Actions have consequences

For much of the past year the Bank of Canada has been aggressively raising interest rates as it attempts to get inflation back to the 2 percent target. Its overnight rate target has risen from 0.5 percent to 4.5 percent, pushing up borrowing rates all across the yield curve. It is no surprise, then, that in its latest Financial System Review (FSR), published this morning, the Bank admits that it is "more concerned than it was last year about the ability of households to service their debt". 

Canada's high household debt has been on the radar for several years, not only at the Bank of Canada but also at international agencies like the IMF and OECD.  Low interest rates during the COVID era kept the lid on the problem, but it was always likely that stresses would begin to emerge once rates started moving back to more "normal" levels. That process is now underway, and the resulting problems are likely to continue to emerge over a period of several years.

In the Bank's words,  "While most households are proving resilient to increases in debt-servicing costs, early signs of financial stress are emerging". Thus far only about one-third of households have seen their mortgage payments increase, comprising those on floating rate mortgages and those unfortunate enough to have a rate reset in the past year. Since most Canadian "fixed rate" mortgages actually have a reset every five years or less, the percentage of households facing higher monthly payments will increase steadily right through 2026.  This fact alone makes Governor Macklem's warning that rate are unlikely to come down any time soon highly significant for the household sector.

In the meantime, amortization periods are already starting to stretch out. Fully 46 percent of new mortgages in 2022 had an amortization period of over 25 years, up from 34 percent in 2019.  The share of households falling behind on debt servicing is actually below its historic level, but has been rising since mid-2022. Moreover, it looks as if many households are only coping by running up credit card debt. Outstanding credit card balances are higher than they were pre-pandemic, with particular growth noted in credit card balances of newer mortgage borrowers. 

For now the Bank seems to think the situation is manageable, but it naturally worries about what could go wrong: "A severe recession with significant unemployment and further reductions in house prices could cause substantial financial stress for some households. Lower home equity could limit refinancing options on mortgages, leading to an increase in defaults. Credit losses to lenders would also rise if the liquidation value of a home in default is less than the value of the outstanding mortgage".

Aside from household debt, the FSR is reasonably upbeat about the stability of the system.  The Bank of Canada has some concerns over the possible impact of a severe recession on the banking system, but it points to "sound risk management and supervisory practices in Canada".  There are also sections of the report dealing stability issues with non-bank financial intermediaries, non-financial businesses, cryptocurrencies ("not currently significant"),  cybersecurity ("concerned")  and climate change ("significant"). It's a long list, but there is no doubt that it is the financial health of the household sector that haunts Governor Macklem's sleep at nights.  

Thoughts on SVB

The situation around the collapse of Silicon Valley Bank continues to move quickly, and at the time of writing it is far from certain that contagion to other banks can be avoided. This live feed from CNN is a useful way of monitoring events as they occur. For now, here are just a few thoughts on some aspects of the situation.

Moral hazard:  Treasury Secretary Yellen was adamant over the weekend that there would be no 2008-style bailouts of SVB or any other bank that got into similar trouble. Then it was announced that the FDIC would be guaranteeing full access to their money to all depositors at SVB, not just those covered by the existing $250,000 deposit insurance limit. Arguably, since shareholders in SVB are going to lose all their money, this is not strictly speaking a bailout. Still, it does raise questions about moral hazard: if all deposits are now in effect FDIC-insured, what incentive do large depositors have to ensure that they are placing their funds in safe institutions? Why should they not just move their money to whosever is paying the most on any give day, secure in the knowledge that Uncle Sam will make them whole if the worst happens/

There is a counter-argument, however. If you are a sizeable company responsible for a million-dollar payroll every week, you can hardly be expected to parcel out your cash in $250k tranches among numerous banks in order to keep everything fully insured. You can opt to deal only with one of the "too big to fail" banks, but if everyone starts to do that, competition within the US banking sector, which has already seen the number of banks fall precipitously in recent decades, will be eroded even further.  

The nature of risk: Secretary Yellen said that suggestions that SVB's problems were largely the result of its concentration on the high tech sector were incorrect. That does indeed appear to be the case: it looks as if an orderly wind-down of the bank's loan book -- something that is obviously not possible any longer -- would have produced enough cash to meet all of its liabilities. 

What actually did the bank in seems to have been....the Fed's aggressive tightening policies. SVB's extensive holdings of Treasuries fell sharply in value as the Fed raised rates. Prudent risk management would have seen SVB selling some of those holdings in order to raise cash. Instead it seems to have held onto them, only trying to unload them when the run on deposits actually began, at which point they were no longer adequate to pay out all those who wanted to be paid out in short order. 

There are many different kinds of risk. Treasuries are considered low risk because they are backed by the credit of the Government, but there are still major valuation risks resulting from interest rate movements, as SVB just discovered. Early in my career I as involved in the asset/liability management committee of a major Canadian bank. This was in the days before the swap market came into being, and the committee's job was to ensure a manageable balance between assets and liabilities within each maturity time "bucket". The swap market has drastically altered how these things are done, but it looks as if SVB was not paying attention to this at all. 

Bad behaviour: as is inevitable when something like this happens, stories are starting to emerge about possibly dodgy events within the bank just prior to its collapse. It has been reported that the CEO sold a chunk of stock not long before the collapse, which is prompting suggestions that he should be made to pay back the proceeds of the sale. There are also reports that employees of SVB received bonus payments just before the collapse; you would hope that the risk management team were not among the recipients. 

It's not just within the bank that there may have been some dubious behaviour. It looks as if the run was triggered by some well-known Silicon Valley names advising friends and competitors to get their money out pronto -- no doubt after first liquidating their own deposits.  In a world of near-instantaneous communication, it's not hard to trigger an all-but-unstoppable bank run that way, which points to the need for regulators to think hard about what needs to be done to contain this kind of issue in the future.

Fed policy: the collapse of SVB may well have been triggered by the Fed,  making Chair Powell's regular assertions that "we know what we are doing" look rather foolish. Does this mean that next week's FOMC meeting will keep rates on hold?  That seems to be the way markets are thinking right now. February CPI data, due out on Wednesday, will be crucial; a low print might give the Fed a convenient excuse to pause the tightening cycle, but it still seems likely that the FOMC would prefer to go ahead with a 25 basis point hike, purely for credibility's sake. 

Interesting times indeed! In a fast-moving situation, much of the foregoing may be proven dead wrong at any second, and no doubt there will be a lot more to be said in due course. 

Same song, different key

The Bank of Canada issued its 2022 Financial System review this morning. Governor Tiff Macklem and Senior Deputy Governor Carolyn Rogers met with the media to discuss the key findings, with a particular focus on what the Bank sees as the principal vulnerabilities in the Canadian financial system. 

Unsurprisingly the number one area of concern is, as it has been for many years now, the elevated level of house prices and the associated rise in household debt. Ultra low interest rates triggered by the COVID pandemic induced a large number of Canadians to take on substantial amounts of debt to acquire a home, which naturally drove up house prices, by as much as 50 percent.  Even the modest rate hikes implemented by the Bank so far this year have been sufficient to trigger an abrupt change from a seller's market to a buyer's market in many parts of the country, underscoring the Bank's concern. 

The Bank acknowledges the "remarkable" improvement in overall household savings and wealth during the pandemic, but then quickly moves on to emphasize the vulnerability of certain homeowners: 

....even as the average household is in better financial shape, more Canadians have stretched to buy a house during the pandemic. And these households are more exposed to higher interest rates and the potential for housing prices to decline.....Throughout the pandemic, a growing number of Canadians took out mortgages that were very large relative to their incomes, at variable rates with amortization periods of more than 25 years. And our models suggest that the most highly indebted households saw only a small increase in their liquid assets in that time.

The Bank acknowledges that vulnerability may at some point constrain its efforts to bring inflation back to the 2 percent target:

With inflation well above the 2% target and the Canadian economy overheating, the Bank’s number one priority is to get inflation back to target, and we are raising interest rates to make that happen....The economy can handle—indeed needs—higher interest rates.... If the economy slowed sharply and unemployment rose considerably, the combination of more highly indebted Canadians and high house prices could amplify the downturn....Were this to affect many households, it could have broad implications for the economy and financial system. This is not what we expect to happen. Our goal is for a soft economic landing with inflation coming back to the 2% target. But it is a vulnerability to watch closely and manage carefully.

In short, the Bank thinks it can engineer a soft landing as it brings inflation down, but it is by no means certain of that. 

The opening statement goes on to talk in much less detail about three other vulnerabilities. Two of these are predictable enough: the war in Ukraine, with its potential for cybersecurity threats, and the transition to a low-carbon economy, which may abruptly reprise financial and real assets. The third is a bit more novel:

Finally, cryptoassets are a growing vulnerability. More Canadians are investing in cryptocurrencies. But the growth of these markets has outpaced global efforts to regulate them. Like other speculative assets, cryptocurrencies are vulnerable to large and sudden price declines. And recently, some stablecoins—a type of cryptocurrency—have failed to deliver on their promise of stability. While cryptoassets do not yet pose a systemic risk to the Canadian financial system, the lack of regulation means they don’t have the safeguards that exist for more traditional assets. And their risks may not be well-understood by investors. Regulators around the world and in Canada have recognized this risk and are working to address it.

Given the collapse in crypto "asset" values in the last couple of months, this is a timely warning, especially as the statement that "their risks may not be well-understood by investors" is almost certainly a colossal understatement. 

All in all, then, plenty for the Bank of Canada to keep a wary eye on -- but as always, it is the housing market that seems to warrant the most concern.   

Things that make the Bank of Canada go "hmmm"

The uptick in inflation reported this week (see previous post) is one of the things the Bank of Canada is worried about at the moment, but it's nowhere near the top of the list. On Thursday the Bank released its Financial System review. Introducing the report to the media, Governor Tiff Macklem listed the Bank's key concerns as investors' rising appetite for risk, high home prices and indebtedness, climate-related vulnerabilities, fixed income market liquidity and the risks of a cyber attack on the financial system.

Regarding risk appetite, Macklem noted that  A rapid change in market sentiment—perhaps due to a setback in efforts to end the pandemic or a stalled economic recovery—could cause a sharp repricing of risk and a tightening of global financial conditions....Wider credit spreads could particularly affect Canadian companies that rely on high-yield debt markets.

As for the housing market and debt, the Bank's view can be summarized as follows:

Consumer preference, combined with low interest rates that make borrowing more affordable, has boosted demand for single-family homes, particularly in suburbs and outlying areas of major Canadian cities. Housing supply has not been able to keep up with this surge in demand, and this has pushed prices for single-family homes sharply higher in several markets.

...some households have taken on significantly more mortgage debt. The increased issuance of mortgages with high loan-to-income ratios is of most concern.... It is important to understand that the recent rapid increases in home prices are not normal. Even without a shock, some of the factors that caused prices to rise fast could reverse later, and that could leave some households with less equity in their homes. And interest rates are unusually low. Borrowers and lenders both have roles in ensuring that households can still afford to service their debt at higher rates. 

Not long after Macklem's speech, the Office of the Superintendent of Financial Institutions (OSFI) raised the "minimum qualifying rate" for new uninsured mortgages by 50 basis points to 5.25 percent. Borrowers must be able to demonstrate that they could still service their loans if rates rose to this level. Given that five-year fixed rate loans have been available this year for 1.7 percent or even less, this is a reasonably stringent test. 

On climate-related vulnerabilities, Macklem stated that The potential impact of climate risks is generally underappreciated, and they are not well priced. That means the transition to a low-carbon economy could leave some investors and financial institutions exposed to large losses in the future....in some parts of the country, particularly British Columbia and Ontario, households that are highly leveraged are also more exposed to severe weather events. The Bank....is also working to assess the financial-system implications of different scenarios for the transition to a low-carbon economy. We’re learning a lot from this work and will publish a report later this year.

On fixed income market liquidity, Macklem commented that While financial markets are currently functioning well, the extreme market stresses that occurred when the pandemic struck highlighted the vulnerability of the financial system to sudden spikes in the demand for liquidity. Over the past decade, the potential demand from the asset-management industry for market liquidity in periods of stress has outpaced the capacity of banks to provide it. We are working at both domestic and international levels to better understand this structural liquidity vulnerability and how best to improve the resilience of core funding markets.

And last but not least on the risk of cyber attacks, the digital transformation of the economy and the interconnected nature of the financial system—globally and in Canada—increase the risks of a cyber attack. The recent ransomware attack on a top US pipeline operator is a timely illustration. This FSR discusses a number of cyber security initiatives the Bank is leading.

It's a long and varied list, so it's perhaps worth concluding with Macklem's customary words of comfort regarding the Canadian financial system:

The Canadian financial system went into this crisis in a solid position and has proved to be resilient. This reflects sound risk management across a range of financial system participants combined with Canada’s strong regulatory and supervisory framework. Unprecedented policy support from governments and the Bank has also played a crucial role. Together, these factors have allowed the financial system not only to weather the huge shock but also to act as a shock absorber for the broader economy—by continuing to provide credit and by deferring loan payments for some households and businesses.

Here's hoping he's right. 

The Digital Loonie

It's literally true that some of the $20 bills moldering in my wallet have been there for the past year.  Almost all my financial transactions have moved to online or contactless payment, and I'm surely not alone. Today Bank of Canada Deputy Governor Timothy Lane delivered a lengthy speech to the Instiute for Data Valorization (what dat??) in Montreal on the subject of "Payments Innovation beyond the Pandemic". Let's take a look.

Lane began his remarks by describing the rapid growth in digital transactions since the pandemic began:

A survey of Canadian retailers shows that e-commerce has nearly doubled from pre-pandemic levels.

.....In our most recent Business Outlook Survey, nearly two-thirds of participating firms reported that they are making some kind of digital investment. 

.....Among these developments is a shift toward the increasing use of digital payments. For example, a November 2020 survey found that two-thirds of small businesses now accept payments online—and half of them started doing so only recently.

Even when Canadians pay for goods in person, contactless options appear to be gaining traction. Interac reports that the volume of Interac Flash transactions grew by two-thirds in July 2020 compared with April.  Consumer surveys also report that contactless payments have increased.

Most of the technologies Lane is describing here are well-established. Indeed, it is almost a surprise that it has taken the pandemic to get so many businesses and consumers to embrace them more fully. Still, it is very clear that there is no longer any way back to the old cash-in-hand world.

Lane then went on to talk about changes in the Bank of Canada's physical bank notes, before musing about the possibility of a government-issued digital currency -- a "digital loonie":

.....for the past decade or so .....and we’ve been asking ourselves: could Canada and Canadians benefit from a digital form of cash?

.....In a speech in Montréal a year ago, I gave our preliminary view: we did not see a need for a central bank digital currency at that time, but we could imagine scenarios that could make a central bank digital currency beneficial in Canada. 

.....A year later, our view remains unchanged: a digital currency is by no means a foregone conclusion.

.....That said, the world has been changing even faster than we expected.....  And so our work to prepare for the day when Canada might want to launch a digital loonie—backed by the Bank—has also accelerated.

....We are not alone. In a recent survey, almost 60 percent of central banks reported the possibility that they will issue a central bank digital currency within six years. This is up from less than 40 percent only a year ago.

Having said that, Lane was quick to point out that he is not a fan of the existing digital currencies:

The other scenario I raised in my speech last year is the increasing use of digital currencies created by the private sector, including cryptocurrencies and so-called stablecoins. While these products have existed for several years, some could see a boost from the acceleration of digitalization in the midst of the pandemic.

Even in this increasingly digital economy, though, cryptocurrencies such as bitcoin do not have a plausible claim to become the money of the future. They are deeply flawed as methods of payment—except for illicit transactions like money laundering, where anonymity trumps all other features—because they rely on costly verification methods and their purchasing power is wildly unstable. The recent spike in their prices looks less like a trend and more like a speculative mania—an atmosphere in which one high-profile tweet is enough to trigger a sudden jump in price.

Lane then poses two fundamental questions: 

.....Are there benefits to issuing a digital form of money? And if yes, who should do so?

In response to the first question, we don’t yet know whether many Canadians will actually want to use a stablecoin or any other kind of digital currency when they have alternatives available—cash, debit, credit and electronic transfer. 

.....In response to the second question, if the public does want a digital cash-like currency, some good reasons illustrate why a central bank—a trusted public institution—should issue it.

Currency is a core part of the Bank’s mandate, and the integrity of our currency is a public good that all Canadians benefit from. Only a central bank can guarantee complete safety and universal access, and with public interest—not profits—as the top priority.

Lane goes on to speak at length about modernizing payments systems and specific issues relating to cross-border transactions, but let's stop at this point and consider the truly fundamental question: what would a central bank-issued digital currency even look like?  The "stablecoins" that he refers to already exist -- Facebook mused about issuing one last year -- but the differ from the more prominent digital coins such as Bitcoin and ethereum in that they are asset-backed in order to provide greater stability and utility as a payment mechanism. 

Today's Canadian dollars, like other currencies, are in effect backed by the full credit of the Government, whether we are talking about notes and coins or digital money. Would a digital loonie have that same backing, or rather, would anyone accept a digital loonie that did not have such backing in preference to the  existing government-backed loonie that can already be widely used for digital transactions? It is hard to see why anyone would want to do that, and so it's not obvious why issuing a specific digital loonie would add much, if anything, to the range of payments alternatives that Canadians already use. 

Bank of Canada steps back

With a very low-key announcement on Thursday, the Bank of Canada scaled back the emergency measures it had put in place to ensure liquidity in financial markets. Specifically:

• The Bankers' Acceptance Purchase Facility and the Canada Mortgage Bond Purchase Program will both be terminated by the end of this month: 
• Term Repo operations will move from weekly to twice monthly, effective from next week, and the range of securities eligible for these operations will be cut back. Only Federal or Provincial government securities will now be eligible. 

Bank Governor Tiff Macklem signaled recently that the use of these facilities had dwindled sharply since the peak of the pandemic.  The Bank's announcement observes that "overall financial market conditions continue to improve in Canada" , so these moves are not a surprise. Needless to say, however, the Bank stresses its continuing commitment to ensuring adequate liquidity in financial markets, up to and including a restart of the discontinued facilities "if necessary".  

Although the second wave of the pandemic is well under way in Canada, there is no evidence of a return of the panic that gripped markets back in March and April.  For now it seems unlikely that the Bank will have to take further emergency measures to support liquidity in the coming months.   

Tiff talks

Even as the second wave of the COVID pandemic sweeps across the country, Bank of Canada Governor Tiff Macklem is looking ahead to the risks that litter the path to eventual recovery. In remarks to the Global Risk Institute this morning, he focused on risks to the recovery itself, risks that may arise during the recuperation phase, and risks related to by climate change. Unsurprisingly, many of the risks he addressed are related to debt. 

After briefly summarizing the steps that Canadian governments and the Bank itself have taken since the pandemic hit, Macklem moved on to discuss the financial risks. Intriguingly, he drew a parallel with the disastrous Fort McMurray fires of 2016, which the Bank has studied closely. "Then, as now, we saw a rapid stop in economic activity caused by a sudden shock. Then, as now, much of the lost ground was regained quickly. But the episode left economic scars that took a long time to heal."

Macklem noted that Canada's banks have provided mortgage relief to hundreds of thousands of borrowers over the past six months, but these deferrals are coming to an end. Moreover, the pandemic has severely hampered the ability of businesses to meet their fixed obligations, although the extension of emergency wage subsidies into 2021 will provide relief. Macklem described the financial system as well-capitalized and able to act as a shock absorber for households and businesses, but cautioned that the Bank is continuing to monitor the level of credit losses.  

As regards risks during the recuperation phase, Macklem's focus was squarely on household debt. A commitment to maintaining low interest rates sine die is a key element of the Bank's support to the economy, but the Bank is aware that low rates can foster both speculative buying and over-borrowing. The Canadian housing market experienced a remarkable bounce as the first wave of the pandemic faded: though Macklem did not mention this, Toronto was recently identified as one of the most over-extended housing markets in the world in a report by UBS. For the moment it appears that Macklem is confident that the Bank has the macroprudential tools it needs to cope with these risks. 

Finally, as regards climate change, Macklem stated that the financial system has a "critical role to play" in supporting the real economy's transition to a low carbon future. "If we are going to do a better job assessing, pricing and managing climate risks, we need better and more decision-useful information that combines climate-data analysis with economic and financial information. This will make the financial system and the real economy more resilient. And it will strengthen the ability of the financial system to fulfill its most critical role, which is to allocate savings to its most productive uses. This will help Canadians take advantage of sustainable investment opportunities."

Macklem's summing-up of the challenges ahead is worth quoting in full:

"The COVID-19 pandemic has made it painfully clear that how well we manage risks has a huge impact on our well-being. Globally, I don’t think it’s an exaggeration to say that the quality of risk management will increasingly influence the success and stability of societies. Of course, I’m talking about much more than financial-risk management. But the financial services sector has a leadership role to play. Two historic recessions in just over a decade have underlined just how much managing risks in our financial system matters to the livelihoods of Canadians. As we begin to recover from the economic fallout of the pandemic and look to the vulnerabilities ahead, sound risk management is more critical than ever."

A full agenda indeed.

Laundry list

The leak of the so-called FinCEN papers has put money laundering back on the business pages for the first time in a while. It has also taken a heavy toll on the shares of some of the world's biggest banks, including Deutsche Bank and HSBC. That's a little odd, inasmuch as these 2500-plus documents are mainly "SARs", or Suspicious Activity Reports. Rather than evidence of wrongdoing by the banks, these reports are proof that they have been reporting such transactions to the monetary authorities, which is exactly what they are supposed to do.   

Detection and prevention of money laundering was a pervasive concern during my thirty years in the banking business, particularly when I moved from Canada to London just before the millennium. There were regular (and very tedious) sessions aimed at teaching staff members how to identify transactions that might constitute money laundering. Everyone was trained in the importance of KYC -- Know Your Client. The Compliance Department grew larger, more powerful and more intrusive year by year.

What was my takeaway from all this?  Sadly, it was that you can never quite keep up with the launderers. Every major bank in the world is just about certain that it is laundering money every day -- it just can't effectively identify every single suspect client and every single suspect transaction. Neither can the financial authorities.  That hasn't changed over the years, and it is unlikely that it ever will.      

Bank of Canada says financial system can cope with the pandemic

Today the Bank of Canada released its annual Financial System Review.  Unsurprisingly, it is all about the impact of the coronavirus pandemic on the Canadian financial system, and the system's ability to cope with that impact.  Equally unsurprisingly, the Bank's conclusion is that, thanks to the pre-pandemic strength of the economy, the soundness of the banking system and the raft of measures taken over the past two months, the system is in good shape to cope with what may be coming. 

Some of the key points, with apologies for a much longer post than usual:

"Strong policies have put a floor under the economy and laid a strong foundation for its recovery. Concerted policy actions by the Bank and other authorities have helped restore market functioning, and liquidity conditions have improved significantly. Government support for households and firms is directly mitigating income losses. Lower policy interest rates are underpinning demand and helping to achieve the inflation target."

Whether this eventually turns out to be true remains to be seen. The scale, scope and speed of the actions taken by the Federal government, shutting down portions of the economy and providing income support to those most affected, have been impressive.  However, while this may have "put a floor under the economy", the strength of the "foundation for its recovery" depends on the length of the shutdown. The longer it takes for the economy to reopen, the more likely it becomes that much of what existed pre-pandemic is effectively gone forever, as the Bank acknowledges later in the Review.

"The Bank of Canada has intervened to support liquidity in key funding markets. Starting in mid-March, the Bank established and expanded a range of facilities and large-scale asset purchase programs to address problems with market functioning......The size of the Bank’s balance sheet has roughly tripled, growing from $119 billion on March 4 to $392 billion on May 6. This increase is much larger and occurred much faster than the growth that occurred during the 2007–09 global financial crisis, when the Bank’s balance sheet increased by 50 percent from September 2008 to the peak of the crisis in March 2009."

What is remarkable here is the sheer scale and rapidity of the growth in the Bank's balance sheet.  The Review goes on to note early evidence that these measures are having some success, including a surge in corporate bond issuance in the month of April.

"Canadian banks have allowed more than 700,000 households to delay mortgage payments and have also provided increased flexibility on payments for credit cards and lines of credit. This is keeping debt payments down for many households. However, after the six-month deferral period ends, debt-service payments will rebound. The proportion of households with debt-service payments of more than 40 percent of their income, an indicator of household vulnerability, is likely to rise. This will be particularly the case for households whose incomes do not fully recover."

The elevated level of household debt has been a long-standing theme for the Bank of Canada (and, for that matter, for this blog), with debt standing at close to 180 percent of household income. This situation will need to be watched closely as the deferral period nears an end, not least because the banks are rolling the deferred interest into the outstanding principal.  The length of the shutdown in the economy will be the key to how this plays out.

"Policy actions are helping businesses manage their cash flow needs and prepare for the recovery. Government policies such as the Canada Emergency Wage Subsidy and the Canada Emergency Commercial Rent Assistance Program help firms continue to pay their workers and make rent payments despite significant declines in revenues.....What started as a cash flow problem could develop into a solvency issue for some businesses. This becomes more likely if the loss in revenues extends over a long period. Lingering concerns about COVID‑19 could lower demand in some industries, damaging their earning capacity. For example, demand for travel services may recover very slowly. The potential for solvency problems also depends on the ability of businesses to access credit from financial markets and banks and therefore becomes more likely if stress in the financial system returns."

Again we see the Bank pointing out that despite the aggressive measures taken to date, problems could become much more severe for the business sector if the slowdown is prolonged beyond a few months. The Bank is clearly correct in identifying the travel sector as being particularly vulnerable here; the restaurant sector, with a heavy predominance of smaller enterprises, seems equally at risk.

"The six largest banks entered the COVID‑19 period with strong capital and liquidity buffers, a diversified asset base, the capacity to generate income and the protection of a robust mortgage insurance system. The Canadian economy was also in a solid position before the onset of COVID‑19. With these strengths, as well as the aggressive government policy response to the pandemic, the largest banks are in a good position to manage the consequences. Without the aggressive policy responses, banks would be faring much worse, with important negative effects on the availability of credit to households and businesses."

This is reassuring, though one would hardly expect the Bank to say anything different. The Bank and the Federal government trumpeted the success of their policies in keeping the domestic financial system safe after the global financial crisis. The current challenge appears to be much greater and a really prolonged downturn might start to impose further strains on the system.

In his remarks introducing the report, Bank Governor Stephen Poloz concluded by saying "To be clear, the pandemic remains a massive economic and financial challenge, possibly the largest of our lifetimes, and it will leave higher levels of debt in its wake. The right combination of fiscal, monetary and macroprudential policies can ensure a return to economic growth and debt sustainability. Further, policy-makers have taken the lessons of past crises to heart and acted to strengthen the financial system. Canada’s adherence to reforms after the 2007–09 global financial crisis, which strengthened the banking sector, is paying off. I am confident that a strong financial system will help Canada emerge from this episode in relatively good shape."

Poloz's successor Tiff Macklem, who steps into the hot seat in three weeks' time, will be hoping Poloz is correct.

First D-SIBs

This week in Ottawa, the Federal financial regulator OSFI has increased prudential capital requirements for the country's biggest banks.  The so-called D-SIBs (Domestic Systemically Important Banks), which are six in number*, will now have to hold 2.25 percent of additional Tier 1 capital (also called CET1 capital) beyond the amounts required by international regulators, up from a current level of 2.0 percent.  This will bring the total CET1 capital requirement to 10.25 percent, starting in April 2020.

In a sense, OSFI's announcement is purely symbolic, in that all six of the D-SIBs already hold significantly more CET1 capital than the new requirement.  However, this is the third such increase mandated by OSFI in the past twelve months. The regulator is signalling that it is increasingly concerned over both domestic vulnerabilities (notably high household indebtedness) and global risks,  and is warning the banks to be guided accordingly. 

Canada's regulators have never stopped bragging about how well the country's financial institutions weathered the financial crisis a decade ago. It looks as if OSFI is determined to make sure that when the next crisis hits, it (and the banks themselves) can maintain that enviable track record.

* Bank of Montreal, Bank of Nova Scotia, Banque Nationale du Canada, Canadian Imperial Bank of Commerce, Royal Bank of Canada, Toronto Dominion Bank. The final two of these institutions are also part of the global "too big to fail" roster. 

Moving target

It's all go at the Bank of Canada these days.  Fresh from announcing the establishment of its new online Financial Stability Hub, the Bank has revealed that it is re-examining the entire basis of its monetary policy framework, which comes up for renewal in 2021.  This press release summarizes the Bank's preliminary thoughts and contains a link to the full speech by Senior Deputy Governor Carolyn Wilkins.

By way of background, the Bank of Canada has based its monetary policy around a 2 percent inflation target for almost three decades. The policy is set via an agreement between the Bank and the Federal Government that is reviewed and updated every five years. This agreement comes up for renewal in 2021, and Ms Wilkins' speech makes it very clear that the Bank is looking for much more than cosmetic changes this time.

As the press release indicates, lessons the Bank has learned in the wake of the financial crisis have led it to believe that a wholesale review is necessary.  There are two key factors: first, the Bank's estimates of a "neutral" rate of interest is much lower than it was before the crisis; second, the fact that nominal rates of interest may be lower in the future than they were historically may lead to excessive risk taking (read: borrowing) by households and businesses.

The problem with the lower neutral rate of interest is that it implies that the Bank has much less room to provide conventional forms of monetary stimulus when crises hit.  If, as the Bank currently believes, the neutral rate is in a range of 2.5-3.5 percent, it has very little leeway to cut rates unless it moves into negative territory, something it has avoided until now.

As for excessive risk taking, it is tempting to suggest this reflects a too-narrow view of inflation on the Bank's part.  It has used all kinds of inflation measures over the years, including its current trio of core indices, but these have all related to consumer prices in one way or another.  Its conception of the neutral rate is likewise driven by its target for inflation at the consumer level. It has become apparent in the past two decades, and especially during the financial crisis, that tame consumer prices do not necessarily mean that monetary policy is correctly calibrated.  The financial crisis was driven by run-ups in asset prices that central banks, led by the Greenspan Fed, chose largely to ignore.

Ms Wilkins' speech is explicitly intended to start a debate on the issues, and to get things going she lays out some of the alternatives being considered by the Bank. There have been suggestions in many countries that a 2 percent target is too low; would 4 percent perhaps allow more policy flexibility?  Ms Wilkins notes that such a step would be hard on those living on fixed incomes, an important consideration as populations age, and could backfire if it triggered concerns that the target, once moved, could be subject to repeated change.

Other possibilities outlined by Ms Wilkins would require more drastic change.  They include price level targeting; an explicit dual mandate, requiring the Bank to hit targets for both prices and output; and nominal GDP targeting.  Each of these brings its own problems, not the least being that they would be much harder to explain to the general public than the present (deceptively) simple target.

Not, of course, that there's anything new about that. Ms Wilkins notes that average inflation since the 2 percent target came into effect in 1991 has been "pretty darn close" to the desired level.  However, I would wager that if you stopped Canadians at random on the street and asked them what the current inflation rate is, not one in ten would give you a figure lower than 5 percent, and many would insist stridently that it's a whole lot higher than that.  Good luck changing that, Ms Wilkins!   

The banks are alright

The Bank of Canada today made an important addition to its website: the Financial Stability Hub, "a dedicated space....for timely analysis and research on financial stability issues".  The Bank and its political bosses at the Department of Finance were little short of smug at the domestic banking sector's stability during the financial crisis a decade ago.  With the next financial conniption only a matter of time, the Bank evidently thinks it's important to get an early start on convincing investors and depositors that the system is well-prepared and resilient.

The new Hub is off to a flying start, with three new papers added on the first day.  A couple of these are worthy of comment: a report on the vulnerability of the financial system to house price corrections, and an analysis of the impact of recent policy changes on the mortgage market.

The paper on house price corrections is rich in acronyms, introducing us to a "suite of models" known as FRIDA:  Framework for Risk Identification and Assessment.  FRIDA and her less pronounceable offspring (including CDM and MFRAF) allow the Bank to model the macroeconomic impact of a house price correction and increase in financial stress. The Bank has specifically modelled the impact of a nationwide 20 percent fall in house prices.  It considers this an improbable scenario, but it is worth noting that in the key Toronto and Vancouver markets, this would represent less than a 50 percent retracement of the price increases recorded in the past five years.

The results from FRIDA are reassuring.  Thanks to tightened regulations, Canada's banks have more, higher quality capital than in the past. As a result, the scenario under consideration would result in lower bank earnings over a five-year time horizon, but would not threaten capital positions. That said, the Bank recognizes that things could turn out worse if a house price correction were to coincide with some other shock to the system -- a national recession, for example, or a loss of international investor confidence. It appears FRIDA will be set to work examining some of these additional risks in future reports.

As for the impact of policy changes on the mortgage market,  the Bank cannot quite avoid taking a self-congratulatory tone. Its policy changes are having "a clear impact" on the market, and in particular the "number of new highly-indebted borrowers has fallen".  This is worth focusing on, because the Bank's definition of "highly indebted" is terrifying: it refers to borrowers taking on a mortgage loan equivalent to 450 percent or more of their annual income.  The Bank provides various measures of how its tighter rules have affected this segment, but the broadest measure is that the overall percentage of new borrowers falling into the highly indebted category has fallen from 18 percent to 13 percent.

The report also looks at regional trends in mortgage lending.  Overall growth in the mortgage market has slowed in response to tighter rules and a pullback in house prices.  The biggest declines have been seen in the formerly overheated Toronto and Vancouver markets.  The number of new highly indebted borrowers in those markets has also fallen, but it remains worryingly higher than in the rest of the country.  This suggests that even if the financial system as a whole could weather a correction, the level of pain in some parts of the country could still be extremely high.

One further vulnerability in the market gets only a passing mention in the report, but will bear watching as things evolve.  Tighter mortgage rules at the major banks have pushed more borrowers into the arms of private lenders, whose lending criteria are unregulated and undoubtedly less stringent. In Toronto, the only area for which the Bank appears to have data, these lenders have boosted their share of overall mortgage lending, though it still stands short of 10 percent.  The systemic issue here is not whether these folks, both borrowers and lenders, will run into trouble if house prices tumble.  They undoubtedly will.  But if I were the Bank of Canada, what I'd be worrying about is, what is the source of the money that the private lenders are so enthusiastically shovelling out?   

Bond market speaks, mortgage rates rise

By the standards that geezers like me used to live by, Canadian interest rates are still extremely low.  What used to be the benchmark long bond, a 30-year instrument that will finally mature in 2021, carried a coupon of 9.75 percent.  That was the risk-free rate that the government of the day had to pay back in the early 1980s.

Still, bond yields are definitely on the rise right now, with the 5-year Canada trading near 2.2 percent and the 10-year above 2.3 percent.  Rates in the US, where the Federal Reserve is seen as bent on tightening, are higher still, with the 10-year Treasury at 3 percent for the first time since 2014.  Canadian banks have taken heed, and today the two biggest -- TD and Royal -- hiked their fixed mortgage rates.  TD boosted its 5-year rate, the most popular choice among borrowers, by 0.45 percent, to 5.59 percent.

The Canadian housing market is already struggling to regain momentum, and these rate moves -- which are all but certain to be followed by the other banks -- must surely put the final nail into realtors' lingering hopes for a rebound later in the year.  That may be no bad thing: the markets in Toronto and Vancouver are still overvalued by historical standards.  However, with household debt still at elevated levels, it is very likely that the upward trend of interest rates will bite into household consumption, and thereby into overall economic growth.

What are the bond markets worried about?  It doesn't seem to be excessively rapid growth and the risk of overheating, at least for now: both the Canadian and US economies have slowed from the pace seen a year or two ago.  That means, in turn, that concerns over a return to much higher levels of inflation cannot be the primary factors driving rates higher.  Although inflation rates on both sides of the border have edged higher, the increase is mainly the result of higher energy prices.  Labour markets look tight, but there is little sign of the sort of upturn in wages that would get either the Fed or the Bank of Canada seriously concerned.

Rather, the concerns seem to be about the fiscal outlook in both countries.  The fiscal stance of the Trump administration is breathtakingly rash, providing a reminder (if one was needed) that Republicans are only fiscal hawks when Democrats are in power.  Choosing this moment to antagonize the biggest buyer of US debt -- China -- by threatening to start a trade war seems foolish indeed, though these days it can hardly be called surprising.

Meanwhile in Canada, the Liberal government up in Ottawa is projecting deficits as far as the eye can see.  In Ontario, the world's largest non-sovereign debtor, the Auditor-General is again arguing that the Provincial deficit is far larger than the government wishes to admit -- indeed the A-G denies that the government ever got the budget back into balance, as it claims to have done. It remains to be seen whether Doug Ford's PC party, which looks likely to be the winner of the election in early June, will be able to do much better on the fiscal front.

In short, it looks as if good old supply and demand offer the best explanation for the upward trend in bond yields.  After the financial crisis, when private corporate borrowing shrank very sharply, markets were easily able to absorb government debt, particularly with the Fed helping out via Quantitative Easing.  QE is being scaled back and private sector financing needs are getting back to normal.  If you're a Keynesian you'll know that this is not the stage of the business cycle for governments to be stepping up their own borrowings, but that's what's happening, and that's why rates are likely to keep heading higher. 

Bank of Canada: the risks are still the risks

The Bank of Canada released its semi-annual Financial System Review this morning.  Introducing the Report to the media, Governor Stephen Poloz noted that the key risks identified by the Bank are the same as they were six months ago, and indeed the same as they have been for several years now: high and rising household indebtedness, and imbalances (read: overvaluation) in the housing market.

Gov. Poloz pointed out that household indebtedness continues to rise faster than household incomes. As the OECD noted earlier this month, Canada's households are now the most indebted in the developed world.  The increase in debt has seemingly not yet been affected by the Bank's increasingly urgent warnings, or its steps toward tighter policy.

Poloz noted that steps by the Government to regulate high-ratio mortgages (less than 20 percent down-payment) more tightly have reduced the issuance of such mortgages.  However, the Bank is concerned over a possible deterioration in the quality of non-high ratio mortgages, with amortizations stretching beyond 25 years and more such loans being taken out by highly-indebted households. New regulations will be forthcoming in the new year to regulate these mortgages more closely and ensure that the borrowers can withstand a rise in interest rates.  The Bank welcomes this prospect, though one wonders whether Poloz ever asks himself why the lenders need the Government to impose such prudence on them, rather than adopting it themselves.

As regards the housing market, Poloz notes that the froth seems to have come off the Toronto area market in response to steps announced by the Ontario Provincial Government back in April.  However, the Bank is waiting to see whether Toronto house prices follow the pattern set in Vancouver, where the effect of earlier government measures seems to have faded, with prices starting to rise again.  Poloz also notes that the fundamentals of the market are strong, with demand driven by rising population and employment.

The Bank's conclusion is that Canada's financial system remains "resilient".  That message is likely to be reinforced over the course of this week by the release of  financial results for the major banks.  The first of these, Scotiabank, today announced an 11 percent year-on-year rise in profits, a remarkable result considering nominal GDP is rising at less than a 6 percent pace.  So far there has been little evidence of any impairment in the banks' credit quality, despite the surge in household debt. Some commentators are suggesting that Gov. Poloz sounded a little complacent today, but for now, he seems to be on solid ground.   

How soon is now?

Just about nobody had been expecting the Fed to raise the funds target again today.  Thus, the only real point of interest in today's FOMC press release was the timing of the previously-announced plan to start unwinding QE (or balance sheet normalization, as the Fed prefers to call it). Would the Fed announce a timetable?

No, it would not.  The press release simply stated that the FOMC "expects to begin implementing its balance sheet normalization program relatively soon". Exact timing, as with the further rate hikes that are surely coming, depends on the data flow.

It's hard to blame the Fed for keeping its cards close to its collective chest.  No central bank has ever tried anything like QE before; the experiment has almost certainly run for much longer than the FOMC expected when it launched it; and there is no playbook for unwinding it.  Ending QE will not be like pulling off a bandage,  where the faster you do it, the less it hurts.  Getting this wrong could be way more damaging than tightening rates a little too fast.  All the same, a touch more clarity from the Fed today might have been helpful, if only to avoid the impression that it doesn't quite know how to proceed.  

Bank of Canada: good to go?

There seems to be very little reason for the Bank of Canada to hold off on raising rates when its Governing Council meets on July 12.  Start with the fact that Governor Stephen Poloz has taken his newly hawkish message on a virtual world tour: after first broaching the subject of higher rates in an interview in Winnipeg, he delivered the same message at an ECB-sponsored conference in Portugal, and this week followed that up with yet more of the same in an interview with a major German newspaper.

It's a mistake for a central banker to send those kinds of signals and then not follow up, particularly as the flow of economic data in the past two weeks has been generally supportive of the case for higher rates.  In particular, the latest set of employment data, released earlier today, shows continuing strength in the labour market.  The economy added 45,000 jobs in June, which caused the unemployment rate to tick down to 6.5 percent.

Although most of the jobs were part-time and most of the gains were seen in just two Provinces (Quebec and BC), the June report means that the economy has added 351,000 jobs in the last year, the fastest pace for any twelve-month period since 2009.  Almost 250,000 of those jobs have been full-time, with the result that the number of hours worked in the economy has grown by 1.4 percent in the past year.

The strong gains in employment through the entire second quarter -- up 0.6 percent over Q1 -- are a clear signal that the strong GDP growth seen in the final quarter of 2016 and the first three months of this year has persisted.  April GDP data, released a week ago, appeared to confirm this, with GDP by industry posting a 0.2 percent month-on-month rise. Aside from a pullback in manufacturing, the gains were broad-based -- and in a uniquely Canadian touch, StatsCan noted that strong growth in the arts, recreation and entertainment sector was driven by the fact that five Canadian teams reached the end-of-season hockey playoffs!  (As this is a serious blog post, we will pass over the fact that the final saw Pittsburgh triumph over Nashville).

Given the strong macroeconomic data, what could hold the Bank back next week?  The only real candidate is the housing market, which seems to be on the verge of a full-scale correction, especially in the Greater Toronto region. The average selling price for a home in the region fell by 8 percent in June; any comparable decline in July would see the year-on-year change, which topped 30 percent in the first part of this year, slip into negative territory, which would be quite remarkable.  Rising listings and a falling number of completed deals are further evidence that the market has changed drastically since the Provincial government introduced its package of calming measures back in April.

You can certainly make a case that housing has been a major driver of the economy in recent years -- but not in any sense that a prudent central bank would be likely to favour.  Low interest rates have largely failed to encourage any increase in new home construction, even though this is much needed.  Instead, what they have driven is a rapid increase in household debt, initially in the form of mortgages, but more recently in the pernicious shape of home equity lines of credit (HELOCs), which have been showing explosive growth.

It may well be the case that a rate hike by the Bank next week will curb consumer behaviour, though it's worth noting that the Bank will, if anything, be lagging the market here: banks are already raising their mortgage rates, so the highly-indebted consumer is about to get squeezed whether the Bank does anything or not.  Monetary stimulus will have to be removed at some stage, and with the economy in its best shape in almost a decade, this is looking like the right time to start.  A 25 bp rate hike seems certain to come on July 12, with the Bank possibly signalling one further hike before year end, assuming of course that the data flow remains favourable.

The Fed's new normal

In line with expectations, the Fed increased its target funds range to 1-1.25 percent at the end of the two-day FOMC meeting.  The accompanying statement stresses that monetary policy "remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation".

The statement leaves little room for doubt that the Fed expects to raise rates further, though it stresses that the timing and extent of any future increases will depend on the data flow, particularly as regards employment and inflation. However, "the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run".

For now, the Fed is continuing to reinvest the principal amounts of the bonds it acquired during its QE program as they mature.  However, it intends to start a program of normalization of its balance sheet before the end of this year, assuming the economy evolves as expected. To this end, it released today a brief but informative document on how this process will work.  (Answer: slowly.) Downsizing the balance sheet is likely to prove a lot trickier than returning interest rates to more normal levels, a fact that the Fed clearly recognizes: "The Committee expects to learn more about the underlying demand for reserves during the process of balance sheet normalization".

The Fed is at pains to stress that is not about to take away the markets' punchbowl entirely.  It expects that its balance sheet, at the end of the normalization process, will be larger than it was before the financial crisis and QE.  It also reassures the market that the Fed will be willing to re-commence securities purchases at any time in the future, if it deems that such a step is necessary to support the economy.  Things may be very slowly heading back towards "normal", but evidently normal isn't what it used to be.

Bank of Canada: can't move, won't move

As expected, the Bank of Canada kept its interest rate target unchanged at 0.5 percent today.  The press release  (which, as one commentator has noted, is unusually short) depicts an economy still facing uncertainty from global developments, especially in the United States.  Low interest rates are supporting steady growth in consumer spending and the housing sector, and there are some signs of an improvement in business investment.  Inflation -- both headline CPI and the Bank's three core measures -- remains well-contained.

Given these facts, it's no surprise that the Bank's Governing Council "judges that the current degree of monetary stimulus is appropriate at present".  And likely not just "at present": the timetable for any removal of stimulus continues to be pushed further into the future, even though this implies that the divergence between the Bank's policy stance and that of the Federal Reserve will continue to widen.

Meanwhile, back in the housing market....It's too soon to tell whether recent actions by the Ontario government will help to cool the buying frenzy in the Toronto area, though there are some early signs that the bidding wars have eased.  However, the overhang of household debt continues to loom ominously.  Manulife is the latest institution to weigh in, as reported here.

Much of this is familiar, but there's one startling statistic: 72 percent of mortgage holders could not absorb a 10 percent increase in their monthly mortgage costs without running into financial problems. Indeed, 38 percent would be in trouble with a 5 percent increase!  Think about that.   Rates have been so low for so long that most of those people are probably paying something near a 3 percent mortgage rate. That means that just one 25 basis point increase would be enough to push a sizable number of homeowners into financial distress.

That certainly shows why the Bank of Canada will need to be cautious when it does start to tighten its policy settings.  But it also begs the question: just why has the Bank allowed this situation to develop, and just how does it think it can get out of it without torpedoing the entire economy?

The Bank's next policy decision, due on July 12, will be accompanied by an updated Monetary Policy Report.  This will doubtless provide a detailed review of the economic outlook, but it is very unlikely to provide any clear pathway for the Bank to extricate itself from the low-rate trap it has created for itself.

Short story

I haven't written about the short-selling of stocks here for a long time -- probably since the financial crisis was at its peak.  Now it seems that the short sellers are back to their nefarious business in Canada again, looking to bring down Home Capital, a higher-risk mortgage lender.

The elevated level of risk in the Canadian housing market, particularly in areas around Toronto and Vancouver where an out-and-out bubble has developed, has become an international story.  Bubbles almost always end badly.  There are grave doubts as to whether the steps taken to cool the market by the BC provincial government (last year) or the Ontario government (last month) can be effective, given that the Bank of Canada seems set on maintaining its ultra-low interest rate policy.

If the bubble is indeed going to burst, the first sign of danger will always be a problems at a higher-risk lender.  This was the case in the UK a decade ago, with Northern Rock, and it was the case also in the United States with Countrywide and others. Home Capital is one of the larger higher-risk mortgage lenders in Canada, and in the last few months it has made a number of unfortunate mis-steps. In essence, the company realized some months ago that some of the mortgage brokers feeding its business had not been fully disclosing the financial situation of the borrowers they were introducing.

Since then, as this article by Terence Corcoran in the National Post explains, it's been all downhill for Home.  The Ontario Securities Commission has become involved, there has been a management and board shake-up, and depositors have started to get cold feet and withdraw their funds, creating a liquidity problem.  Most ominous of all, short-sellers have become actively involved, although as Corcoran notes, it's all but impossible to discover just how big the short positions are.

Matters seem to be coming to a head.  Last week Home arranged a large line of credit at a very fancy interest rate -- 22 percent! -- with a consortium of non-bank lenders. This week it has announced a deal for an unnamed buyer to take over a portion of its mortgage book, and also announced its intention to re-orient its entire business model.  To reduce funding pressures, it will focus on sourcing mortgages that can be packaged for sale rather than kept on the company's own books.

It remains to be seen whether this will be enough.  It may at least permit an orderly wind-down of the business, rather than a sudden collapse that could put the entire financial system under strain.  In the meantime, it's appropriate to ask again just what value short sellers bring to the market in these (or any other) circumstances.  When even a right-winger and ardent free-marketeer like Terence Corcoran is all but accusing the shorts of pushing Home into bankruptcy with no regard for the wider consequences, maybe the regulatory authorities need to take a fresh look at the whole pernicious practice.

Canada's debt spiral

Another day, another record level of household debt in Canada.  It was reported yesterday that the ratio of Canadian household debt to disposable income reached a new record of 1.673 (i.e. $1.673 in debt per $1 of income) in the final quarter of 2016.  It was only a couple of years ago that this ratio topped the 1.63 peak seen in the US just before the financial crisis, and it's only been onwards and upwards since then.

An economist at my old shop, Toronto Dominion, Diana Petramala, tries to find comfort where she may: "Debt growth has accelerated somewhat, but it is not growing at the double digit pace that would normally be considered dangerous".  I'm not sure where that rule comes from, and I would suggest to Ms Petramala that if a ratio reaches an all-time record high at a time when interest rates are at a record low, that might be danger enough to be going along with.

The other thing that is regularly trotted out as a reason not to worry about the level of debt is the seeming rise in household net worth. Sure enough, that's being cited again now, but it's still a dangerous fallacy.  Your home is a very illiquid asset, especially in the event of a downturn in the market.  High  house prices have only been possible because of rising debt; when the music stops, a large number of people are going to find themselves unable to find the financing to keep up their debt payments.

Canada may, in fact, be close to a situation in which the household debt burden is unmanageable whether the economy expands or falters. If growth continues at the pace seen in recent months, the Bank of Canada will be forced to follow the Fed in raising rates, which would immediately push some of the most highly indebted households over the brink.  And if growth stalls and people start losing their jobs, widespread mortgage defaults would be inevitable.  Stress tests supposedly show that bank balance sheets could easily withstand a significant housing market correction.  Let's hope so.