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The kiss of debt

Consumer credit has exploded in last two decades

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When it comes to credit cards, the kids may not be alright.

That's the finding of recent data uncovered in a TD Canada Trust survey. Of course, we're really talking about young adults aged 18 to 34.

In Manitoba and Saskatchewan, 61 per cent of young adults do not pay off their monthly balance while 45 per cent only make the minimum payment, the survey found. On the upside, 71 per cent of those surveyed use cards for points to save up for big-ticket expenses while 65 per cent use plastic to build a credit rating.

While the latter statistics are good news, the former concern the bank, says Stephen Menon, associate vice-president for credit cards with TD Canada Trust.

"The reason for the survey is because financial literacy is a very important issue, and we want to make sure people are aware of what some of the challenges are with credit cards," he says.

Poor credit-card use is nothing new. Consumer debt among young Canadians -- or for that matter all Canadians -- has been a growing problem for more than a decade.

"We have a major problem on our hands," says Jacob Ziegel, law professor emeritus at the University of Toronto, an expert in bankruptcy law. "The key question is whether consumer credit is too widely available -- and the answer is yes."

It's no secret we have a debt problem. The barometer of indebtedness -- our debt-to-income ratio -- has hit record highs for the last three years. For the first quarter of 2012, it reached 152 per cent.

The recent meteoric rise in housing prices has been a contributing factor. In Winnipeg, housing prices have more than doubled over a decade.

This cuts both ways. Existing homeowners benefit from higher home equity, allowing them to borrow more at low rates. At the same time, new homebuyers become more indebted because they have to pay more to own a house.

Low interest rates have fuelled this situation -- a necessary measure by central bankers to keep the economy going amid one market meltdown after the other.

Yet one could argue the sharp end of the spear of our debt problem is high-interest consumer credit -- often young adults' first access to borrowing.

For many, credit cards are indeed beneficial. But an equally compelling case can be made that a lot irresponsible lending and borrowing has gone on -- and not just involving the youthful, skinny-jeans crowd, but everyone.

Shortly after the 2008 meltdown, Ziegel completed a report funded by the Canadian Insolvency Foundation, which found insolvencies in Canada have increased at an alarming rate.

While insolvencies have decreased slightly from a peak of about 130,000, about 120,000 Canadians filed for bankruptcy or entered into a consumer proposal in 2011. These statistics are on par per capita with the United States and among the highest in the world.

The over-extension of consumer credit is a major contributing factor to these high rates, and Ziegel says you can trace the growth of consumer debt and insolvencies to rapid expansion of consumer credit products.

About 40 years ago, consumer debt -- incurred by purchasing consumables that don't appreciate in value -- was largely an anomaly. Credit cards were curiosities, but they caught on quickly. By 1977, about eight million credit cards in Canada accounted for about $4 billion of transactions. By 2006, the number of cards had exploded to 26.4 million, a 320 per cent increase.

And the amount of transactions had grown to about $242 billion, about a 6,000 per cent increase, Ziegel says in his report.

But the popularity of credit cards and other consumer credit products really took off in the 1990s, says Nora Spinks, CEO of the Vanier Institute of the Family.

The Ottawa think-tank has been tracking Canadian families' debt for the last 13 years along with other indicators such as income, spending and assets.

The institute found incomes have remained static while expenses have increased -- good fertilizer for consumer indebtedness.

But another contributor is the marketing of credit itself.

"'Don't pay a dime until 1999,' " Spinks says. "That type of motto was the beginning of massive debt increases because in the late '90s the message was 'Don't save to make a big purchase; get it now with credit.' "

While credit is widely available to most income-earners, Spinks says its improper use has the most long-lasting, negative impact on young consumers.

"The earlier you go into debt, the tougher it is to get out."

Nevertheless, young adults are inundated with marketing.

"The minute you're a college student, you're getting a credit card," she says. "Historically, nobody got a credit card unless you had hard assets to back it up."

But lenders have come to see education as a hard asset, so they're willing to invest in potentially bright futures. Education costs, however, have increased. More students are graduating with student-loan debt into a job market where boomers are hanging onto their jobs because they too are indebted to retire.

Boomers are saddled with home-equity credit lines -- another development of the last decade -- instead of credit cards, she says.

To compound the problem, young adults in school compete with their grandparents for part-time jobs because seniors are working longer -- often in low-paying service-industry jobs -- to supplement their retirement.

"So what do they do? They go back to school to get an advanced, graduate degree," she says. Or they become under-employed, earning less while paying more.

"Their debt increases, so the cycle continues."

Ziegel says solutions to the problem aren't one-sided.

"It's grossly misleading to put the majority of the blame on consumers when we've created this consumption market and people are encouraged to spend, spend, spend," he says.

Lenders must become more prudent. But that's likely difficult for them to do by themselves, so the federal government should step in -- as it's done with mortgage lending.

"The reason the minister of finance is tightening the mortgage belt is because even if one bank was inclined to adopt a more conservative stance, it couldn't do that because it's in a competitive market and it has to follow the lowest common denominator," Ziegel says.

In other words, the rules of the game must change to alter player behaviour.

"What I recommended was that if a consumer goes bankrupt and the bankruptcy court finds the creditor was reckless in extending the credit, then the court should be able to disqualify the creditor from trying to enforce its claim or it can reduce the size of its claim," he says, adding this idea has been around for decades.

Ultimately, however, no one solution will unravel this complex problem. "It's all interconnected," Ziegel says.

Our culture is addicted to overconsumption -- and it's tough for consumers, businesses and governments to stop.

The problem hasn't gone unnoticed by the lenders, either, Menon says. TD could have swept the negative survey results under the mat.

"A great example of our concern about it is the fact that we're having this conversation in the first place," he says.

giganticsmile@gmail.com

You think the Europeans are spending irresponsibly? Hold on now...

Many a pundit these days has been wagging a finger at the Europeans for overspending, but Canadians, Americans and the British have the highest consumer debt in the world.

"You find that in the Latin nations of Europe that it's the governments that have been splurging and not so much the consumers," U of T law Prof. Jacob Ziegel says. "We in North America do it at both ends."

A recent Bank of Canada report found Canadians have become world-beaters in personal indebtedness. We have the highest household debt-to-disposable-income in the world. Canadians lead the Brits and Americans, all of whom are above 140 per cent, while the Eurozone nations have about a 100 per cent household debt-to-disposable-income ratio.

Prescription for deleveraging

U of T law Prof. Jacob Ziegel says a number of steps should be taken to deal with increasing consumer debt, some he outlined in his report:

More than the minimum: Under current rules, lenders only require minimum payments of three per cent of the total debt owed on a credit card. Ziegel says this should be increased so borrowers must make progress against their debts.

Hold lenders more responsible: The European Union has rules for lenders that, before granting credit, they must examine the borrowers' income and living expenses and be certain surplus income is available to meet debt obligations. If the creditor fails to do so, and the debtor defaults, the lender can lose the right to recover any of the borrowed money.

Establish non-profit loan providers: Low-income Canadians with no access to conventional banking credit should have a choice for emergency credit and borrowing for other prudent uses between non-profit lenders and payday lenders. The federal government should encourage financial institutions to help establish a non-profit lending network because the sector will ultimately benefit the financial health of everyone. At the same time, provincial governments should increase welfare payments to cover the cost of living and cut the need to go to payday lenders when their money runs out before the next cheque.

Create a regulator with teeth: Harvard law professor and bankruptcy expert Elizabeth Warren recommended the United States adopt a regulation similar to those used to protect consumer safety with other products such as vehicles and appliances. The U.S. never adopted the measure. Canada has the Financial Consumer Agency of Canada, which does a fairly good job, but its enforcement role could be strengthened.

Greater provincial enforcement: While the feds regulate banks and interest rates and have the ultimate authority to regulate lending practices, they leave the provinces with jurisdiction over consumer contracts dealing with lending rules. Five provinces (Manitoba, B.C., Alberta, New Brunswick and Newfoundland) already oblige a lender to choose between repossessing goods sold on credit and suing for the balance owing, Ziegel says. Saskatchewan's law is even stricter. It only allows the seller to recover goods sold on a title retaining basis if the buyer defaults, but it doesn't permit the seller to sue for the balance owing on the price of the goods. Still, Ziegel says more could be done to ensure consumers who have been misled into a bad loan have legal recourse.

Republished from the Winnipeg Free Press print edition July 1, 2012 B9

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