U.S. interest rate hike is tough medicine for indebted Canada

America has had its housing market correction, Neil Macdonald writes. Canada's is yet to come and may well be hastened by today's interest rate hike by the U.S. Federal Reserve.

America has had its housing market 'correction,' ours is yet to come

Federal Reserve Chair Janet Yellen at the Economics Club of Washington earlier this month. She raised the Fed's main interest rate by a quarter of a percentage point today — the first increase in more than nine years. (Susan Walsh/Associated Press)

Let's look at the unfortunate facts for a moment.

The U.S. Federal Reserve raised interest rates slightly today, because it believes an American recovery is well underway. The U.S. economy is now at what economists would call full employment — about five per cent.

Good for them. An American recovery cannot be anything but good for Canada.

And yet.

The Canadian economy is weak enough that Bank of Canada governor Stephen Poloz is now actually talking about the possibility of going the other way, all the way to negative rates, which means you'd be better off stuffing cash into a mattress.

That would penalize savers and push people to take risks in search of return. (It also means an even lower Canadian dollar; what a difference a few years make.)

The unemployment rate here is now 7.1 per cent.

Americans, having been terrified out of their wastrel-grasshopper lifestyle back in 2008, when it looked as though their financial world was coming to an end, have been trimming back debt and actually saving.

As a result, American household finances haven't been in this good shape for many years.

But Canadians, addicted to the cocaine of nearly free money, keep setting records for household debt. The average Canadian household now owes $1.64 for every dollar of income.

Canadian debt, to put it plainly, is increasing a lot faster than Canadian incomes.

The young and indebted

In recent days, business writers have been reporting the findings of economist Sebastien Lavoie at the Laurentian Bank, who set the number of "fragile" Canadian homeowners at 12 per cent.

What that means is that 12 per cent of households have a debt that is at least 250 per cent of their annual household income. Those highly indebted households carry about 40 per cent of overall household debt.

But Lavoie acknowledges that the situation is actually worse than that.

New Bank of Canada figures suggest that the number of Canadian households with a debt-to-income ratio of 350 per cent reached 7.9 per cent in 2014, up from 4.1 per cent in 2007.

That level of debt — 350 per cent of your income — is just scary.

Those households now hold 21 per cent of all household debt, and if they collapse under the weight of higher interest rates they will come crashing down on everyone. 

The 'greater fool'

Acting on this, Finance Minister Bill Morneau last week implemented another set of rules designed to reduce irresponsible borrowing.

The question, though, is have Canadians taken on too much irresponsible debt already?

The basic difference between Canadians and Americans is that Americans have gone through a correction in their all-important housing market, and we haven't.

Finance Minister Bill Morneau moved last week to cool the housing market by forcing those who want to buy expensive homes to have a bigger downpayment if they want insurance. (Chris Wattie/Reuters)

Morneau, being a politician, strictly avoids talking about a real estate bubble in Canadian cities.

To name it a bubble, after all, can make it real in the public mind, which in turn can burst it.

The U.S. housing market shed trillions in value after the crash in 2008 — up to 60 per cent in some cities — before coming back to more realistic levels, Canada sailed on, congratulating itself, while its housing prices just kept rising.

As a result, "There is way more risk in the Canadian economy than most people understand," says Garth Turner, a former MP and housing expert who writes the wryly-titled blog The Greater Fool. "And most of that risk is in housing."

"The greater fool" is a maxim in the housing industry; it is the assumption that even if the price you pay for your home is foolish, a greater fool will some day pay more.

Americans followed that guideline from the Second World War onward, and it worked just fine, until suddenly, in 2008, it didn't.

Turner, it might be noted, is a Cassandra. He's been warning of undue risk, especially in cities like Vancouver and Toronto, for years.

"A generation of people have bought houses they cannot afford," he says. He doesn't like to talk about or define bubbles, but he uses language no finance minister would use: "People should just use their goddamn common sense."

Well. That's a wonderful idea, but common sense is almost always overcome by greed, until it crashes on the rocks of panic.

Pushing on a string

In Vancouver and Toronto, there have been double-digit increases, year over year, for many years, and people have made ever more reckless bets, egged on by the real estate industry.

When I lived in the U.S., my "holy shit" moment came in 2007 when I met a short-order cook, making not much more than minimum wage, who owned two large homes, and was planning to buy a third.

Other more educated American observers had reached that moment of clarity much earlier, but were shouted down by irrationally exuberant stakeholders and government officials. Including the financial geniuses at the Fed.

And then came 2008, and the great collapse, and the great recession.

Christopher Ragan, an economist at McGill University in Montreal, is chary about pronouncing a housing bubble in Canada's hot markets.

Still, he says, "it can be a nothing little event that starts the fall." And that "the panic on the downside is a much more powerful force than the optimism that builds the market."

Everyone, though, seems to agree on this: Canada's economy is more fragile than America's right now, even as house prices roar on in some Canadian cities.

As for Poloz's signals that he may lower interest rates here further, Ragan is hardly the only expert who thinks that course is a fool's cure: "Pushing on a string," is how he characterizes it.

Making money even cheaper in Canada will just encourage an already heavily indebted population to borrow more money, and there's plenty of cheap money as it is.

Having lived in the U.S. during the meltdown, I've seen a version of this movie. I'm not anxious to buy a ticket to the re-release.


Neil Macdonald is a former foreign correspondent and columnist for CBC News who has also worked in newspapers. He speaks English and French fluently, as well as some Arabic.