Canadians' debt-to-income ratio is now higher than Americans' for the first time in a dozen years, leaving policy makers with a dilemma: Rein in spending and risk hampering the recovery, or do nothing and risk a cascading financial failure.
Measures that track Canadians' ability to repay loans have shown an increase into record territory. A sudden shock, such as a drop in house prices or higher interest rates, would leave some homeowners unable to make their payments and trigger personal and corporate bankruptcies. That has policy makers ratcheting up warnings about the too-high level of consumer debt and acknowledging that more might have to be done if the situation worsens.
The ratio of household debt-to-disposable income reached the highest on record in the third quarter, at 148.1 per cent, Statistics Canada said Monday, a 6.7 per cent rise in Canadian household obligations from a year ago. The ratio tops the 147.2-per-cent ratio in the United States and comes as incomes fell 1.5 per cent during the same three-month period.
The report underscores a red flag that policy makers such as Bank of Canada Governor Mark Carney have been raising for months - that some families are becoming increasingly vulnerable to the effects of potential job losses or other financial setbacks. Though interest rates aren't likely to rise until about mid-2011, policy makers are worried that too many Canadians won't be able to handle higher payments when they do. Further, the longer that rates stay low, the more abruptly they may need to rise to curb inflation when the economy improves.
At the same time, even as Mr. Carney frets about the growing debt - as he did again in a speech Monday to the Economic Club of Canada - he also warns that a pullback by consumers as they work to repair their personal balance sheets could impair the rebound and make things harder in the short term.
The central bank has raised interest rates three times since June, and the federal government has made it tougher for some borrowers to get mortgages. Those measures have had some effect, Mr. Carney said. "We've seen a bit of deceleration in the rate of growth of consumer debt, but it's still growing faster than income," he told reporters after his speech.
"The responsibility obviously starts with the individual, it extends to the financial institutions, and then we as policy makers need to ensure that a suite of policies are appropriate to ensure sustainable growth."
In February, Finance Minister Jim Flaherty announced measures requiring borrowers to qualify for a five-year fixed-rate mortgage even if they choose a lower-rate variable mortgage. Also, when refinancing, homeowners may now withdraw no more than 90 per cent of the value of the property, down from 95 per cent.
Those measures fell short of some bankers' recommendations for a significant reduction in the maximum amortization period of new mortgages, or a substantial increase in down payments.
The Globe and Mail reported Monday that Ottawa, in its pre-budget consultations, is in talks with Bay Street financial executives about possible further steps, but Mr. Flaherty said he sees no cause for extreme concern. If necessary, he told reporters outside Parliament, "We'll tighten up the mortgage rules more."
Acknowledging that the government is looking at the number of people who might not be able to afford to pay off their debts in the event of a sharp rise in unemployment, Mr. Flaherty said "it's a matter of concern but it's not a matter with respect to which we're going to act immediately."
"We continue to warn Canadian households that interest rates are unlikely to go down in the future," Prime Minister Stephen Harper said Monday. "They're far more likely to go up, so Canadians should plan accordingly."
Economists and analysts, meanwhile, echo Mr. Carney's warnings about the potential threats to the financial system. For instance, if too many borrowers default on their debts, banks could tighten lending standards for everyone else.
"It's an elastic band that's stretching and the question is, how far can you stretch it? We have no clue how far it can go," said Queen's University finance professor Louis Gagnon.
Much of the surge in debt stems from a flurry of home-buying triggered by record-low interest rates and the belief that values will continue to rise. But the Bank of Canada says the risk of a "negative shock" to property prices has grown.
In addition to mortgages, Canadians have been borrowing heavily on their personal lines of credit, with many of those loans secured against their homes. "We are levering more and more against the housing sector in Canada," Mr. Carney said Monday.
As well, Canadians increasingly have no buffer in their budgets, said Jeffrey Schwartz, executive director of Consolidated Credit Counseling Services of Canada. He said the volume of calls has risen about 15 per cent this year, led by growth among older Canadians who are supporting family members.
"Interest rates could rise, work hours could be cut, the labour market could soften - but it's almost like people need a crisis or shock … before they make any drastic changes."
Debt may be growing in Canada, but so is household net worth, which expanded 2.7 per cent in the third quarter as stock markets rose, the strongest quarterly growth in a year. The average household net worth is $178,600 per person, up from a year earlier but at its slowest pace since the recession.
As a result, not everyone is pushing the panic button.
"The singular focus on debt portrays an overly negative picture of Canadian household finances, which have proven incredibly resilient this cycle and likely still have enough cushion to provide a soft landing for spending in the year ahead," BMO said in a report Monday.
With reports from Bill Curry in Ottawa and Tara Perkins in Toronto