Recently, an article from theglobeandmail.com written by Rob Carrick addressed the concept of financial literacy in Canada. As household debt loads continuously creep higher and higher, author Rob Carrick asks whether recent efforts to increase financial literacy have been effective in addressing the growth in Canadian household debt.
Carrick states that another problem with the financial literacy strategy in Canada is “that it hasn’t been aggressive enough in challenging important economic franchises such as the banking and real estate industries”.
It is interesting that the author refers to the ‘banking and real estate industries’ in the financial literacy strategy being undertaken in Canada. The moment in the mid 1990’s when the CMHC buckled to the demands of the banks and/or real estate franchises is a moment where the foundation of financial literacy began to crumble. Let me explain…
Up until the early to mid 1990’s, CMHC had a purchase price cap for first time buyers set at $300,000 (in Toronto and Vancouver) and approximately $250,000 for the remainder of the country where borrowers could purchase a home with a 5% down payment. This purchase price cap served to maximize the borrowers debt load relative to the value of their home. If a borrower wanted to purchase a $301,000 home, that Canadian had to have a 25% down payment – they were no longer eligible for CMHC insurance under the first-time home buyer program.
It was well known to Canadians at the time that if you wanted to move up into a larger home (over the $300,000 cap in Toronto & Vancouver), you would need to come up with a 25% down payment. How did home buyers do this?
Either by:
The ‘savings’ approach was alive and well because there was no other cost effective way to get into a larger home unless you were willing to pay a high interest rate second mortgage. During this time, one could make the argument that financial literacy and prudency was alive and well. Canadians understood that in order to buy a larger home, we had to have a minimum of a quarter of the home value in equity/savings – these were the “financial rules of wisdom” passed down from friends, parents, lending officials and realtors!
When the previously mentioned ‘price cap’ was removed, this had a damaging effect on the savings rate in Canada. A borrower could now put down only 5% on a $1 million home. In this example, a borrower, who previously needed $250,000 to purchase that million dollar home, now only needs $50,000 to purchase that same home.
Financial literacy, in the past, was handed down from those around us and not from the internet or learning work-shops. While the efforts to share with Canadians the skills needed for financial literacy are commendable, it becomes difficult for those same Canadians to exercise financial prudence when everything around them, even including the markets themselves, seems to discourage saving and living according to your means.
It is one thing to know your yields, your returns and what the MER on your mutual fund investment is, but it is another thing to see financial prudence practiced by those people around you. Equipping Canadians with the knowledge they need to be financially savvy is the first step, but we must also look at the rules that govern our markets and the habits we Canadians take on as spenders.
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