Canada and Brazil Taking on U.S. Like Characteristics in Debt Exposure

January 13, 2011

5 minute read

We've mentioned in the past how Australia and Canada [Jun 30, 2010: BW - Vancouver, Canada; Housing Bubble North of the Border?] seem to be following the same path as the U.S. in some of their debt markets - especially housing. That said, you never know when these things end as anyone who was shouting warnings in the U.S. in 2006 can attest to. And unlike American central bankers who were on Capital Hill suggesting all Americans take out adjustable rate mortgages (thanks Alan!) or American regulators who never see a risk they cannot overlook, there are at least warnings being declared (and actions taken by regulators) in these other countries - we'll see if they are heeded.

We continue to see troubling LONG term signs out of Canada, and now we can add Brazil to the list of countries who are following the U.S. path to "prosperity" in terms of debt fueled consumption. Canada is especially troubling because much of their residential mortgage market is one big adjustable rate rollover plan (or short term fixed rate plans that "roll"), and their rates have almost nowhere to go but up.

First to our neighbors to the north, via Bloomberg.

Canada’s top economic officials yesterday urged households to be wary of taking on too much debt after data showed the indebtedness of Canadians surpassed U.S. levels for the first time in 12 years. Bank of Canada Governor Mark Carney, Finance Minister Jim Flaherty and Prime Minister Stephen Harper said in separate public appearances that they are concerned about rising debt. The ratio of household debt to disposable income in Canada was 1.48 in the third quarter according to Statistics Canada, exceeding the U.S. level of 1.47.
“Our parents were more inclined to pay off that mortgage as soon as possible, and some Canadians are not as inclined to do that now,” Flaherty told reporters yesterday. “I encourage them to do it.”
The comments by the policy makers underscore government concern that debt levels in Canada could threaten the recovery if borrowing costs rise and households struggle to pay their bills. Canada has relied on regulatory steps to rein in mortgage borrowing, most recently in February, and Flaherty said yesterday he is prepared to take additional measures if needed.
“The fear is that were we to see sharp rises in interest rates or were we to see sharp rises in unemployment, that a significant number of people might not be able to afford their debt obligations,” Flaherty said. In Canada, where banks largely escaped the global financial crisis and continued to lend even as credit dried up elsewhere, low interest rates have encouraged consumers to take on debt.
Carney, 45, left the benchmark target rate at 1% this month to gauge the global recovery after three earlier increases.
While Canada’s economic recovery could be threatened in the future by elevated debt levels, higher Canadian interest rates could also cause the Canadian dollar to appreciate. Carney noted that the bank had flagged as a risk to the economy that “persistent strength of the Canadian dollar” and weak productivity could crimp exports and hinder Canada’s recovery.
Measures to restrain lending taken earlier this year included changes for government-backed mortgages that forced buyers to meet standards for five-year, fixed-rate mortgages even if they opt for variable rates. Limits on refinancing were made stricter and down payment rules were tightened.
The proportion of Canadians in a stretched financial position “has grown significantly,” Carney said in his speech -- entitled “Living with Low for Long” -- adding that authorities continue to monitor households’ finances. “We have debt levels that are unprecedented in this country,” Carney said in an interview broadcast today on BNN Television. “We are in uncharted territory.”

That should sound familiar to American readers, flashback 5 years...

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Meanwhile down in Brazil, one of the long term positives is the transformation of an economy with limited credit to one where mortgages and credit cards become more mainstream. (things we take for granted in the States) However, you don't want to see a super surge at any point as debt should expand with income not at a pace far ahead of it. Via BusinessWeek:

The Nov. 9 rescue of Brazil's 21st-largest bank, Banco PanAmericano, has exposed cracks in what many had regarded as one of the most solid financial systems among emerging-market countries.
Brazil's economy grew at a 8.4% clip in the first nine months of 2010—its fastest pace in more than 15 years—powered in part by a sharp increase in government-subsidized loans and a rapid expansion in consumer credit. That can be a lethal cocktail.
The data in Brazil are troubling: Late payments on credit cards and other consumer loans jumped 23% in November from a year earlier, prompting government leaders to begin scaling back their easy-credit policies. "It's time to be a little bit careful about the B in BRIC," says Jim O'Neill, chairman of Goldman Sachs Asset Management and the man who coined the BRIC acronym for Brazil, Russia, India, and China.
Former President Luiz Inácio Lula da Silva, a founder of Brazil's Workers' Party, impressed Wall Street with his commitment to free-market policies. Yet even he was unable to resist the temptation of indulging in an age-old Brazilian tradition: the election-year splurge. The national development bank, known as BNDES, made $101.1 billion in loans in the 12 months to October, a 33% increase from the same period a year earlier. Lula's protégée and successor, Dilma Rousseff, pledged to rein in spending as she assumed power on Jan. 1.
The country has witnessed a fivefold expansion in consumer credit over the past eight years, with the total value of outstanding loans reaching $440 billion in October, according to central bank figures. This explosion was triggered in part by a 2001 regulatory change that allowed lenders to package auto, payroll, and other consumer loans into securities called FIDCs. The market for such notes has grown from nearly $290 million in 2003 to more than $35 billion last year. (i.e. securitization)
Big Brazilian banks have stopped buying the credit portfolios since a November government probe into PanAmericano revealed losses stemming from improper accounting of sales of its loans. "PanAmericano was the wake-up call," says Denise Debiasi, the São Paulo -based managing director for Latin America at FTI Consulting .... "There's risks people may be overlooking—like credit quality—as the market booms."
To head off a subprime-style crisis, Brazilian authorities in December upped reserve requirements on time deposits held by banks to 20 percent from 15 percent. Banks must put aside more capital to back consumer loans whose terms exceed 24 months.
The average debt load of Brazilian consumers amounts to 18% of total disposable income, compared with 13% in the U.S. In a Nov. 30 interview, Henrique Meirelles, who at the time was Brazil's central bank chief, indicated that a special task force would be convened to study the industry. "Some supervision could be proper," he said. "The case of PanAmericano showed how important this is."

Unlike U.S. regulators who claim no problem can be seen in advance and their only job is to mop up the crashes their lack of supervision cause with a tsunami of liquidity, other countries are taking a more pro-active stance on regulation to try to stave off an "American-like" outcome. We'll see how successful they are in the coming years.