Financial questions swirl as the curve flattens and recovery crests the horizon. Any prior vulnerabilities in the Canadian economy will be exacerbated by the national shutdown.

Two issues directly impacting many Canadians will be real estate values, with their volatile equity, and record levels of consumer debt. 

We’ll have a look at where we are, what got us here, and future considerations for our attitudes regarding consumer debt and housing.

The Numbers

There are plenty of factors at play, so we’ll just touch on the main ones.

Low interest rates, relative insulation from the 2008 crash, hot housing markets, and over leveraged consumer spending have been the major contributors to both increasing real estate costs and looming financial liabilities.

What does this mean for everyday people? Personal debt is at record highs“The average Canadian owes $1.70 for every dollar of income he or she earns per year, after taxes.”

Even on a global scale, few countries have a ratio this high.

The bottom line for financial liability when the economy is at a standstill and recovery is likely to take time?

If debtors aren’t paid they’ll flirt with insolvency, potentially spreading 2008-esque credit crunch ripples through the economy. If Canadians can’t pay their bills they’ll be forced to sell assets or default on loans, with foreclosures leading to higher interest rates and tighter loan qualifications, further depressing economic recovery.

The Bank of Canada’s (BOC) latest quantitative easing measures addressed these issues by supplying cash to the economy, and have been effective so far.

On the private industry side, mortgage loans make up 42% of Canadian banks’ overall lending. There may not be much love lost on banks as people struggle to pay their basic bills, but keep in mind what we mentioned above, that if a bank’s cash flow is restricted they will have to raise interest rates and be more picky about who they lend to. This would also affect businesses, who may need short term loans just to pay employees and keep the lights on.

And what about the housing sector?

A critical, national-level metric released late last year, is that the real estate market “represents a significant amount of total growth”.

In other words, most of our recent GDP growth is from something which does not represent a fundamental contribution of value to the economy. If housing cools, especially in over-heated markets, a big chunk of our national economic growth will disappear from balance sheets.

The market has been aided by record population growth, mostly immigration, another demand shock which will hit as world travel and movement freeze.

Last year, Toronto and Vancouver graced the top 7 cities around the world on UBS’ real estate bubble index.

Toronto is number two on that list. Vancouver is sixth.

We’ll look at both those markets — what they say about our spending, and how we might think about recovery.

Toronto and Vancouver

Although global house prices have slowed, and some Canadian cities like Calgary have experienced decreases in recent years, Toronto’s prices tripled between 2000 and 2017. On the other side of the country, Vancouver has also experienced explosive price increases, completely disconnected from local wage growth.

To cool both these markets, local governments introduced similar measures: foreign buyer’s tax, tighter mortgage rules, and cracking down on money laundering.

Many of these indicators point to real estate being treated as an investment tool over the practical need for people to have affordable housing. The fact there is low housing supply in locations desirable to newcomers is also a major factor.

Remember, these real estate transactions are the majority of Canada’s recent GDP growth.

From the government’s point of view, any GDP growth looks good, especially when global growth had slowed and murmurings of market correction were being whispered even before Covid-19. The only problem is, house value in and of itself does not produce anything — it’s a disingenuous play of smoke and mirrors.

For cities, higher property taxes equal more revenue. But the opposite, and one that has already caused major issues for Calgary’s finances, is a drop in value means less tax revenue for the same population. Budget shortfalls have to made up somewhere: either increased tax rates, cuts to services, or both.

So, although real estate does have the benefit of high returns (in the right markets), that valuation is based on the assumptions that continuing population growth will maintain housing demand, and outside speculation that property values themselves will continue to increase.

This is good news in an era of low interest rates, when real estate can be treated as a haven for wealth growth, but does not bode well for everyday Canadians wanting to live comfortably in population centres.

If we take a step back from all these details, how does the overall assessment look?

Some recent quotes from the BOC offer a very poignant summary.

It views mortgage debt as the “principal vulnerability for Canada and its financial system“.

The BOC governor is quoted as saying if a “nasty shock” came along, the following recession would be bigger and more prolonged than if the debt wasn’t there.

Suffice to say, the pandemic and subsequent lockdowns more than qualify as a “nasty shock”.

What's next?

At the very least, Canadians should expect to experience what Calgary recently has: barely stable prices and no major year-over-years gains in the short term due to depressed economic prospects.

If lockdown is sustained, with foreclosures and business closures sending ripples through the financial system, we should expect worse.

The single ray of light, though, is that low interest rates will be necessary for the duration of this pandemic; not only to preserve solvency, but to also make sure Canadians already feeling the pinch are not burdened with larger interest payments.

The question remains: how do we treat real estate and debt going forward?

We discussed new frameworks for Canadian economic perspectives in previous articles about personal spending and export diversification. Now we need to assess how we treat housing: do we introduce indirect price controls, or do we allow them to be treated as an investment commodity?

The government can pass legislation enforcing one view or the other, as we touched on earlier.

Additionally, many Canadians will be re-thinking basic finances, debt loads, and emergency funds. It is easy to spend at the limits of financial capabilities when times are good — no one could have foreseen a wholesale lockdown of our economy, virtually overnight. Recent events will certainly alter our feelings of security.

When the inevitable talks of housing and personal debt come up, maybe we’ll discuss the intangibles: like less stress of being over leveraged, working Canadians being able to afford reasonable housing wherever they live, and a sustainable, resilient economy less sensitive to commodity bubbles.

Maybe cities need to reconsider how much foreign ownership they allow, at the cost of affordable housing.

On the other hand, are Canadians willing to accept increased tax rates or service cuts in response to lower property assessments, and lose an instrument for wealth generation? 

The fundamental question for the future is how we balance high returns leveraged by low interest rates against what is sustainable and resilient.

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