Debt Nation: Canada Borrowed in Difficult Situation, Now Needs to End Coronavirus Crisis


Murdoch Alexander MacPherson had come to Toronto with stories of debt wellness. “I want to read another case letter,” said Saskatchewan lawyer and politician, “a manager’s report to one of these so-called soulless companies in the city of Toronto.”

The story of a debtor returning from a meeting with his “fully satisfied” creditors was one of the sons MacPherson would turn that day in November 1934 (another involved $ 125 debt and a mare), while whipping the Farmers’ Creditors Arrangement Act as a director. The legislation was Prime Minister R.B. Bennett’s response to resolve the deadlock between farmers who owed money and those who loaned them.

Part of the solution was to soften the attitude of society towards debt; rather than punishing debtors for succumbing to forces beyond their control, MacPherson urged creditors to share some of the pain for the greater good.

“It is based on the belief that Parliament believes that the people of this country, whether they owe or owe money, are reasonable and fair and that they all recognize, whether they are or should be, that a sacrifice must be made by everyone before normality. can start getting, “he told the Canadian Club of Toronto.

A speech of almost 86 years may seem strange to speak of, but there are not many precedents on which the world can rely on regarding the economic fallout from the coronavirus pandemic. The recent Great Recession could be a logical point of reference for the current crisis, but the Great Depression may be more relevant when it comes to understanding what we are going to face, especially when it comes to amassing debt.

Canadian Prime Minister R.B. Bennett in 1931.

Canadian Prime Minister R.B. Bennett in 1931.

Handout / Government of Canada / Post-Media News Files

During the crisis, drought and low commodity prices crushed farm incomes and made it difficult for people to repay their loans. The federal government of the day was finally shaken enough to put aside its laissez-faire ideology and act.

Yet even after MacPherson’s speech and actions, the return to economic stability was still years away. The economy didn’t really turn around until the government of William Lyon Mackenzie King (who ousted Bennett) launched a massive spending program to help win the Second World War.

King’s current heir, Justin Trudeau, also plans to spend a lot to avoid an economic disaster, but to eradicate a different existential threat. But there are also echoes of Bennett. Canada will once again demand reasonableness and fairness in debt matters. And, like the Depression, the coronavirus pandemic paralyzed everyday life, only it happened in weeks, not years.

The virus sent the economy off a cliff. According to DBRS Morningstar, Canadians filed about 929,000 new EI claims in just one week in March, more than 20 times the usual weekly total and representing almost 5% of the country’s workforce.

“The severity of the recession intensifies our concerns about the solvency of some Canadian households and businesses, especially since many of them were heavily in debt at the start of the crisis,” the rating agency said in a recent report.

Economic production was also hit hard. A recent note from Capital Economics predicted that Canada’s gross domestic product would contract 35% annualized in the second quarter.

A closed store in Toronto.

A closed store in Toronto.

Stan Behal / Toronto Sun / Postmedia Network

The recession has left many people and businesses facing the possibility that their income and cash flow, used to pay bills and pay off debts, will quickly dry up.

If consumers and businesses do not have cash, it is apparently incumbent on the government to give it back before they start to default on their loans. And the way governments will have to get this money during the current crisis is to borrow.

In other words, Canada’s problem and solution are the same: the debt puts us in a difficult situation, the debt must now get us out.

“The federal government is going to have to take on huge short-term debt, then turn around and pay off much of that debt to businesses and households,” said Philip Cross, Macdonald-Laurier fellow. Institute and former Chief Economic Analyst at Statistics Canada. “Because there is no way for the private sector to increase its debt so quickly in the short term, the markets would trust only the federal government and its infinite power of the printing press to repay all this debt . “

One misstep could leave many businesses and consumers on the brink of bankruptcy. French economist and university professor from California, Berkeley professor, Pierre-Olivier Gourinchas, believes that a sudden economic downturn “can easily trigger a chain of events in cascade”, because modern commerce is made up of a number of connections between consumers, businesses and lenders.

If people are at home and avoid each other, they may not be able to work and may not be able to buy certain things – they may not want to anyway if they are concerned about safety. employment. If people can’t or don’t buy, companies make less money and may have to lay off, leaving even more people with less money. Banks may end up with loans that their customers (businesses or consumers) cannot repay and may be reluctant to lend more.

A lonely pedestrian in downtown Toronto on April 1.

A lonely pedestrian in downtown Toronto on April 1.

Cole Burston / Getty Images

“Panic or loss of confidence adds another layer,” said Gourinchas in a policy note for Economics for Inclusive Prosperity, a network of academic economists. “This would result in cascading business failures, with an associated increase in layoffs and an accumulation of financial weaknesses.”

One of the oldest financial weaknesses in Canada has been our high debt level.

Total non-financial sector credit as a percentage of Canada’s gross domestic product exceeded 300% (or more than US $ 5.2 trillion) in the third quarter of 2019, the most recent period for which the Bank for International Settlements, a bank central banks, has data. It’s one of the highest standards in the world. Among advanced economies, the average was around 270%.

Unless payments are deferred, all of that debt must be “repaid” or repaid, even if the revenues and revenues are wiped out. Otherwise, people and businesses will become insolvent, which was already a concern when things were normal.

The total number of month-to-month insolvencies rose 8.7% in January and 10.4% year-over-year, according to the Office of the Superintendent of Bankruptcy.

One of the oldest financial weaknesses in Canada has been our high debt levels

In November, the Bank of Canada’s senior deputy governor, Carolyn Wilkins, said that the bank’s research had revealed that Canada “would be particularly affected” by a scenario in which increasing uncertainty exacerbates a global economic slowdown. which is quite similar to the situation we are currently experiencing. Canada is extremely sensitive to the collapse in commodity prices and declining export demand, but the concern at the time was trade wars, not a global pandemic.

“The fact that household debt is higher than in 2008 would only make matters worse,” said Wilkins. “This is because indebted households facing a deteriorating financial situation should adjust their consumer spending more than they should have done in the past.”

More recently, the vulnerability reported by Wilkins has become more apparent. For example, a survey by the insolvency division of the accounting firm MNP LLP found that 25% of respondents were already unable to meet all of their monthly debts.

The Canadian housing sector, the main engine of economic growth over the past decade, is not immune either.

For years, rising prices and high debt levels have raised skepticism about the strength of the housing market. When in a hurry, however, lenders report the low unemployment rate in Canada. Rising house prices have also led to an increase in overall household wealth, a move by some economists that has mitigated the threat of debt.

But the arguments relating to employment and wealth could now be tested. Recent reports from the Royal Bank of Canada’s economic unit have predicted that unemployment could exceed 11% (or about double what it was in February) and that property values ​​could fall for a short time if “tight sellers” were forced to make concessions.

“An increase in defaults by highly indebted households could be seen in the medium term,” noted another recent report from DBRS Morningstar.

The Canadian Federation of Independent Business also recently surveyed its members and found that about a quarter of small businesses were unable to pay the April commercial lease or mortgage payment due to COVID- 19.

Canadian government officials are likely aware of all of this data. The federal government must and does intervene to try to “ease this pain as much as possible,” said Kevin Page, director general of the University of Ottawa’s Institute for Tax and Democracy Studies.

To date, the federal government has announced more than $ 250 billion in measures, such as wage subsidies and faster access to EI sickness benefits, to try to help consumers and businesses. Ottawa also pushed banks to better house their customers during the crisis, and lenders responded by offering, among other things, deferred mortgage payments of up to six months.

In addition, the Bank of Canada lowered interest rates to historically low levels, committed to buying tens of billions of dollars in bonds and provided a “term liquidity facility” to lend to banks. commercial conditions on favorable terms, including nine banks, including the largest in the country, have already benefited.

Bank of Canada Governor Stephen Poloz.

Bank of Canada Governor Stephen Poloz.

David Kawai / Bloomberg

The federal bank regulator has also reduced the amount of capital that the country’s largest banks must carry, freeing up $ 300 billion in credit, and authorizes loans on which payments are deferred to be accounted for as debts that are always reimbursed.

However, to ensure that everyone pays their bills and that the economy emerges from the crisis on a solid footing, the federal and provincial governments must ultimately go deeper into debt.

Governments “are the only game in town” at the moment, said Cross.

Ottawa’s game plan is to return borrowed money to consumers and businesses earlier to keep them solvent, improving the chances of the federal government recovering money through faster economic growth and stronger tax revenues later.

But even before all the government’s measures had been described, the Parliamentary Budget Officer of Canada predicted that the federal deficit could explode to more than $ 112 billion in 2020-2021, or about 5.2% of GDP, against about $ 26.7 billion in 2019-2020. Federal authorities currently have more than $ 700 billion in debt, which represents more than 30% of GDP, but the debt-to-GDP ratio could exceed 38% in 2020-2021, according to the PBO scenario.

Borrowing even more also raises questions about debt that no one has time to think about right now.

“How does that affect the recovery on the other side of the picture, after we get through most of this public health care crisis? Asked Page, who was also Canada’s first Parliamentary Budget Officer.

The level of borrowing would be sustainable if the economy recovered quickly, said Cross. But Canada was already in a period of slower growth, and the outlook for many companies, particularly in the energy sector, looks bleak at the moment.

“It is hard to imagine that we are going to have a meteoric recovery,” he said. “You would think that in the recovery, businesses and households, in particular, will seek to pay down the debt, not spend more, and this will structurally limit the speed of the recovery and make debt service difficult. ”

It’s hard to imagine that we’re going to have a meteoric recovery

Philip Cross

As a result, rating agencies may downgrade their opinion on Canada’s creditworthiness, which is likely to increase borrowing costs. Finance letter Bill Morneau’s mandate letter received from Trudeau included orders to protect Canada’s highest AAA rating, but maintaining it could be a challenge unless agencies make COVID-19 concessions .

Provincial debt is also a concern. Newfoundland and Labrador Premier Dwight Ball recently wrote to Trudeau warning that his province had “run out of time” as it tried and failed to borrow money to deal with the crisis current.

The call for help was eventually answered by a provincial bond purchase program by the Bank of Canada.

The federal government still has a lot of fiscal space, at least for now.

“Given access to the credit market at historically low rates and taking into account historical experience, suggests that the government could undertake significant additional borrowing if necessary,” said the current PBO in his COVID scenario analysis. 19 and the oil shock.

As an example, the watchdog highlighted the measures taken by the Canadian government at the height of the Second World War, which “resulted in massive deficits” which represented on average 21% of gross national product from 1942 to 1945 .

Prime Minister Justin Trudeau speaks at a press conference at Rideau Cottage on efforts to slow the spread of COVID-19.

Prime Minister Justin Trudeau speaks at a press conference at Rideau Cottage on efforts to slow the spread of COVID-19.

Blair Gable / Reuters files

These deficits, however, were not permanent. In 1947, the federal government recorded its largest budget surplus ever in relation to the economy, which represented 5% of GDP.

Also keep in mind that there will be a time lag in transferring money to consumers and businesses, some of which are already struggling. For example, funds from the government’s $ 71 billion emergency wage subsidy are not expected to be released for approximately six weeks.

The grants will not help everyone. The Canadian Center for Policy Alternatives estimates that approximately 862,000 unemployed workers will receive no EI or Canadian Emergency Benefit support.

Scott Hannah, executive director of the Credit Counseling Society, an accredited non-profit charity that helps consumers pay off their debts, said that less than 10% of the company’s clients have so far requested relief from short term. Despite the big layoff figures, many people are still working, he said.

“There is the initial fear of” I have to make sure that we have enough food and supplies at home for the next two or three weeks, “he said. “We now see consumers contacting us who say,” I was touched by this, I don’t know what to do, or what my creditors are going to do. “”

Government grants will not help everyone.

Government grants will not help everyone.

Getty Images / iStockphoto

Naturally, banks and other creditors do not want to suffer large losses, said Hannah, so they must work with their customers to prevent defaults by deferring payments and other strategies. Some consumers have been frustrated with trying to get relief from their bank, but lenders have handled thousands of calls and are ready to help.

Case-by-case compromises of lenders may have to overwhelm a number of borrowers and creditors until the coronavirus crisis passes or government assistance arrives.

Such a compromise is something Mr. MacPherson, the administrator of a forgotten law, suggested in 1934. Those who owe and those who borrow should find a common cause, he said.

“In the final analysis, everyone – almost everyone – in this country, whether debtor or creditor, is willing to help the other fellow if the other fellow is in distress,” he told back then at the Canadian Club.

The longer the current crisis lasts, the more MacPherson’s analysis will be tested.

Financial Post

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