Canadians’ debt to income levels have soared since the economic crisis of 2008. But does that mean the Canadian economy is in deep trouble heading into the COVID-19 economic recession? Maybe not. Maclean’s Peter Shawn Taylor sits down with Adam & Matt to discuss Canadian debt loads, high real estate prices, a potential recession, and why you shouldn’t hit the panic button just yet. Turns out many analysts may have been running the numbers all wrong. This is one of two episodes launching this week. Join us later this week for another view on whether you need to cover your assets!
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Who is Peter Shawn Taylor?
Peter is a journalist, contributing editor at Maclean’s Magazine and Senior feature’s Editor at C2Cjournal. He also is a freelance writer for the Globe & Mail, the Toronto Star and other publications.
Do Canadians have too much household debt entering the Covid-19 pandemic?
Peter argues that many economic talking heads cite the debt to income ratio in Canada to make an alarming case that Canadians are currently far too indebted. But the debt to income level is only one measure and it has received far too much press. It is actually not a great indicator of overall financial risk and, Peter argues, we should not be overly concerned about.
Why is debt to income not a good measure for overall financial health?
The latest debt to income numbers say that Canadians have a $1.77 debt for every $1 of income. Many see this as too high and a sign of future economic disaster. Since the financial crisis in 2008, moreover, the numbers between Americans and Canadians have diverged greatly, with Americans being far less indebted using this metric. Time to sound the alarm Canada!
Statistics Canada recently undertook a study to investigate what this all means for Canada. Does it actually foretell grave financial problems? StatsCan used three categories to test whether high debt to income meant general financial strain using three tests. Have high debt to income folks missed a non-mortgage payment recently like, say, a credit card payment? Have high debt to income folks missed a mortgage payment? And have high debt to income folks accessed payday loan services in the last 3 years? StatsCan found that there was no connection at all between high debt to income levels and markers of financial strain.
Peter outlines how StatsCan then dug deeper in order to find a better measure to capture financial distress. The conclusion was that the debt to asset ratio is a much better guide than the debt to income ratio.
What is a debt to asset ratio? Why is a debt to asset ratio a better way to measure financial health than debt to income?
Instead of measuring debt in relation to annual income, the debt to asset ratio measures debts in relation to an individual’s assets.
Peter details how StatsCan found a much stronger correlation with is ratio: the higher one’s debts were in relation to assets tied closely with how often payments were missed or payday loans were accessed. In other words, it actually captured financial distress.
Conversely, the lower the debt in relation to assets meant the less frequent any of the financial stressors were used.
The good news is that the debt to asset ratio has been declining in Canada since the great recession.
Why does everyone cite debt to income instead of debt to asset in speaking about Canadian debt?
People are drawn to bad news! Spiking debt-to-ratio is arresting and the divergence from the USA is interesting. Peter thinks it is also easier to understand.
Also, before we saw the big run up in housing over the last decade, debt to income and debt to assets moved in tandem whereas now there is a large disconnect. The analytical tools have not changed, though, to match the new reality of high housing costs in many Canadian urban centres.
What does debt to asset ratio tell us about Vancouver real estate and Toronto real estate?
Real estate assets in Toronto and Vancouver are appreciating faster than incomes – somewhat dramatically so. And these markets are part of the reason why the debt to income ratio paints an overly negative picture that is out of line with reality. Many people in these markets have significant assets that allow them to take on debt outsized for their annual income.
Large assets such as real estate, in Peter’s view, actually provides some insulation or insurance for an economic downturn, like the one we are entering caused by Covid-19. Because assets like real estate can be used as collateral for loans, or you can rent out a property to generate income, an individual has more tools in their financial toolbox. A job loss on the other hand means lost income, full stop.
We often talk about generational wealth transfer on the podcast as well as gifting of large amounts of money that goes on in our market. There is a massive transfer of wealth taking place and this is entirely overlooked in debt to income ratios, especially in regard to younger millennials.
How will the Covid-19 crisis impact the economy? How will Canadians fare in the next six to twelve months?
These are unprecedented times. Peter points out we are witnessing both a demand shock and supply shock. People are not going out to restaurants and buying goods more generally but manufacturers, for instance, are also closing up shop. The best outcome may be a temporary freeze, in which we return to relatively normal activity afterwards. The graph would look like a V shaped correction in this case. If life becomes altered in a more fundamental way because of Covid-19, however, the outcome is any one’s guess at this point. The longer the “pause” the more challenging the return to normalcy.
One comparison Peter has been thinking about is to the Spanish influenza of 1918. It was a dramatic pandemic as well; and we know looking back that the roaring 20s saw great economic progress that started not long after.
Will Canadians do better than Americans during the Covid-19 recession?
That’s a tough one. Looking just at Canada, it is frustrating that the Federal Liberals have run significant deficits even when times have been good over the past years. Do we have all the bullets in our gun for this grim time? The US is in an even worse situation, from that perspective, but the world still looks to the US to invest and everything else so there is a lot of capacity there.
Find out more about Peter Shawn Taylor.