Canada At Risk Of Another Banking Crisis


The steady decline in the Federal Funds rate in the United States is clear from the chart above.
What is not obvious is the impact of raising interest rates on a heavily indebted nation.
If one can visualize a downtrend line from the highs in 1989 to 2001 and then to 2007 and extrapolate to the present, we can see that rates might only hit 2.0 or 2.25% before the impact of the trendline is felt.
So we could be only 2 or 3 interest rate hikes away from a market sell off and a recession in the United States.

What does this have to do with Canada?

Canadian interest rates follow a similar trend to that of the USA.  Lately, the governor of the Bank of Canada has released quite dovish statements regarding the path of interest rate hikes.  And no wonder, the Bank of International Settlements (BIS) just published a report stating that China and Canada were at the top of their list of countries at risk of a banking crisis.

Why?
Canadian debt service ratios are very high and far beyond a sustainable level.


As discussed previously on this blog, we know from historical prices and income ratios that housing prices in major Canadian cities (Vancouver and Toronto in particular) are far beyond reasonable levels.

We know that a house or condo is typically the largest "investment" a person makes in their life.  What seems to be incomprehensible to the majority of the public is that housing is not a store of value but a consumption (albeit very long term).  So when housing prices begin to slide, (due to higher interest rates) the equity bubble in housing starts to deflate, producing wide ranging effects on multiple sectors in the economy.

Consumer spending drops due to a drying up of credit as lines of credit secured by mortgages shrink.  Banks profit margins eventually are squeezed as bad debts accumulate from mortgage delinquencies, bank lending then tightens to all customers including small business.  Since small business is the major driver of the economy, the economy slows or even goes into recession.

What is not apparent, is that Central Banks around the world are serial asset bubble blowers.  This is why they fear deflation as it is an existential threat to their power and that of the socialist big governments world wide.
Once deleveraging triggers asset deflation, as we saw in the 2008 crisis in the United States, a banking crisis quickly develops.  Canada escaped the worst of the housing price collapse during the last crisis, but that only allowed an even bigger bubble to build.
The day of reckoning is now at hand, and the recession that accompanies it should be a doozy.  The IMF came out with a plan in 2013 that has now been implemented in most developed countries called a "bail-in" in the event the banks (inevitably) get into trouble again.  Supposedly this is to protect the taxpayer from bailing out banks.  Effectively it punishes depositors in Canada if they have more than $100,000 in any given institution.  Expect to see deposits seized in the next crisis.  While timelines for the crisis are fluid, the present trajectory suggests 12 to 24 months from now as a target area. 

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