The trap

When the cost of money tanks, debt swells. People devote more income to making payments. They save less, spend less and worry more. Liquid assets vanish. Children go shoeless. Dogs run free. Relationships crumble. But realtors and divorce lawyers are happy. Audi guys, too.

That may be a tad exaggerated. But you get the drift. People can’t resist low rates. They pig out and buy assets (houses) they couldn’t otherwise afford. Demand increases prices. So families must borrow more. Cheap money begets high prices. If those assets ever fall, the debt remains. It’s a helluva gamble.

That’s the theory. Here’s the reality.

This week the eggheads at Scotia Economics demonstrated clearly what’s happening. After (a) the price of a mortgage dropped, (b) the stress test rate declined and (c) the federal shared-equity moister-trap T2 program clicked in, borrowing bloated again. Look at this…

As mortgage rates & stress test go down..

...mortgage borrowing again goes nuts.

It’s stark. Mortgage debt is about $1.6 trillion now, approaching the size of the entire economy. Worse, it’s increasing. Fast. The year/year jump in debt is twice the inflation rate. The month/month pop in family indebtedness is more than 5%. Yikes. Growth is accelerating – far above last year’s level. It reverses a trend firmly in place since the market peaked back in 2016 amid a flurry of government actions.

Say the bankers: “The expansion in total household credit was boosted by easier borrowing conditions, which led to a strong acceleration in both residential mortgage and consumer credit growth. Despite an all-time high household debt-service ratio and a near-record ratio of debt to personal disposable incomes, Canadians are still responding to lower market interest rates and strong labour markets by borrowing more.”

Are people this dumb? To load up on even more debt when the economy is slowing, real estate is still priced for perfection, the savings rate has crashed and wages have hardly paced inflation?

Yes, baby!

All it took, apparently, was for the stress test rate to inch down from 5.34% to 5.19% in August. That accompanied a general easing in mortgage rates, so a fiver is now available everywhere for less than 3%. Plus we had the feds boost RRSP withdrawals for downpayments by a whopping 40%, then implement a plan to have the government pay part of new buyers’ mortgages. And, Bam!, up she went.

In August residential credit blew past expectations for the biggest jump in two years. And it will get worse, we’re told, since the Bank of Canada is too chicken to raise rates and curtail the lemmings’ borrowing. “With the BoC looking to insure against a Trump-imposed slowdown, residential mortgage credit growth is expected to remain robust as the popular five-year rate returns to the same level as five years ago.”

Now, as you know, there’s even more gas being thrown on the fire as federal political leaders desperately try to win Millennial support with more housing giveaways and debt inducements. Trudeau’s goosed the shared-equity plan to cover houses worth up to $800,000 in the Bubble Cities, guaranteeing they remain that way. Scheer would gut the stress test, make mortgages easier to get and bring back 30-year amortizations – ensuring a rise in demand and prices. Both Libs and Cons would give or loan a few more billion to homeowners to install energy-efficient hot tubs and environmentally-sensitive towel warmers.

As a result, markets are moving back into nosebleed territory. Sales and increased along with mortgage borrowing. Prices in the GTA have regained 2017 levels. Vancouver is still 8% below its peak, when was insane. After October 21st we know that whomever forms government will be catering once again to the nesting instincts of people without remorse or fear of borrowing like a Third World nation.

And what next?

With more than $2 trillion in family debt can the central bank easily move interest rates higher? How about financing the $20-$30 billion a year in federal deficits that are coming? If Trump blows up and the American economy has a recession – even mild and short (like me) – then our bankers will want to stimulate, taking loan rates lower. Surely that will deepen the pile of loan muck. How do folks think they’ll ever climb out?

They don’t. The Mills don’t sweat loan principals. They focus on payments. In their world mortgages have never topped 3% with houses always beyond reach. You can’t blame them for being Faustus.

You can only warn.