Last week, the Canadian Association of Insolvency and Restructuring Professionals warned that rising interest rates could result in more insolvency filings, but Ira and Brandon Smith believe that belies a greater truth.
While CAIRP pointed to antecedent periods during which insolvency filings followed rate hikes within a couple of years, the father-son duo at Ira Smith Trustee & Receivership Inc. believe the real culprit for bankruptcies and consumer protections is unemployment.
“Interest rates changed a little bit in the 2008 to 2010 period, but there was a lag time in unemployment,” said Ira Smith. “As unemployment went up, there was a slight rise in insolvencies. The interest rate not only caused harm to consumers but also to companies. When companies’ costs go up and they have to keep producing profits for shareholders, they look at cutting other costs. Labour is good to cut and that’s what must have happened because unemployment went up.”
Although CAIRP provided graphs to support its assertions, Brandon Smith says the explanation the former provided lacked depth.
“I saw a much stronger correlation between unemployment and the insolvency rate, almost mirroring it throughout the graph, not just at that one point in time,” he said. “I didn’t see a stark correlation between rate in insolvency and increase or decrease of the interest rate.”
In recent years, surging home equities in tandem with low interest rates have allowed homeowners to consolidate unsecured debt, however, with the Bank of Canada committed to raising the benchmark rate through next year and home values peaking, turbulent times could be ahead.
“With the new stress test, people may not qualify for more financing, and as rates go up that will give consumers problems, as they can’t refinance anymore to a lower-rate mortgage or home equity line of credit to pay off their 20-odd-percent credit card debt,” said Smith. “If unemployment goes up as a result of interest rates going up, it will be a double whammy.”
Exacerbating that problem is Canadians’ addiction to debt, for which the national average could hit 200% of income by 2020.
“Canadians have been able to ride a wave of rising house prices and low mortgage rates and financing themselves, but they may very soon hit a brick wall of the higher interest rate, stress test and real estate values reaching their peak,” said B. Smith.