Debt Crisis

December 12, 2018

You, or someone you know, may be in a debt crisis, or have one pending.  The IMF (International Monetary Fund) is warning of another global financial collapse.  A debt crisis can be international, national or simply personal, but the impact is always the same – financial hardship.

The last big collapse we saw was in 2007/8 and precipitated by reckless lending, mostly by banks.  Mortgages were speculative, a person buying a house with a present value of $200,000 obtained a mortgage of $250,000 for the property because the appraiser felt that would be the future value of the property.

People were (as they are today) flocking to buy properties before the values went higher and banks were writing mortgages like drunken sailors.  Eventually, someone blew the whistle on the worthless stock (bundles of mortgages) that were being sold and the market collapsed.  Canadian taxpayers forked over more than a hundred billion dollars to bail out Canadian banks.

The impact on ordinary Canadians was far more severe than it was for the banks, after all government came to the aid of banks for fear of a complete monetary collapse.  Ordinary people were not so lucky, new mortgage rules came into effect to stem the flood of borrowing.   Unable to continue using their homes as ATMs, people were forced to find alternative solutions for dealing with credit card and PLC debts.  Bankruptcy trustees saw business boom and were servicing record numbers of consumer debtors.

According to the IMF, all indices seem to suggest that will happen again, it appears not to be a case of “if” but rather “when”.  Meanwhile, Canadians continue to pile on record levels of debt and continue using their homes to consolidate that debt, typically on a three to four-year cycle as mortgages are being renewed.  But if that source of debt renewal were suddenly cut off, many consumers would find themselves in a debt crisis.

Interestingly, there was a, very brief, time when a Canadian dollar would have purchased $1.03 in US funds.  Very quickly after that peak, the values flipped back the other way and a Canadian dollar would only get you 67 cents.  Had you bought all the US dollars you could get you would have made over 30% on your investment within a week.   Very few Canadians cashed in even though “the writing was on the wall”.

Once again, the writing is on the wall, Stephen Poloz, Governor of the Bank of Canada, has suggested that the Bank of Canada should target a “neutral overnight rate of 3.5%” which would likely raise posted bank mortgage rates to around 7%.  At those rates new money will be hard to find and downward pressure would be placed on real estate values possibly creating a similar situation to 2007/8.

The best way to protect yourself from the (IMF’s) pending debt crisis is to find a solution to excessive levels of debt and focus on paying down mortgage obligations.  Debt service ratios are increasingly stretching budgets.  As taxes and living costs continue to rise banks still apply antiquated formulas, based on gross income, that were developed when taxes were half of what they are today.

You can avoid a debt crisis by budgeting better, reduce debt loads, buy a more modest dwelling, stop using credit cards and lines of credit for everyday purchases.  If your cash flow is challenged to the point that you must keep using credit to cover the cost of necessities you may already have a debt crisis, come in for a free consultation, consider other options to allow you to get back in control.