Business & Policy
All things considered: March 2010
By Jim Knisley
As the country begins its slow slog to economic recovery much, if not
all, of the attention will be focused on federal and provincial debt
As the country begins its slow slog to economic recovery much, if not all, of the attention will be focused on federal and provincial debt and deficits. This is with good reason. The numbers are huge and it’s going to take time, care and diligence to bring them back to a more manageable level and, at the same time, not maim the economy.
Less noticed, except by individuals, will be consumer or household debt. It too has burgeoned and, while it isn’t as well publicized as government debt, it can be just as much of a threat. In effect government debt looms and intimidates. It can be like a mythical monster made real. You see it, you hear it and justifiably fear it.
Consumer or household debt is more like an earthquake beginning stealthily deep underground and then breaking loose.
Mark Carney, the Governor of the Bank of Canada, said in a December 2009 speech that with household debt “financial vulnerabilities are much less predictable. They develop over time and can persist for longer than expected.”
“In our most recent FSR (financial system review), we judge that most of the risks to the stability of the Canadian financial system have ebbed in recent months. At the same time, our assessment of the risks related to household balance sheets is that they have increased further.”
The deterioration of household finances is the result of a toxic mixture of unemployment, stagnant and falling incomes, low saving rates and increased debt.
“The vulnerability of Canadian households to adverse wealth and income shocks has grown in recent years. Aggregate debt levels have risen sharply relative to income. Those debt levels have continued to grow fairly rapidly this year, unusually so for a recession.”
This has increased the financial risks facing many Canadians. In a best-case scenario, incomes will rise as part of an overall economic recovery, debt will be reined in and savings will be replenished.
But it is a delicate process that could be derailed by an economic shock from any number of sources or directions.
“The Bank believes that overall risks to financial stability arising from the household sector have continued to increase. In particular, the combination of sustained growth of household debt relative to income and a rising interest rate environment could increase the vulnerability of households to an adverse shock,” Carney said.
One simulation done by the bank “generates a scenario indicating that, by the middle of 2012, almost one in ten (9.6 per cent) Canadian households would have a debt-service ratio greater than 40 per cent, the threshold above which households are considered financially vulnerable,” he said.
If another financial shock hits households the impacts could ripple (or rip) through the retail and housing sectors and then spread.
This shock, if it materializes, is unlikely to begin in Canada. Canada entered the recent recession in reasonable shape and, thanks in part to rigorous regulation of Canadian banks, is emerging in better shape than most other countries.
But the United States is of concern. It is slowly emerging from the recession, but has a national unemployment rate of 10 per cent (compared to Canada’s 8.5 per cent), a very large deficit, higher per capita consumer debt than Canada, a low savings rate and a political culture so toxic that ours looks like a well-behaved kindergarten by comparison.
The political culture is troubling at a time when they have no easy choices, only necessary ones. At the national level, they must find a way to get their unemployment rate down, they must deal with their continuing housing crisis, they must bring entitlement programs such as social security and Medicare under control and they must increase tax revenues if they are to reduce the deficit.
Hopefully, the United States will get its act together.
On the home front it is not just urban consumers that have taken on debt.
Farm debt outstanding in Canada in 2008 was 14 per cent higher than the 2003-2007 average. This likely continued through 2009 and into 2010.
Carney had some straightforward advice for Canadians that can also be applied to Canadian farmers.
“Responsibility starts with the individual,” he said.
“Ordinary times will eventually return and, with them, more normal interest rates and costs of borrowing. It is the responsibility of households now to ensure that in the future, when the recovery takes hold and extraordinary measures are unwound, they can still service their debts.”
He also added a phrase that should perhaps be put on welcome mats or wall hangings beside “Home Sweet Home.” That phrase is: “While asset prices can rise and fall, debt endures.”