Household debt now rising faster than wealth

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The debt of Canadian households is now rising faster than their wealth in the wake of the stock market correction and a housing market slowdown, a major financial institution said Monday.

And with the slowdown in the economy, personal bankruptcies – especially in Ontario and Quebec – and mortgage arrears are starting to rise, CIBC World Markets said in its quarterly review of Canadian credit markets.

“The cumulative number of consumer bankruptcies rose by 3.8% during the year ending June 2008, with Ontario and Quebec leading the pack,” it said. “With the economy slowing, look for the number of bankruptcies to continue to rise.”

Ditto for mortgage arrears, which – while still at extremely low levels – have risen to 0.27% from a low of 0.24% last year.

Compared with a year earlier, the level of household borrowing remains impressive, CIBC said, but recent figures suggest the credit market in Canada is starting to reflect developments in the real economy, where growth has virtually stalled and where job losses have started to outweigh job gains.

The mortgage market is still expanding by 13.4%, the report said, although it will likely slow by more than half to no more than 6% due to the correction in the formerly overheated markets in western Canadian cities and the tightening up of federal mortgage lending restrictions.

There are also early signs that the pace of growth in non-mortgage consumer credit is slowing, it said, predicting that consumer credit growth will also slow from its current 10% year-over-year pace.

And that’s a good thing, said CIBC economist and author of the report Benjamin Tal.

“If household credit were to continue to rise by 13% a year at some point I would become concerned because you would have too much credit and not enough wealth to support it,” Tal said in an interview. “You don’t want a gap between the growth in credit and the growth in the economy with credit growing and the economy slowing.”

During the first quarter of the year, overall household debt rose by almost 3%, while personal disposable income rose by 2%, resulting in a further increase in the debt-two-income ratio, which climbed to 130% from 122% last year.

Some analysts have downplayed concern about steady increases in the debt-two-income ratio of Canadian households because their debt-to-asset ratio had been declining. But that key ratio is now rising as well.

In the first quarter of this year, household debt rose by about 3% while the value of household assets was hardly changed, the report said.

“With the recent correction in the stock market and a slowing housing market, Canadians are seeing their net wealth position shrinking,” it said, noting that debt is now rising faster than assets and has pushed the debt-to-asset ratio of Canadian households to a five-year high of 18%.

The good news, it said, is that when adjusted for inflation, the growth in credit during the current business cycle has not been as strong as in previous cycles and, as such, the slowdown in borrowing over the coming year will not need to be as dramatic as in previous cycles.

And the slowdown in household borrowing should bring the debt-to-asset and debt-to-income ratios back to what are more normal and sustainable levels, Tal said.

However, the report added that markets and policy-makers in North America are facing a major challenge with the economy slowing at the same time as inflation is rising.

The annual pace of Canadian economic growth has slowed to less than 1% this quarter while the U.S. economy likely contracted, even though U.S. inflation is running at a 17-year high of 5.6% and the Bank of Canada has warned that inflation here will top four per cent in the first quarter of next year.

As a result, the central banks have stopped cutting interest rates, it said.


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