Tuesday, February 16, 2010

Canadian Household Debt: Pass the Crack Pipe

To much lesser fanfare than the announcement on the new mortgage rules, the Vanier Institute for Families released the annual report on Canadian household finances.  To summarize: Canadians are credit junkies that just can't get enough. Link to the entire report (worth reading).

A few "highlights":
The debt to income ratio moved up to 145% at the end of the third quarter 2009. This is another new record. Given the trends evident in the first part of 2009, the Bank of Canada estimates that this ratio could be up to 160% by the end of 2012.10 This ratio has been found to be a key determinant of personal bankruptcies.
A more precise indicator of the burden of debt has been developed by the Bank of Canada. In the third quarter 2009, about 6% of all Canadian households (about 825,000 households) had a DSR (Debt Service Ratio) that exceeded 40%. The DSR measures the percentage of gross income spent on household debt plus payments on the principal. These high DSR households are in a very vulnerable position and the Bank of Canada model assumes that one out of every four households in this situation will eventually default.
The Bank of Canada created two scenarios to see what percentage of households would be in this vulnerable situation given current trends in the debt to income ratio, and if the average cost of borrowing increased by the end of 2011. In the first scenario, interest rates increase by about half a percentage point, and, in the second scenario, they increase by about one percentage point.
Under the first scenario, there would be about 1.1 million households with a high DSR at the end of 2011. Under the second scenario, there would be approximately 1.3 million households with a high DSR at the end of 2011. These are increases of 30% or 50% from the third quarter 2009 situation.
As worrisome as these numbers are, the average cost of borrowing could easily increase by much more than the percentages assumed in these two scenarios. A two percentage point hike could easily cause the number of households with this dangerously high DSR to climb to 1.5 million or so. This would represent an increase of about 80% from the situation in the third quarter 2009 in the number of households with a dangerously high DSR.
And this is only considering the immediate implications of higher rates in the coming year or two.  Remember, as Canadians don't have the luxury of locking into 30 year fixed rate mortgages, we have to renew our terms, typically every 5 years.  Rising rates are going to cut into affordability massively, couple this with government attempts to balance budget and you're looking at higher tax rates, meaning less disposable income.  In short, rising debt levels to service with at best stagnant incomes, and more likely declining disposable income due to tax increases.  Oh, and that debt you're holding, it's a recourse loan as well, so no walking away from your ill conceived plunge into a ridiculously bloated housing market.  How's that vice feeling?

Credit card and mortgage delinquencies rose (somehow we never seem to hear about these things in the media, ever).
The number of consumer insolvencies was up by 26% (3-month moving average) in October 2009 from a year earlier. The year to year increase had been as high as 42% in mid-summer 2009.
Delinquencies rose. Mortgages held by chartered banks, which are 90 or more days in arrears, were up by over 50% in October from a year earlier. Visa and Mastercard credit card holders, who were delinquent for at least 90 days, were up by over 40% in July from a year earlier.
The relevant chart below (click to enlarge):

In general, if you're 3 months delinquent on your mortgage, you're defaulting.  You're not making those payments up unless you come into a family inheritance or win the lottery.  Let's cut the crap and call it what it actually is, which is a gauge of soon to be mortage defaults.  Keep in mind the chart above is the percentage change from the previous year, so that dip you see does NOT indicate that delinquincies are falling.  They are still increasing, just at a slightly slower pace.

So how much have we lost in this debt fueled debacle?  Canadian average net worth, is still below it's peak. (click to enlarge).

As of the end of the third quarter 2009, the average net worth (total assets minus total debt) per household stood at about $390,000 in constant 2007 dollars. This was down by approximately 6% from the peak of about $416,000 in 2007. That is a substantial decline of $26,000 per household. The decline was much deeper at the end of the first quarter 2009, but was reduced by a rapid improvement in share prices and the rebound in house values.
(Emphasis mine).  That's right, despite a massive equity party from the 2009 March lows AND a 19% increase in home prices in 2009, household equity is still $26000 below the 2007 peak.  Where would we be without the market rally and house price explosion due to a combination of zero interest rates and massive government stimulus?  It's scary to think, yet this is the direction we are most likely headed back towards.  Unless maybe you think a 50% increase in the stock market and 20% increase in home prices is sustainable annually.  Brace yourselves.

And finally, the best chart of the report (click to enlarge):

Hmm...let's try to determine when housing prices came unglued from incomes...might it have something to do with crashing interest rates due to the dot.com bubble collapse + 9/11?

Central banks: blowing bubbles decades at a time...until they can't because the weight of the debt taken on is too much.  We're at that point now.

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