Household debt reaches worrisome levels

The following article was written by Julian Beltrane of the Canadian Press, and published online at www.msn.ca on September 15, 2010. It is a grim reminder to many of us of the harsh reality many Canadians live beyond their means - bolstered only by access to credit. A day of reckoning will come for many. 

OTTAWA - Canadians are taking on too much debt, with potentially serious consequences for both their own finances and the Canadian economy.

The warning from economists and a leading global think-tank comes amid fresh evidence that floor-low interest rates the past two years have induced households to borrow more than they may be able to comfortably afford.

Even Canadians instinctively seem to sense their vulnerability.

A new survey reveals that 81 per cent said that if they won $1 million in the lottery their first thought wouldn't be what new shiny car they could buy, but paying off debts.

"People are worried that interest rates are going to increase because, once that happens, their debt loads are going to get bigger," said Cindy Forget, chairman of the Canadian Payroll Association, which did the poll.

More to the point, the new survey found that 59 per cent of employees said they were living from paycheque to paycheque, and that about half put aside only five per cent, or even less, of net income in savings.

The Bank of Canada began driving down interest rates more than two years ago — eventually setting the trendsetting policy rate at the hyper-low level of 0.25 per cent — to stimulate a faltering economy.

But now analysts say the good medicine is becoming toxic, which is why bank governor Mark Carney appears determined to continue hiking interest rates — the last increase coming last week — despite a hard-braking economy.

Lured by low mortgage interest rates, Canadians have been borrowing and buying homes at an unsustainable rate, the Paris-based Organization for Economic Co-operation and Development said Monday.

"[But] this situation is bound to change as the Bank of Canada withdraws monetary stimulus and longer-term rates move up in response," the think-tank said. "In any case, household debt credit needs to slow down, which may well moderate private spending and residential investment in the coming quarters."

• The caution was released before Statistics Canada issued its latest report on household worth showing Canadians got slightly poorer in the second quarter, the first such reversal since the recession.

The agency found household net worth fell for the first time in a year in the second quarter, mainly due to lower stock prices. Net worth declined by $34 million to $5.9 trillion in the April-to-June quarter, a period when the Toronto Stock Exchange index declined almost 6.2 per cent.

On the plus side, the key debt-to-income ratio fell from a record 148 per cent to 145.7 per cent, while the debt-service ratio fell to a four-year low of 7.2 per cent. But that may well be a temporary improvement doomed to be reversed in the third quarter.

Reached in Toronto, federal Finance Minister Jim Flaherty said market pressures have already caused a softening in Canada's housing market, but if the government has to do more to curb overborrowing, it will.

"Rates are much more likely to go up than go down in the future and they [Canadians] have to make sure they can afford to pay the monthly payments on their mortgages," he said.

The new data is illustrative of both the ability of Canadians to carry large levels of debt, for now, and their vulnerability in the future.

The main danger is not so much that Canadians will be unable to meet their debt obligations — although some could be driven into insolvency, said Scotiabank economist Derek Holt.

But if Canadians are tapped out just trying to pay interest and principle on debt, they won't spend on consumer items, thereby slowing economic growth.

That's what happened to Canadian governments in the 1980s and first half of the 1990s when they were running up huge deficits.

"Household debt has moved in to vacate the space left by once heavily leveraged Canadian governments and corporations," he noted.

"I think the issue is significant enough to cause concern that Canada is frittering away many of the hard won advantages that have been created in repairing public and corporate finances over the past twenty years."

TD Bank economist Diana Petramala cautions that the near future is not rosy in terms of debt and net worth.

Debt ratios have been rising sharply since 2007, and even the second quarter's slight decrease appears temporary, a result of a 15 per cent annualized surge in tax refunds.

Meanwhile, any improvement in stock market performance will likely be more than offset by the 3.7 per cent decline in house values since April, which are expected to fall further.

"Weak asset growth in combination with still strong liability growth will likely have households feeling buried under more debt than they ever have," Petramala said.

By Julian Beltrame, The Canadian Press, thecanadianpress.com, September 15, 2010