This latest bout of concern is being fuelled, among other things, by:
1) Record consumer debt
2) Mark Carney’s debt warning
3) Concern by TD & BMO’s CEOs over 35-year amortizations
It’s clear that debt-to-income ratios cannot be left unchecked forever. Eventually consumers will have to reign in credit or the government will do it for them. The repercussions are undeniable. Unabated debt can put Canada’s economy in peril. If macro shocks occur, high debt ratios mean people have less ability to weather income reductions or home price declines.
The nightmare scenario is runaway defaults. Defaults sparked by economic crises can create a “negative feedback loop” says Mark Carney. That occurs when desperate home sellers drive down prices and beget more desperate home sellers.
The good news is that Canada’s regulators are keenly aware of these risks. The Bank of Canada, default insurers and major lenders regularly collaborate on ways to control systemic risk. One important tool is “stress testing,” which involves creating “what-if” scenarios using dire economic assumptions.
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