- Household debt levels in Canada and the United States
are at record highs, and are continuing to grow rapidly. Is that a dangerous
sign of financial instability and underlying economic weakness? U.S. Federal
Reserve Board chairman Alan Greenspan says it isn't - but others disagree.
They say the impact of rising interest rates on that mountain of consumer
debt could well have severe repercussions for the economy.
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- A look at debt in Canada and the United States reveals
some eye-popping numbers: In both countries, the level of debt to disposable
income is at about 115 per cent, meaning residents owe more than their
entire available annual income. A decade ago, that ratio was closer to
85 per cent, and even as recently as three years ago it was less than 100
per cent.
-
- Rather than scale back consumption during the recent
economic downturn, consumers took on debt at an unprecedented rate - and
that has continued, despite the promise of higher interest rates. In the
first quarter of 2004, U.S. household debt rose at an annual rate of 10.9
per cent, the second fastest in 15 years. It has risen by 30 per cent since
2000 to $9.4-trillion (U.S.).
-
- The primary engine for this has been record-low mortgage
rates, which have driven a refinancing boom in the United States and to
a lesser extent in Canada. That, in turn, has poured billions of dollars
into consumption of all kinds, including house buying. And the main driver
behind low mortgage rates, of course, has been the lowest interest rates
in half a century.
-
- Not surprisingly, considering the Fed has been the central
architect of this "easy money" policy, Mr. Greenspan says he
isn't concerned about high levels of household debt. He and others argue
that it isn't a problem because most of it is mortgage-related (about 70
per cent in the United States and about 60 per cent in Canada). In other
words, it is backed by a hard asset, and one that has been increasing in
value.
-
- But investors such as Bill Gross of Pacific Investment
Management Co. of California - whose bond fund is the largest in the world,
with $400-billion in assets - say they are worried that Mr. Greenspan is
being a little too sanguine about the risks posed by household debt levels.
One problem is that the rise in asset values that justifies all that mortgage
debt is in part a byproduct of that debt. In other words, house prices
have been rising in part because consumers are taking on more debt to pay
those higher prices.
-
- The risk is that as interest rates rise, that cycle gets
unwound, something that could cause severe pain to consumers who are overexposed.
-
- While most mortgages are at long-term fixed rates (80
per cent in the United States), the number of adjustable-rate loans has
been growing at a rapid pace, to the point where they now account for close
to 30 per cent of new mortgages in the United States.
-
- Mr. Greenspan may be calm, but his British counterpart
ó Bank of England governor Mervyn King - raised a yellow flag this
week about the risk of high mortgage debt. "When people take out very
large mortgages ..... stretching themselves to the limit in the belief
that house prices will always go up to bail them out - that's a slightly
risky assumption to make," he said.
-
- In his confirmation hearing before the U.S. Senate this
week, however, Mr. Greenspan said he was "not actually concerned at
this point that we are looking at a real serious consumer debt problem,"
because mortgages add an asset to consumer balance sheets and delinquency
rates are low. The Fed chairman says debt levels should be less of an issue
as the economy grows.
-
- The fact remains, however, that U.S. household debt has
risen twice as quickly as household income has over the past three years,
while mortgage debt has soared by almost 50 per cent. That may have helped
the U.S. economy through the recent downturn, but it still represents a
very large bill that will have to be paid - and the cost of paying it is
going up.
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