Canada's Housing Bubble

Analysis of the real estate bubble in Canada --

Bank of Canada issues fresh warning on debt Print E-mail

The Bank of Canada is warning again that growth in household debt supported by a decade-long increase in home prices means families and the economy as a whole are vulnerable to a correction in the housing market.

“Rising house prices can facilitate the accumulation of debt,” the central bank said Thursday in a collection of its recent research on the subject. “Households could therefore experience a significant shock if house prices were to reverse.”

Governor Mark Carney and his policy team at the central bank have long flagged record levels of household debt as the No. 1 domestic risk to Canada’s economy and financial system. Still, while the report contains little new information and does not include any policy prescriptions, it comes at a time of escalating concern among policy makers about how overstretched many households have become.

Since much of the growth in debt has come from households borrowing against the value of their homes – through home-equity lines of credit, or HELOCs – the report suggested a swift reversal in prices could have a “relatively large impact” on consumer spending, which Mr. Carney and his officials are counting on to fuel more than half of economic growth this year amid slower demand for Canadian exports. (According to one simulation the central bank pointed to, a 10-per cent drop in home prices could translate into a 1-per-cent decline in consumption.) “A fall in house prices decreases the value of collateral held by households, leading to a deterioration in the state of household balance sheets,” the bank said.

Mr. Carney, who has left his key interest rate at 1 per cent since September, 2010 – the longest pause in decades –has repeatedly warned that low borrowing costs are enticing too many Canadians to take on debt that won’t be affordable once interest rates rise. In his last decision in mid-January, he even took the unprecedented step of noting that he expects the debt-to-income ratio, currently at 153 per cent, will keep rising. Plus, he indicated he is increasingly uncomfortable with the a byproduct of his policy stance, attributing the debt growth to “very favourable financing conditions” – i.e. the Bank of Canada’s low policy rate, and its influence on the cost of mortgages.

In Thursday’s report, central bank officials said loans backed by homes made up almost 50 per cent of all consumer credit last year, largely to finance home renovations, a surge from 11 per cent in 1995. Although low borrowing costs and rising home prices have been significant factors, the central bank also pointed to financial innovation that “makes it easier for households to access this credit,” as well as increased marketing of such loans by financial institutions.

The central bank said Canada’s housing market has not yet shown signs of “the excesses seen in other countries,” such as the United States and the United Kingdom in the years before the global financial crisis, which in no small part was triggered by the bursting of real-estate bubbles. However, other comments in the report reinforce the notion that the central bank – which is not expected to be able to counter a runup in debt through higher interest rates any time soon – is more and more worried about this issue.

For instance, the central bank noted that while income and population growth account for some of the gains in house prices over the past 30 years, more recently other factors such as a drop in long-term interest rates and the expectation among borrowers that prices would keep rising have also played roles.

“Over history,” the central bank said, “these other factors are associated with the medium-run tendency of house prices to rise faster than their long-term trend for a number of years and then subsequently adjust back to trend.”

Also, the central bank published data showing that younger Canadians are more debt-strapped than Canadians of the same age were just over a decade earlier. In 2010, the bank said the mean real debt load of a typical household led by people aged 31-35 was $120,000, up from $75,000 in 1999.

“Given the increase in household indebtedness, the exposure of households and the financial system to fluctuations in house prices has increased markedly,” the bank said.

Speaking in Toronto, Finance Minister Jim Flaherty also urged prudence for Canadians.

“People have to be wise in how they look at things. Interest rates are going to go up. They have nowhere to go but up,” he said. “So people need to be sure that they can afford higher mortgage interest for example.

“It isn’t necessary for everyone to have the most expensive house they could possibly buy, maxing out the potential mortgage they could get from a financial institution. In fact, it’s probably easier on people if they do a little less of that and have more cash in their lives and enjoy life a bit more. So moderation in all things.”

With a file from Bill Curry

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