Household debt accumulation
The Canadian household debt burden has climbed ever upward over the last 30 years. That trend generally held globally, amplifying in the years preceding the financial crisis.
Unlike in the United States and the United Kingdom, Canada refrained from the worst of those “excesses,” and thus averted a good amount of the economic carnage that ensued, the report said.
But as households elsewhere in the West now agonize through a period of deleveraging, Canadians have continued borrowing at about the same pace, compelled by income growth, low interest rates and ever rising home equity.
While those debt levels are mostly driven by mortgage borrowing, consumer credit now accounts for about one-third of the household debt burden.
Instruments like home equity lines of credit (HELOCs) have encouraged homeowners to borrow against the equity afforded by rising home prices.
“Financial innovation that made it easier for households to access this type of borrowing” has likely helped facilitate debt accumulation, the report said.
Borrowing and spending
Home-equity extraction, which includes HELOCs and mortgage refinancing, accounted for a large increase in total household debt since 1999, the report said.
Over that period, as a percentage of disposable income, borrowing on equity rose from 2.2% to a peak of 9.0% in 2007.
Through the recession and its aftermath, Canadians appeared to compensate for declines in income by resorting to credit secured by their homes. In 2009, HELOCs drove one-quarter of the increase in average household debt.
A significant share of those borrowed funds — about 40% — were used to finance consumption and home renovations.
Canadians invested about 35% of those proceeds and used 25% to repay other debt. A portion of the debt in that final category, however, would be consumer debt, understating the extent to which Canadians increasingly finance their consumption through home-equity extraction.
Given the recent emphasis of borrowing in household expenditures, “this suggests that household spending on consumption and home renovation can become vulnerable to house price shocks, since lower house prices would reduce the value of housing collateral,” the report said.
Housing prices
An indebted household, particularly one that has borrowed against home equity, is one that is vulnerable to the forces of depreciation.
The behaviour of the Canadian housing market over the past several years alone has some convinced of an impending correction. On average, real house prices in Canada increased by 88% since 1980. Since 2000, prices rose nationally almost without interruption.
Over the long term, housing prices are a function of income and population — factors that fall short in explaining medium-term price fluctuations.
With housing, supply is slow to respond to demand, leaving movements in prices to correct the imbalance in the interim.
Additionally, interest rates and credit conditions skew the forces of demand and supply of housing.
One model described in the report attributes 60% of the rise in Canadian home prices from 2001 to 2010 to population and income growth.
Other possible factors explain the remainder, including: declining mortgage rates, changes in expectations of future price growth and changing liquidity measures in the housing market, like vacancy rates, the time it takes a house to sell and volume of houses listed for sale, the report explained.
Much is at work in the housing market and it’s risky to count on a steady upward march of prices.
Insolvency
The rate of insolvency, which includes both bankruptcies and debt restructurings, has been on the rise in recent years in Canada.
Approximately 100,000 Canadians file for insolvency each year — triple the rate of the 1980s. The average debt of those declaring bankruptcy amounts to about $92,000, rising to $115,000 for those applying to restructure their debts.
Considering the rising levels of average household debt, “the number of households that may be vulnerable to a negative economic shock is rising as well,” the report said.
The main domestic sources of risk to financial stability, as identified by the central bank, include that vulnerability and the deterioration of the credit quality of household loans.
“Fragility in the household sector can have substantial adverse spillovers to the financial system and the entire economy,” the report said.
That phenomenon was illustrated most starkly in the recent experience of the United States.