Canada thinking that they are immune from debt crises:
The same picture appears for Australia, which also wasn’t effected much by the global recession. Their household-debt-to-GDP looks very similar.
Meanwhile, the Bank of Canada has lowered interest rates near the zero lower bound in an effort to stave off its oil slump, which is setting itself up with a liquidity trap if nothing changes. Either the BOC will raise interest rates, which will burst the debt-bubble, or it will choose the liquidity trap, which will take enormous fiscal policy (debt) to get out of. Either way, the debt bubble will burst based on the Bank of Canada’s decisions.
Other than the Bank of Canada’s liquidity-trap preference, at some point, people will simply borrow more than they can pay back, all in the name of “due diligence.” Canada doesn’t seem to have learned anything from the global financial crisis, spurred by the Untied States’ version of due diligence. The result will be a lot of suffering Canadians, with some U.S. and Eurozone causalities for good measure.
** A side note: I’m using the Federal Reserve Economic Database, which is tapping into the OECD datasets because the Government of Canada has slashed funding for Statistics Canada, making direct Canadian datasets unavailable for economic measures.