59% of Canadians Live Paycheque-to-Paycheque; Implications of a Canadian Housing Bust; How Sound are Canadian Banks?

In today's Breakfast with Dave, Rosenberg notes "Most Canadians Still Living Like It's A Recession"

According to Statistics Canada, Canada’s recession was short-lived, beginning in Q3 2008 and ending a year later in Q3 2009. But why doesn’t it feel like that for nearly 60% of Canadians?

According to the Canadian Payroll Association, 59% of Canadians are living paycheque-to-paycheque and report they would be in trouble if their paycheques were delayed by a week. This is the same number of people that said they were stretched last year when this poll was conducted (and the economy was in a recession).

Risks to Canada's Economic Outlook

The OECD published an in-depth report on Canada. Before launching into the negative aspects of the report, it pays to stand back and appreciate that the world recognizes that Canada was able to weather the recession quite well due to “a sounder banking system, a less leveraged corporate sector and a relatively strong fiscal position”.

Despite these strong fundamentals, there are significant risks to Canada’s economic growth. Yesterday’s release of the National Balance Sheet accounts was case in point, showing that the household debt-to-GDP ratio is now at a record high of 94.2% and debt-to-personal disposable income is at 146% (about 20 percentage points HIGHER than the U.S.), which the OECD says “implies a growing vulnerability to any future adverse shocks to any future adverse shocks.”

As the OECD points out, most of the increase on household balance sheets has been through mortgage debt. They figure that “housing looks too overpriced on the basis of price-to-rent and price-to-income measures.” Our models suggest Canadian home prices are about 10-20% overvalued, which would pose another negative risk to the economy.

How Big is that Bubble?

10-20% overvalued is overly optimistic. Vancouver in particular could easily see a 40% haircut if not much more.

Like Australia, it is more difficult in Canada to "walk away". See Australian Lenders Learn Nothing from US Housing Bust: Mortgage House offer 105% Mortgages, Westpack offers 97% Mortgages for a discussion.

Question of Soundness

The so-called "soundness" of Canadian banks stems from the fact that Canada's central bank is on the hook guaranteeing the vast majority of residential mortgages.

That Canadian banks do not have a skin in the game allows housing bubbles to build over a longer time period and get bigger than they otherwise would.

Is that a good thing? For who? The banks or the taxpayers?

The answers should be obvious: The ultimate setup is similar to US taxpayers bankrolling Fannie and Freddie for unlimited losses. Alternatively the Canadian Central Bank could print money and paper over the losses.

Neither setup is any good.

No Escape from Illiquid Greater Fool's Games

The most important question is "when will it matter?" There are signs now of hugely growing inventories and that is how a housing bubble always bursts.

Nonetheless, it will not matter until it does. When it does matter, it will be sudden and irreversible (as is typical of every illiquid Greater Fool's Game or Ponzi scheme). There will be no escape for underwater sellers, just as happened in the US, with the further restriction that Canadian borrowers simply cannot walk away.

The economic implications are enormous with so many living paycheque-to-paycheque already.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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