Bank of Canada: Despite what you heard, it's not that bad

The Bank of Canada today released its semi-annual Financial System Review or FSR [PDF} In it, the Bank warned that if times get tough, people will lose their jobs and when people lose their jobs, they'll have a hard time making their mortgage payments. Of course, you probably didn't the Bank of Canada to figure that one out for you but that's what they “warned” today.

Now some news organizations took that warning today and ran with it, blaring headlines that might make one think that a wave of mortgage defaults was not only imminent but unavoidable. In fact, as the bank notes, just one of every 250 mortgages is in arrears in Canada right now (arrears is still a long way from default) and that's much better than the average since 1997.

In fact, the big news, it seems to me, from the Bank was its assessment that by-and-large Canadian households are holding up very nicely, thank you, in this economic storm. Now remember, this is an economic storm that our prime minister two weeks ago said was as dangerous as anything we've seen since 1929. And yet, the Bank says, right there in black-and-white, that, so far as the average Canadian household goes, “the overall situation remains relatively positive.” Now that's news!

The Bank also notes that the national debt-service ratio — the ratio that essentially measures our ability to pay — is near historical lows which means, to use the Bank's phrase, “households can comfortably manage their financial obligations.” Now the Bank doesn't say this directly but I'll be happy to make the leap: Canada's consumers have plenty of room to take on more debt by buying more stuff which would, on its own, help stimulate the economy. Plus we'd all end up with lots of neat new stuff.

In any event, while the Bank worries we're all going to hell in a handbasket — and many journalists took that to mean that we actually are going to hell in a handbasket — it's pretty clear that it is the Bank of Canada's considered opinion that the Canadian consumer is a long, long, way from booking that ride. I've bolded the key phrases that support that view in this passage, taken from pp. 21-22 of the today's FSR:

The June FSR noted that the financial position of the Canadian household sector remained sound. Developments since then suggest some deterioration, but the overall situation remains relatively positive.

Household credit has continued to increase at a strong pace recently (11 per cent year-over-year in September 2008). With the more moderate growth in disposable income, the debt-to-income ratio rose further in the second quarter of 2008 to 137 per cent. Still, household debt remains lower as a share of disposable income than is the case in the United States and the United Kingdom. Reflecting lower effective borrowing rates for households, the debt-service ratio (DSR) has edged lower from 8.0 per cent in the fourth quarter of 2007 to 7.5 per cent in the second quarter of 2008. This is below the historical average of 9.2 per cent, suggesting that, at the aggregate level, households can comfortably manage their financial obligations.

The debt-to-asset ratio rose to 17.8 per cent in the first half of 2008, its highest level since 1991. After increasing strongly over the preceding five years, household real net worth has remained roughly unchanged since the onset of the turmoil in financial markets and has likely declined in the second half of this year, following the sharp drops in global equity markets, together with declining Canadian house prices. In the near term, asset values are unlikely to provide much support to the financial situation of Canadian households.

Indicators of household financial stress also suggest some slight deterioration in the financial position of households in the first half of 2008. After having been stable at historically low levels for the past three and a half years, the proportion of mortgages in arrears rose to 0.26 per cent in the second quarter of 2008 but remains below the average level since 1997 of 0.38 per cent. Personal bankruptcies are also slightly higher than they were in 2007, although they remain well below the peak reached in the late 1990s.

Overall, despite a modest deterioration, the financial position of the Canadian household sector remains relatively positive. On the other hand, rising debt levels mean that more Canadian households are becoming vulnerable to negative economic shocks at a time when the economy is expected to slow, raising the risk that the incidence of financial stress among households may increase. This bears close monitoring, given the deteriorating economic outlook.