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Outlook 2018, Part 4: The eroding wealth and hideous finances of Canadian families
Michael Babad

This article was published more than 6 years ago. Some information may no longer be current.

Briefing highlights

  • How wealth is eroding
  • How the debt burden is growing
  • Rising costs to hit home
  • The potential impact of it all
  • Markets at a glance: Dow cracks 25,000
  • Brookfield to buy Westinghouse
  • Toronto home prices see tiny gain

Some of us no doubt woke up this morning wondering how we're going to achieve that New Year's resolution to get our houses in order.

Welcome to 2018, the year of living frugally for many of us.

Canadian families are facing heavier debt burdens, higher credit costs and eroding wealth. Because, you know, we didn't let a little thing like a financial crisis teach us that partying for 10 years might not be such a good thing.

This year could be a tough one for many of us as interest rates rise, new mortgage rules come into effect and we realize we should have paid attention when the Bank of Canada, the Bank for International Settlements, the Organization for Economic Co-operation and many others were waving their arms frantically.

"This rise in their debt-servicing costs will likely be a shock to many Canadians who have been enjoying relatively flat interest charges on their debt for the last eight years," warned Matthew Stewart, who heads up national forecasting at The Conference Board of Canada.

There promises to be a broader economic impact, as well, as consumers pull back.

Here's how things look for Canadian households a decade after the crisis:

Eroding wealth

It's not by much. Yet.

But notice that dip at the top right corner of this chart, which shows a fairly steady rise since the depths of the crisis.

Up until this point, we could tell ourselves that at least our wealth was rising along with our debts. No longer, it would seem, although there have been dips in this fever line before and much will be decided by whatever happens to home prices.

But "household net worth as a share of household income contracted for the second straight quarter, consistent with reported falling home values and shrinking housing equity," as David Madani pointed out, referring to the worrisome fever lines in that chart.

"The recent increases in interest rates and tougher mortgage rules [this] year will only make matters worse," said Mr. Madani, senior Canada economist at Capital Economics in Toronto.

Mr. Madani used a scenario of average home prices falling by 20 per cent. In his words, that's hypothetical, and goes beyond what many economists see happening. Indeed, Vancouver's housing market has already perked back up after the B.C. government slapped a tax on foreign buyers in the area, and economists believe Toronto may follow Vancouver's path. So the pace of price growth may simply slow rather than contract outright nationally.

Nonetheless, our net worth would erode by about $1-trillion were prices to fall by Mr. Madani's hypothetical 20 per cent, he calculated.

Governments and regulators have been struggling with how to tame housing markets, and ever-rising consumer debt, largely in the Vancouver area and southern Ontario. The latest mortgage rule changes from the commercial bank regulator, the Office for the Superintendent of Financial Services, are just coming into effect, so we'll see the impact in later data.

As the chart shows, net worth among Canadian households now stands at 860.7 per cent of our disposable income, having edged down again in the third quarter as property values eased in the first such move since the crisis.

That's a far cry from the 670.43 per cent of the third quarter of 2008, but note that this latest number came as household residential property values fell by $3-billion over the three months.

"Owners' equity in real estate fell four ticks to 74.4 per cent, but that's still above the historical average of the series (which starts in 1990)," added Benjamin Reitzes, Canadian rates and macro strategist at Bank of Montreal, referring to Statistics Canada's quarterly reports.

"This ratio has trended higher since 2011, but Q3's decline might be the end of that trend as the new OSFI rule further dampens the housing market."

Debt burden

This is the key number that has been raising eyebrows as Canadians shrugged their shoulders after the financial crisis and headed back to the bank to borrow more.

It's the ratio of household debt to disposable income, and it now tops 171 per cent as of the third quarter of last year, a level that's among the highest in the world.

"Perhaps what draws attention to Canadian household debt is not its level but its rapid expansion since the 1990s," economists at National Bank of Canada said in a new report, noting the marked run-up from 85 per cent 25 years ago.

It may have climbed higher in the fourth quarter, too, as economists wonder whether home buyers rushed to beat the new mortgage rules.

"However, that suggests we could see some flattening out of the ratio in 2018 - though don't bet on it as housing has been persistently resilient," said BMO's Mr. Reitzes.

Along with this comes the debt-service ratio, or how much we have to pay in principal and interest, also compared to disposable income. It's obviously going to rise along with interest rates as the Bank of Canada moves gradually this year.

This ratio rose in each of the first three quarters of 2017, but "remains in line with levels that have prevailed since 2010, so no sign of stress there yet," Mr. Reitzes said.

"Look for a continued creep higher as interest rates are likely to climb further in 2018, which is a reason for the BoC to tighten cautiously."

These are what underscore those New Year's resolutions.

The Bank of Canada is expected to raise its benchmark lending rate up to three times this year, from its current 1 per cent after the two hikes of 2017.

Some economists expect something less forceful, but the bottom line is that rates are going to rise further still. There are pressures from elsewhere, too, given that mortgage rates are linked to the bond market.

"Interest payments on debt will rise 12 per cent in 2018 and a further 9 per cent in 2019, the two largest gains since 2007," warned The Conference Board's Mr. Stewart.

Here's another calculation, from Royal Bank of Canada chief economist Craig Wright and senior economist Robert Hogue: "Our view is that the days of ultralow interest rates in Canada are over. We expect the Bank of Canada to build on the increases it made to its overnight rate in July and September by hiking it again three times in 2018 by a total of 75 basis points. And we expect longer-term rates to rise in tandem … Household income would need to climb by 8.5 per cent to fully cover the increase in home ownership costs arising from a 75-basis-point hike in mortgage rates."

While that highlights the "material vulnerability" among Canadian families, however, "the reality is bound to be less threatening as other factors such as income gains will mitigate part of the impact," said Mr. Wright and Mr. Hogue.

The impact

Canadians are lousy at keeping their debts in check …

… but we're pretty good at paying what we owe. Even when house prices correct, to use a gentle term.

"Canada has witnessed some big price corrections since the late 1980s that corresponded with big shifts in the macro environment, notably in Toronto and Vancouver, and yet each time mortgage arrears barely budged," noted Derek Holt, Bank of Nova Scotia's head of capital markets economics.

Still, "the worry is that Canadian households, which have a notoriously high and rising debt-to-income ratio, will not be able to afford higher debt payments," said economist Paul Matsiras of Moody's Analytics, a sister company to the rating agency.

"If income growth disappoints, debt loads may become unmanageable and trigger insolvencies."

Even if that weren't to happen, we still have to meet those rising costs. And so we'll pull back our spending elsewhere.

"True, strong employment gains in 2017 will be met with strong wage growth in 2018, supporting consumer pocket books," said Nick Exarhos of CIBC World Markets.

"But data through Q3 outlined that consumers now have a very slim savings buffer, and some of the strength in consumption was supported by a ramp-up in non-mortgage credit - something which will face the headwinds of a few more rate hikes from the Bank of Canada," he added.

"Don't expect the consumer to fall off a cliff, but the underlying dynamics for the sector won't live up to 2017's stunning results."

Here's how Mr. Madani of Capital Economics illustrated his point: The household savings rate tends to rise as net worth declines, so go back to his suggestion that a 20-per-cent drop in home prices would equate to an erosion in wealth of $1-trillion.

"That would be consistent with an increase in the saving rate from 2.6 per cent, where it was in the third quarter, to around 3.5 per cent," Mr. Madani said.

"Assuming no change in income, this amounts to a 1-per-cent shock to household consumption, or more than half a percentage point of GDP."

Canadian consumers have been a mainstay, accounting for about two-thirds of 2017's economic growth, noted RBC, so a pullback has obvious consequences.

Like Mr. Madani, RBC's Mark Chandler and Simin Deeley also noted the "normal response" of the savings rate falling, to that 2.6 per cent from 4.2 per cent over the course of a year, as wealth and asset prices rose. Notably, home prices.

But RBC forecasts that sales of existing homes in Canada will fall 4 per cent this year, with the gains in benchmark resale prices slowing to 2.2 per cent from 2017's 11.1 per cent.

With the labour market also projected to show gains at a slower pace, "the consumer is expected to contribute much less to overall growth - just 1.2 percentage points in 2018," said Mr. Chandler, head of Canadian rates strategy at RBC Dominion Securities, and rates strategist Mr. Deeley.

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