Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Insanity

Is Canada due for a Financial Crisis?

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The real estate bubble and the potential of rising interest rates have put Canada on the verge of financial crisis, analysts at The Bank of International Settlements (BIS) have concluded.

Canada’s problem is a high level of debt that might be hard or impossible to pay down, the BIS Quarterly Review for March 2017 stated. Economists are worried because Canada’s credit to Gross Domestic Product (GDP) ratio is now at 17.4%.

The debt to GDP ratio is a comparison of the amount of debt in a nation to national wealth. The BIS team considers any ratio over 10% dangerous and a signal that a financial crisis is brewing, The Financial Post reported. Canada’s ratio now exceeds the danger level by 7.4% and it has risen since Fall 2016.

A financial crisis usually occurs three years after the credit to GDP measure exceeds the 10% mark. Canada’s crossed that line in Summer 2014, a graph based on BIS data prepared by The Financial Post indicates. If that’s true Canada’s financial crisis might start this summer.

The Danger from Canada’s Real Estate Bubble

The BIS noted some other danger signs in Canada’s economy including:

  • High housing prices which indicate a real estate bubble and drive debt because people have to take out big mortgages to buy a home. A major fear here is “underwater” homes where the mortgage far exceeds the value of the property.

 

  • This would not be as great a danger in Canada as in the United States because the maximum length of a mortgage in the country is 10 years. The normal lifespan of a mortgage in Canada is five years, so the country would probably avoid a crisis like the one in the United States in 2008.

  • Residential property prices in Canada are increasing faster than those in Australia which is in the midst of a massive housing bubble.

 

  • Canada’s debt service rate was among the second highest of nation’s surveyed. Only the People’s Republic of China which is plagued by questionable lending practices had a higher rate of debt service.

 

  • Canada’s banking system is very vulnerable to problems because of high levels of debt. That might create serious problems in the United States because the two countries’ banking systems are interconnected.

  • If interest rates in Canada were to return to normal debt costs would rise from 3.6% to 7.9%. That means interest rates on variable mortgages would rise from around 3.5% to 8% or higher.

 

  • The Bank of Canada has also been concerned with the prospect that many Canadian households would not be able to pay their debts if interest rates rose.

 

This report raises concern about companies that are heavily exposed to the Canadian market such as Walmart (NYSE: WMT) and Costco Wholesale (NASDAQ: COST). Also vulnerable are automakers like Ford (NYSE: F), Fiat Chrysler Automobiles (NYSE: FCAU) and Volkswagen (OTC: VLKAY) which are heavily dependent on financing. A major problem they face is the huge amount of auto loan debt; and the collapse in used vehicle prices, which makes trade-ins worth less and rives down vehicle prices and profits.

A long term problem that Canada faces is the decline in oil prices because the country is far more dependent on natural resources than the United States. Much of the economic growth in Canada over the past decade has been driven by the oil boom.

Not Just Canada

The Bank for International Settlements is a lender and clearing house for the world’s Central Banks. Disturbingly the BIS found similar conditions in two other nations, Turkey and China, the world’s largest economy.

China is potentially in worse trouble than Canada because its credit to GDP ratio is now at 26.3%. If that is correct the amount of debt in the People’s Republic now exceeds one quarter of the nation’s wealth.

It looks as if Canada is entering an era of dangerous economic instability. Such instability might some dangerous repercussions here in the United States so investors should watch our neighbor to the North carefully.