A new debate has opened up on a question that has many households worried: Have Canadians taken on too much debt?
On one side of the debate is the right-leaning Fraser Institute, which last week issued a report urging everybody to chill out — fears of excessive debt are “overblown,” former StatsCan chief Philip Cross wrote in the study.
Yes, Canadians’ household debt is at a record high (about $1.63 of debt for every dollar of disposable income), but it's higher in some countries considered to be very stable (Australia and Norway, for example) and thanks to low interest rates, debt servicing costs are at a record low. In short, Canadians can afford it, the Fraser Institute says.
On the other side of the debate is David Madani of the research house Capital Economics, who issued his own report accusing the Fraser Institute’s study of being “misleading.”
Madani, who has been raising the alarm about Canadian consumer debt — particularly mortgage debt — for years now, says the Fraser Institute was wrong to look only at debt servicing costs, that is, the interest paid on borrowed money.
That “completely misses the point in a high debt, low interest rate environment,” Madani wrote in a recent client note. “Other evidence suggests that household debt obligations are becoming a burden.”
Madani says you have to look at the capital being paid down as well, because that constitutes a large segment of what people actually have to pay.
“Should interest rates rise over the next several years, as we anticipate, household debt obligations will become much more onerous,” he wrote.
Madani cites research showing that some households in Canada are spending as much as 40 per cent of disposable income on debt payments, as well as research suggesting a quarter of households with a mortgage spend at least 30 per cent on shelter costs. Those are the kinds of numbers that can tip households into crisis when rates rise, but "deeper analysis is needed to determine the burden of household debt,” Madani writes.
Evidence is mounting that Canadians are under increasing pressure from their debt. According to Desjardins, housing affordability in Canada has declined for three quarters in a row, while house prices jumped 9.5 per cent, on average, over the past year.
CIBC noted in a recent research note that consumer insolvencies have started to rise for the first time since the financial crisis of 2008-2009, though much of that is related to the economic slowdown in oil-producing parts of the country, and hasn’t spilled over to the broader economy.
The BoC kept its key lending rate at 0.75 per cent in its rate decision Wednesday morning, but the bigger questions that remains is when — or if — interest rates will start to rise at all.
With the slowdown in Canada’s economy caused by the slump in oil prices, most economists don’t see the Bank of Canada raising rates this year, and some actually see more rate cuts coming before any rate hike.
“The prospect is for a low interest rate environment for the foreseeable future,” the Fraser Institute study concludes.
Even Madani concedes we are in a new, lower-interest rate environment, and “when rates do begin to rise they should top out at lower levels than in past cycles.”
“Even so, those small increases will prove to be a challenge for households already facing affordability problems, with negative implications for household spending,” he writes.