Tuesday, January 12, 2010

Household Debt, Jim Flaherty and Early Childhood Education

The biggest threat to the Canadian economy is private debt. It is now over 150% of income and growing at an astounding pace.

Many would contribute much of private debt problem is the availability of cheap credit. Interest rates are at all time low and many of the regulative barriers to getting credit have been lowered or eliminated. The problem though is not chiefly one of supply. Even if the fed could raise interest rates, and a rate hike right now would kill a recovery and make the aforementioned debt situation much worse, would not eliminate the problem. This is not a moral hazard problem.

No the root cause of the problem is that household debt is going through the roof. Indeed, even though it is much more common for both couples to work than it was 30 or 40 years ago, a much larger portion of what a family makes now goes towards housing, child care, transportation and yes taxes than before. The financial gain of having both parents work has been whipped out by a decline in real wages, paying taxes on two incomes and not one and increased costs associated with having both parents working, particularly transportation and child care costs. Factor in sky rocking housing costs and you have a recipe for annual debt to income rise of 7%.

The Conservatives, Jim Flaherty, have made things much worse. One of the first things the Conservatives did upon coming to power was to extend the mortgage amortization period from 25 to 30 years then 4 months later to extend it to 40 years. To top it off the Conservatives reduced the needed down payment on second properties from 20% to 5% and for a time allowed for 0 down home loans. Conservatives actions resulted in the creation of housing bubbles in some of Canada's largest cities.

Since the crash the government has reduced the amortization period by a token amount to 35 years and mandated a 5% down payment. However, much of the damage is already done, and the government has to find of a way of cooling off the market while all the while not setting off a real estate crash that could kill the recovery. This is something that needs to done. After all, in the long term, interest rates are going to go up and no matter how good the recovery there are going to be a lot of people under water when that happens. Prices in Vancouver, in particular, are too high. A 2 to 3% hike in interest rates will hurt a lot of people.

One way of chushing the blow of the inevitable interest rate hike is to address some of the other costs mentioned above. A Conservative would say cutting taxes, but targeting the high cost of childcare is a far more effective way of dealing with the problem. It is not uncommon for families to pay $1000 plus per month per child. If the Liberals were to be truely bold and provide all day kindergarten and preshool to every 3, 4 and 5 year old in country, the savings for young familes, arguably the most vunerable home owners, would be huge. Some familes would stand to save up $20,000 a year in childcare costs.


KC Lowlife said...

I never knew Canada used to have a limit on mortgages to 25 years. It's horribly sad that in the face of the US' problems the conservative party in Canada is trying to drive you guys straight into the gulch the US is trying to dig out of.

The happiest day of my life so far was when I bought a shitty old house for cash a few years ago. Made me really realize just how much money I was pissing away to bankers who don't give a fuck about me.

Koby said...

We did. It is too bad, that is no longer the case. The consquences are not just short term. Extending amortization period will mean that a generation of Canadians will head into their "golden years" without any savings just as the number of Canadians without pensions grows by leaps and bounds. At no time in many Canadians working lives will they be mortage free.

Of course, Canada and the US are not alone. Housing prices are a problem everywhere in the Western world. Ireland, England, Spain, in particular, are in terrible shape as a result. Forget all this talk about public debt. It was mounting private debt that got us into this trouble in the first place and it is private debt to poses the biggest risk to us in the furture. The one saving grace for people outside of the States is they do not having many of the same expenses that people in the US have.

As Elizebeth Warren notes, the American middle class in particular is in danger.


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