Low interest rates and an entrenched culture of spending are changing the face of indebtedness in Canada, driving people who already are deeply in debt – particularly those over the age of 45 – to borrow ever more, even as incomes stagnate.
A new analysis by Canadian Imperial Bank of Commerce on consumer debt shows that families that already are borrowers are driving virtually all of the increase in the country's debt load. Much of the rise is being driven by the baby boom generation, raising concerns that a demographic group that should be focusing on saving for retirement is instead digging itself faster into a financial hole.
The findings have broader economic consequences. More people are heading into their 50s and 60s in a financially vulnerable position, and any shock – from a rise in the unemployment rate to an external shock from the global economy or, eventually, rising interest rates – could force this group to sharply reduce spending to make ends meet, creating a drag on growth.
"The two negative implications are that retirements will have to be postponed or compromised, or people will have to de-leverage [cut their debt] with a sense of urgency, so there will be major impact on consumer spending," said CIBC World Markets deputy chief economist Benjamin Tal, who co-authored the report with Avery Shenfeld.
"Things are fine now – and nothing close to the U.S. – but what we do and how we behave over the next two years will be crucial," he warned. Many economists expect interest rates to begin rising in that time.
Other economists, too, have discovered that it is older Canadians who are piling on debt. In October, a TD report found the 65-plus age group is racking up debt at three times the average pace.
"The traditional cycle was when you were younger, you take on debt, when you're older, you save more and pay down your debt. And when you hit retirement, you live on your savings," said Toronto-Dominion chief economist Craig Alexander. Now, as people stay in school longer and retire with debt, we are witnessing "fundamental changes to the life cycle that people have."
Bank of Canada Governor Mark Carney has warned that ballooning household debt is the No. 1 domestic risk to Canada's economy. Mr. Alexander agrees, and has asked his economic team to spend more time this year analyzing the shifting patterns.
Eva McKaeff knows just how easily debt levels can spiral. At first, she had just one credit card. Then another. And then she added a slew of them, including department-store cards with 29-per-cent interest rates. While travelling for work, it was hard to resist new shoes in Vancouver, or work clothes in Toronto. Before she knew it, her credit card debt hit $63,000.
She knows discipline was the main problem. But also, "I didn't fully understand that more credit cards wouldn't be better," says Ms. McKaeff, 47. The ease of getting them "gave me false impression that I had an endless amount of credit."
She sought credit counselling, got rid of all her credit cards and has a goal of being debt-free by age 50. To do that, she has drastically reduced her spending, still drives her 2003 Honda, and has taken an additional part-time job.
Jeffrey Schwartz sees stories like hers all the time. "Interest rates are so low, credit is available to people because the business of credit is making money, and people are sapping it up," says the executive director of Consolidated Credit Counseling Services of Canada Inc.
The CIBC study finds virtually all of the rise in debt in the past four years comes from people with a high ratio of debt to gross income. "The indebted have piled on still more debt," it said.
As a result, the share of heavy borrowers has soared – to 34 per cent of all indebted households today, compared with 26 per cent in 2007. Among provinces, British Columbia and Alberta have the highest share of heavy borrowers.
Current economic conditions aren't helping. In Canada, weak wage growth is a key driver of the higher ratios, the bank said. Household income growth was tepid last year, just as inflation heated up. As a result, real disposable income fell 0.1 per cent in the first three quarters of 2011, a 15-year low.
"The economy's not growing as quickly as everyone thought. Food and fuel are expensive, and housing costs are extremely high, especially in the larger urban areas," Mr. Schwartz said. "So … the people who haven't been living within their means and continue to act as consumers are living a lifestyle beyond their grasp. And it's forcing them to go further and further into debt."
It finds that the most heavily-indebted are responsible for all of the rise in debt since 2007, and that those who should be saving for retirement and building assets are moving fastest into a financial hole.
"While a crisis does not appear imminent, there are cracks emerging in the financial foundation of Canadians that are likely to impair spending growth ahead," says the report, titled "Punch Drunk", by CIBC economists Avery Shenfeld and Benjamin Tal.
Ballooning household debt has made headlines in recent months, and Bank of Canada Governor Mark Carney has warned it is the No. 1 domestic risk to Canada's economy.
Low interest rates have driven recent debt growth. But that's not all – household income growth was weak last year, just as inflation heated up. As a result, real disposable income fell 0.1 per cent in the first three quarters of 2011, the bank said – another reasons why people got squeezed.
High household indebtedness doesn't necessarily mean Canada is facing a U.S.-style crash -- as CIBC points out, Denmark's levels are "light years" ahead of Canada, and so are those of the Netherlands and Switzerland.
But they do bear watching closely, because they suggest more Canadians are financially vulnerable to sudden changes such a job loss, drop in housing prices or increase in interest rates.
Other economists, too, have flagged that it is older Canadians who are piling on debt. In October, a TD report found the 65-plus age group are racking up debt at three times the average pace.
The findings have implications for retirement trends, and consumer spending. "Canadians nearing retirement who should be in their prime savings years are, instead, getting themselves deeper into debt," the CIBC report said.
"We are already seeing an uptrend in bankruptcies for those 50 and over, but the more material impact will be that this group's ability to spend could be severely squeezed upon retirement."
As for heavily indebted borrowers, the study finds virtually all of the rise in debt in the past four years comes from people with a high-debt-gross income ratio. "The indebted have piled on still more debt," it said.
As a result, the share of heavy borrowers has soared -- to 34 per cent of all indebted households today, compared with 26 per cent in 2007.
Among provinces, British Columbia and Alberta have the highest share of heavy borrowers.
The bank doesn't anticipate any sharp run-up in household bankruptcies. But it does suggest consumers won't contribute much to economic growth this year, just as governments are cutting back. Businesses, therefore, will have to do the heavy lifting in propelling growth.