The R-word

Yes, recession.

The household debt service ratio is just under 15%. That may sound manageable – the proportion of gross income dedicated to paying back debts – but it’s a zinger number. The highest ever, which is pretty staggering considering interest rates are near historic lows. Just imagine, for example, if mortgages averaged 8% as they did two decades ago.

So collectively Canadian families paid $202 billion in debt payments in the first quarter of 2019. That’s $670 million a month. About half was for mortgages, the rest for HELOCs, credit cards, cars and tat financing.

Creeping rates helped push the number up, but mostly it was because we can’t stop borrowing. Worse – for the first time in six years we’re spending more on the interest on debts than we are on paying those debts down.

Chew on that.

More money thrown out the window on interest means less available for important stuff like dog food and a new car. The economy takes a hit as billions a year are transferred from the paycheques of employees to the coffers of lenders.

Plus, following up on yesterday’s much-maligned high-income moisters with latent house lust, this news should make you wonder why owning is better than renting. In the absence of capital appreciation on residential real estate, how is spending $100 billion every 90 days on mortgage interest payments (collectively) better than throwing your money out the window on rent? Add in property taxes, strata fees, insurance payments, hot tubs, shrubs, utilities, repairs and kitchen renos and a shocking amount of after-tax income is sucked up by a house. No wonder the majority of people have stuff, but no money.

Last month we borrowed another $20 billion – thirteen of that for new mortgages. In total we now owe $2,230,000,000,000 (that’s trillions). That pile of dough is bigger than the country’s entire economy ($1.9 trillion). It dwarfs the amount of money spent by the federal government ($330 billion a year).

Most significantly, however, it will destroy a lot of people when the next recession arrives. Already the little hairs on the necks of people who bought into Vancouver real estate two or three years ago are bristling as property values fade and yet the debt remains constant. Just imagine if a 30% further decline hit here, as it did nation-wide in the US during that recession-fueled housing correction. (Actually the hottest real estate hoods there – Phoenix, Vegas, parts of Florida – ended up losing 70% of their value.)

Recession, you say? What recession?

Well, one is inevitable. It’s been a 10-year expansion and recovery so far since the abyss of 2009, and we’re due. The bond market has been rumbling about this for a few months, and now that we’re into a full-blown trade war between the world’s two biggest economies, the timing of the next slowdown is being advanced.

Tariff Man might correctly gamble that the US can power its way through a recession, and his political base will stick with him. Despite higher costs, more unemployment and leaner times, Trump supporters will probably support their guy because he’s sticking it to the Chinese. It’s Politics 101. Us vs Them. People will put up with a surprising amount of grief it they believe in vengeance.

But in Canada? Yikes. We need more China trade, not less. More importantly, our capacity to withstand a storm has been seriously compromised by our piggy attitude towards borrowing. We owe more than families in any other developed nation. Our savings rate is almost down to zero. We continue to buy houses that cost ten or twelve times what we earn and will require decades to pay off. Most TFSAs are filled with junk. Retirement accounts are shriveled. And the borrowing continues.

Yes it’s depressing. How can the next, inevitable, recession not result in lower house prices and higher family stress?

Therefore do not pursue a strategy which will put all or most of your net worth in one asset. Your house. Use the Rule of 90 as a guideline. (Ninety less your age should approximate the amount of total net worth that’s in real estate.)

Remember that in recessions, assets shed value as economies weaken and jobs are punted. It’s been so long since the last one (a decade) that many have forgotten. Prior to that, we fell into tough times in the mid-Eighties, then again in the early 1990s. The average dip lasts about 11 months, and governments try to shorten them by doing two things: (a) spending a ton more money to stimulate activity and (b) lowering interest rates to encourage borrowing.

Well, guess what.  We’re coming off ten years of recovery and the feds are already in deficit. The kitty is bare. And, second, the Bank of Canada benchmark rate is still at 1.75% – less than the inflation rate. The tool box is almost empty.

The good news?

There’s time for you to prepare. To get balanced, diversified, de-risked and de-leveraged. Tick tock.