If you're ever trapped in a seminar room full of Ottawa's chattering classes, you will hear an outpouring of self-congratulatory rhetoric about Canada's remarkable escape from suffocating levels of federal debt in the 1990s and its subsequent emergence as a beacon of fiscal rectitude.
It's a lovely story. Too bad it's so incomplete.
A more comprehensive narrative would show that Canada hasn't so much emerged from debt as shifted it around. A grand shuffle that began in the 1990s saw households embark on a borrowing binge that more than offset government's successful fight against deficit addiction.
Tote up both public and private debt and it turns out that Canadians are now deeper in hock than ever. The risks that faced the country a generation ago haven't disappeared. They've just been transformed – for now, anyway – from a public issue into a private one.
Oddly enough, this shift has not been accompanied by much in the way of finger wagging. A clanging chorus of politicians, business groups and pundits constantly warn of the dangers of too much government borrowing. But the voices opposing a runup in household debt speak in whispers.
That may be because lots of people are making money from the big surge in personal debt. Unlike in Ottawa, where opposition parties have a vested interest in denouncing the spendthrift ways of whoever is in power, there's no natural critic of families that borrow hand over fist. In fact, if you have a decent job and are going into debt to buy a house or a condo, there's usually a welcoming party of lenders who will clap you on the back and encourage you to borrow even more.
Until recently, the don't-worry-be-happy attitude has worked out just fine. But our collective love affair with personal debt has now reached levels that exceed anything on record.
Last year, for the first time, the accumulated burden of Canadians' household borrowing edged past the total value of the country's economic output, as measured by gross domestic product (GDP). According to the Bank for International Settlements, Canadians are now deeper in debt, relative to the size of our economy, than Americans were at the height of their own housing boom a decade ago.
Perhaps not coincidentally, Home Capital Group Inc., one of Canada's major subprime mortgage lenders, saw its shares plummet this week after revealing that it had to arrange an emergency $2-billion loan facility. The company's problems may turn out to be unique to Home Capital. Still, you can't help but wonder if its agony is an indicator of broader stresses.
"The levels of [private] debt we're seeing are troublesome and alarm bells should be getting ready, if they're not already sounding," says Kevin Milligan, a professor at the Vancouver School of Economics at the University of British Columbia. Surging levels of mortgage debt have been the primary fuel behind a dramatic runup in household borrowing, he notes. Regulators have been steadily tightening rules in that sector since 2010, but "they seem to be two steps behind the housing market."
In contrast to the rampant debt accumulation in the private sector, Ottawa has tended to its own financial position quite diligently, Prof. Milligan says. The federal government is running a deficit but its projected shortfall is quite manageable in the context of a growing economy. Ottawa faces no danger of falling back into a 1995-style debt crisis any time soon – at least, not so long as the economy avoids a major calamity.
The biggest single worry would be a housing-sector collapse that would force Ottawa to step in and shoulder a large portion of the private sector's bad debts, just as Ireland's government did a decade ago when it decided to backstop its own lenders after the country's housing market collapsed. An emergency of similar magnitude could capsize Ottawa's hard-won fiscal stability in an instant.
"As things stand right now, there is a lot more reason to worry about the private debt side of things than the public debt side," Prof. Milligan says. "But you can envision a situation where you could have a public debt crisis that would be driven by a private debt crisis."
Just to be clear: Prof. Milligan isn't predicting that the housing sector will collapse and he certainly isn't suggesting that a slide is imminent. But he is concerned that more than two decades of falling interest rates and steadily rising personal debt have desensitized borrowers to potential risks.
The danger is heightened because financial history demonstrates that lenders nearly always move as a herd. If one lender is grabbing market share by freely dispensing loans, other lenders typically feel they have to follow suit. In an environment of falling rates, the result is constant pressure on managers to loosen standards and dispense even more money. "Nobody gets promoted at a bank for the deals they don't do," Prof. Milligan notes.
The psychological shift over the past generation is both sweeping and troubling. "The fact that rates have been so low for so long has not been a good thing over all because it's lulled people into taking on debt," says Livio Di Matteo, a professor of economics at Lakehead University in Thunder Bay, Ont. "The ethos of society has shifted from saving to spending. Basically, if you're a saver, you're almost punished because of low interest rates."
To be sure, there are a couple of ways to view this story. Low rates have enabled both households and governments to carry large amounts of debt far more easily than they did a couple of decades ago, Prof. Di Matteo points out. Households' interest payments are now lower, as a percentage of their income, than they were in 1990, despite steadily rising levels of debt.
In addition, today's consumers are unlike the federal government of the 1990s in one important respect – households have accumulated lots of assets to put against their ballooning debts. While the collective net worth of Canadian households was 265 per cent of GDP in 1990, it is now about 500 per cent, thanks in large part to soaring real estate values.
But low rates and high levels of assets go only so far. "If interest rates were to suddenly go up, if the economy were to slide into recession, I think there would be problems for both households and governments," Prof. Di Matteo says.
Exactly how deep the problems could go is open for debate, but history suggests grounds for concern. The Great Mortgaging, a research paper published last year, surveyed 17 advanced economies and concluded that booms in mortgage lending have become both more common in recent decades and also more treacherous.
"Our work confirms the crucial importance of mortgage credit in the build-up of financial fragility," write Oscar Jorda of the Federal Reserve Bank of San Francisco, Moritz Schularick of the University of Bonn and Alan Taylor of the University of California, Davis. They add: "Since World War II, it is only the aftermaths of mortgage booms that are marked by deeper recessions and slower recoveries."
Why do mortgage booms sting so badly? One reason is that apparently bountiful asset prices often turn out to be a mirage. During the U.S. financial crisis, home prices melted away, leaving many borrowers paying interest on loans that far exceeded the value of their properties. A similar dynamic could unfold here.
"The argument you hear a lot is that there are assets to back up all the private debt, at least to the extent that we're looking at the housing market," Prof. Milligan says. "The problem, however, is that the valuation of assets can vary a lot.
"Talk to our American friends on that issue. They ran up hundreds of billions in debt trading air back and forth … Perhaps the value of air will continue to go up. But I'm not a fan of building up huge amounts of debt by trading air back and forth."
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Ian McGugan