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IMF warns Canada over perilous, longer-than-average credit boom

Briefing highlights

  • What lurks in 2017?
  • NAFTA negotiators meet again
  • Swedish court acquits Bombardier employee
  • Markets at a glance
  • Sears Canada at a glance
  • Rosenberg’s ‘unlucky 7s’

The IMF appears to be taking pains to warn Canada about a dangerous credit boom.

Indeed, Canada comes in for special mention in an IMF global financial stability report released today.

Canada is not alone as the body also cited a handful of other countries for high credit levels and "debt-servicing pressures."

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"In other economies where debt service ratios for the private non-financial sectors have risen to high levels - such as Australia, Brazil, Canada, China, and Korea - there is a particularly strong need for financial sector policy vigilance to guard against any further buildup of imbalances," the IMF said.

Such issues go hand in hand with rising property values, and those in Canada have spiked, largely in the Vancouver and Toronto areas.

Provincial and federal governments, along with regulators, have done just what the IMF suggests, taking action to tame overheated markets. But Vancouver has since rebounded, and Toronto is showing signs of following suit.

With debt levels so high, the Bank of Canada's two recent interest rate hikes were a warning shot on their own, as markets believe more increases will follow, heightening the vulnerability of overburdened consumers.

Indeed, Bank of Nova Scotia warned just last week that it expects average mortgage carrying costs for new home buyers will spike by about 8 per cent in 2018 and 4 per cent a year later.

The IMF compared Canada to both Australia and the United States, noting the stark differences.

"Although not all credit booms lead to recessions it is interesting to compare the credit booms in economies most likely to face payment pressures with past experience," the group said.

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"While the boom in Australia is similar to the average of past credit booms that did not lead to a financial crisis, the boom in Canada has been longer than the average of these benign booms, and the boom in China has been steeper than the average of past credit booms that did coincide with a financial crisis," it added.

There was no suggestion about what could happen, however, only comparisons and a history lesson.

"Experience has shown that a buildup in leverage associated with a run-up in house price valuations can develop to a point that they create strains in the non-financial sector that, in the event of a sharp fall in asset prices, can spill over to the economy."

In a special section, the IMF also noted the evolution of household debt levels in Canada and the U.S., which were similar until the financial crisis.

Between 1995 and early 2008, such levels rose to 100 per cent of gross domestic product from 56 per cent in the U.S., and to 80 per cent from 62 per cent in Canada.

"Afterward, U.S. household debt fell to below 80 per cent by early 2017, whereas in Canada, it continued to rise to more than 100 per cent," the IMF said.

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"This reflects different house price and unemployment trends, as well as difference in the evolution of net wealth, which left Canadian households relatively better off than their U.S. counterparts."

In Canada, it added, household debt "became more tilted toward" mortgage debt, which rose to 66 per cent of the total by last year. In the U.S., the share of mortgage debt fell while consumer credit rose markedly, largely because of rising student debt.

Not only that, the leverage among Americans stayed "broadly constant," but for the poor, among whom it rose marginally.

"In Canada, on the other hand, debt-to-income ratios increased across all income groups, resulting in an average ratio almost 50 per cent higher than in the United States," the IMF said.

"Moreover, highly indebted households (those with debt-to-income ratios above 350 per cent) held more than $400-billion (Canadian), or 21 per cent of the total household debt in Canada at the end of 2014, up from 13 per cent before the crisis."

And, as every Canadian knows, because they've been warned repeatedly by groups such as the IMF, the OECD, the Bank of Canada and the Bank for International Settlements, "high leverage may expose households to potentially adverse income shocks" that can ripple through an economy.

"The past recession in the United States showed that highly indebted households substantially reduced spending, which contributed to a significant decline in aggregate demand."

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NAFTA in spotlight

The North American free-trade agreement is back in the spotlight, with Prime Minister Justin Trudeau in Washington and hundreds of negotiators sitting down for Round 4.

This comes as President Donald Trump again threatens to pull out of the pact, as The Globe and Mail's Laura Stone and Adrian Morrow report.

"As the negotiations proceed, the issues covered are becoming more contentious (the less contentious issues have been quickly dealt with) and these talks will start to touch on difficult issues such as rules of origin and Trump's 'sunset clause,' which would see the whole NAFTA agreement re-examined every five years," said Adam Cole, Royal Bank of Canada's chief currency strategist in London.

"As the negotiations get more difficult, expect to hear more speculation of failure being a real possibility."

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Markets at a glance

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Sears Canada at a glance

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Unlucky 7s

David Rosenberg wonders what might lurk in the final quarter, given what he dubs the 'unlucky sevens' of the past.

Those would be the 1977 correction, the stock market crash of 1987, the Asian crisis of 1997, and, of course, the beginning of the meltdown in 2007.

"Well, we have three months left in the year before we see if the streak of years ending with 7 proves to be a disaster or not," said Mr. Rosenberg, chief economist at Gluskin Sheff + Associates.

"So far, the biggest correction we have endured was the grand total of 2.8 per cent, and daily and weekly swings have been amazingly small," he added in a recent report.

"Total calm."

Well, 1967 was the Summer of Love, not just for the kids in Golden Gate Park but also for the folks on Wall Street.

A 15-per-cent gain in stock prices may have been groovy, but many of us were listening to Sgt. Pepper or The Doors at the time, rather than following the fortunes of the Dow Jones industrial average, though Abbie Hoffman and his fellow protesters did shower the NYSE trading floor with dollar bills.

And that's where the love ended, paving the way for Mr. Rosenberg's unlucky sevens.

1977: Rapid-fire rate increases by the Federal Reserve sent stocks tumbling in what would be a correction to the tune of 16 per cent.

1987: The market crash of October: "But this wasn't apparent through most of the winter, spring and summer that year as the market was hitting fresh highs almost daily (and the movie Wall Street was released).

1997: The Asian crisis began, then "steamrolling" into the collapse of huge fund manager Long-Term Capital Management and then, in 1998, Russia's default.

2007: Still a little fresh in our minds? The housing and credit "bubble" popped, leading to what would become a full-scale global rout in 2008. At the time, "many pundits were fooled and thought all we would get was a 'soft landing' (mostly everyone was still drinking from the punch bowl leading up to the October peak).

As Mr. Rosenberg put it, "not that I'm superstitious, as much as that we still have three months to go!"

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