Yahoo Finance What is a housing bubble, and how could it cause the Canadian economy to fail?
There has been no shortage of warnings about the nation’s housing bubble and Canadians’ record-high levels of debt.
And the Bank of Canada continues to sound the alarm about the potential economic calamity that could occur should a spark strike this kindling.
In a video posted to YouTube, the central bank laid out the scenario in which the Canadian economy could tank. Its release was part of the Bank’s semi-annual financial system review, which came out last Thursday.
In the video, Joshua Slive, the BoC’s senior policy advisor, notes that people can cope with the aforementioned vulnerabilities of heavy household debt burdens and housing prices rising at an unsustainable rate for an extended period of time, but an economic shock like a severe recession could send the economy spiralling out of control.
And the conditions could be ripe for this possible scenario.
Statistics Canada data from earlier this month indicated that the ratio of household debt to disposable income rose to 166.9 per cent from 166.4 in the second quarter, which marked a new record.
While steps to cool Vancouver’s red-hot housing market have succeeded, many Canadian cities are still seeing record-high prices, including Toronto, Hamilton and Victoria. In fact, the Teranet-National Bank National Composite House Price Index rose 0.2 last month.
So should the economy go into a severe recession, a sharp increase in unemployment could mean that many Canadians could have trouble meeting their debt payments.
“Some households would likely default on loans,” said Slive in the video.
“This would affect loaners, such as banks and trust companies. When a default occurs, the lender tries to recover the value of the loan by foreclosing and selling the house.”
While homeowners are struggling, Slive said, other households would be forced to put off buying a property until the economy improves, potentially causing a “large drop” in prices.
And with less household wealth at their disposal, consumer spending could drop, which has become the main “engine of growth.”
Added stress on the financial sector would also cause the economy to take a hit, as small and large lenders would be forced to cut back on making new loans.
However, it wasn’t all talk of fire and brimstone from the BoC. Silve said there is a reason to be optimistic about the protections in place should such a scenario occur.
“The good news is that stress tests show that the big Canadian banks are able to handle even a large drop in house prices.
“Still the impact on the broad economy and on the financial system would be significant. “
