The Bank of Canada is ignoring the risks

Recently the Deputy Governor of the Bank of Canada, Paul Beaudry, made a speech about the resilience of the Canadian financial system.

He discussed several serious vulnerabilities threatening the system but claims that financial institutions will be fine, even if those risks trigger a financial crisis.

Is the Bank of Canada ignoring the risks?

The speech was delivered by webcast to members of the Ontario Securities Commission. The audience, regulators of part of the financial system, would be expected to agree that the system is strong. If not, they could be criticized along with the BOC and others for failing to do their job.

In the speech two key vulnerabilities are identified:

Housing market imbalances

“Unusually high demand for single-family homes” is mentioned along with the fact that “low borrowing costs supported demand”.

“Prices expectations may have become extrapolative” is “particularly worrisome”, to the BOC.

“Expectations of a capital gain can make homes a very attractive asset for investors.”

“Expectations of future price increases can become self-fulfilling … and that can expose the market to a higher chance of correction.”

The BOC is confident that even if there is a housing crash (my words) “the financial system as a whole is in good health and “a drop in housing prices” would not “put the financial system at risk.”

High levels of household debt

The speech mentions concerns about household debt, such as the fact that one in six households are “highly indebted,” but then jumps off course by introducing the misleading trope that “$8,300 in extra savings” appeared in household accounts recently.

As Blair Fix points out in his recent post “The Truth about Inflation,” in his blog if Jeff Bezos is worth $200 billion and another person is worth zero, they are worth about $100 billion each, on average.

The use of average household savings data is just as ridiculous.

To be fair the speech includes good information on several key risks to the financial system, including climate change and elevated mortgage borrowing.

The Bank of Canada conducted a survey of participants in the financial system such as asset managers, pension fund managers and other industry participants. That Financial System Survey, published in November 2021, highlighted the top two concerns of respondents as inflation and rising interest rates. This is similar to the findings in a recent survey in the U.S. by the Federal Reserve.

But neither of these concerns is mentioned in the speech. In fact, “inflation” and “interest rates” do not appear, even once, in the transcript.

In the face of Canada’s dangerous housing bubble and extreme level of household and corporate debt I do not understand the level of the BOC’s confidence, given what happened in other countries with less extreme housing and debt problems.

But the bubble has not burst, and Canadians seem to be able to handle their debts, so far.

The impact of the BOC’s effort to regain control of inflation will be the ultimate test of that optimism.

 

Hilliard MacBeth

 

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