Canadian economists talk about bailout; U.S. economy

Benjamin Reitzes, Bank of Montreal economist: It won’t be a cure-all, though hopefully it will ease the pressure on banks so that they are more willing to lend to each other. But the U.S. is still facing a recession.

Richard Kelly, TD Bank senior economist: Will it work? That’s the $700 billion question. I think it’s a step in the right direction, but it’s not going to stop the recession. In terms of trying to get a grip on the financial crisis and return to a state of economic normalcy, that is the best move at this point.

Aron Gampel, Scotiabank vice-president, deputy economist: What the government is proposing is to replace bad assets with good ones, which will help many financial institutions in righting themselves. It doesn’t necessarily mean the credit taps are turned on immediately, but it’s part of the healing process.

Paul Ferley, RBC assistant chief economist: It’s probably the best option that’s available at the moment. The package is intended to free up the markets and get the product moving again. At this point, you have to come into the market in a sizable way, and the government has the resources to do it. There have been discussions in terms of looking for private-sector participation, but actions have to be taken fairly quickly. I’m not sure you can get that type of response working within the private sector.

Advisor.ca: What’s really happening in the U.S.? Why does the government need to intervene at all?

Kelly: The issue is, basically, that the financial sector can’t sit there and hold its toxic assets forever. The government, though, can buy it and hold it to maturity. These things are like bonds, and the Feds can hang on to them for 10 or 20 years. If the system recovers in five or six years, they can sell these things back into the market.

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Reitzes: We need to make the distinction that the government is buying assets with that money, not just spending it, so they’re likely to get a significant chunk of that money back. They could actually make money. It’s not the same as spending the money.

Advisor.ca: What happens if the bailout doesn’t get approved?

Gampel: It sets the stage for more turbulence in the financial markets and more consolidation among financial institutions. You’ll have a further breakdown in the credit-making facilities, and the U.S. economy would go through a deep and long downturn.

Ferley: How this is playing out is that it keeps driving the wholesale cost of funds higher. That means it’s getting more expensive for financial institutions to raise money, and as a result, the investment hurdle that has to be cleared to lend out funds keeps getting higher and higher. This weighs on investment activity and overall growth.

Kelly: Banks are caught in a vicious cycle. They have debts linked to the housing market, so as the housing market weakens, it lowers debt, [and] there’s less money to get into the system for lending. That means if there’s less lending, housing falls further and the value of these assets drops even more, which means less lending. They have to get the debts that are driving this off the balance sheets.

Advisor.ca: Speaking of the housing market, does the bailout affect the sub-prime meltdown at all?

Kelly: It’s not going to stop the housing crisis. In fact, the housing issues are exacerbating the financial crisis just by existing. But home prices haven’t fallen enough yet. It needs to drop about 10% more before it gets to a state where people feel good about investing in a home. That’ll take at least another year.

Ferley: There will still be an ongoing slowing in the housing market. But there are other factors at play here. You’re seeing new construction continuing to be cut back and an attempt to bring down inventories of unsold homes. The other worry, and this is related to the issue of sub-prime to the extent that it’s weighing on equities — it’s doing damage to household net worth.

Advisor.ca: What other issues are putting pressure on the American economy?

Gampel: The job market, confidence questions, high gas prices, the value of homes — there are so many compounding factors, and that’s why the mood has soured and expectations are that the States could be in a more deeply protracted downturn.

Kelly: The problem is that credit goes into all sectors. There’s less borrowing by households and businesses. The general business sector doesn’t have cash to take opportunities to grow business. We’re seeing retrenchment in business investment now as well. The non-financial corporate sector doesn’t give cash either, so we’re seeing job losses and less hiring as business investment is scaled back. That’s when you get into a normal recessionary spiral. Job losses mean less interest in housing, so it brings down the market, depresses things, then there are more job cuts.

Advisor.ca: Is the U.S. really facing a depression? Even President Bush used the word “panic” in his address recently.

Gampel: Everyone has a different take on it. What we’ve seen is the bark is worse than the bite so far. Some sectors — housing, automotive, financial — are under tremendous stress, but others are doing quite well. Exports are going like gangbusters because of the expanding global economy. And the U.S. produces high-value-added products, whether it’s medical imaging equipment, technology products or heavy earth moving equipment. We could keep going down the list. While the domestic side has been weakening, there are certain undercurrents of strength.

Advisor.ca: What’s it going to take for the U.S. economy to turn around?

Ferley: In terms of housing sales, we might be starting to see a floor take shape, though that’s still tentative. Housing starts have been cut from 2 million to 1 million, and we’ve seen aggressive action on cutting back construction. Hopefully that will do the trick on lowering inventory on homes. So you’ve got developments in place that should eventually produce a bit more stability in terms of the financial markets and recovery.

Kelly: There are two pieces we’re missing right now. The U.S. has got to get to a place where people expect that their home will be worth more than it is now, and banks have to have capital to lend, and lend to people who can afford their mortgage.

Advisor.ca: How is this affecting Canada?

Reitzes: The risks to Canada all relate to the risk to the U.S. We’ll weaken with them, but America’s downside risk is higher. We’ll have a slower economy as we export a large majority of products to the States. Also, if the global economy slows sharply, commodity prices could fall even more, and that would hurt. We’re expecting under 1% GDP growth for the rest of the year.

Gampel: It affects Canada primarily through reduced demand for products by American consumers. We produce goods and services Americans want. We’ve become an energy- and commodity-exporting country. Still, things have been selling like hotcakes. The issue here is manufacturing in Ontario and Quebec is under significant stress.

At the same time, the housing market isn’t the same, and we have better financial underpinnings — there’s less risk; the tax system doesn’t subsidize speculation; and financial institutions are more conservative lenders. But the bottom line is a slower U.S. economy, increasing strains overseas and in our export-sensitive sectors [mean] manufacturing is going to find it tough sledding, which will drag down performance of our economy.

Kelly: Even though we’re talking about one of the worst global crises in years, we’re seeing a Canadian economy that’s remained resilient. There’s ongoing job hiring, income growth, a strong housing market and strong business investment. But losing the nation’s number one export buyer causes weak demand, and we’ve seen competitiveness erode in moves the Canadian dollar has made. A global slowdown is feeding into Canada, so we’re seeing the market slow a bit. Still, the economy is avoiding a recession; there are strong fundamentals, but there will be a cool-down because the entire global economy isn’t growing as fast as it was.

Advisor.ca: One last question. If the bailout goes through — and all indications point that it will — what’s going to stop the financial industry from making a mistake like this again?

Kelly: The history of financial crises is that the industry never makes the same mistake twice, but it makes different mistakes repeatedly. Crises tend to come about when there’s rapid growth in the economy and the regulatory environment doesn’t keep up in pace to reflect new developments. That’s how we got into this, and we’ll find more crises in the future.

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@Advisor.ca.rogers.com

(09/29/08)