Easy money men

Mark Carney and Jim Flaherty have been scolding us about debt. But are they to blame?

by Chris Sorensen

Easy money men

Carney (below) slashed interest rates and kept Canadians spending—but helped fuel debt—while Flaherty tightened mortgage rules | Chung Sung-Jun/Getty Images

When Mark Carney took over as governor of the Bank of Canada in early 2008, he had relatively little central banking experience under his belt. As fate would have it, the former Goldman Sachs managing director got plenty of opportunity to test his mettle later that year when the U.S. financial crisis erupted. He responded, perhaps predictably, by slashing already low interest rates until, by April 2009, they stood near zero. But he also took the unusual step of telling Canadians that rates would likely stay there until mid-2010.

It was a departure from the style of central banking popularized by former U.S. Federal Reserve chairman Alan Greenspan, who was once dubbed “maestro” for his seeming ability to orchestrate economic growth (critics would say “bubbles”) through the 1990s and early 2000s. Greenspan’s speeches and statements were often masterworks of ambiguity, forcing investors to parse their true meaning and lending the man behind them an Oz-like aura.

Carney’s straight-talking gambit worked. Canadians, reassured, took advantage of the rock-bottom borrowing costs and bought everything from big-screen TVs to new homes, with the housing market in particular helping prop up the economy. But a new problem has emerged: household balance sheets are now stretched to the limit, with Canadians’ debt to disposable income ratio sitting at 148 per cent, exceeding the U.S. level for the first time in 12 years and raising concerns about the country’s ability to withstand another economic shock.

And so Carney now finds himself wedged between a rock and a hard place: if he raises rates, he risks killing the recovery, but if he leaves them low, Canadians may be enticed to heap on even more debt—a risk that is already putting pressure on Finance Minister Jim Flaherty and Prime Minister Stephen Harper to demonstrate that Canada’s monetary policy isn’t about leading Canadian families to financial ruin. And, once again, Carney appears to be hoping he can use some blunt words to help head off another crisis.

In mid-December, he stood in front of a crowded room in a downtown Toronto hotel and gave a speech that began by outlining the fragility of the global economic recovery and ended by effectively lecturing Canadians about the perils of overextending themselves. “Cheap money is not a long-term growth strategy,” he said. “Households need to be prudent in their borrowing, recognizing that over the life of a mortgage, interest rates will often be much higher.”

That some Canadians are at risk of drowning in debt is likely obvious to anyone who has tried to buy a house in recent years. Prices have soared across the country, fuelled by bidding wars and a rush of first-time buyers armed with small down payments and big mortgages. It raises the question why Carney doesn’t simply throw a wet towel on the party, by resuming a program of gradual rate hikes that he initiated last year. “It’s like he’s brought out a fully spiked punch bowl and gave everyone in the room a cup, but told them not to have any,” says Douglas Porter, deputy chief economist at BMO Capital Markets.

While Porter doesn’t agree Canadians are in grave danger just yet—he argued in a recent report that household finances aren’t nearly as weak as they might first appear because the value of Canadians’ other assets, including stocks, life insurance and pensions, has also increased—he says Carney has little room to manoeuvre because low rates are still needed to maintain the bank’s two per cent inflation target and encourage growth in the corporate sector. “This is really the push and the pull the bank has been dealing with for the better part of the year, and will probably continue to be dealing with for 2011,” Porter says. He expects the bank will begin raising rates later this year. In the meantime, “the only tool they have is to jawbone us, to hector and cajole us.”

It’s not unlike the conundrum faced by Greenspan after the dot-com crash, when U.S. rates were dramatically cut and kept there for an extended period in a bid to ward off deflation fears. That decision, some now argue, set the stage for the disastrous 2008 crash by fuelling a housing bubble. But at least Greenspan and U.S. lawmakers had a measure of control over their own destiny. By contrast, Carney’s hand is increasingly being dealt by Washington, where the U.S. Federal Reserve is unlikely to raise rates for the foreseeable future as efforts continue to prime a sputtering U.S. economy. That means that raising rates in Canada would add more to the soaring loonie, which is already back at parity with the U.S. greenback. “The Canadian dilemma is made in Washington with the Fed’s policy of zero short-term interest rates plus QE2,” says Ronald McKinnon, professor emeritus of economics at Stanford University, referring to the Fed’s second attempt to juice the economy with a policy of quantitive easing—basically printing money.

A soaring Canadian dollar, in turn, would put further pressure on the battered manufacturing sector in Ontario and Quebec, as well as other export-dependent industries, leading to more job losses—precisely the sort of shock that Carney warns could tip some debt-heavy Canadian households over the edge. “Another 100 basis points [hike in rates] isn’t going to deter consumers, but it will put the Canadian dollar well over par,” says Peter Dungan, an economics professor at the University of Toronto’s Rotman School of Management. While Carney has reason to be confident that he can avoid fuelling a U.S.-style housing bubble because of Canada’s more conservative standards around mortgage lending, that will undoubtedly be of little comfort to those Canadians who find themselves in over their heads.

Carney’s not the only one trying to figure out how to save debt-ridden Canadians from themselves. He works closely with Flaherty, who has the power to rein in riskier mortgage lending activities through the country’s main insurer, the Canadian Mortgage and Housing Corporation. He’s done it once already. Last February, Flaherty introduced changes that included forcing buyers with government-backed mortgages to meet standards for five-year, fixed-rate mortgages even if they opt for variable rates. He also put stricter limits on refinancing and tightened rules around down payments. Flaherty has said that he is keeping a close eye on the current situation—“If necessary, we will tighten the mortgage rules again,” he said in December—but has so far suggested that further measures aren’t yet warranted. In fact, he has pointed the finger at the country’s big banks, saying they are the ones ultimately responsible for ensuring prudent lending practices.

But at least one top banker, TD Bank chief executive Ed Clark, has suggested banks are unlikely to voluntarily clamp down on their huge mortgage lending businesses for fear of losing customers to rivals.

It’s a lot of finger pointing. And at least one industry-watcher argues that’s likely by design since Ottawa is backed into a corner with few other options. Chris Ragan, an economics professor at McGill University and a former special adviser to the Bank of Canada, says even though Carney appears to be kicking the ball to Flaherty, who, in turn, is admonishing the banks, the reality is that both men are hoping their words will convince Canadians to get their financial houses in order before it’s too late. “These guys talk to each other a lot,” says Ragan, who also served as a visiting economist in the federal Finance Department. “I think we should view this as a co-operative effort.”

Will it work? “It is certainly a bit unusual, but it’s no bad thing,” says U of T’s Dungan of the warnings. “Of course, it’s not clear how much the relatively few people who need to pay attention to this actually will.” Indeed, unlike Greenspan, few people are hanging on Carney’s every word these days, or Flaherty’s for that matter. It just seems like a lot of empty talk—at least until it’s backed up by tangible consequences. But the strategy—to the extent that it can be called one—does accomplish one key objective in the meantime: it gives Ottawa political cover if some overzealous Canadian households are eventually pulled under by broken balance sheets. “The one thing you don’t want to happen,” Ragan says, “is to look back two years from now and say, ‘Gee, we should have warned people about this.’ ”

Easy money men

  1. I get a bit of a chuckle out of the concern of Carney and Flaherty for my debt levels. If someone lends me so much money that I am unlikely to ever repay it, isn't it the lender that is likely to get screwed in the deal. It is hard to imagine the average Canadian going through a detailed analysis of an upcoming financial shock in assessing their ability to take out a loan, but don't the banks hire exactly those sort of people. So according to my admittedly crude understanding of economics, the banks must have built in the anticipated costs of future forfeitures by increasing the margin between the bank of Canada rate and their own loans.

    On the other hand, I could be wrong and perhaps the banks all ignore good economic advice and hand out loans to whomever shows up at their door. If that is indeed true then Coyne should forget his meddling with road tolls. If simple economic theories fail for bank leading rates surely we should not risk applying them important like our transit system.

    • Good reply Mr Stewart Smith.

    • The problem lies in the fact that the bulk of new credit creation has been via mortgages, the vast majority of which have been underwritten by CMHC…..the taxpayer by extension.
      http://financialinsights.wordpress.com/2010/09/10

      However, the banks are waking up to the fact that when the inflated house prices that they've helped create begin to correct, what they have at stake is their unsecured debt exposure, which represents up to a $350 billion and is typically the first to be defaulted on.
      http://financialinsights.wordpress.com/2010/12/14

      Cheers

    • Reminds me of an old Int'l Political Economy "joke" from back in the IMF-Structural-Adjustment days that went something like 'If Brazil owes you $50Million, then Brazil has a problem; if Brazil owes you $50Billion, then YOU have a problem." (But now Brazil is kicking bums and taking names in the world economy and designing innovative solutions for fixing their social problems at home, so I guess it worked out okay for them in the end, eh?)

  2. First they want us to spend our way out of the recession; then they chastise us for racking up debt to do so. Meanwhile, Ottawa and many of the provinces are racking up their own debt levels and fail to see the hypocrisy in telling us not to do the same.

    Time to make up your minds, people – and then lead by example.

    • Yes and no…

      The Conservatives forced debt on to Provinces and Municipalities if they wanted to take part of the "Economic Action Plan". This is far more deceitful then Martin downloading costs to the provinces.

      Lead by example? You are joking right? The Harper gov't will only do what America tells them to do. Leadership is a foreign concept to the latest reincarnation of the Conservative Party.

      • Wishful thinking on my part…

    • No, no, no… we do *not* want the government to lead by example. Government needs to work counter=cyclically to balance out the public. I don't have a problem with how this gov't went into debt. I do have a problem with the crap they spent the money on, but going into debt wasn't the bad thing.

      A large portion of this problem stems from the government not being aggressive enough in controlling it's spending and raising tax revenues while times were good. This wasn't helped, of course, by the Conservatives moaning about how surpluses were bilking the taxpayer, but still.

      You see, government needs to act in the best long-term interests of the people, while the people act in their best short-term interest. So when the economy is booming, they need to slow it down so it doesn't go too fast (not that anybody would have stood for that), that way when the economy slows, they can devote the resources they've collected to speeding it back up again. Why do we need to do it this way? Because people are in general lousy in looking toward their long term interest over their short term interest. Hence why we need gov't in the first place.

      • While I also have a problem with where or how the government spends taxpayer money I question the assertion that the government is responsible for long term strategic planning considering they usually run on 4 year (if not shorter) mandates.

        If anything individuals should better planners than whatever party has the current reigns in Ottawa considering whatever financial choices they make today will invariably affect them throughout the entirety of their lives lives.

        • Yes, and poutine should be fat free. Unfortunately, life doesn't work that way. Does the banks calling for gov't to curtail 35 year mortgages mean nothing to you? Did the sub-prime mortgage crises not happen? Sure, people should spend more time planning out their own long term future. They don't. And because we're all inter-related, when they suffer, we all do — again, the sub-prime mortage fiasco should have taught us this.

          The people in government are specifically hired to spend their time looking at the broader and longer picture. They're supposed to be looking at the best information we have, aided by specialists and experts in each field, and using their time to gather all of this information and make judgement calls on what the best route for the country is.

          The people? We don't have that kind of access to high quality information, and even if we did, we don't have the time to process it as thoroughly because once we're finished earning a living, we still have to plan and implement things in the short term.

          Again, that's why we hire government. So that they can specialize in figuring out the bigger picture, while we all specialize in living our lives and being productive.

  3. So… there is no personal responsibility at all? It's all just someone else's fault if you're in debt?

    • Actually, in some ways that's literally true, After all, loan interest is simply made up debt.

      After all, if you were to lend somebody a hammer, would you expect a hammer and a half back? So why when we lend someone the price of a hammer do we expect more back?

      • sounds like something the founder of a major world religion might say.

  4. 'But at least one top banker, TD Bank chief executive Ed Clark, has suggested banks are unlikely to voluntarily clamp down on their huge mortgage lending businesses for fear of losing customers to rivals'

    My brother in law [ who's in banking] would probably endorse this opinion [ it's almost word for word his reply to my question: Why lend irresponsibily] It raises the worrying question: does the economy serve us or we it? It would appear competition does have its downsides? Which is kind of ironic since it seems a mindless desire to not be "left out" is part of what is driving the insane property market.
    I guess you could say markets are rational,but people aren't.

    • People are entirely rational — in the short-term.
      Unfortunately, capitalism is great at harnessing those short-term interests, but pretty lousy at rewarding longer term interests.

      The tragedy of the commons isn't that the sheep devastated the field. The tragedy of the commons was that it's assumed the answer is to remove the commons, not to make the shepherds see that they'd all be better off if they co-operated rather than competed.

  5. Rearranging the deck chairs, after you hear the horrendous crunch.

  6. Consumers have to consume in order to stimulate the economy, produce positive growth in GDP and prevent the scourge of deflation. This is exactly what central bankers around the world have done. As Mr. Charles Bean, Deputy Governor of the Bank of England says in this article, interest rates have been kept deliberately low to stimulate spending:



    http://viableopposition.blogspot.com/2010/09/quit

    Whether or not we stimulate the economy by taking on debt has been, up to this point in time, relatively unimportant to central banks around the world. Unfortunately, now that they've supplied us with too much of a good thing, they are recanting on their plans.

    • why would put Mr. Bean in charge of the money?!

  7. If we go out and buy a big screen TV with our credit card, whos economy are we supporting if it is made in China? Sure it will be taxed by provicial and federal governments but the pay cheques will be handed out to the Chinese people who made it in the first place. They have our jobs and we have their stuff.

    • You're missing some important facts; while the company may be Chinese, it isn't only the Chinese who benefit. The TV is bought in either a Canadian/American/European store. The store benefits, and many times the salesperson makes a commission on the goods they sell. We have the jobs that provide an outlet to sell Chinese products (stores), and it is us (Canadians) who benefit from the product being bought in Canada. While the people at the top of the TV corporation does rake in cash, the Chinese whom are making the product do so at $1 per day, if they're lucky. Would you rather work in an office/as a salesperson in a Western retail company, or work in a Chinese sweat factory? Believe me, we're not the one's being shafted.

      • The salesperson still has a job selling a Canadian, Japanese or Korean made TV. Kaspar is pointing out that manufacturing jobs have gone overseas, not retail. In fact, our economy is more dependent than ever on the "service sector".

        • Welcome to twenty years ago.

          It's a very well known fact that the service secotr is what drives our western economies.

        • But some of that "service sector" work is high-value stuff, that makes the whole system work more efficiently, like the people in logistics running the supply chain that getts the parts together from around the world for their assemblyin China (for now, this is still what "Made in China" means for many high-value products), and the people who insure the transportation, and… and… Another example to consider, Blackberries are "Made in China" because that's where the parts are assembled for final shipping, but everyone knows the product was conceived in Waterloo, and the components were designed (and in some cases still manufactured) in Korea, Japan, Singapour, etc.

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    • this is spam

    • What's funny is I can't tell if this is spam or somebody making a wry comment on the article.

      • and what does "god fearing" have to do with it, shouldn't you fear the repo man? (sounds like a BOC song…)

  9. Let's not forget that it was F who brought in 0 down 40 year mortgages creating a housing bubble with we taxpayers on the hook via CMHC should owners default on their mortgages. F then raised the rate to 5 and 35.

    See http://canadabubble.com/bubble-defined/bubble-jud

    I blame the lax lending policies of this govt and real estate pumpers who provide much of the MSM's advertising dollars.

    • Yes – and the CPC was considering other moves to deregulate and Americanize our banks until everything fell apart. The cynic in me laughs uproariously every time I hear Harper or Flaherty praise our banks and how they are a "model for the world", knowing that we'd have been as bad off as the Americans if the CPC had had enough time to follow through before the feces hit the fan…

      • Totally agree.

  10. In addition to Flaherty's – down 40 year mortgages, and the 5-35, I just can't imagine that 100%, or 75% of Canadians who will have receivee the full value of the home improvement tax credit spent their savings on these improvements. I'd bet a twenty, at least, hell I'd be willing to bet a hundred, that most put these on their line of credit or credit cards.

    By announcing ahead of time that the low interest rates would be with us for a few years Carney has at once discouraged savings and encouraged debt.

    • I disagree. The home improvement tax credit was an opportunity for anyone who was thinking about making any kind of improvement to do it and at the same time, obtain a tax savings. It even included landscaping so you could buy shrubs and perrenials. If people paid for the items using credit, that is their business. It is not the job of the government to babysit the citizens. This tax credit also stimulated the economy by providing work for construction trades.

    • We did take advantage, somewhat, but bought with cash. Unfortunately, bought most home reno fixtures, e.g. 3/6 litre toilets, etc. the year before so could not claim the majority. I'm one who does extensive research before I buy so it takes me a long time. Luckily, we managed to get under the wire for the Home Energy Program, which the cons cancelled as they don't believe in climate change.

      • actually, it was cancelled because it was too succesful and was costing too much. Meanwhile the ecoAuto rebates were cancelled because they were too ineffective and were costing too little.

  11. The more I learn, the more I understand that our economic system is a farce and the people in charge of it are nothing but snake oil salesmen out to bilk us.

    Here's a personal economic plan to follow:

    Only borrow for things you need, i.e. you might need a house, but you don't need a mansion; you might need a car, but you don't need a new one.

    Pay cash. Not overdraft-protected debit card and certainly not credit card. Cash. When you run out of money, quit buying things.

    When you want something, save up for it. Really want that cool old tractor? Don't have the money? Put a little away every week until you have the cash.

    When some alleged money professional encourages you to spend or borrow or both, keep in mind that he/she is a professional liar trained by other professional liars. If the alleged money professional is also a politician, run the other way as fast as you can.

    Now, if you'll excuse me, I have to go buy a rear blade for my tractor now. It's used and needs to be welded, and I'll be paying cash.

    • What you don't understand Reverend Blair is that too many people feel entitled to a mansion and not only a new car but a top of the line car and all the toys.

      • Its about competition for status – people want to be the "most successful", and many people judge success by the number of toys one has. Whether or not they can actually afford those toys is unobserved, so it doesn't fit into the calculation.

        Then there is the tyranny of FICO. People have this vague sense that our credit score is a good measure of our financial probity (and indeed the standard advice seems to be to get a credit card so you can develop a credit score). However, FICO doesn't really measure our prudence, rather it measures the expected profitability of lending to us. People that borrow often, pay off the minimum balance but don't default are great cash cows.

        As somebody who wants to own property some day, I am stuck in a dilemma. I don't want to have a credit card, but would probably need one in order to get a decent interest rate on a mortgage, unless I plan on paying for a house in cash (which, when you consider rent costs, etc., could cost more than the interest on even a short-term mortgage).

        Alternately, most young people genuinely can't pay for tuition. They are unlikely to be able to earn enough to pay tuition, both because the cost of going to school is so high, and because you need a degree for a lot of good jobs these days.

        Finally, most businesses through history have relied on credit for at least part of their existence (even selling stocks are a kind of borrowing).

        Credit is necessary for a lot of basic features of modern life, and to turn away from it entirely would be problematic. At the same time, the way we dole it out, and the effects it have are pernicious.

  12. Yeah finance Minister and Bank of Canada must be to blame for Canadian's high debt.

    The other alternative is people could actually take personal responsibility for their own irresponsibility. But that is unthinkable, right?

    • The converse to your argument is that if people are personally responsible for their own bad financial situation then Flaherty and Carney are blameless?

      Monetary policy, tax policy and housing policy provide the framework in which people are personally responsible for either acting prudently or imprudently. Personal responsibility and government responsibility are not mutually exclusive.

    • Did you even read the article?!

  13. Firstly, Carney has a limited scope of action when it comes to interest rates. Canadian interest rates cannot stray too far from American interest rates without a significant run-up of the dollar. Given that a Canadian recovery depends in part on exports to our largest trading partner, Carney can't exactly lead a crusade against Canadian personal debt.

    Secondly, I think a think the tension some of you are seeing (they told us to spend in the recession, and now they want us to get rid of debt) regards the difference between the short-term and the long-term. We live in a consumer driven economy in the short run. With a given level of productive capacity, the economy will do better when we spend more (ie. use more of the productive capacity we have). There may also be critical points where low spending triggers unemployment which triggers less spending (eg. in recessions).

    However, over the long term, it is the growth of our productive capacity (productivity growth) that really matters for our well-being. In that sense, it is important that we save. Our savings are invested (either directly by us, or indirectly by banks or other intermediaries) in the development of new technologies, the construction of new plants and all of the activities that drive our capacity to produce.

    Both of these tasks are important, yet they sometimes require us to do opposite things. Given the difficulties inherent in Carney's job, I'm inclined to give the guy a break.

  14. people will borrow too much until they raise interest rates from these artificial lows

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