By Tom Bradley
Last week the media latched on to a report from BMO on the topic of Canadians’ debt load. The report, based on research by Pollara, found that Canadians are carrying, on average, $93,000 in debt. This is up 22% from a year ago.
What’s interesting here is not the numbers (although 22% is pretty amazing), but rather the spin the bank puts on them. In the press release, BMO’s Senior Economist Sal Guatieri said, "Given the angst about high debt burdens, it's somewhat comforting to know that Canadians are generally accumulating good debt to finance investments in their homes and educations, as opposed to bad debt such as discretionary spending on vacations and entertainment."
Hmmmm. Good debt - houses, renovations and education. Bad debt – restaurants, U2 concerts and Puerto Vallarta.
So a prominent lender in Canada is labeling some debt as ‘good’ at a time when people are already drunk on credit. At a time when interest rates are at historic lows. And at a time when the Bank of Canada is petrified about the risks related to consumer credit and is warning people about carrying too much debt.
As you might suspect, I find this framework to be troubling. I agree that some reasons for borrowing are worse than others. Vacations and entertainment should be paid for out of current income, not a line-of-credit. But to characterize any debt as ‘good’ is dangerous.
Let’s take the house. Yes, the debt is used to purchase a hard asset - an asset that could potentially earn an income (i.e. rent). But it’s also an asset that has a lot of price volatility (we’ve only seen prices go up over the last 20 years, but these explosive ups reinforce that there will be dramatic downs as well). It’s also an illiquid asset. It can’t always be sold quickly and transaction costs are high.
If we want to put ‘good’ and ‘debt’ in the same sentence, I think we need to look at it another way. Borrowing is good when:
The purchase price of the asset is reasonable.
- There’s lots of equity behind the purchase (i.e. a significant down payment).
- The mortgage payments, taxes and other carrying costs are well within the family budget and there’s a cushion for when interest rates are higher.
- There’s room in the budget for some long-term investing for retirement (my bias showing here).
- The borrowing is not being used for spending that’s above what the family can afford – i.e. electronics, restaurants, entertainment, high-end cars and exotic vacations.
Bad borrowing? Well, it’s the opposite of those things. It’s stretching to buy a property with little money down and no cushion in the household budget. It’s on-going use of the line-of-credit to meet household expenses. It’s desperately needing interest rates to stay where they are to make things work.
At this stage of the credit cycle, I think it’s inappropriate for BMO to be providing comfort to Canadians on their debt load. The banks had benefited hugely from the ramp up of consumer debt in Canada through mortgages, home-equity loans, lines-of-credit, car loans, investment loans and credit cards, and appear to be just as drunk on credit growth as their customers. Maybe their judgement has been impaired.