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The young and the heavily indebted

With household debt on the rise, should the government really be encouraging more borrowing? The Harper Conservatives seem to think so. They’re wrong.


 
Mark Blinch/Reuters

Mark Blinch/Reuters

Judging from the political rhetoric of the past two months, you might think young families have never had a better friend than Stephen Harper. During a campaign stop at a construction site in Vaughan, Ont., two weeks back, the Prime Minister promised that a re-elected Conservative government would help more than 700,000 “young families” buy their own homes over the next five years. Earlier, he’d vowed that “young families” would benefit from new rules allowing them to withdraw more money from their RRSPs to make down payments. His government would also conduct a count of foreign real estate buyers to ensure they weren’t squeezing “young families” out of the market. And the Tories have promised a permanent renovation tax credit to help “young homeowners” fix up their digs.

But if young families like what they’ve been hearing, there’s a demographic that is even more receptive: those at the other end of the wealth and age spectrum, a.k.a. Harper’s base. Coded into all those promises about promoting greater home ownership is a dedication to maintaining Canada’s frothy housing market, which is vital for those Baby Boomers counting on the future sales of their homes to finance their golden years. Harper’s implicit message to that group: I’m the one who has your back.

This is not a diabolical scheme to lie to one group while favouring another. Harper firmly believes there is no better path to financial independence than owning a home. He’s far from alone in that. But there are inherent dangers when it becomes the official policy of the state to get more people into the housing market. For one, that exact mantra was spelled out exactly 20 years ago by U.S. president Bill Clinton in his National Homeownership Strategy, which set a specific target for home ownership in the country and deployed the full force of U.S. government agencies to meet it. We know how that turned out. Lending standards were lowered, and a sprawling subprime-mortgage industry rose up to help low-income Americans buy homes they couldn’t afford.

Canada is different, in some ways. We don’t have a subprime market the way it was understood in the U.S. Moreover, over the past three years, several moves have been taken through the Canada Mortgage and Housing Corp., which insures traditional lenders against losses, to tighten mortgage rules. But as the big banks have pulled back, a growing and thriving shadow lending industry has rushed in to meet demand from hopeful borrowers who would otherwise be out of luck. Yet, because the availability of data in this country is so poor, no one really has a grasp of how large, or how precarious, that sector really is.

What we do know is that after a brief pause, household debt in Canada has begun to soar again. That could have serious repercussions for the economy, according to a new working paper by a trio of American economists.

The researchers, from Princeton and the University of Chicago, examined the relationship between household debt-to-gross domestic product (GDP) across 30 (mostly advanced) countries between 1960 and 2012. What they found was that an increase in the household debt-to-GDP ratio is a solid predictor of slowing economic growth to come. Soaring debt loads are typically accompanied by booms in consumption that put downward pressure on a country’s trade balance (it imports more than it exports).

When the household debt boom ends, investment and consumption go into decline. A country’s exports are then likely to rise again to cushion the impact, however that only works when the rest of the global economy is healthy. (Interestingly, the researchers were able to go back using their data from before 2000 and accurately predict the scale and intensity of the Great Recession to come.) Given that Canada’s household debt levels are rising, accompanied by a consumption boom and swelling trade deficits, it raises the question of whether our growth could be set to slow even more than it has.

With young families struggling to get into an overpriced housing market, should the answer really be, then, for government to encourage them to take on even more debt? The fact is, the most direct way for homes to become more affordable would be for prices to drop. But since no government wants that, Harper is instead proposing to deploy Ottawa’s regulatory and tax muscle to keep the housing market afloat—and spur a massive generational wealth transfer from young families to old, from real estate have-nots to equity-enriched haves.

Now, would a real friend do that?


 

The young and the heavily indebted

  1. This is an incredibly simplistic regurgitation of American based research which may, or may not, have applicability to an accurate assessment of the severity of household debt in Canada. For well over 5 years now, Canada has been a target of hedge funds seeking to justify shorting the Canadian dollar, largely because of the economic strength demonstrated heading into the global financial meltdown. So called authoritative, but often highly unbalanced research is “commissioned” to encourage quick buck investor participation in such schemes. The Harper government has done much that has impaired GDP growth, including tightening of 3rd party mortgage insurance rules. But the reasons for the level of personal indebtedness as against GDP have very little relationship with borrowing by average Canadians. Real Estate prices have skyrocketed over the past several years in the 3 largest markets in Canada. Many of the new buyers will not have conventional mortgages, but will have taken out equity secured lines of credit for as much as 60% of market value. Even under these circumstances, such lending is light years away from the obscene sub-prime mortgages with which global investors were afflicted that contributed to the mass explosion of real estate prices en mass in America and in European countries. Furthermore, the level of these facilities are often 3 or 4 times the amount most Canadians could come close to affording, resulting in a serious skewing of the amounts used in the ratios. While the Harper government does have much to answer for, devising a complex plan for the intergenerational saddling of real estate from one generation is highly doubtful. What the tightening has done is make it substantially more difficult for younger Canadians in the middle and early stages of their earning years to even contemplate entering the real estate markets.

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