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Mr. Carney's warnings, and the perils of pride

Of all the things we've supposedly learned from The Great Recession, there is one lesson that Canadians hold dear, one that fits oh-so-neatly with the country's latent anti-Americanism. It is this: We are not Them. We are different, better, more responsible.

Post-crisis, an entire mythology has been built around this notion, all the better to explain why Americans suffered so much more in the downturn than Canadians have. Why are there still 6.3 million U.S. residents who've been unemployed for at least six months, and only 330,000 in Canada? Why is the U.S. in the middle of a wretched, multiyear collapse in housing prices, and we are not? Well, that's easy, right? They were stupid. We were smart. They cut taxes to make the rich even richer and borrowed money from China to fund the deficit. We ran surpluses. They allowed bankers to give $400,000 mortgages and American Express cards to Wal-Mart greeters. They were being so American - wearing their faux wealth on their sleeves. We were so prudent, by comparison.

As with all caricatures, there is some truth in this, but a good deal of exaggeration, too. And maybe, just maybe, Canadians have carried their sense of financial superiority too far, become too self-satisfied. A cure for that smugness lies in the Bank of Canada's latest review of the financial system, and its warnings that Canadians are still spending money they don't have. Some facts leap out.

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Item: Canadian families, with debt totalling 146 per cent of disposable income, are now as deeply in hock as U.S. families are. Item: Canadian house prices are now 4½ times disposable income; historically, they've been between three and 3½ times. (The same thing happened in the U.S. before the real-estate bubble burst.) Item: our responsible, prudent, sober bankers have been doling out credit lines in the manner of Santa Claus distributing candy canes. (Personal credit lines have been growing about 16 per cent a year for the past decade, though the pace has slowed this year.) Most Canadians, if they are aware of these points at all, just shrug. An excess of debt, expensive houses, so what? Tell us something new. Mark Carney, the Bank of Canada Governor, has been bleating about consumer borrowing for more than a year, and the sky has not fallen. What does he know that the rest of us don't? A thing or two about financial history, which high schools don't teach but should.

The history books are rich with examples of countries whose citizens believed they were immune to financial bubbles, or who thought their banks were impregnable, and who felt that nothing bad could ever happen to them. It's overconfidence that leads to too much borrowing, and Americans have no monopoly on that. The best book on the subject is This Time is Different, by economists Carmen Reinhart and Kenneth Rogoff (of the University of Maryland and Harvard, respectively), who document centuries of debt crises. Most instructive is their chapter on banking disasters, which, the authors write, tend to happen this way (I'm simplifying here): A country finds itself very popular with international investors and sees a surge of foreign capital. (Check.) Housing prices rise at a rate much faster than the rate of inflation for a sustained period of time. People argue that the old rules of valuation no longer apply. (Check.) Eventually, real estate values start to fall. Banks show signs of stress, usually soon after home prices hit their peak. As defaults rise, the banks are shorn of capital and pull back on their lending, causing a downturn. (Not yet.) The evidence, say Ms. Reinhart and Mr. Rogoff, is that "when housing booms are accompanied by sharp rises in debt, the risk of a crisis is significantly elevated" (emphasis added).And, as Americans and Irish and Swedes and Spanish have discovered, recessions that spring from banking crises tend to be deep, protracted, and expensive. They drive up government debt quickly.

Not all credit booms end in crisis, and Canada's might not, either. But the longer consumers ignore Mr. Carney's alarm bells on debt, the harder it will be for policy makers to engineer a soft landing for the real estate market. And if it's a hard landing? That would end the complacency in a hurry.

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