It's all about debt

Amid mounting fears over just how far and how fast the Bank of Canada might raise interest rates, the Canadian media are suddenly full of scare stories about the financial plight of the household sector. On Monday Statistics Canada released data on national wealth and financial flows for the first quarter of the year, which provided fresh insights into household balance sheets. And on the same day, Manulife Bank of Canada released a survey outlining some scary scenarios if mortgage rates continue to rise. 

In many respects the StatsCan data paint a positive picture of household finances. The net worth of the household sector rose by about 1.2 percent in the first quarter, with higher non-financial assets (mainly real property) offsetting falls in the value of financial assets. The aggregate value of residential real estate rose by more than 10 percent in from Q3/2021 to Q1/2022. The household savings rate rose to 8.1 percent in Q1, the highest level since 1995 if you ignore the bloated levels briefly recorded early in the COVID pandemic. Lastly, the ratio of household debt to disposable income edged down to 182.5 percent in Q1 from the record 185.0 percent posted in the previous quarter; it need hardly be stated that this is still an extremely high ratio by global standards. 

If there are positives to be taken from the data, why is the media coverage so bleak?  In part this relates to the media's voracious appetite for bad news, and in part it reflects the sheer speed with which a multi-year sellers' market has U-turned into a buyer's market.  It is also important to keep in mind that the data are highly aggregated: the "average" household may be in fine shape, but there are many that are not. Those that stretched their borrowing to the limit in order to get into last year's hot housing market and also opted for a floating rate mortgage are particularly vulnerable -- and according to the StatsCan data, 30 percent of outstanding mortgages are at floating rates. 

It may be argued that the rising aggregate value of household net worth means the problem is not a serious one. This again ignores the risks now being faced by the most heavily indebted households. It also fails to recognize the distinction between bankruptcy and insolvency. A household with substantial equity in its home many not be at risk of going bankrupt, but it may still lose the home if its cashflow becomes insufficient to service its mortgage debt.  

This brings us to the Manulife survey, which polled 2000 households across Canada in mid-April. Here are the key conclusions:

• Nearly 25% of homeowners say if interest rates increase further, they’d be forced to sell.
• 1 in 5 homeowners believe they can no longer afford the house they own.
• Nearly half of Canadians said they would struggle to handle unexpected expenses.
• NEARLY 40% of Canadians do not feel like their wages are keeping up with inflation.
• 80% of Canadians think there is an affordability crisis in Canada.

This is all quite remarkable, particularly as the Bank of Canada had only just started its tightening cycle when the survey was conducted. For anyone who carried a mortgage at a rate well above 10 percent in decades past, it's hard to grasp that current interest rates have pushed so many Canadian households so rapidly to the point of despair.  Interestingly, Manulife Bank itself -- in sharp contrast to the media latching on to the story -- is cautious in interpreting the data. Here is its "key takeaway" from the report:

With the shift in the housing market, rising interest rates and inflation concerns, it’s normal to worry about your long-term financial future. But feeling like you can’t afford your home doesn’t mean you’ll be forced to sell if interest rates continue to rise. Once you know more about how interest rates work, you’ll have a better idea of how this may impact you and will help you feel more in control when it comes time to make any major financial decisions.

That seems like excellent advice, though no doubt too late for many people. Experts have been fretting for years about what might happen when the Canadian housing market stopped racing ahead. We're starting to find out, and it doesn't look as if it will be very pretty to watch. 

Do your homework!

I haven't had a rant about the incompetence/laziness of business journalists for a while.  Time to correct that.  This article from today's Toronto Star, headlined "Toronto leads new housing starts in August", contains a statistical error so blindingly obvious that you would think a grade school student would catch it.

The author is one Michael Lewis*, described as a "business reporter", so this is kind of story is his everyday bread and butter.  In case the link fails to get you past the Star's increasingly onerous paywall, here's the offending paragraph:

According to the Canada Mortgage and Housing Corp., Ontario led the increase with seasonally adjusted starts jumping to 81,457, followed by Quebec at 48,772. Toronto was tops in metropolitan areas with 3,131 starts in August, while Montreal placed second with 2,031.

Let's dig into that for a second. Toronto is by far the biggest city in Ontario. According to World Atlas,  Ontario's population in 2016 was about 13.5 million, with the City of Toronto accounting for about 2.7 million of that.  Note that Lewis refers to the "metropolitan area"; if you add in the various groupings commonly cited -- in increasing order, the Greater Toronto Area (GTA), Greater Toronto-Hamilton Area (GTHA) and Greater Golden Horseshoe (whatever), you can easily come up with a population for the metropolitan area that's more than half of the Provincial total.

But we don't have to do that to spot Lewis's error.  Using the numbers he quotes, it seems as if Toronto (population 2.7 million) had 3,131 housing starts in August, while the rest of the Province (population 10.8 million) had over 78,000!  You'd think a reporter sitting in a Toronto newsroom and writing about business stories every day might have twigged to the fact that that's wildly implausible.

What happened here is perfectly simple.  After using the seasonally adjusted and annualized data for the province, Lewis switched seamlessly, incorrectly and quite possibly unwittingly to the raw monthly numbers when referring to the individual cities.  The source data can all be found in the original report from Canada Mortgage and Housing Corporation.  In case you actually care, in Table 1 we find that housing starts in Ontario in August totalled 7,316 (not annualized or adjusted), with Toronto accounting for 3,131 of those. 

This isn't rocket science.  It isn't even economics in any real sense.  It's just the sort of fact-checking that's supposedly the job of every journalist.  Sadly, as I've often said in the past, if you want accuracy these days, you're probably better off relying on a blogger. 

* Not that one!!

Canadian seniors in debt

Despite years of warnings from the Bank of Canada and others, Canadians' addiction to debt shows no sign of waning. A new report from Canada Mortgage and Housing Corporation (CMHC) shows that the ratio of household debt to income hit a new record high of 178.5 percent in the final quarter of 2018.

There were some signs of moderation (or pullback) in the housing market during the course of the year.  The number of transactions and the average price were both lower than in 2017 as tighter mortgage eligibility rules began to bite.  The average size of new mortgage loans declined by just under 4 percent, though the average value of all outstanding mortgages actually rose by 3 percent.

The rise in the debt/income ratio is mainly attributable to continuing growth in non-mortgage debt.  CMHC reports that mortgage borrowers' non-mortgage borrowings (mainly via credit cards and the pernicious Home Equity Lines of Credit, or HELOCs) rose faster in 2018 than in the preceding year.  This was particularly noticeable in Vancouver and Toronto, where homeowners were cashing in on the rising equity in their homes, but also, more surprisingly, in Edmonton, where the travails of the energy sector may have forced some homeowners' hands.

Encouragingly, CMHC reports that overall delinquency rates remain low, but the report does draw attention to one worrisome trend.  Over the past four years, the age cohort that has shown the most rapid rise in delinquency rates is the over-65s -- yes, the good old baby boom generation.  It used to be rare for people to carry mortgage debt into their retirement years, but the self-indulgent boomers have put an end to that.  The airwaves are full of offers to encumber the family homestead in order to keep that unaffordable lifestyle in place just a few years longer -- "let your home lend a hand", as one such advertisement has it.   

In effect the boomers (my own cohort) are distorting the housing market six ways to Sunday.  Some  are setting up "The Bank of Mom and Dad" to get the kids on the housing ladder, which mainly serves to keep prices artificially high.  Some are staying in their homes for many years longer than used to be customary because of the lack of affordable and desirable smaller accommodation.  And some are loading debt onto the family home, a sure-fire way of robbing the kids of their inheritance.  It's little wonder that younger generations, watching their elders refuse to go gentle into that good night, expect to have a lower living standard than their parents.

Another warning on household debt

The high level of household indebtedness in Canada has been causing alarm in official circles (and on this blog) for several years now.  Even as the Bank of Canada has been gently moving interest rates higher, it has continued to identify high household debt as a factor that could limit its ability to move policy toward more neutral settings.

On a national basis, the household debt/income ratio seems to have stopped increasing this year, although at 1.71 (or debt at 171 percent of income, if you prefer) as of mid-2018 it is hardly reassuring.  That's a significantly higher figure than was seen in the US before the financial crisis.  South of the border the debt burden has been heading lower for the past several years, whereas in Canada it had been steadily rising before appearing to plateau this year.

Now we have a new report from Canada Mortgage and Housing Corporation (CMHC),  pointing out significant and worrisome differences in the debt burden between major cities across the country.  The lowest ratio, at 1.06, is found in the small city of Saint John, New Brunswick.  The highest by far is in Vancouver,  at 2.42,  followed by Toronto at 2.08.  Given that these are respectively the third largest and largest cities in Canada by population, these numbers suggest that a significant number of Canadians are at significant risk of financial difficulties if interest rates continue to rise.

It seems likely that the Bank of Canada will be keeping rates on hold for the next few months, mainly because there are few signs that the apparent tightness in the labour market is leading to wage pressures.  The problem for the Bank is that the CMHC data seem to show that, despite actual increases in debt servicing costs and repeated warnings of more to come, Canadians are showing little inclination to start paying down their debts.  With the housing markets in both Toronto and Vancouver showing signs of moving higher again, high household debt promises to remain a headache for policymakers well into the future. 

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?   

HELOC to pay

Canadian households' debt to income ratio seems to have stopped rising in recent quarters, and even retreated modestly, although it still remains near 1.70, well above the peak level recorded in the United States ahead of the financial crisis.  The housing market has gone off the boil, with the result that mortgage lending growth has slowed.

That's all well and good, but there's another form of household debt that's causing concern for the Bank of Canada: the Home Equity Line of Credit, or HELOC.  As this article  from the Financial Post reports,  the average outstanding balance on these lines of credit is C$ 70,000; a quarter of HELOC borrowers only pay down the interest each month; and the repayment schedules that borrowers describe to the Financial Consumer Agency of Canada (FCAC) look "optimistic".

Borrowing more money against the family homestead when property prices are rising is a time-honoured Canadian tradition, and in a sense the HELOC is just a new way of playing an old game.  In its most benign form, remortgaging is a low-risk way of securing funds for property improvement, and this was the original notion when banks started making HELOCs available to their customers.

The FCAC is now concerned that some HELOC borrowers are not using the vehicle responsibly -- it has become a means of financing day-to-day consumption rather than investing in home improvements.  Borrowers with no clear repayment strategy are likely to find even the interest payments burdensome as rates continue to rise.  In the event of a downturn in property prices, the equity against which the line of credit is secured will start to shrink, potentially creating asset quality issues for the lenders.

For the last decade, household debt has seemed to be a looming problem that never quite erupts, and the rising concern over HELOCs is unlikely to signal an imminent crisis.  However, many homeowners seem quite happy to enter retirement still burdened by mortgages and HELOCs, and there are ads all over the TV encouraging retirees to slap a reverse mortgage on their homes in order to boost their spending power.  The younger generation would be well advised to temper its expectations for a windfall when my own cohort passes on.

Canada employment data -- ignore the headline

At first blush,  Canadian employment data for April, released by StatsCan this morning, look disappointing.  The analysts' consensus had been looking for a 20,000 increase in employment, but in the event the actual number was a decline of 1,100, well within the statistical error of this volatile data series.  Even so, further analysis of the details suggests that the report is neutral, at worst, in terms of its implications for Bank of Canada policy.  Consider:

• The unemployment rate remained at 5.8 percent, a 40-year low;

• Full-time employment rose by almost 29,000 in the month; the near-flat headline number was the result of a loss of less-desirable part-time positions.  Over the past year the economy has added 378,000 full time jobs, only partly offset by a reduction of about 100,000 in the number of part-time positions.

• Wage gains continue to move higher, with the year-on-year increase in hourly wages up to 3.6 percent.

It is this last factor that is most likely to get the Bank of Canada's attention, particularly with headline CPI (as well as the Bank's preferred inflation measures) all at or above the 2 percent target and set to move higher in the near term.  It remains probable that a further 25 basis point rate hike will come within the next three months.

And after that?  It seems likely that the Bank will be more cautious than the Fed about pushing rates up quickly.  One reason for that is the housing market and the associated high level of household debt.  This week the Bank raised its benchmark mortgage reference rate by 20 basis points, to 5.34 percent.  

Of course, the Bank of Canada itself does not make mortgage loans; this reference rate is designed to allow lenders to assess the ability of new borrowers to meet their mortgage payments, as part of the tighter rules imposed at the start of the year.  Uniquely, it can be described as a "reactive" central bank rate, set in response to the 5-year mortgage rates posted by the chartered banks.  Those rates have been rising in the past few weeks, reflecting rising bond yields, and the Bank of Canada has raised its reference rate in response.  

The good folks at CIBC Capital Markets estimate that a remarkable 47 percent of all Canadian mortgages come up for renewal this year, so rising mortgage rates and the higher reference rate will bite into household spending power.  Add in the fact that the household debt/income ratio remains perilously close to its all-time high, and it becomes easy to see that the all-important consumer sector of the economy could face headwinds this year, even if the job market remains strong.  This week's increase in the mortgage reference rate may well be the most important policy move the Bank of Canada makes this year.  

Rebound? What rebound??

The Canadian housing market has been weakening since this time last year.  After reaching dizzying heights early in 2017, the market was pushed lower first by the imposition in April of new controls by the Province of Ontario, then by the start in July of the long-awaited Bank of Canada policy tightening cycle, and finally, since the start of this year, by new rules designed to limit mortgage availability for highly-indebted buyers.

Realtors, as is their wont, have remained confident that once these one-time factors have been taken on board by buyers and sellers, prices and activity will stabilize and then start to move higher again, likely by the middle of this year.  Market data for March, just released by the Canadian Real Estate Association, cast a long shadow over that rosy scenario.  Home sales agreed in March fell 22.7 percent from a year ago, with Montreal and Ottawa the only major cities posting gains. Sales for the first quarter as a whole were the lowest for any quarter since 2014. 

In terms of prices, the national average fell 10.4 percent, led by the Toronto and Vancouver markets.  Unsurprisingly these are the cities that led the prior unsustainable run-up in prices, and both have been targeted by their Provincial governments with measures aimed at cooling the market.  Excluding those cities, the national average home price is down by a much more modest 2 percent year-on-year.

Before we draw too many conclusions about the outlook for the rest of the year, it is worth recalling that the winter months are traditionally by far the slowest all across Canada for the housing market, for obvious reasons.  Sales generally pick up once the snow melts.  However, the normal seasonal  rebound may be late in arriving this year, as temperatures from the Rockies to the St Lawrence have been far colder than usual for the last several weeks. 

Even when warmer temperatures finally arrive, it may take some time before prospective buyers forget the key lessons that the past year's market action should have imparted: prices can go down as well as up, and sometimes you can score a better deal just by waiting a while.  Remarkably, and in defiance of precedent, it looks as if the authorities may have found a way to prick a housing bubble without triggering an outright collapse.

You can't say you weren't warned

It was always just a matter of time before we started seeing stories like this one.  A group of homeowners have managed to get on the front page of the Toronto Star with their tale of woe about getting sideswiped by the measures taken by the Ontario government and the Bank of Canada last year to cool the housing market.

Briefly:  these people already owned $1 million-plus homes and were mortgaged to the hilt.  For a variety of reasons they decided to buy new but unbuilt homes off-plan in a new development.  They were counting on being able to sell their existing homes at the then-current market price in order to make the transactions work.  However, the Ontario government's calming measures, introduced last April, put the market sharply into reverse. Their existing homes are now worth much less than they were when they signed up for the new ones. Now that it's time to close on the deals, they find themselves scrambling for cash to make up the shortfall.

The homeowners are using the word "reckless" to describe the actions of the Ontario government, which sounds as though they may be considering lawyering up and taking the matter to court.  Think about it for a second:  you have a nice home already; everyone with a pulse and a brain* is warning that the housing market is way overvalued and headed for trouble; the Provincial government is musing aloud about following in the footsteps of the British Columbia government and taking steps to rein the market in.....and you see fit to make an unconditional deal to buy a new home that only exists on paper, which means that the transaction can't close for a very long time.  And it's the government that's reckless?

What would have been reckless on the part of the Ontario government would have been to allow things to continue they way they were a year ago.  I don't give Kathleen Wynne credit for much, but she got this exactly right.  Absent the steps announced last April, we might now be looking at a market in which the price bubble had collapsed very messily.  In that case we would be looking at a whole lot more people in a whole lot more distress than the folks in today's paper.

Do I sound heartless here?  Well, I've been in the same position as these folks. Many years ago I bought a new house only to find I couldn't unload the existing one at the price I'd been counting on.  For a couple of months I was carrying a lot of mortgage debt.  In the end we had to swallow our pride, cut our losses and sell up for whatever we could get.  It was a painful lesson, but we got through it, and so, I'm sure, will the people in today's headlines.

And if you still think I'm heartless, well, it's not just me.  Check the online poll embedded in the linked article.  Seems as though more than 80 percent of respondents think that if you choose to buy a home in a hot market, the risk is yours and yours alone.

* Obviously this excludes realtors, who only have one of those things. 

Assets, liabilities and cashflow

Rejoicing in the land, or at least in the business pages, at the news that the seemingly inexorable rise in Canadian household debt may have halted.  StatsCan reported on Thursday that the ratio of household debt to disposable income edged down from 170.5 percent in Q3/2017 to 170.4 percent in Q4.  Moreover, the Q3 number was itself revised lower from an initially-reported figure of 171.1 percent, an all-time high.  The dollar value of household debt rose by about 5 percent in 2017, with both mortgage and non-mortgage debt rising at approximately the same pace.

There is other good news in the survey, if that's what you are inclined to look for.  Household net worth rose 2.1 percent in Q4, led by gains in the value of financial assets, which account for about 60 percent of total wealth.  In contrast,  the value of the national housing stock rose only marginally in the reporting period as major markets, notably the Toronto area, pulled back in response to government measures to cool things down.

The asset side of the balance sheet bears closer scrutiny.  Note that the data are for the final quarter of last year, when the nine-year equity bull market was still going strong.  Although it may be too soon to call an end to that bull run (the second longest on record), market action in the current quarter  suggests that further significant gains in the value of financial assets will be harder to come by.

Then there's the housing component. The Canadian Real Estate Association just reported that the average price of a Canadian home fell by 5 percent in the year to February.  Prices in the Toronto region have fallen much more sharply, by more than 12 percent over the same period.  Despite the usual whistling past the graveyard on the part of realtors, there is little prospect of any near-term rebound. 

Then there is the cashflow question. Despite the apparent signs of leveling-off in the second half of 2017, the debt-to-income ratio is at a record high.  Canada stands almost alone among major economies in not reducing the debt burden in response to the global financial crisis.  Something like 20 percent of all outstanding mortgages come up for renegotiation in the next twelve months, inevitably at higher rates, so the burden on disposable cashflow will increase.  This is not to suggest that households are about to default in droves, but the problems facing the rising number of highly-indebted households will only get worse.

The bottom line here is that in 2017 household debt increased by about $5 billion, while national net worth lagged slightly with a gain of just more than 4 percent for the year as a whole.  But while debts are intractable and fixed, asset values fluctuate, sometimes violently.  It is reasonable to surmise that while the value of household debt at the end of the current quarter will be little changed from the end of 2017, net worth will have shrunk, as a result of the pullback in house prices and the headwinds facing financial markets.  In short, yesterday's data from StatsCan are good news, but it is way too soon to suggest that the risks posed by household indebtedness are on the wane. 

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. 

Non-residents a non-factor?

A new report from the Canadian Government's housing agency, CMHC, seems to suggest that only about 5 percent of the country's housing stock is owned by non-residents.  Ergo, in the instant opinion of the news media, foreign buyers are not the primary cause of the unaffordability of housing in major cities, particularly Toronto and Vancouver.

No doubt there are other factors at work, especially the availability of cheap money and the apparent willingness of many Canadians to take on enough debt to choke a horse. All the same, there do seem to be grounds for assuming that the CMHC's data are understating the influence of foreign buyers and, credit where it's due, many of the problems with the data have been picked up in the comments on the linked article.

• The data are based on self-reporting, which is intrinsically problematic.  For example, how are dual passport holders classified? 

• Given that the ownership of the overall housing stock changes hands only gradually, it would be more informative to know what proportion of sales were attributable to foreign buyers, rather than what proportion of the country's total housing stock they now own.

• CMHC's data appear to count a home as foreign owned only if the owner is not resident in it, yet it is well known that many Asian buyers have purchased properties for their offspring attending Canadian universities, often registering the properties in the child's name. Such properties should surely be counted among those foreign owned, but in the CMHC's methodology, they aren't.  

Regardless of these problems with the numbers, it seems reasonable to conclude that the lion's share of the blame for high house prices should not be laid at the door of foreign buyers.  That blame belongs with the central bank, as well as with lenders who have continued to dole out money even as warnings of building stress levels have become ever louder.  The evident intention of the Bank of Canada to keep raising interest rates, coupled with new mortgage stress tests in the New Year, could make 2018 a much trickier year for the Canadian housing sector.

All housing, all the time

It's forecasting season in Canada, and the housing industry is front and centre.  Following on from yesterday's rosy forecast for house prices from Royal LePage, today brings several more tasty morsels.

• Here is a much less bullish outlook from another huge realtor, ReMax, forecasting that Toronto-area housing prices will fall sharply in early 2018 as a result of new mortgage stress tests (see yesterday's post), before bouncing back later in the year to end up basically unchanged from current levels.

• Here we have the Canadian Real Estate Association (CREA) predicting that those same mortgage rules will lead to a more than 5 percent fall in home sales in 2018, with prices nationwide edging lower. 

• Here is a report, originally from Bloomberg, suggesting that borrowers facing problems as a result of the new mortgage rules are increasingly turning to unregulated mortgage lenders, paying fancy prices for the privilege and increasing systemic risk.

• And if that's not scary enough, here is a report on new data from Statistics Canada showing that Canadian household debt has reached yet another record high, at 171.1 percent of disposable income. 

You've got to love the last sentence in that final story, a quote from a gent at the Credit Counselling Society: "Canadians need to gain control of their finances and use a budget/spending plan to effectively manage their expenses".  Good luck with that one, sunshine -- you're going to be a busy boy in 2018. At least, that's my forecast.

Guess who's forecasting higher house prices!

Today brings us a new forecast that house prices in the Toronto region will rise 6.8 percent in 2018, the fastest rate for any major Canadian conurbation.  Here's a link, but before you open it, try and guess what kind of person or company is making the forecast. 

Got it in one, I'm guessing.  The rosy forecast is from Royal LePage, one of Canada's largest realtors.  Now there are good reasons to think that the long-term direction of house prices in Toronto is upward.  The region's population growth is steady, thanks in part to the fact that it is the preferred destination for new immigrants.  As a result, demand for new housing units can be expected to increase.  At the same time, new construction, particularly for detached family homes, remains sluggish.  Developers blame this on zoning and planning restrictions, but it seems more likely that slapping up condo towers hither and yon is more lucrative.

All of that may be true, but there are headwinds that the market is certain to face next year.  One is the introduction of new stress tests for borrowers.  Studies suggest that 20 percent even of existing borrowers would fail to meet these tests, so it seems likely that the percentage of would-be new buyers who fail to meet the new criteria may be even higher.  The Royal Le Page forecast acknowledges this, but expects it to have an impact only at the start of the year.

Then there's the economic environment.  Royal LePage thinks that strong job creation and income growth will support housing demand.  Indeed it would, but most forecasts call for the slowing in growth that was already evident in Q3 GDP figures to persist into next year.  If that doesn't happen, the Bank of Canada will certainly continue its policy of gradual monetary tightening.  Either slower growth or rising borrowing costs could easily invalidate Royal LePage's rosy scenario -- and we could well be looking at both.

But who takes house price forecasts from realtors seriously anyway?*  I believe it was the philosopher Bertrand Russell who used the term "arguing against interest", best defined through an example:  if I tell you there is no God, you can safely ignore me, but if the Pope starts telling you there is no God, that's a different matter altogether.  If realtors predicted a softer housing market once in a while, it would be easier to take them seriously. 

* Aside from me, I guess.

Bank of Canada has no reason to hike rates

Economic data released by Statistics Canada this morning virtually guarantee that the Bank of Canada will hold interest rates steady when its Governing Council meets next week.

Headline CPI ticked up to 1.6 percent year-on-year in September from 1.4 percent in August.  That's well below the Bank's 2 percent target, and in any case the increase was mainly attributable to a jump in transportation costs, which was in turn attributable to the impact of Hurricane Harvey.  Excluding gasoline, September CPI was up only 1.1 percent.  The Gulf of Mexico oil patch is back in full operation, so that jump will prove transitory, though it may be noted that retail fuel prices in Ontario are still well above their pre-Harvey levels.  The Bank of Canada's three slightly arcane "preferred measures" for CPI were little changed from August, all standing between 1.5 and 1.8 percent year-on-year.

Separately, StatsCan reported that retail sales fell 0.3 percent in August.  If higher spending on gasoline is excluded (again the result of price increases rather than volume changes), the fall in sales was a more noteworthy 1.3 percent. Since Harvey struck right at the end of the month, its impact at the pumps likely crimped other categories of retail spending into September.  The Bank of Canada may also take note of a monthly decline in sales of home-related items (e.g. hardware and furnishings),  which may be evidence that the impact of the slowdown in the housing market is spreading outside the housing sector per se.

Add in the major developments going on in the background -- the aforesaid housing slowdown, with more mortgage regulation coming in 2018; and the signs that the NAFTA renegotiations are not going well -- and the case for the Bank to hold off on further tightening this month is iron-clad. In fact, expectations that there will be one further rate move before the end of this year may now have to be rethought.

Yawn! Household debt hits another new record

Statistics Canada reported this morning that the household debt to income ratio in Canada jumped more than one percentage point in the second quarter of the year, reaching a new all-time high of 167.8 percent.  At the same time, household net worth (which primarily means the equity value in family homes) fell slightly. Separately, survey data suggest that reliance on home equity lines of credit continues to increase and that seniors are. remarkably enough, now going into debt at a faster rate than younger Canadians. Is there any way that this debt spree ends well?

Logically, we should be at a pivot point now.  Consider these factors:

• House prices have been falling in the key Toronto market since April, when the Ontario Provincial Government announced a package of measures to calm the market.  Falling house prices should mean that those Canadians still looking to enter the housing market will need to take on less debt in order to do so.

• The collapse of housing prices should have alerted people to the fact that a stable level of household net worth (i.e. the equity in the family home) is scant consolation when debt is too high.  Over the past four months or so, millions of people have seen the value of their home fall sharply, and the marketability of that home dwindle, while their debt burden has remained unchanged. Now that StatsCan is reporting a small decline in household net worth for Q2,  this truth should be doubly apparent.

• The modest rate increases delivered by the Bank of Canada since June, and the evident risk that more will soon follow, have triggered a tsunami of advice from financial advisors, urging Canadians to ensure that their debt burden remains manageable.  

None of these three factors has been in place for very long, and they can have had little if any impact on the Q2 data released this morning.  The current quarter is a different matter: if, in the face of these cautionary signals, it emerges that households have continued to amass further debt, there will be only two possible conclusions,  neither of them palatable.  Either Canadians are too reckless to rein in their debts when they clearly should, or they are simply unable to do so.  If debt continues to increase, the Bank of Canada will have to think long and hard about how far and how fast it can tighten monetary policy. 

This is getting serious

Another month, another decline in Toronto-area house prices.  The Toronto Real Estate Board (TREB) reported today that home prices in the region fell 6 percent in July.  That's the third straight monthly decline since the Ontario Government introduced a package of measures aimed at reining in the market.  It's all but impossible these days to find anything attempted by the provincial government that goes according to plan, but this surely has.

TREB is trying to put on a brave face.  It notes three factors that, at least in its view, mitigate the pain.  First, prices are still higher year on year, by about 5 percent.  This is true, but it won't stay true for long if the month-on-month declines continue.  Second, it argues that the summer season is usually quiet, with activity often picking up after Labour Day.  That's not much of a mitigation, given that a year-on-year price comparison is by definition measuring the change between comparable periods (i.e., presumably the market was quiet last July also).  Third, it notes that a similar sharp pullback was seen in Vancouver last year, when the provincial government there also imposed market cooling measures.  That market has now begun to see prices rises again, albeit at a modest pace.

Is that Vancouver experience likely to be repeated in Toronto?  The very sharp decline in sales (down a remarkable 40 percent from July 2016) and the rise in listings (up 5 percent) seems to suggest that the entire direction of the Toronto market has changed.  There must be very few potential buyers out there right now who don't think they can afford to wait a little longer in hopes of getting an even better deal.  Moreover, the fact that the Bank of Canada has started to raise interest rates, together with the prospect of tighter regulation of the mortgage market in the coming months, also argues against a sharp rebound.

Recent reports estimate that there are close to 50,000 registered realtors in the Toronto area, although many of them seem to pursue it as a side gig, doing few if any deals.  Despite the number of chancers who have jumped into the "profession" in recent years, real estate fees remain at sky-high levels, close to 5 percent.  Realtors directly contributed to the price spiral seen in recent years, encouraging bidding wars at every turn in order to boost their own incomes*.  Despite their stoical public posture, TREB and its members must be starting to feel very queasy indeed.  It's hard to feel sorry for them.

* As this article reports, fees associated with home sales now account for almost 2 percent of Canada's GDP.     

One small step for the Bank of Canada

The Bank of Canada raised its overnight rate target by 25 basis points to 0.75 percent today, in line with the very heavy hints dropped by Governor Stephen Poloz over the past few weeks.  This was the first upward move in rates in seven years. The press release issued by the Bank was considerably longer and more detailed than usual. Surprisingly, however, neither the release nor Poloz's opening statement to the media   made any mention of what many would consider to be the elephant in the room: the state of the housing market, especially in the Toronto area.

We'll come back to housing later, but let's focus first on the Bank's justifications for today's move.  Poloz has extolled the strength of the Canadian economy in recent weeks as he has softened up the markets for a rate move.  The Bank does not expect the 3.5 percent GDP growth rate seen in Q1 of this year to persist; it sees growth for 2017 as a whole at 2.8 percent, slipping to 2 percent in 2018 and 1.6 percent in 2019.  However, it expects the output gap in the economy to disappear by the end of 2017, considerably sooner than previously forecast.  Moreover, since the Bank sees the economy's potential growth rate as no more than about 1.5 percent, even the modest growth projected for the out-years of the forecast will trigger capacity constraints, and hence generate inflationary risks.

The imminent absorption of excess capacity in the economy is the driving factor behind today's action, but the Bank readily acknowledges that it is slightly incongruous to launch a tightening cycle while inflation is well below its 2 percent target.  Both headline CPI and the trio of core measures used by the Bank have seen inflation stuck near 1.5 percent in the last several months.  The Bank clearly believes this is driven by temporary factors, such as the electricity rebates being offered in Ontario by the increasingly desperate Wynne government. As these temporary factors wane and capacity use tightens, the Bank looks for CPI to move up to its target in 2018, with a slight overshoot of the target in 2019.  

So, what about the housing market?  All of the recent data confirm that the Toronto-area market, which was spiralling higher just three months ago, has hit a wall.  Prices have fallen sharply, listings are up and the number of transactions is down.  Ever since Governor Poloz started talking tough, personal finance experts in the media have been ramping up their warnings about how stretched some households' finances are, and urging those on floating rate mortgages to consider locking in a fixed rate.  Gov. Poloz's rate hike hints have of course been reflected in the bond market, so fixed mortgage rates have risen even ahead of the Bank's actual move.  

Given the possibility that higher rates could trigger problems for household finances, why has the Bank chosen to raise rates anyway?  The obvious answer is that the Bank has to run its policy in the interests of the entire country; it cannot allow monetary policy to be dictated by the actions of panicky homebuyers in just one market, even one as dominant on the national stage as Toronto's undoubtedly is.  Moreover, the Bank can clearly see that the long-awaited correction in the Toronto market is fully underway, rate hikes or no: the calming measures introduced by the Province of Ontario in April have had a much more rapid and profound effect than even the government itself can have expected.  

Despite the lack of focus on it in the Bank's statements today, there can be no doubt that the reaction of the housing market will play a major part in the Bank's thinking as it ponders its next move.  Gov. Poloz described the Bank's stance this way:

Governing Council acknowledges that the economy may be more sensitive to higher interest rates than in the past, given the accumulation of household debt. We will need to gauge carefully the effects of higher interest rates on the economy.

Future adjustments to the target for the overnight rate will be guided by incoming data as they inform the Bank’s inflation outlook, keeping in mind continued uncertainty and financial system vulnerabilities.

Data-dependent, then, as always.  Markets appear to be looking for one more 25 bp hike this year, with a further 50 bp to follow in 2018.  That looks about right, and would still leave rates well below historically normal levels.

 

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.

Canada inflation lower; house prices too

Remarks last week by Bank of Canada Governor Stephen Poloz and his senior deputy, Carolyn Wilkins (see earlier post, Loonie turns on a dime), led a number of analysts to conclude that the start of a policy tightening cycle in Canada might be closer than anyone had previously thought.  Both officials noted the broadening strength in the economy, with Poloz specifically stating that the Bank's rate cuts had "done their job".

Well, maybe so, but May CPI data released by Statistics Canada today suggest the Bank still has plenty of room for manoeuvre.  Headline CPI rose just 1.3 percent year-on-year in the month, down from 1.6 percent in April. Food and energy prices, always subject to volatility, heavily influenced the headline number, but the various core measures introduced by StatsCan last year all tell a similar story: consumer inflation is well below the Bank's 2 percent target, and showing no real sign of moving up any time soon.  It would be surprising and indeed unprecedented for the Bank to initiate a tightening cycle under these circumstances; the likely timing for the first rate move is still the first half of 2018.

Meantime, there are growing signs that the real estate market in the Toronto area, a major concern for the Bank (not to mention the IMF and the OECD) has hit a brick wall. Data for the first half of June show a further fall in selling prices, a rise in the number of homes listed and a fall in actual transactions.   Realtors are trying to put a brave face on the data, describing June as "normally a quiet month", but there seems to be more than that happening.

Reports are starting to surface of buyers whose offers were accepted before the correction began (in late April) discovering that their mortgage providers are now assessing the properties at a lower than expected value, and reducing their loans accordingly.  This is starting to raise the possibility of supposedly agreed transactions collapsing in a flurry of foregone deposits and acrimony.  It's no surprise that buyers are increasingly taking a wait-and-see attitude, in the hope that the market will come to them.  An outright collapse in prices is still unlikely because of Toronto's underlying demographics.  However, those realtors who confidently claimed that the slowdown would be brief look increasingly likely to be proved wrong.

All good news for the Bank of Canada and the underlying economy then, right?  Well, yes, but then there's this. It seems that consumers are still enthusiastically building up their debts: the average household now owes more than $22,000 in addition to its mortgage debt.  Delinquency rates and other signs of distress remain comfortingly low, but that's hardly surprising with interest rates at today's levels. It's perhaps just as well that the Bank of Canada has room to postpone any tightening steps for a few months more, because it's not at all clear how households, and by extension the overall economy, will react once rates finally start to edge higher.