Consumer confidence is surging just as banks brace for defaults. What’s going on?

It is an unfortunate rule that bad things also happen to optimistic people.

Just as new consumer confidence figures from the Conference Board of Canada show “a three month streak” of growing optimism, worrywarts from the commercial banks, the Canada Mortgage and Housing Corporation (CMHC) and the Bank of Canada, seem to be saying “not so fast.”

For Canadians trying to make sense of a series of frightening headlines, the difficult question is whether the warnings of potential economic turbulence are a signal to take the crash position or if we should trust our fellow travellers who seem to be taking the distressing indicators with a grain of salt.

Warnings come thick and fast

The gloomy warnings have been coming thick and fast. On Wednesday, the latest arrivals to the misery party were the Canadian commercial banks. BMO and Scotiabank were the first in what is likely to be a trend by all the Canadian banks to set aside extra hundreds of millions of dollars — more than a billion for BMO — to cover loans that borrowers cannot afford to pay back in full.

While those numbers are large, they are not as large as they would be if the taxpayer didn’t cover mortgage default losses. This week, however, the government agency that has to pay out if mortgage loans go bad had warnings of its own. 

“We see early warning signs that more and more consumers are getting into financial difficulties,” said CMHC’s deputy chief economist Aled ab Iorwerth in a release on Tuesday.

WATCH | The mortgage borrowing that may yet eat the economy:

In the past, Canadians have been reliable in paying back their loans, especially the mortgages that make up so much of our borrowing. But as longtime financial advisor and author Hilliard Macbeth has warned in the past, this time could be different.

There are signs ab Iorwerth and the CMHC could be coming around to a similar perspective. While current debt levels  are not necessarily dangerous alone, ab Iorwerth said rising interest rates and the risk of a downturn that leads to unemployment could do serious damage to Canada’s economy.

Debt remains even after jobs are gone

That was also the message from the Bank of Canada’s annual Financial System Review (FSR) released last week.

As in previous years, senior deputy governor Carolyn Rogers added the proviso that “the FSR is not a forecast.” But that proviso itself deserves an addendum — in the past, bleak non-forecasts have hit very close to the mark.

A year ago, the bank warned rising interests would hurt the fortunes of those who bought homes when interest rates were low and prices were high. In the prior FSR, the bank warned Canadians were accumulating too much mortgage debt.

Among this year’s warnings, there are concerns banks could face a shortage of cash reserves, if demand for money exceeded conventional sources, including the cash Canadians hold on deposit. Compounding the problem could be a global shortage of money, meaning that banks could have to restrict lending, even in emergencies.

“If global stresses were to return and persist, bank funding costs could rise beyond the higher levels intended by tighter monetary policy,” said Rogers.

Wishing for lower interest rates

While central bankers insist there are no plans to reduce interest rates, a shock to funding costs is the kind of drastic situation where it could happen.

Even if most Canadians have not listened to the dire warnings, the banks clearly have. Loan loss provisions, while they cut into profits and leave less cash for lending, are a boost for the economy in the longer term because they make banks safer. Setting aside money for defaults in advance, even if the funds are never needed, means banks would go into any crisis forearmed.

So, why, amidst all the warnings, is consumer confidence on the upswing, I asked Walter Bolduc, the economic forecaster who compiled the Conference Board report, in a phone interview on Wednesday.

Bolduc said the reason for the increase in confidence may be partly seasonal, but he also attributed it to the pause in the Bank of Canada’s increase in interest rates. 

“You may have had people who were expecting [a rise in rates],” said Bolduc. “And then with the Bank of Canada holding the rates steady, they may have re-evaluated the situation.”

Fading optimism?

But according to Bolduc, that optimism which came with a new rise in real estate prices, may fade once people realize they too will likely be affected by rising mortgage costs. He said the Alberta forest fires could also cut into confidence.

The central bank warned last week that half of all mortgage holders will find their mortgage payments have risen by the end of 2023; others will feel the effect as they renew in the coming years. The bank also warned that rates may have to stay higher for longer until inflation is defeated.

WATCH | How these Canadians are dealing with the high cost of living: 

How these Canadians are dealing with the high cost of living

CBC News spoke to several people in downtown Toronto about the financial challenges they’re contending with, including housing, food and child care, and what they’re doing to keep expenses down.

Bolduc foresees a potential “snowball effect” as people spend a little less, creating a wider slowdown in economic activity.

“We might have some households which are completely unable to cope with these higher costs and maybe have to default on their mortgages,” he said.

Some have said Canada is already witnessing “a per capita recession,” where an increase in population means everyone is getting a little less of existing GDP. But the fact is, as the Bank of Canada said, in an economy of richer and poorer, those at the bottom of the heap are getting it worse.

“We can talk in averages, but those averages hide extremes,” said Rogers last week.