Bank of Canada governor Mark Carney has been warning about the high level of consumer debt in Canada since 2011, and this advice has been largely ignored.

Canadian consumers’ debt levels today are by any measure higher than they have ever been. The irony is that we are on the cusp of the second phase of the financial crisis that began in 2008 and, this time, Canadians are more vulnerable than Americans or even the Europeans.

We knew the cause of this financial crisis when it arrived in 2008. The previous 20 years, consumers in the Western world had embarked on a spending binge financed by debt.

Consumers piled on unprecedented levels of debt to purchase their homes, investment properties, cars and anything else the banks and credit card companies would finance. Economic reality arrived in 2008, initially in the U.S., and the rest is history.

We do not need to be financial experts to understand that if we keep eating tomorrow’s lunch today, then when tomorrow arrives, there is no lunch. Consumers faced that moment in 2008. The world’s financial system almost went off the cliff. We know how we pulled back from the brink: The U.S. and other economies bailed out the banks and stimulated their economies with trillions of dollars of freshly created debt.

Of course, we never really solve a debt problem by creating more debt, although this is a good Band-Aid that kicks the can down the road. However, now, as we see in Europe (and soon in the U.S.), the governments have too much debt and are finding it difficult to borrow more without paying very high interest rates.

The question that needs to be asked is, who bails out the governments? After 19 economic summits in two years, Europe is still trying to figure this out.

‘It was debt that caused the crisis to begin with and, in Canada, we are happy to ignore the lessons’

And what of the Canadian consumer — what has he been doing while the euro Titanic struggles to stay afloat? China’s response during the economic crisis was to undertake a huge spending binge, building new cities, malls, office towers and condos. This lifted the commodity prices that had crashed and cushioned Canada’s downturn.

We should remember that oil prices had sunk to $40, and the other resources responded in a similar fashion. In a way, this has given Canadians a false sense of security. While house prices have been crashing in the U.S. and Europe, Canadians have gone on a borrowing binge, bidding up house prices to frothy levels completely oblivious of the reality.

Canadians look at the news that emerges daily from places such as Greece, Portugal and Spain as if these events are taking place in a far distant galaxy. Huge austerity measures and 25% unemployment rates in some of these countries have done little to temper the Canadian consumer’s appetite for debt.

It was debt that caused the crisis to begin with and, in Canada, we are happy to ignore the lessons. That is, of course, until the same movie arrives in Canada.

Canadian consumers should be aware that “GREECE R US” will probably arrive by 2014. This is not a prophecy, just economics.

Europe represents almost 25% of the world’s trade, and Europe is in a recession that is getting worse by the day. The U.K. is also in a recession, while the powerhouse economies of China, Brazil and India are decelerating so fast that we can see the skid marks.

Finally, look at the U.S. economy. We see it muddling through with the risks of a recession rising by the day. The International Monetary Fund has once again reduced its growth forecasts and issued the following statement: “Growth in most major economies has showed signs of slowing in recent months, partly due to Europe’s chronic debt crisis and economic malaise.”

This is stating the obvious. So what we have taking place right in front of our eyes is a synchronized global economic slowdown.

The fact this is happening at a time when interest rates are almost at zero in the U.S. and Europe, and that the Western governments are already burdened with too much debt, which limits what they can do, should be a warning sign to everyone, especially the Canadian consumer.

‘Canadians will be going into a very slow economic period, and maybe even a global recession, with unsustainable debt levels’

Here it is in plain English: Every economy we trade with is slowing down, and this will impact us more than most. Why? Because Canadians will be going into a very slow economic period, and maybe even a global recession, with unsustainable debt levels.

The high debt levels will have a magnified effect as unemployment increases during the slowdown, and house prices start to drop from their overinflated valuations.

Our federal government obviously doesn’t get it. In fact, besides tinkering with the mortgage amortization, it has done little to prepare Canadians. So Canadians would be wise to take proactive steps to anticipate and prepare for a crisis that is heading to Canada.

The best thing Canadians can do is go back to the basics of prudence and financial management. Recessions come and go; it is the weak hands that get into trouble.

Here is a checklist:

– Build up a safety nest of at least six month’s expenses.

– Don’t live within your means, live below your means. The bigger the margin, the more you save.

– Get rid of debt. If you have investment properties, consider selling them as soon as possible, as this winter may be too late.

– If you have a mortgage on your home with a floating rate, consider locking in the rate for between three to five years. Similarly, with lines of credit that you cannot pay off. Interest rates may jump without warning.

– Pay off your higher interest rate debt, such as credit cards, first.

– Look for a secondary source of income to increase your safety net, such as a part-time job or by renting out an eligible basement.

– Expect a lot of volatility in the stock markets. If you have money invested in the markets that you may need soon, you shouldn’t be in the market.

– We are entering an age of frugality, so be frugal, but not cheap.

– It would be wise to put off big-ticket purchases and make do with what you have.

– If you are considering selling your home to buy another, make sure yours is sold first or you risk being stuck with two homes and extra debt in an uncertain economy.

– Think twice about quitting your job.

– Reconsider whether you need all the cars you have. Each car has hidden costs.

With yields on Canadian and U.S. bonds at their lowest levels in a generation, the only direction for interest rates would seem to be upward.

But investors and savers may be waiting far longer than they expect for those higher rates.

A weakening global economy, combined with a flood of money from safety-seeking investors has dragged borrowing costs dramatically lower over the past year and a half. Neither trend shows signs of reversing direction and long-term yields could have even further to fall before the trend to lower rates that began more than three decades ago finally hits bottom.  “I don’t think [that falling yields are] over by a long shot,” said Lacy Hunt, an economist at Hoisington Investment Management Co. in Texas.

Low bond yields are important because they set the stage for borrowing costs across the broad economy, from mortgage rates to the payouts on savings accounts. They make it easier for governments to finance large deficits and for borrowers to support their debt loads, but punish savers with paltry rewards for thrift.

Bond prices move in the opposite direction to bond yields, so falling yields would mean more profits for bond investors. However, they would also create pain for pension funds and insurance companies that must fund long-term obligations with bonds that are paying less and less.

Bond yields have been tumbling for years. In Canada, 10-year federal government bonds paid over 11 per cent as recently as 1990, but hit a record low below 1.6 per cent last week.

Back in 1981, with inflation at full roar, 30-year U.S. Treasuries offered a lush 15.21-per-cent payout. This week, it was a scant 2.6 per cent.

Gary Shilling, president of A. Gary Shilling & Co., a New Jersey-based money manager, and Mr. Hunt both believe that yields on long-term U.S. government bonds will eventually bottom out at 2 per cent.

Mr. Shilling, who made a name advising investors to load up on Treasuries back in 1981, says bond yields will fall because of the global economic slowdown, a flight to quality by investors fearful over the safety of their money, and a turn to deflation, or falling consumer prices.

He’s confident bonds aren’t yet in the irrational buy-at-any-price stage that typically signifies the end of a bull market because so many investors remain skeptical that yields can go lower. Bonds, in his view, remain a contrarian play.

“At every step of the way down in yields and up in price, the consensus has been: ‘Okay, it can’t last, yields can’t go any lower,’” he observed.

That consensus remains in place. A survey by Bloomberg News shows that economists expect the 10-year Canada bond rate to climb to more than 2 per cent by year-end. It closed Friday at 1.613 per cent.

In contrast, Mr. Shilling said, bond yields will inevitably be pulled lower by a faltering global economy. Europe is already in a downturn, while China’s growth rate is slowing.

In the U.S., retail sales have fallen for the past three months. On 25 of the 27 occasions since the late 1940s that retail sales have fallen three months in a row, the U.S. was either in recession or within three months of the start of one, he says.

Another factor that may drive down yields in North America is an inflow of skittish cash from Europe. A Statistics Canada report last week showed record purchases of Canadian securities by foreign investors in May. Even German government bonds, currently considered a haven, could lose their lustre because the country is exposed to European bailout costs, Mr. Shilling said.

If deflation breaks out, Mr. Shilling said consumer prices may start falling by about 2 per cent a year, which means that even with a lowly yield of 2 per cent, U.S. Treasuries would still be decent investments providing a real return of around 4 per cent annually. This would echo the experience of Japan, which went into a deflationary funk after its economy tanked in the early 1990s and where 10-year government bonds now pay a nearly invisible 0.74 per cent a year.

Mr. Hunt based his yield forecast on the history of the bond market after previous debt-induced financial panics. After the panic of 1929 and a similar collapse in 1873, “long bonds” with 30-year maturities eventually bottomed at 2 per cent yields, with the lowest point reached 14 years after the crash. In both cases, interest rates were still around the 2.5 per cent level 20 years after the beginning of the panic.

If the current blowout dating from the 2008 collapse of Lehman Bros. follows the same script, yields could stay low for far longer than is widely expected. “You go down there and then you bounce along the lows for a long time,” Mr. Hunt said.

Existing home sales dropped 1.3% in June from the month before and were down 4.4% from the year before, suggesting that Canada’s housing market was already cooling before Ottawa tightened mortgage rules.

The national average home price in June was $369,339, down 0.8% from the same month last year, Canadian Real Estate Association reported Monday.

“Even before the new mortgage rules kicked in, all signs suggest that the Canadian housing market was already cooling—the new rules will simply pull hard on a closing door,” said Douglas Porter, deputy chief economist at BMO Capital Markets.

The new rules “will chill a market that had already seen 16 of 26 markets post June sales drops. Vancouver is leading the way down, but four Southern Ontario cities also reported double-digit sales declines.”

Finance Minister Jim Flaherty announced stricter mortgage lending rules in June because of concern of a possible housing bubble, particularly in the condominium sector in Toronto — and rising household debt.

Under the rules that went into effect last week, borrowers will be allowed to use up to 80% of their property’s value as collateral for home-equity loans, down from 85%.

In addition, the maximum amortization period dropped to 25 years from 30 years for government insured mortgages.

Flaherty also said government-backed mortgage insurance will be limited to homes with a purchase price of less than $1 million.

Canada’s housing market lost a little altitude in June, but it’s still flying pretty high

Gregory Klump, CREA’s chief economist, said home buyers didn’t rush to make purchases before the latest restrictions on mortgage regulations came into effect in July.

“That’s a big change compared to what we saw as a response to previously announced changes,” Klump said.

“It will take some time before the compound effect of previous and recent changes to regulations on Canada’s housing market becomes apparent.”

Big regional divergences persist in the housing market, said Porter. Toronto prices are up 6.8% year over year, while Vancouver, whose 13.3% slide was the only double-digit drop in Canada, has become a buyers’ market.

Calgary is the strongest market, with sales up 16.7% in the past year, one of only three markets reporting double-digit sales gains.

There have been several reports saying some real estate markets and some types of housing are over valued, although there’s a range of opinions about how much and how quickly prices will decline.

Economists and consumers have been closely watching for signs that demand has softened to the point where prices will start going down.

But the association, which represents real-estate boards and associations that handle most of the country’s property transactions through the MLS system, said Monday the decline in sales activity and an increase in new listings resulted in a “more balanced” national housing market in June.

“Canada’s housing market lost a little altitude in June, but it’s still flying pretty high,” association president Wayne Moen said in a news release.

“That said, sales activity and average prices bucked the national easing trend in a number of markets, which underscores that all real estate is local,” Moen said.

The number of newly listed homes rose 1.4% in June compared to May, led by the Toronto market. Some 42 local markets, out of 100 markets across the country, registered a monthly increase in new listings of at least 1%, the association said.

RBC senior economist Robert Hogue noted the resale market eased again in June but the number of homes newly listed for sale rose 1.4% last month.

“Market conditions, therefore, eased a little, providing more breathing room for Canadian buyers,” Hogue said in a research note.

“Despite this easing, the demand-supply equation continued to be balanced in the majority of markets in Canada. The previously tight Toronto market became much more balanced, whereas the Vancouver market inched closer to conditions favouring buyers,” Hogue said.

In the first half of 2012, a total of 257,193 homes traded hands over Canadian MLS Systems, up 4.7% from the same period in 2011.

With files from Canadian Press

Effective yesterday, mortgage shoppers with less than 20% equity are subject to thenew mortgage rules announced recently by the government.

These regulations will cut buying power and refinance ability for a minority of Canadians.

If these changes shut you out of the market, and if renting is not appealing, you don’t have a ton of options.

One alternative is to buy with a strong co-borrower. Another is to get an uninsured mortgage. But the downsides of those are higher rates and limited loan-to-values (Uninsured lenders typically don’t allow LTVs above 85%).

For those of you with mortgages already, these regs will end up pinching a few of you who renew or refinance. Here’s our story from today’s Globe and Mail on that: New mortgage rules could make switching or refinancing tougher.

And in related news, BMO released poll results this morning suggesting nearly half of Canadians are “unfamiliar” with these new rules. We’d submit that a majority still don’t understand the potential ramifications on the real estate market.

Only 45% of those surveyed knew that the maximum amortization on insured mortgages is now 25 years.

Some other findings from the BMO poll:

• 14% of prospective home buyers say the government’s changes reduce the chances they will buy a new home in the next five years.
• 41% of those still planning to buy in the next five years say these changes increase the odds that they’ll spend less on a home than they otherwise would have.
• 45% say this makes it more likely they’ll take out a smaller mortgage.

Borrowers also have OSFI’s new underwriting guidelines to deal with. This additional set of mortgage restrictions will take effect in the coming months (by October 31, 2012 at the latest in most cases).

Canada’s federal finance minister is urging his provincial counterparts to heed the lessons of Europe and keep tightening their budgets as he seeks to keep Canada’s debt-to-GDP ratio the lowest in the Group of Seven rich nations.

In remarks summarizing a conference call he held with the provincial ministers on Wednesday, Finance Minister Jim Flaherty warned on Thursday that the domestic economy could be hurt by the European debt crisis and the stalled U.S. economy.

We see the lesson in Europe if public finances are not sustainable and budgets are not balanced

“I recognized my counterparts for their work in controlling expenditures and reducing their deficits, while reinforcing the need for all governments in Canada to maintain that focus,” Flaherty said in the emailed remarks.

“We see the lesson in Europe if public finances are not sustainable and budgets are not balanced,” he said.

Canada’s federal budget deficit amounts to about 1.5% of gross domestic product and is on track to be eliminated by 2016. But the economically and politically powerful central provinces of Ontario and Quebec are grappling with more serious shortfalls.