When it comes to debt, unemployment is the big risk

Warning people about the dangers of rising interest rates has done precisely nothing to curb borrowing.

I know because I've tried. So have various people in the financial sector and in government, and we've all been largely ignored, if you judge by borrowing trends.

So let's take a different approach. In the view of some experts, indebted people have a lot more to fear from rising unemployment than they do from rising rates.

"The highest risk is unemployment," said Rick Lunny, a financial industry consultant who previously served as a top mortgage executive at Toronto-Dominion Bank. "The correlation of mortgage default and unemployment is unbelievable. The two lines are on top of each other."

The risk of rising rates has been highlighted since borrowing costs were pushed to record lows in the recession of a few years ago. Endless drama in the global financial system has kept rates low and made debt easily affordable. The status quo on rates seems to holding – just last week, BMO Economics said it was pushing back the date of the next rate increase by the Bank of Canada to fall of 2013 from summer.

"The reality is that in today's economy, an interest rate spike would almost be good news," BMO deputy chief economist Doug Porter said. "We'd probably be dealing with a bit of an economic boom in that environment."

Fortunately, the unemployment rate is not as reflective of the sluggish global economy as interest rates are. The jobless rate last month was 7.3 per cent, which compares to more than 10 per cent back when I started writing about business and economics 20 years ago. In the United States, the rate in August was 8.1 per cent.

Looking ahead, the worry is that the same factors depressing interest rates will further weaken the economy, possibly putting us into recession again, and causing the unemployment rate to rise. The firm Moody's Analytics raised this risk explicitly last week by telling The Canadian Press that the chances of new recession in this country are in the range of at least one in five.

Those estimates came out of a study by Moody's titled "Storm Clouds Gather Around Canadian Consumer Credit." It argues that the Canadian economy is vulnerable if global financial conditions deteriorate because of our high household debt levels. Not only would Canadians be unable to deliver the spending needed to sustain economic growth, but they'd be under pressure to keep paying their debts as job losses mounted.

BMO's Mr. Porter is a little less pessimistic about the chances of a recessionary relapse in Canada, but he's realistic about the external factors that affect us. "If the U.S. economy did go into a downturn, it would be extremely difficult for the Canadian economy to avoid it."

Forecasts from bank economists suggest the unemployment rate may improve slightly over the next year to the low 7-per-cent range. But that's an average number that may not reflect what's happening in the industry or sector where you work. If you have any concerns about losing your job, having your hours reduced or otherwise seeing your income drop, then you need to think about how you'd manage to keep up with your debts.

A survey by the Canadian Payroll Association indicates that 47 per cent of people would be in financial trouble if their pay was late by a week. That's down from 57 per cent a year earlier, a rather dramatic variance that suggests these numbers aren't rock solid in terms of telling us what's really going on. But they do still suggest there's a high level of anxiety about living paycheque to paycheque.

Rising interest rates will hurt you if debts are causing you to spend everything you make, but you'll likely suffer in silence. Mr. Lunny, the consultant and ex-banker, recalls the early 1980s, when five-year mortgage rates got close to 20 per cent. "What happened? Well, nothing. There was a small increase in delinquencies, but generally Canadians paid their mortgages."

With rising rates, you can reallocate to get by. You can shut down your contributions to registered retirement and education savings plans, sell a car, cancel a trip and stick to basics at the grocery store.

If you lose your job, measures like these won't help for long. You might have to draw down on a line of credit, or raid your RRSP. Along the way, your financial stress adds to the economy's troubles. "Ultimately," says BMO's Mr. Porter, "that is the real risk of households carrying such high debt levels."

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Outlook for Unemployment

Increasing job losses would be bad for people who are heavily indebted. In fact, some experts say a rising unemployment rate is a bigger risk than rising interest rates. Here's the unemployment rate (actual and projected):

Source: BMO Economics