Debunking bubble economies - Canada pt6

Here's some food for thought for those who are still wondering what is the source of the Canadian "miracle":

Dec. 14 (Bloomberg) -- Canada’s top economic officials yesterday urged households to be wary of taking on too much debt after data showed the indebtedness of Canadians surpassed U.S. levels for the first time in 12 years.

Bank of Canada Governor Mark Carney, Finance Minister Jim Flaherty and Prime Minister Stephen Harper said in separate public appearances that they are concerned about rising debt. The ratio of household debt to disposable income in Canada was 1.48 in the third quarter according to Statistics Canada, exceeding the U.S. level of 1.47.[...] 

In Canada, where banks largely escaped the global financial crisis and continued to lend even as credit dried up elsewhere, low interest rates have encouraged consumers to take on debt.

[...] Measures to restrain lending taken earlier this year included changes for government-backed mortgages that forced buyers to meet standards for five-year, fixed-rate mortgages even if they opt for variable rates. Limits on refinancing were made stricter and down payment rules were tightened.

The proportion of Canadians in a stretched financial position “has grown significantly,” Carney said in his speech -- entitled “Living with Low for Long” -- adding that authorities continue to monitor households’ finances.

“The level of vulnerabilities of households remains high” Carney said at the press conference. “The authorities are cooperating closely, we are continuing to monitor the situation closely.”

To be sure, Harper said his government cannot “exaggerate” the degree with which it can control borrowing. [...]

To spook Central Bankers and government officials so much, the data must be particularly awful. I don't think Canada will dare raising interest rates, given that so many people are already stretched. This means that the most probable sequence of event will be:

1. Massive increase in personal bankruptcies and mortgage defaults
2. Lower interest rates to rock bottom (ZIRP)
3. Massive borrowing by the gov to cover for the guarantees it made on the mortgages
4. Sharp fall of the CAD and potentially drop of the sovereign debt.
5. Deflation followed by rise of sovereign debt (this is difficult to forecast, as I don't know the Canadian Central bank enough, but that's currently my bet anyway).