House of Cards

house_of_cards_lgBack in September it was reported that for the first time ever, the level of debt held by Canadians has exceeded the country’s gross domestic product as the red ink spilled over in the second quarter to 100.5 per cent of GDP, up from 98.7 per cent during the previous three-months. At the same time, Statistics Canada said the ratio of credit market debt to disposable household income climbed to 167.6 per cent between April and June, from 165.2 per cent in the first quarter of the year.  Total credit market debt was $1.97 trillion at the end of the second quarter 2016, while consumer credit alone, reached $585.8 billion and mortgage debt stood at $1.29 trillion.

Now, if that’s not enough to question Canadian’s insistence of continuing to skip through the current economic environment with rose colored glasses, this past week the Canada Mortgage and Housing Corporation (CMHC) released a report from its latest round of stress tests that a sudden increase in borrowing costs could lead to a 30 per cent drop in home prices, and even the failure of a Canadian financial institution.

The so-called “reverse stress test” scenario was based on a cumulative 240-basis point rise in rates over two quarters in 2016 and 2017. All over a measly 2.4% interest rate increase! If that’s not living on a knife edge we don’t know what is. Such a rise in interest rates would be far more devastating for the domestic housing market than oil at US$20 per barrel or an economic depression if you can believe it!

In the case of a high-magnitude earthquake, CMHC says home prices could dip 0.6 per cent and unemployment could peak at 8.4 per cent. Meanwhile, an oil price shock could lead to a 7.8 per cent drop in home prices and unemployment at 8.8 per cent. A deflation-induced depression could take home prices down 25 per cent and cause the unemployment rate to hit 13.5 per cent, according to the CMHC.

Naturally an individuals level of concern as to which one of these catastrophic events are the most probable; 2.4% interest rate increase, US$20 per barrel oil, economic depression or a high-magnitude earthquake will ultimately determine their “worry level” and will motivate them accordingly to prepare and protect themselves from the fallout.

Since the Trump presidential victory stateside less than two weeks ago, US 10 year treasury rates have risen 0.5% while the 30 year US fixed mortgage rate has also risen 0.5% to 4.00%.  One half-percent in only two weeks! But this is Canada right? This won’t have any type of impact on our rates. Not so fast, a big component that determines the strength of a countries currency is domestic interest rates. How long can Canada expect not to follow? The Loonie is currently worth 0.74 cents versus the US dollar. Canada standing pat on rates in order to maintain the house of cards may not do it. How would things be better for us with a dollar worth 0.60 or 0.50….sure our housing prices may be supported but what about the cost of everything else we import?

In response to the machinations above RBC announced on Nov 15, 2016 rate increases to current mortgage products of anywhere between .25% and .40% depending on mortgage type while the TD announced at the beginning of the month an increase to their prime lending rate of .15% to 2.85%

Craig Alexander, chief economist at the Conference Board of Canada was quoted as saying this past week, “For the next couple of years, interest rates are going to remain close to current levels. As a consequence Canadians can continue to finance their debt. Because there’s so much debt, the Bank of Canada can’t raise rates very quickly, or to very high levels.”  The vast majority of pundits and  prognosticators are singing from this same song sheet.  The degree of “confirmation bias” on the whole issue is running rampant!

It appears we’ve clearly painted ourselves into a corner. The contrarian in us is saying the surest bet at this point may very well be on an unexpected rise in interest rates as being the big ugly finger to topple our house of cards. That’s what makes big catastrophic events so big and catastrophic. The herd doesn’t see it coming. As debt collectors, we’re ready for it.