The Question Is: Is Canada sitting on a household debt land mine?

 There’s a saying that perhaps illustrates my concerns with current debt levels in Canada and the pace of debt accumulation over the past decade:“It’s not the fall that kills you. It’s the sudden stop at the end.”While Mr. Lascelles and I agree that household debt poses a risk to the economy, and the pace of borrowing over the past decade is unsustainable, we seem to disagree in two key areas: The likelihood of a hard stop in borrowing and the economic implications of such a hard landing.

 

My belief is that a hard landing in borrowing is likely, and that such a hard landing would likely cause a recession. This concern is framed by one key issue: Housing.

 

To understand why housing is such a driver of current debt loads, we need to look at the composition of credit growth over the past decade. There is currently roughly $1.65-trillion in household debt in Canada. Roughly $1.15-trillion, or 70 per cent of this, is in the form of mortgage debt. The remaining $495-billion is in non-mortgage consumer debt such as lines of credit, credit cards, etc. But within this total, we find that home equity lines of credit account for roughly $225-billion after accounting for the $206-billion reported by chartered banks and making conservative estimates of HELOC originations by other lenders such as credit unions.

 

So in other words, $1.38-billion or nearly 85 per cent of the total household debt burden is tied directly to housing. It’s the HELOC component of this debt that has grown most dramatically – up 700 per cent since 2000. In fact, it was the flow of this very credit that I believe provided an enormous and temporary boost to the economies of certain provinces coming out of the recession. For example, in B.C., annual line of credit growth coming out of the last recession amounted to over 4 per cent of provincial GDP. That’s one heck of a stimulus.

 

So significant has this home equity withdrawal been, that it has been estimated by the Bank of Canada to currently amount to over 8 per cent of aggregate personal disposable income in the country – or roughly where the U.S. peaked in 2005. No matter how we slice it, economic growth has been goosed by the additional spending power provided by home equity extraction while mortgage debt has also provided a significant economic tailwind.

To put all of this in perspective, if we separate credit-driven industries like residential construction and the FIRE groups (finance, insurance, real estate) from all other components of GDP, we find that real GDP growth generated by all other industries are essentially unchanged since 2007 while real GDP growth from these credit-driven industries are up over 10 per cent in the same time frame.

 

The question then becomes one of sustainability. I don’t have the space to outline my views on the likelihood of a Canadian housing correction, but needless to say, I would suggest that there is a very high likelihood of a “hard landing.” We have a pretty clear example south of the border of how the flow of mortgage debt and home equity withdrawal reacts to a housing correction. It is most certainly what I would call a “hard stop.”

 

I’m not predicting a U.S.-style correction, but I also don’t believe we need such a severe correction to significantly crimp demand for mortgage and consumer credit. And if that happens over a short time frame, as I worry it could, the economy looks vastly different than it does at present.


  

 

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