Household debt: nothing to worry about?

The ratio of Canadian households' debt to their disposable income has risen inexorably over the past several years.  This is in sharp contrast to other developed countries, including the US, which saw rising debt burdens in the wake of the financial crisis but have since experienced net paydowns of debt.  Everyone from the lowliest financial blogger, through the Bank of Canada all the way up to the OECD and IMF, has warned repeatedly of the risks that the debt burden poses to the economy.

In today's Toronto Star, business columnist David Olive tries to argue that there is nothing to worry about here.  And he's not alone: a recent study from National Bank Financial also made the case that the risks have been overstated -- indeed, they argue that in the aggregate, Canadian households' finances are actually quite conservative.  Some of the numbers that Olive uses are from that piece of research.  Are Olive and NBF right? Let's take a look, focusing primarily on the David Olive piece*.

Olive's primary reason for not worrying about debt is that the relevant authorities, including the Bank of Canada and various levels of government, have been aware of the emerging problem for years and have been taking steps to head it off.  This is true, at least to the extent that the indebtedness problem is housing-related.  Both the Province of BC (in 2016) and Ontario (in 2017) took steps to cool the overheated markets in their major cities (Vancouver and Toronto, respectively), and these steps seem to have had the desired effect. At the national level, the government has been acting for several years to enforce tighter lending standards; at the start of this year, stress-testing for new mortgages was extended even to borrowers who were not looking for mortgage insurance.

This is all well and good, but as Olive admits, the household debt/disposable income now stands at 171 percent.  Olive claims as mitigation the fact that half of households report having no debt at all, but since the quoted ratio includes all households including the debt-free, it follows that the ratio for those who actually have debt is in fact much higher.  Indeed, StatsCan reported late last year that for low-income households, which by definition are the least able to afford to carry debt, the ratio is an ugly 333 percent. 

Separate reports have shown that the number of such ultra-high debt households has been rising steadily.  The percentage of households reporting that they would be unable to meet their obligations if they missed even one paycheck has also been rising, although the surveys that produce these reports may not be as scientific as StatsCan or Bank of Canada data.  In any case, while Olive may be correct to assert that a personal insolvency crisis is "not in the cards", the number at risk is undoubtedly high enough to represent a major social crisis if the worst were ever to occur.  Olive's suggestion that higher minimum wages will alleviate the problem seems Pollyannaish, not least because the minimum wage increase at the start of the year only applied in Ontario. 

While Olive notes that the Bank of Canada's steps to remove monetary stimulus will add to some borrowers' problems, he suggests that the much lower absolute level of rates will mitigate the impact.  He reminds us that in the 1980s, rates peaked at "a nosebleed 24 percent or so", whereas today the Bank of Canada reference rate is just 1.25 percent. 

The all-time peak for the Bank Rate was actually 21.03 percent, hit in August 1981.  That's still pretty nosebleed-y, but Olive's is not an apples-to-apples comparison. Households do not borrow at the Bank of Canada rate.  One of the justified gripes against the banks in recent years is that the rates charged to consumers have not fallen by anything like as much as official rates have.  Moreover, even though mortgage rates are certainly much lower than they were in the not-too-distant past, a large part of the household debt buildup has been in the form of home equity lines of credits (HELOCs) that command much fancier rates.  And that's not to mention the plethora of usurious payday-style lenders that clog the airwaves with their pitches every day of the week.     

What's the bottom line here?  Olive argues his case persuasively, but it's foolhardy to second-guess such authorities as the Bank of Canada and the OECD.  It is probably safe to assert that, barring a major reversal in Canada's economic fortunes, the overall household debt burden is manageable, and does not put the vaunted stability of the financial system at risk.  Even so, millions of Canadians live in households that are at serious financial risk even if nothing goes wrong at the macro level.  Luck and good policy decisions have kept the wolf from the door up until now; more of the same will be needed for a good many years to come. 

*For some reason this appears only in the print version of the paper and not online.  I will post a link as soon as one appears, and in the meantime you will have to trust me to quote him accurately and fairly.