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Jim Flaherty mortgage intervention and Canadian debt

March 21,2013

Interesting news lately was Jim Flaherty's second incident of mortgage intervention.

Interesting news lately was Jim Flaherty's second incident of mortgage intervention. This latest incident was discussed in "Jim Flaherty mortgage intervention ripped by small business minister"

"Small Business Minister Maxime Bernier says he believes the finance minister overstepped his bounds by having his office phone Manulife Financial and ask they withdraw their discount on five-year mortgages to 2.89 per cent from 3.09."

Maxime Bernier is right and the problem is Jim Flaherty is trying to have his cake and eat it too.

The Bank of Canada will not raise prime rates because there is too much debt in the Canadian economy. If the Bank of Canada increases interest rates, a lot of Canadian households will struggle with the increase cost in servicing that debt - this will both cause a drag on the economy and result in defaults.

Consider the first paragraph in the article: "Canadian debt at record highs, but soft landing in sight: analysts" which is "Canadian households continue to get into deeper debt, but the most recent data also offers a bit of a respite ” credit accumulation is slowing and there's evidence the Bank of Canada is correct in saying the problem appears to be stabilizing."

When interest rates decrease, you can borrow (service) more debt with the same interest cost. So if Jim Flaherty doesn't intervene and interest rates are allowed to go lower, there is a chance that Canadian household debt will increase. If this happens, suddenly the Bank of Canada is wrong, Canadian household debt isn't stabilizing, it will get worse.

Jim Flaherty is left with trying to juggle keeping the Bank of Canada prime rate low to keep existing debt manageable for Canadian households (to give them time to pay it down) but at the same time he can't let interest rates go lower or Canadians households might increase their debt burden instead of paying it down.

Further into the article is this: "A Statistics Canada report Friday calculates the average household owed a record $164.97 in market debt for every $100 of disposable, after-tax income they earned in the fourth quarter of 2012 ” slightly more than the previous high of $164.7 in the prior three months. That is only a few percentage points shy of where U.S. household debt levels reached before the country's real estate market collapsed, and was a key reason why Finance Minister Jim Flaherty tightened mortgage rules last July."

Now consider that last statement with the article "No crash in store for Canadian housing market: Scotiabank" and the statement "While Canadian home sales may continue to slump, the report said, prices will likely remain above year-ago levels until at least the second half of 2013, and will not drop as dramatically as they did in the United States."

Everyone sees the similarities with what happened in the US but no one wants to consider that it could (or will) happen here in Canada. Either way:

1) Pay down your debt (especially high interest rate credit cards)

2) Have cash savings available equal to three month earnings

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