Canada’s Housing Debt Crisis

Arrow Capital’s McGovern warns on HELOCs, debt and house prices.

February 28, 2012

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story_images_for_saleArrow Capital Management’s Jim McGovern has weighed in on Canada’s consumer debt crisis in his latest blog post. He’s reacting to a piece of Lombard Street Research his firm received called “Behind Canada’s Facade” – the research looks at Canada’s too-good-to-be-true economic performance both during and after the 2008 credit crisis.

McGovern joins the growing ranks of doubters who think that Canada’s headed for a fall as consumers loaded with debt tip us off the cliff.

In his post, McGovern examines the starring role Home Equity Lines of Credit have played in putting consumers further into debt and inflating housing prices. HELOCs have been a key factor in ramping up levels of household debt and now reports show Canadians are at the upper limit of what they can carry. Even scarier: a big portion of the debt that’s been issued is among people over 45 – not a good statistic demographically speaking.

As more and more consumers tap their homes for loans in order to consume (40% of HELOCs were used for consumption, fyi), McGovern notes that it’s a “virtuous cycle of rising debt, leading to more HELOCs, etc., etc., has kept things above water. “

And there stands the façade so many economists around the world are pointing to in greater numbers. McGovern throws in a sobering chart from the Bank of Canada that shows how closely HELOCs and home prices have been correlated from 2000 onwards. click image to enlarge


So are we headed for a US-style crisis? Possibly not – but taxpayers are on the hook if the bubble finally bursts because of the role the CMHC has played in all this. Taxpayers, note McGovern, should certainly worry about the role of the CMHC given the fact that it has $500+billion of “in force” insurance with only $11 billion of equity (Q3/2011).

“I suspect Canadians are unaware that they indirectly support a subsidized housing policy in Canada, especially since 1999,” says McGovern.  “To date, over 90% of all mortgages are guaranteed by the CMHC.  One of the direct consequences of the CMHC’s activity has been to inflate the rate of home ownership (versus renting).  While this has positively impacted economic growth, it has also introduced risks, similar to those in the U.S. prior to its housing bust.”

“Today, the ratio of home prices to household income is approximately 5x – versus an average of 3.5x.  That is simply too high, as many people are forced to stretch for home ownership.  As they say, nothing cures high prices like high prices.”

McGovern says that while some pundits are calling for a mild correction, history would suggest Canada is highly vulnerable to a worst-case scenario, especially given the potential for shocks to Canada’s economy due to higher oil prices etc.

So are we headed for a hard landing? McGovern doesn’t really make a firm conclusion, noting instead that what happens depends on whether our economy can continue to perform well. That says McGovern is the subject of another blog post….

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The problem isn't so much debt, as what people do with that debt. If you borrow money on your house for a big screen TV, then you can expect to lose your house. If you borrow money on your house to buy something that generates revenue, then you are probably better off. As for CMHC, this article was written nearly a year ago...

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