Insolvencies exposing cracks in Canada’s economy

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For a while there, it looked like government support programs had saved Canadians from widespread insolvencies and business failures in the COVID-19 recession. Maybe we declared that victory too soon.

New data published by the Office of the Superintendent of Bankruptcy Canada last Friday showed that household insolvencies (combined bankruptcy filings and proposals to restructure debt-repayment terms) were up 11 per cent in the second quarter compared with a year earlier. Proposals alone were up more than 20 per cent.

The rise in business insolvencies was even more dramatic – up 31 per cent. The bulk of those were actual filings for bankruptcy.

This was a shoe that we normally would have expected to drop in the depths of the pandemic-induced recession of 2020. But the federal government poured hundreds of billions of dollars into replacing lost income for workers, and propping up businesses that were shuttered or severely restricted by public-health measures. Those actions certainly saved us from a very deep, prolonged recession two years ago.

But for some, at least, it now looks like those supports only delayed financial calamity, which has arrived at the doorstep as government programs have wrapped up, the economic recovery has levelled off, and inflation and interest rates have soared.

As my colleague Jason Kirby recently reported, the boom in household savings that Canada experienced in earlier stages of the pandemic has slowed dramatically. Net savings in the first quarter still grew, but at only a little more than half the pace of a year earlier. The return of opportunities to spend, particularly on travel and tourism, is certainly a factor. But high inflation – and, since the first quarter ended, dramatically higher interest rates – are taking a toll on household balances. The strain is, not surprisingly, most pronounced on lower-income Canadians, who had smaller savings cushions to begin with. In the bottom two quintiles of income earners, savings are in substantial decline.

Meanwhile, the number of active businesses in Canada, which had grown consistently and strongly since the middle of 2020, essentially stalled from January to April (the latest data available from Statistics Canada). Formation of new businesses fell sharply in March and April, when interest rates began to rise.

None of this should be hugely surprising. The Bank of Canada’s rate increases, which lifted the bank’s key rate from an inviting 0.25 per cent to an imposing 2.5 per cent in just four months, were bound to weigh on consumer and corporate borrowers. That’s the whole point of raising rates: It’s supposed to make debt more expensive, to impose new costs on spenders and, thus, slow their consumption.

But all of these figures cast Friday’s tepid employment statistics in a new and unflattering light.

Statscan reported that the economy shed 31,000 jobs in July, adding to June’s 43,000-job decline. It marked the first time since the spring of 2021 that the job count had fallen in consecutive months – and the first time since the pandemic began that the declines couldn’t be blamed on the tightening of public-health restrictions.

The declines aren’t large in the grander scheme of things, and the unemployment rate remains at a half-century low. It’s tempting to shrug it off as a well-deserved breather for a labour market that had added nearly half a million jobs from February through May.

But the slowdown in business creation and the rising insolvencies suggest that these employment dips aren’t just a statistical blip. These are signs of deteriorating business conditions that could translate into a meaningful slippage in labour demand.

And if hiring is heading into a slowdown, the rising consumer insolvency count could be the tip of the iceberg. The booming labour market has been critical to sustaining high household debt levels. But rising interest rates and slowing employment will put a lot more consumer debt at risk.

So what to make of all this? It certainly appears that the cushion that economists have been counting on to support a soft landing – a big pile of savings, thriving business creation, stable finances – might not be so cushy any more.

For the Bank of Canada, the rise in insolvencies may begin to provide answers to some of the key questions it has about the impact of its rapid rate hikes. The bank has assumed all along that high debt levels, especially on the consumer side, would leave the economy acutely sensitive to increases in interest rates. The impact on the housing market was almost instantly apparent. Now, the effects on indebted households and businesses are emerging.

The central bank will need to see more data as the year progresses and the full weight of its rate increases sinks in; interest rate changes typically take several quarters to be felt across the breadth of the economy. But this rapid reversal of financial health, so soon after rate hikes began, suggests that the financial foundations under this economy are not as strong as we had thought – or, at least, hoped.

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