By Dr. Peter Andersen
Global financial losses keep climbing. World-wide investment and credit losses are up to an estimated $290 billion. This reduces balance sheet capital and puts limits on the ability and willingness of banks to lend.
Regulators force banks to adhere to strict capital-asset ratios. Financial losses reduce capital and therefore reduce these capital ratios. This makes it hard for banks to increase loans, which are the asset part of the ratio. The result is a credit crunch, despite lower central bank and government interest rates. Loan growth is what creates money supply growth and it is being held back by lenders' balance sheet problems. The bottom line is that traditional monetary policy is not working.
So far, nothing has happened that will solve the core problem. Mortgage defaults in the U.S. keep rising. There are reports that even homeowners with the best credit are having difficulty keeping up with payments. U.S. foreclosure filings jumped by 57 per cent year-over-year in March and bank repossessions more than doubled from a year ago.
It is estimated that almost 9 million U.S. households are "upside down" on their mortgages. The mortgage is larger than their homes are worth. It will be several years before the scheduled resets on sub-prime mortgages return to more tolerable levels. Without a massive taxpayer-funded U.S. Federal Government solution, the credit crisis seems likely to still have a long way to run.
Global Investment Losses
The International Monetary Fund (IMF) released its World Economic Outlook report on April 9. It estimates that global investment losses could reach $945 billion (US). This would be far in excess of the losses stemming from the Asian financial crisis or the U.S. savings and loan crisis in previous decades. According to the IMF, European banks will soon join their U.S. counterparts in writing down losses and there will be a lagged shock effect on the global economy.
The IMF estimates about half of the losses will be absorbed by global banks and the rest by insurance companies, pension funds, money market funds, hedge funds and other institutional investors. The IMF predicts that de-leveraging will shrink available credit throughout the global financial system and puts the probability of a global recession in 2008 and 2009 at around 25 per cent.
The emerging market economies have been resilient up to now but they are not immune to the credit crisis. Countries in emerging Europe have relied heavily on foreign bank credit to finance rapid economic growth. Banks in the large industrial countries could begin to pare back lending to their subsidiaries in developing countries. Emerging market economies could also face increased funding costs as global financial institutions contract balance sheets.
Canadian Firms Not Expecting Recession
The latest Bank of Canada (BOC) business outlook survey indicates that opinion on future sales growth has turned negative, but not by much and business leaders expect a growth rate similar to what has been experienced over the past 12 months. Outside of manufacturing, the non-financial part of Canada's economy is doing relatively well. Canada's new home builders and renovators should feel encouraged. Employment increased strongly by 104,000 in the first three months of 2008. Employment growth will support consumer confidence and this will allow declining Canadian mortgage rates to have a positive effect on housing demand.
The Bank of Canada's decision to cut its target overnight interest rate by another 50 basis points on April 22 will give another downward nudge to mortgage rates. Governor Carney is taking a pre-emptive approach as Canada is vulnerable to a deeper and more protracted U.S. slowdown. Also, credit crises do not respect international borders and Mr. Carney is anxious to limit the fall-out in Canada.
Fortunately, inflation has dropped sharply in Canada, despite soaring energy prices, giving the Bank of Canada leeway to take out an extra measure of recession insurance. According to latest figures, Canada's all-items CPI inflation rate is down to 1.4 per cent year-over-year.
This shift away from the gradualist policy moves of the past makes sense in today's environment. The IMF warning of a possible global recession is not to be taken lightly. It would deflate the commodity bubble that is contributing to the ongoing momentum in energy, mining, agriculture and Canada's overall general economy. The Bank has indicated that further monetary stimulus will likely be required.
Home Sales Will Rebound
The first-quarter decline in existing home sales has raised fears that a housing market downturn has now begun in Canada. Unit sales are estimated to have declined by more than 10 per cent from the first quarter of last year. Brutal winter weather in the Toronto market played a big role in the national results. New home sales for low-rise units in the GTA were down in March by more than 20 per cent year-over-year. In our view, however, the economic fundamentals are still positive and are consistent with a second-quarter rebound in home sales.
