Concerns that rising consumer debt could trigger a collapse in the housing market are overblown, and Canadians are very aware of the dangers of excessive debt leverage, according to a report released Thursday by Scotia Economics.

“Our analysis suggests that the odds that current household debt leverage will trigger a full-blown relapse — either in the housing market, or more generally in the economy — are relatively low,” says Warren Jestin, chief economist, Bank of Nova Scotia.

“Today’s situation is much different than the early 1990s when corporate, household and government balance sheets were simultaneously imperiled and monetary policy was much more restrictive. Canada entered the recent downturn with close to two decades of government fiscal repair, strong corporate balance sheets, and a world-class banking sector,” says Jestin. These advantages mitigate household debt risks.

He adds that “even with the continuation of low borrowing costs, existing debt burdens coupled with reduced employment gains point to a cooling of consumer spending and housing activity in the year ahead.”

Households preparing for balance sheet repair

“By one common measure — debt-to-income — Canadian borrowers are establishing new record levels of indebtedness, well above the euro zone average and closing in on other high-debt advanced nations, including the U.S., the U.K. and Australia,” says Jestin. “By mid-2010, household credit market liabilities as a share of disposable income totaled 144%, just shy of a high of 146% in March.”

However, the Scotia Economic report notes that households today are comfortable carrying a higher debt load relative to their annual income flow in part because they have greater wealth. The steady rise in household debt mirrors rising household wealth, and average household net worth (i.e. assets minus liabilities) is still close to record highs.

“A reassuring note is recent evidence that Canadians are already beginning to trim back the pace of borrowing while boosting their precautionary savings,” adds Jestin. “Home sales have cooled sharply this year, consumer discretionary spending is slowing, and the personal savings rate is moving up. We expect credit growth to slow more in line with underlying income trends over the next year, suggesting a leveling out in the aggregate debt-to-income ratio.”

IE