The Bankwatch

Tracking the consumer evolution of financial services

BMO relies on rising stock prices to cover over the risk inherent in increasing debt

I really have to call out BMO for irresponsible commentary in this report on Canadian debt.  Basically the report says that despite even faster increases in debt of Canadians, that increases in the stock market cover the increase so overall its ok. Does anyone at BMO really believe that]?

Family debt rising but financial health improving | BMO

“Balance sheet repair is quietly underway among Canadian households thanks to a slight rise in savings and firmer equity markets, while debt growth is poised to slow amid the clear cooling in the housing market,” the report said. “A singular focus on debt portrays an overly negative picture of Canadian household finances, which have proven incredibly resilient this cycle and likely still have enough cushion to provide a soft landing for spending in the year ahead.”

What are they talking about?

  1. Fast increased debt supported by historically low interest rates is an accident waiting to happen.  When rates rise as they inevitably will, it is household income sufficient to make the payments.  Bank of Canada does not think so.
  2. When rates rise, what will the stock market do?  It will fall because that’s how it works.  So the supposed asset value coverage will disappear.  A higher proportion will have insufficient income to service the debt, and by the way, the stock value that could be sold to pay it off has gone.
  3. The report looks at averages.  Are the people with debt the same people that have asset value increases in stock values?

Relevance to Bankwatch:

Banks are worried.  They are worried that their franchise is being eroded because in a deleveraging environment, people reduce both Bank assets and liabilities which means reduced income for banks.  I get that, and the need to source alternative products and revenue sources is the order of the day.

However to make statements such as “A singular focus on debt portrays an overly negative picture of Canadian household finances” is to turn a blind eye to the lessons of the lasts 1,000 years.  Debt bubbles always end badly and are never resolved by asset bubbles.  Everything comes back to income and ability to service debt.  That’s why I introduced this uncharacteristically negative post on my own alma mater.

Written by Colin Henderson

December 1, 2010 at 20:53

Posted in economy

2 Responses

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  1. Why is household Canadian debt rising in the first place? (Just low interest rates?) Does it matter what the cause is, or does it “always end badly” regardless?

    johnphilipgreen

    December 2, 2010 at 11:26

  2. jpg – it matters because the level of debt is increasing faster than the level of income. This implies the debt is only affordable at current interest rates. If rates go from earlier this year 2 – 3% up to say 10% which is quite probable in the next year or two, that is a five fold increase in interest costs for many. Bank of Canada estimates in that scenario up to 10% of Canadians will suffer some type of default.

    Colin Henderson

    December 2, 2010 at 14:19


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