This is what a balance-sheet recession looks like, and it's not pretty

I had never heard the expression "balance-sheet recession" before this recent episode, and it's time I got around to a comparison of the household balance sheets of the US and Canada. Of all my "Canada is not the US" posts, this is the one that makes me most grateful.

The quarterly data goes back to 1990, and it's good to put the last few years in context. I've scaled all the series by price (the consumption spending deflator) and population. Here is the net worth series:

There's been talk of a Japan-like 'lost decade' in the US; that seems optimistic. US real per capita net worth is back to what it was back in 1999.

The US problem is on the assets side:

The effect of the recent recession on assets in Canada is similar to that of the demise of the dot-com boom.

Aggregate household liabilities have also fallen in the US, but as can be seen in the net worth data, not by enough:

Few will be surprised to learn that the collapse of US house prices had an important effect on US asset holdings:

Although the fall in US housing assets was more dramatic, other assets lost value as well:

And lastly (although if someone can think of another interesting graph, I may add it), here is real per capita housing equity:

The US data go back to 1952, so I was able to check the last time the real, per capita value of US housing equity was at its current level. Even after looking at all of these graphs, the answer astonished me: 1978. Nineteen seventy-freaking-eight.

Comments

[Andrew F]

Isn't it weird how US housing equity started dropping precipitously two years before the price of US housing assets peaked? What happened there that suddenly caused that drop in equity? Did everyone decide to refinance their mortgage and buy a Lexus?

And that Canada has run up as far also seems to suggest that Canada is not the US yet. I can imagine a more substantial decline in Canadian housing assets, especially if anything pops the bubble in Vancouver. It seems to me that even a modest interest rate increase will be like a bucket of ice water on that market.

How else do we explain away the divergence in Canada and US housing values as something that can persist? It seems to me that US house prices ought to rise or Canadian ought to fall, or both.

[Determinant]

By "Recent Episode" do you mean the Financial Crisis of 2008 or some more personal incident? Just curious. The term was invented by Richard Koo to describe what happened in Japan in the 1990's and he found it neatly and realistically explained what happened in the US in the 1930's without twisting the facts or spinning them around in so much theory that you can't understand things anymore.

"There's been talk of a Japan-like 'lost decade' in the US; that seems optimistic. US real per capita net worth is back to what it was back in 1999."

Yeah, I have come to this conclusion too. A few things. First, my working career in high school and such taught me how much trade matters to the Canadian economy. Before I graduated University I had worked for a Norwegian company and a French company, both with plants in my hometown. I subsequently worked for a Canadian company that was acquired by an Indian company while I worked there. American trade was the dominant part of the business of all three of those companies. Trade matters.

The past few years have left me wondering why it seems to be a crime to be young, educated and to want a career. I have seen companies liquidate before my very eyes. I have seen job opportunities vanish in the blink of a banker's eye (that was a strange interview), I have seen good people who have done nothing wrong thrown to the dogs by economic forces beyond their control.

Yes, I do think this will be a Lost Decade. I have long said that 2008 sent the economy into a place it hadn't been in 80 years. We managed to avoid repeating the fateful circumstances of 1929 - 1932 for eight decades until 2008. Then, against two generations of promises from economists and politicians that they would never, never let it happen again, it happened again.

These graphs are stark truth and I thank you for them. I believe that the greatest problem we have is the inertia in government, politics and central banks about what the problem really is. Inflation hawks make me want to hang my head. We don't need inflation hawks, we need Keynes come again. We need to realize that things will not get better until we deal with the balance sheet issues and the aggregate demand problems that causes. The first step to solving a problem is to admit we have a problem. Admit the Depression and then deal with it. Maybe this truly is the Great Recession.

[Nylund]

Does this have anything to do with the Canadian government buying up $75 billion in insured mortgages back in 2008? As Canada is (roughly) 1/10th the size of the US (in population and GDP), this is roughly the equivalent of $750 billion here in the US.

[Stephen Gordon]

No. The IMPP wasn't a bailout; the federal government actually made money on it.

[Declan]

"Of all my "Canada is not the US" posts, this is the one that makes me most grateful."

Did you mean to say 'grateful' or 'concerned'?

Did Canada magically become vastly wealthier than the U.S., starting in 2006, or does it seem more likely that housing remains overpriced here, while it has corrected back to historical norms in the U.S.? The only plausible optimistic case I can think of is that with Canada being an oil exporter and the U.S. an oil importer, the rise in oil prices has caused a fundamental shift in wealth between the two countries. But I'm not sure if oil (and other commodities) are really that important to the economy or not.

Also, I imagine a young family with children, facing the choice between mortgaging their life away for an inflated piece of property or trying to find suitable long term rental accommodation might be more grateful to be in the U.S. right now.

And yes, the IMPP was a bailout. From the government's own press release:

"At a time of considerable uncertainty in global financial markets, this action will provide Canada’s financial institutions with significant and stable access to longer-term funding,"

...

"The Government will reduce the base commercial pricing of the Canadian Lenders Assurance Facility by 25 basis points. It will also waive the 25 basis point across-the-board surcharge for insurance provided under the Facility until further notice."

...

"The Office of the Superintendent of Financial Institutions (OSFI) announced yesterday an increase in the allowable limit of innovative and preferred shares in Tier 1 capital."

...

"As the Bank of Canada noted in its announcement on October 13, the Bank will continue to provide exceptional liquidity to the Canadian financial system as long as conditions warrant."

...

"The Government of Canada is prepared to take whatever steps are necessary to ensure that Canada’s strong financial system is not put at a competitive disadvantage by developments in other countries."

Any time the government takes action to benefit a company or industry in trouble, that is a bailout. This is especially true when the amount of money involved is about 10% of national GDP. The fact that they made money in the process just means it was a prudent bailout, not that it wasn't a bailout.

[Jim Rootham]

@Andrew

No, it's not weird. That was the subprime mortgage scam.

[jesse]

It makes me wonder that Canada might be experiencing some, ummm, over-valuation in its assets. Just saying... are Canadian asset values backed by future cash flows or do we dance to a different fiddle?

[Curmudgeon]

Question for Gordon, Rowe, et el:

Do you think the US will pull out of its employment and aggregate demand slump within the next twenty five years or have the Americans fallen into a permanently sustainable low level equilibrium?

When the crash hit I was of the opinion that the American political economy was too dysfunctional to see a turnaround in employment and household net worth (excluding the ultra rich) for a generation. Now I'm thinking I might have been too optimistic.

[rp1]

The US experience was excessively raw, no doubt about it, but US households are now paying down or defaulting on debt. That's progress. Excessive, unproductive debt is really the problem. Canada sailed through the crisis only because we convinced enough people, mostly young people, to lever up with even more unproductive debt. Now we have a higher debt to disposable income ratio than the Americans, and we are approaching their tipping point too.

All of that debt has to be financed, reducing future disposable income. It is largely unproductive, so instead of increasing national income it mainly adds to inflation, reducing future disposable income. So enjoy your housing wealth while it lasts, it was purchased by sacrificing a generation. People have been thrown to the wolves, they just don't realize it yet. Families with $120k income and $500k mortgages are screwed. That's a Toronto townhouse or Vancouver 2 bedroom condo. Younger people will find themselves stymied by impossibly high barriers to entry, causing longer delays in their careers, starting a family, and settling down. Note, it is that order now due to house prices.

Meanwhile, others will find their consumption subsidized, at least until it all goes bad. I am watching people buy RVs, trailers, boats, new trucks to pull them with, and renovate their house, all on lines of credit at 2%, all since 2009. Or they decide one house is not enough and buy two more. What the hell. It is a total binge, and it is fairly easy to connect the dots. These people are spending money they are not really earning. Someone has to pay for that.

@Declan: "Also, I imagine a young family with children... might be more grateful to be in the U.S. right now."

The question you should be asking is, what happens when they leave?

The linch-pin of this entire scheme is that future generations will pay any price to live here. But if I save 250k on a house in the suburbs, do I care about socialized medicine? Not if I'm young. What about post-secondary education for my kids? I'll get a 30 year fixed and invest the difference. If interest rates go up, I laugh. What about a job? Well despite the recession, America is back to hiring young educated people and working them harder and paying them better than Canada. And thanks to NAFTA is it quite easy. It seems like if you go you're set for life, barring some Mad-Max scenario. There are always risks. But there's a plan there and there isn't one here.

The two things young families need are opportunity and affordable housing. If you don't think Canada has a serious problem, you just aren't thinking about it. US household formation is showing consistent gains, and while their recovery may be very slow, I don't think it will retreat no matter what happens in the global economy now. One glance at HGTV reveals all. American vs Canadian house buyers. People there are buying at low prices, with lots of cash, while others are paying down debt. Americans are building a foundation for the future. Canada is still digging a hole.

[Gregor Bush]

I would bet that real per capita household assets - both housing and non-housing - would be alot higher if NGDP were at its pre-crisis trend instead of being 10% below trend.

Is it weak balance sheets casuing the recession or is it the recession causing weak balance sheets?

[Bob Smith]

Declan,

I'm not sure we can say that the mere fact that the government does something that's favourable for a particular industry, it's a bail out. Does, a positive regulatory change to an industry constitute a bail-out? Is the bank of Canada bailing out the private sector whenever it reduces interest rates?

Was IMPP really a bail-out? It wasn't like GM where the government was risking it's money to support the banking sector. At the end of the day, the mortgages the government bought were already guaranteed by the government (since IMPP applied to insured mortgages and CMHC is explicitly backed by a government guarantee), the government wasn't taking on any risk that it didn't already have. Had borrowers defaulted, the government would have been no worse off. All it was doing was agreeing to trade illiquid assets (government backed morgages) for liquid ones (cash) at a premium. Essentially, it was a costless (indeed, profitable, at least for the fiscc) way for the government to inject liquidity into the banking sector. I'd call that good policy (indeed, clever policy), not a bail out

[Patrick]

The desired outcome when the BoC lowers interest rates is a pop in housing and consumption, and yes, more debt. That's what they wanted, and they got it. Good! Monetary policy worked! It means we aren't in a liquidity trap.

On the US: the US situation went from terrifying plunge to just plain awful - and that's cause for relief, but it is hardly cause for celebration.

I just don't see a plausible story that goes from the popping of a housing bubble in Vancouver to the destruction of the Canadian economy. How do you go from a price decline in Vancouver housing to unemployment in Calgary of Fort Mac or St. John's?

[JP Koning]

Stephen, nice graphs. Any chance that in subsequent posts you can affix the numbers for the CANSIM series from which you've pulled the data? Are your Cdn asset numbers from 378-0083 and then divided by population?

[JP Koning]

I am looking at the yearly Canadian household net wealth statistics which go back to 1970, and the yearly US equivalent which goes back to the 1950s. In both data series there are no year over year drawdowns until 2001-2002. This despite a terrible equity market in 1969, 1974, 1976-78, a real estate collapse in the early 80s and a particularly brutal Canadian one in the early 90s. (I've deflated the Canadian numbers, not US, too lazy).

So why do deteriorating prices in asset markets have such a huge influence on net worth these days when they didn't in previous decades?

[adjacent / q]

how does total GDP divided by total assets look for Canada? that's a decent measure (similar to cash flows / asset value) to indicate that things might be out of whack.

[CBBB]

@rp1 is right especially about jobs. Despite the bad situation in the US it's a hell of a lot easier to find university-level jobs there then it is in Canada. Look at the housing prices in Vancouver and Toronto, we have two cities where the price of a house has skyrocketed and yet neither city is exactly generating a surplus of good jobs. The housing market is simply being pumped up by people borrowing at low interest rates. In Canada jobs are scarce, pay is bad, productivity is low, I guess natural resource prices are high - for now and that's what's keeping everything afloat. Canadians shouldn't pat themselves on the back.

[Stephen Gordon]

JP: The Canadian data are from Cansim Table 378-0085 - National balance sheet, persons and unincorporated business. The US data are of course from the flow of funds. The US PCE deflator is from the St Louis Fed, and the Canadian deflator is nominal consumption expenditures divided by the constant-dollar series.

Assets: v52223657
Residential assets: v52223659
Liabilities: v52223680
Mortgage liabilities: v52223683
Net worth: v52223685

[Determinant]

Canada's problem is the same problem we've always had: under-capitalization of business and its related problem of underinvestment. We're a small market and the US is a big market. The big show has always been down there.

I still don't want to move there.

[Stephen Gordon]

how does total GDP divided by total assets look for Canada? that's a decent measure (similar to cash flows / asset value) to indicate that things might be out of whack.

I was thinking about putting that in somehow. Real GDP per capita is about 130% of its 1990 levels. I think GDI might be higher.

[Mitch]

The telling moment will be when interest rates begin to rise higher. We'll see just how solid, if at all, this whole situation is.

[CBBB]

@Mitch, the situation is not solid at all. Canadians have been patting themselves on the back since 2007 for such great "economic management" when really it's all been luck, low interest rates, and high resource prices.

[Mitch]

@CBBB

" Canadians have been patting themselves on the back since 2007 for such great "economic management" "

While I agree the housing (cost) situation comes off as quite concerning, I still believe there are some (economic) decisions we can pat ourselves on the back for.

[CBBB]

I don't, I think Canadians take way too much credit for just happening to have some valuable natural resources within our borders.

[Determinant]

There is a difference between denting your car and smashing your car's front end. Canada is the former; the US is the latter.

[crf]

Most of the assets that made the US a relative economic success, like its highly educated workforce, and easy access to financing, have not been permanently damaged. The aim to replace lost consumer spending with government spending is at least talked out as the right medicine for the recession, if not taken in sufficient dosages.

Most of the things that made Canada trail the US have not been dealt with: business underinvestment, and lagging worker productivity. We could soon have a similar recession as the US, and we're not as well equipped to get out of it, even with the "right" government fiscal policy. Most people don't work for an export industry. Industry cannot be expected to make up ground if Canadians decide they need to pare debt in response to a housing slowdown.

[RN]

Can anyone point me to a graph of rent/home price ratio in Canada?

That's where the US really began to show bubble. Seeing where those data for Canada might help answer the housing bubble question here.

[Too Much Fed]

"I had never heard the expression "balance-sheet recession" before this recent episode, ..."

If you look at the people who correctly called the middle and lower class debt bubble and the housing bubble, they used budgets and too much debt of the major economic entities to call it. I'm not sure about their exact timing.

Try replacing balance-sheet recession with a type of too much debt recession with some entity having a big enough budget to affect the economy.

The other thing those people said was that asset prices could go down, but the debt would remain (unless there were defaults).

[Too Much Fed]

Determinant said: "By "Recent Episode" do you mean the Financial Crisis of 2008 or some more personal incident? Just curious. The term was invented by Richard Koo to describe what happened in Japan in the 1990's and he found it neatly and realistically explained what happened in the US in the 1930's without twisting the facts or spinning them around in so much theory that you can't understand things anymore."

1930's USA:

Japan 1990's:

2007-2008 USA:

All three with too much private debt that did not produce price inflation but had asset bubbles then a "crash".

Too much debt the problem with the solution to too much private debt not being more gov't debt?

[Too Much Fed]

Patrick said: "The desired outcome when the BoC lowers interest rates is a pop in housing and consumption, and yes, more debt. That's what they wanted, and they got it. Good! Monetary policy worked!"

I agree. I'm interested to see if you get some pushback from that description. I'm not sure I would call that good.

[Too Much Fed]

CBBB said: "I don't, I think Canadians take way too much credit for just happening to have some valuable natural resources within our borders."

What would the trade deficit/surplus (I don't know the numbers) look like without the natural resources?

Same for Australia?

[jesse]

"Can anyone point me to a graph of rent/home price ratio in Canada?"

http://theeconomicanalyst.com/content/examining-house-prices-and-rents-major-canadian-cities

But don't worry, we're rateful. ;)

[Declan]

@Bob:

I said, "Any time the government takes action to benefit a company or industry in trouble, that is a bailout."

You said in response, "I'm not sure we can say that the mere fact that the government does something that's favourable for a particular industry, it's a bail out."

Once you spot the difference between what I said, and the straw man you responded to, feel free to try again. To be honest, I'm not sure why people seem to want to deny that it was a bailout - the government doing the bailing was pretty upfront about it - banking industry had problems, government intervened to get rid of the problems for them, it's not complicated.

@Jesse

"don't worry, we're rateful" - I would have said rateempty myself...

[James]

While the rise and fall of U.S. housing is obvious from the two housing graphs, the thing I notice is that they were both basically flat prior to 1998. In fact, that's what Robert Shiller's research says: Inflation-adjusted housing values tend to be flat over time.

The only way real per capita housing assets should rise is if people build larger houses (or if there's a bubble). I'd like to see the graphs extended back to 1952.

[rp1]

@James: "I'd like to see the graphs extended back to 1952."

You'll have a lot of trouble finding anything earlier than 1980. It takes a lot of work to compile this data. Here's the Sauder data:

http://cuer.sauder.ubc.ca/cma/index.html

[jesse]

"The only way real per capita housing assets should rise is if people build larger houses"

They can also build more houses on the same tract of land. I find it hard to believe that once-farmland-now-housing-development land in Vaughan and Richmond Hill hasn't dramatically gone up in value over the past 59 years due to its increased utility.

[Adrian Meli]

Great charts, thanks for all the great news. Seriously, though, I had not seen this data displayed this way and think it is thoughtful

[RN]

"http://theeconomicanalyst.com/content/examining-house-prices-and-rents-major-canadian-cities

But don't worry, we're rateful. ;)"

Thanks!

[carsjam]

Tsk tsk tsk
Chart 3 - Liabilities - has a different y axis than the other 4 charts.

[Stephen Gordon]

The axes were all set automatically. The fact that the other graphs have the same y-axis is a coincidence that I hadn't noticed before now.