Better late than never

The best that can be said for the Bank of Canada's low interest rate/low dollar policy is that without it, things might have been worse over the past decade.  It's not as though the Bank's stance has produced strong growth in investment or exports, but at least the economy has for the most part stayed out of recession.

The worst that can be said about that same policy is that it has driven a boom in consumer debt and house prices that cannot be sustained indefinitely.  The Canadian household debt/income ratio stands at an all-time high of 167%, which is higher than the peak reached by the (not exactly comparable) US ratio just before the financial crisis.  The well-publicized problems now being experienced by the higher-risk mortgage lender Home Capital may be an early indication that the bubble may be about to pop.

A few people,  including your humble correspondent, have been saying for years that the Bank of Canada needed to start signalling, and then start implementing, a change of course.  Now we read in the Financial Post that "some economists fret about a rapid rise in domestic house prices after eight years of rock bottom borrowing costs".  

One of the quoted economists, David Rosenberg, used to work at Royal Bank of Canada, while the other, Krishen Rangasamy,  is with National Bank, Canada's sixth-largest lender.  This definitely counts as progress.  Even as the Toronto housing market has blasted off into the stratosphere, bank economists have tended to focus on speculation, foreign buying, lack of supply and so on as the causes of the boom, downplaying the obvious impact of Bank of Canada policy.

Most galling of all, many economists have tried to argue that the growth in household debt burdens is not a problem because household assets (i.e. the value of the homes themselves) have also been rising, as if the two sides of the balance sheet -- the ultra-cheap debt and the soaring house prices -- were completely unrelated.  This is nonsensical.  House prices will inevitably stall out and reverse at some point, but that won't reduce the debt burden; a lot of homeowners will quickly find themselves "upside down", as our American friends refer to it when the mortgage is worth more than the house.

But even if house prices don't correct, the debt burden poses an enormous risk to the economy.  Even without any policy signals from the Bank of Canada, mortgage rates have been creeping up as domestic banks find their funding costs rising, in response to developments south of the border.  Survey after survey shows that the proportion of Canadian households that would be in immediate trouble if the missed even one paycheck is rising inexorably.  

Raising rates is not a risk-free strategy for the Bank of Canada, not least because it would immediately start to push some of the most-indebted households over the edge.  However, continuing to do nothing is surely even riskier, because in the absence of some sort of shot across the bows, many households will continue to pile up debt, making the correction all the more painful when it finally comes.  The chances that the Bank will pay attention to David Rosenberg et al are still very slight, but I hope that won't discourage them from continuing to speak out.