“People can often cope with these vulnerabilities for an extended period,” Joshua Slive, a senior policy advisor with the Bank of Canada, said in the video.
“But an economic shock such as a severe recession could trigger a negative chain of events.”
Here’s what Slive says might happen in that “negative chain of events”.
First, a sharp hike in unemployment would leave many households in a “difficult position,” forcing Canadians to default on mortgages. Roughly 70 per cent of debt in Canada is mortgage debt.
A rash of foreclosures would be next. If Canadians default on their mortgages, lenders could try to recoup the cash by foreclosing and selling the properties, often at rock-bottom prices.
“At the same time, other households are likely to delay house purchases until the economy improves,” Slive said.
“In a housing market that is already vulnerable, this pressure could cause a large drop in house prices.”
The glut of homes on the market would cause house prices to plummet, leaving many high indebted households with loans that eclipse their property’s value.
Then consumer spending would likely fall across the board, impacting businesses big and small, and as a result, the people employed by those business. This could lead to fewer hours and job cuts, putting even more pressure on the job market.
Then, because lenders are stressed, it would be harder for Canadians to secure a loan.
The central bank’s scenario is just one possible threat to Canada’s economy.
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Meanwhile, a “sudden increase” in interest rates could send house prices crashing and unemployment rates soaring, data released by the Canada Mortgage and Housing Corporation (CMHC) suggested last month.
Fortunately for Canadians, our financial institutions undergo rigorous stress tests, Slive said, and should be able to weather the storm. But things would get messy.
“Still, the impact on the broader economy and the financial system would be significant.”