Why Are Consumer Insolvencies Increasing Among Responsible Canadians?
I am what is called a Licensed Insolvency Trustee. People come to me when they need help with debt relief, in particular Canadian consumer insolvencies proceedings under the Bankruptcy and Insolvency Act.
If they have little in assets or income, they’ll usually file for personal bankruptcy. If they have significant assets or income, they’ll usually settle with their creditors by a legal proceeding called a consumer proposal.
Regardless of the proceeding chosen, a debtor is required to undergo something called Insolvency Counselling.
So what is it?
In colloquial terms, Insolvency Counselling is when the LIT sits down with a debtor and examines where she screwed up and teaches her how to adopt better spending and budgeting habits. The objective is to ensure that she learns something from the LIT and doesn’t repeat the same mistakes she previously made.
While some of the debtors I’ve worked with made genuine financial mistakes due to a lack of financial education, many more already knew how to budget and adopt good spending habits before they met me. They obtained this widely available information from online discussion forums like Personal Finance Canada on Reddit or the numerous Canadian personal finance blogs and podcasts. Yet they somehow still ended up at my office broke and in debt.
How can this be?
A Brief History Of How Canadians Became Debt Slaves
How did we get to this point? Let’s rewind back to March 2000 with the bursting of the first Dot.com bubble in the United States.
Alan Greenspan, the Chairman of the U.S. Federal Reserve at that time, cut interest rates after the bursting of the Dot-com bubble took down the stock market and threatened the global economy. He cut interest rates yet again after the 9/11 attacks due to a perceived threat to the American economy. If I recall correctly, the Fed rate was cut from 3.5% to about 1% in the span of 18 months.
Because Americans (and Canadians) lost so much money in the stock market, housing became the favored asset class, because unlike stocks, real estate was something physical which you could touch.
Cheap money and financial deregulation (thanks to the Clinton administration’s repeal of the Glass-Steagel Act) led to the U.S. housing bubble which culminated in the global Financial Crisis of 2008 after American homeowners started defaulting on their mortgages starting in 2006.
To deal with the Financial Crisis, the Fed started its money-printing program in late 2008, euphemistically referred to as “Quantitative Easing” to the tune of $4 trillion in order to save the American (and global) economy. The reasoning was as follows (simple version):
- As American homeowners started defaulting on their mortgages en masse starting in 2006, credit (which is a form of money) was being destroyed because mortgages couldn’t be repaid. And as credit was being destroyed, the U.S. economy started contracting along with it. The extent of this was unknown until Wall Street banks started failing in 2008, culminating with the bankruptcy of Lehman Brothers in October 2008 which set off the Crisis. Wall Street banks became insolvent because many of them carried mortgage backed securities as assets, which became worthless once the underlying mortgages went into default.
- Consequently, in late 2008 the Fed started printing money to replace credit that was destroyed via mortgage defaults in order to save the American and global economy.
Both China and the European Union followed suit with their own money-printing programs in order to rescue their respective economies.
Now, here is the problem with cheap money over long periods of time (via money-printing and low interest rates):
- It creates inflation in the asset markets such as real estate and the stock market. Why? Because there is a limited amount of land in which to build housing and there is a limited amount of publicly listed stocks in which to invest. When you have an additional $4 trillion US dollars in the global financial system chasing a limited quantity of global assets, this will create global asset inflation. This is the reason why housing costs in global urban centres such as Toronto, Vancouver, Berlin and Amsterdam have become so expensive this past decade: excess dollars and global demand for real estate in these cities, particularly among China’s burgeoning middle class of 400 million, have created a global real estate bubble.
- Cheap money is the financial equivalent of crack cocaine or heroin – it’s addictive both to governments and consumers and hard to wean off of. Both governments and consumers around the world have become so indebted during the last 10 years of ultra-low interest rates that raising interest rates by just 1 percentage point would result in serious harm to the global economy. And as interest rates remain low, governments and consumers become even more indebted, which explains why Canada’s household-to-debt ratio now stands at 177.1 percent.
Now, let’s examine the Canadian housing market, and how its rising cost has contributed to the debt enslavement of Canadians who would otherwise be considered diligent and responsible.
Rising Housing Costs Contribute to Canadian Consumer Insolvencies
Using Toronto as an example, consider the following:
- The average rent for a one-bedroom apartment in Toronto was $2,250 in May 2019.
- The average freehold home in Toronto cost about $394,000 in January 2009. As of October 2019, an average freehold cost just over $1,000,000, or an increase of over 250% this past decade.
This sounds insane, but is completely explainable based on my foregoing analysis of the last 20 years of global economic history.
The cost of buying a freehold in Toronto has more than doubled in the past 10 years, but the wages of the average Toronto employee has not. And percentage-wise, the cost of rent has gone up even more.
Is it any wonder then why normally responsible people are getting into serious debt to pay for their groceries, clothing, and transportation after making their mortgage and rent payment? They have no money left over for basic living costs, so they charge their purchases on their credit cards and lines of credit. Is it any wonder why normally responsible people would end up seeing someone like me?
Canadian Consumer Insolvencies Are Increasing – But Economists Don’t Know Why!
Here’s an excerpt from a Globe and Mail article dated December 13th 2019 entitled “Canadians’ debt burden rises, sparking concern“:
Insolvency data suggest there are signs of mounting financial distress at the household level. Through October, the number of personal insolvencies has climbed 10 per cent from the same period last year, with notable increases in Ontario and Alberta, federal data show.
Many economists have said the insolvency increase is somewhat confounding given the jobless rate is near an all-time low, and with some of the strongest wage gains in years.
To those of us in the consumer insolvency profession, this development is not at all confounding. In particular:
- A low jobless rate is irrelevant. The vast majority of my clients are employed, with many in that subset earning very good incomes. Despite this, they come to my practice in search of debt relief because over the past few years, the rate of increase in housing costs has greatly exceeded the rate of increase in wages. My average client spends between 40% – 50% of her income on rent or on the carrying costs of home ownership. In my view, one of the contributing factors to the increasingly exorbitant housing costs in major urban centers is the Bank of Canada’s policy of keeping interest rates too low for too long.
- After totaling the cost of housing, transportation and groceries, there isn’t much money left over for servicing credit card payments and other unsecured debt. Consequently, as noted in the previous section, they end up seeing someone in my profession for debt relief.
Conclusion: Who’s To Blame?
There’s plenty of blame to go around:
- The U.S. Federal reserve and other central banks such as the Bank of Canada which didn’t consider the second order consequences of excess money printing and keeping interest rates so low for so long. These consequences are now obvious – one of them being housing inflation which has contributed to mass indebtedness among Canadians as explained in the previous section.
- The Government of Canada, which for whatever reason has failed to introduce restrictions on ownership of real estate by non-residents. In the last decade, Canada has become an oasis of economic and social stability in an increasingly unstable world. Hence, its real estate market has become a safe haven where foreign nationals can park their money, driving up real estate prices and consequently, consumer debt. In my view, Canada should implement rules similar to Australia’s. In Australia, non-residents must obtain approval from the Foreign Investment Review Board (FIRB) before they can buy a property. A non-resident can purchase an established property as a home but it must be his primary residence. If someone doesn’t intend to live in Australia full-time, or is purchasing several properties in Australia as an investment, they must be new-build properties. These laws are designed to ensure that there is a sufficient supply of new housing stock across Australia.
- Consumers themselves. Yes, some of the blame still lies with people who spend more than they should due to cheap money; be it a second home purchase using their low interest home equity line of credit or the purchase of a new car due to low interest vehicle financing.