APRIL 23, 2012
I've often pointed out that talk of "low Canadian federal debt levels" is quite misleading. To give credit where it's due, we did experience an austerity drive in the 90s that saw federal debt-to-GDP levels fall from high water marks that have not since been revisited, a point I illustrated in a post last year. However, Canada is unique in that the provinces are larger borrowers than the feds. When provincial debt is added to the burden, the net debt figure jumps to 70% of GDP and gross debt jumps to 110% of GDP. Certainly not Japan, but comparable to the US figures that seem to capture so much media attention.
An interesting article by Macleans recently depicted how the composition of this debt has changed over time:
Of note, loans made to crown corporations are the largest financial asset the federal government holds on its balance sheet that offset gross debt figures. These account for roughly 12% GDP. Of these loans, by far the largest has been made to CMHC under the Insured Mortgage Purchase Program, which aimed to provide liquidity in the mortgage market by buying insured mortgages off bank balance sheets when credit markets froze during the financial crisis. Without venturing into a discussion of how likely it is that CMHC would be rendered insolvent in the event of a significant and sustained housing downturn, it seems to me that these loans would likely become on-balance sheet liabilities in such an event.
Measuring the potential fallout:
Three Canadian provinces account for 75% of the total Canadian population: Ontario, Quebec, and British Columbia. With all three provinces having released their budgets recently, it’s worth taking a moment to visualize what a real estate correction would do to the estimates used in these budget projections.
I'm not going to try to precisely quantify the potential fallout of a real estate crash on the provincial tax base and balance sheet, but to again remind readers that real estate has been a massive driver of these provincial economies and labor markets, providing juicy tax benefits through higher income, sales taxes (particularly considering that home equity withdrawal is adding 8% to personal disposable income in Canada), and land transfer taxes. I have little doubt that a severe correction would implode tax revenues and force the provinces to either embrace austerity measures or face steeper borrowing costs.
Canada’s largest province with nearly 40% of the total population is currently wrestling with a 2.4% deficit which it plans to eliminate by 2018 through a combination of mild austerity and economic growth. Real GDP growth estimates range from 1.7% in 2012 climbing steadily to 2.5% in 2015.
Projections are also for the unemployment rate to decline steadily from 8.7% currently to 6.7% in 2015. Full budget can be read here:
A significant correction in real estate would hit provincial revenues on at least three fronts:
1) Income taxes: Currently 21.6% of total revenues
2) Sales taxes (primarily the 13% Harmonized Sales Tax which is added to sale price of new homes): 18.6% of all revenues
3) Land transfer taxes which apply to any real estate sale: Roughly 1% of all revenues.
Quebec is the most indebted Canadian province with net provincial debt amounting to 50% of GDP, and they are squarely in the cross-hairs of major ratings agencies. After tackling a 2.5% budget deficit in 2010-2011, Quebec now faces a tame 1% budget deficit and hopes to eliminate that by 2014. Full budget can be read here:
A real estate correction would hit Quebec revenues in several ways:
1) Income and property taxes (reported together): 44% of total revenues
2) Consumption taxes: 22% of total revenues
BC had better enjoy its AAA credit rating while it still can. BC has net provincial debt of only 16% of GDP but has an economy shockingly reliant on real estate (annual MLS resale dollar volume is equal to 20% of GDP). As one analyst friend of mine recently noted in an email, the best parallel to BC’s current predicament is Spain:
"There are parallels to BC's predicament, the best and most chilling one is that of Spain. Several years ago Spain had the following: large trade deficit, dependency on construction employment, foreign capital investment (vacation homes), and relatively benign government debt. Now Spain has: severe construction recession, ballooning government debt, high unemployment, insolvent banks. BC looks awfully similar to Spain a few years ago and my fear is that it is in danger of being hamstrung by a slowdown in construction activity due to lower dwelling formation. With household debt levels already near a point of no return, there aren't many options left to fill the void save substantial foreign investment and government spending, both of which are not guaranteed to continue ad infinitum."
A real estate correction would hit BC in several ways:
1) Personal income taxes: 15.2% of revenues
2) Corporate taxes: 4.8% of revenues
3) Sales taxes including taxes on new dwellings: 14% of revenues
4) Property taxes: 4.6% of revenues
5) Property transfer taxes: 2.2% of revenues
In short, a potential housing correction would make current budget projections look very rosy indeed.