Pity the poor Canadian policymakers who are fighting a deteriorating economy and troubled financial systems that reside far beyond their control. Despite their best efforts, they must hope that their counterparts in other countries do much of the heavy lifting necessary to get the markets back on track.
The global economy is quickly sliding into a co-ordinated recession, taking Canada down with it (along with most parts of the developed and developing world). Economic forecasts are deteriorating quarter by quarter, despite aggressive monetary and fiscal policy actions designed to stimulate demand.
The problem, policymakers agree, is that a prerequisite for economic recovery is the stabilization of the financial system, which has yet to happen. “A sustained economic recovery will not be possible until the financial services sector’s functionality is restored and credit markets are unclogged,” says the International Monetary Fund in its latest forecast.
This position was echoed by Mark Carney, governor of the Bank of Canada, in his testimony to the House of Commons standing committee on finance in mid-February. During his testimony, Carney reiterated the BofC’s belief that “stabilization of the global financial system is a precondition for economic recovery globally and in Canada.”
Carney noted that central banks around the world, including Canada’s, have kept the financial markets working by pumping unprecedented quantities of liquidity into the system. However, he also pointed out, it has subsequently become clear that this is a solvency crisis rather than simply a liquidity crisis.
The challenge of repairing the financial system is far from being met, Carney noted. Moreover, it also lies outside the purview of the BofC — or of any other Canadian authority, for that matter. “The reality is that,” Carney told the parliamentary committee, “the financial crisis and subsequent recession originated beyond our borders and the necessary triggers for a sustainable recovery must be found there as well.”
Central bankers in Britain find themselves in much the same position. Mervyn King, governor of the Bank of Eng-land, admitted in mid-February that the British economy is now in a “deep recession.”
There, too, monetary, fiscal and other policies have all been deployed. But, King warned, the length and depth of Britain’s recession will “depend to a significant extent on developments in the rest of the world.” And, the biggest policy challenges — restarting lending and restoring market confidence — will not be solved easily or quickly.
There is some agreement on what needs to be done. Carney stressed that there must be efforts in the U.S. and elsewhere to remove the toxic assets that are hampering banks’ ability to lend. He also said that efforts to create a core of so-called “good banks,” among other things, will be critical to restoring the global financial system to good health.
The IMF report recommends similar actions, noting that new initiatives are required to carve out bad assets, provide capital to viable banks and to produce credible loan-loss recognition.
If these measures “are not timely, bold and well executed,” Carney warned, “Canada’s economic recovery will be both attenuated and delayed.”
The problem, of course, is that these actions must come from the authorities in other countries that have their own political, financial and cultural constraints to accommodate.
The big hope is that the new U.S. administration will be able to do what its predecessor could not in saving the global financial system. Newly appointed Treasury Secretary Tim Geithner sketched out the broad strokes of his plans in mid-February — an approach that includes further capital injections for banks; the creation of a fund to buy bank assets using a combination of private and public money; an initiative to reduce foreclosures; and the expansion of an existing Federal Reserve Board program that’s designed to revive securitization and expand lending.
The plan’s announcement was initially met with disappointment by the markets, expressed in the form of a deep sell-off — led by the financials services sector.
The resulting market action was explained by some analysts as a response to the lack of specific details in the plan. A report by Montreal-based research firm BCA Research attributed the market’s reception to the “lack of detail about how it will work, following a buildup of expectations that concrete measures were ready to go.”
This assessment was echoed by analysts at UBS Financial Services Inc. in a research report: “The plan clearly falls short of providing a comprehensive solution to the financial crisis and lacks detail.”
@page_break@Without a clear understanding of how the next round of capital injections will work, and absent a solid blueprint for the proposed public/private fund to get bad assets off banks’ balance sheets, there was little in the plan to comfort investors. Instead, it came across as a work in progress — and that did not immediately inspire confidence.
The markets may also have been expressing displeasure about what doesn’t appear to be in the new treasury secretary’s plans. In the weeks leading up to the unveiling of the latest plan, there was some hope that the U.S. Treasury would opt to create a “bad bank” to hold troubled assets, or otherwise fence off these assets from the healthy parts of the banks that do hold them.
The need to get these bad assets off banks’ balance sheets was recognized in the early days of the crisis. Indeed, this was the original purpose of the US$700-billion bailout crafted by Geithner’s predecessor last fall. But actually accomplishing this task has proven easier said than done, and the government opted to use the money to inject capital into banks rather than buying their troubled assets.
This latest plan is doing little to convince some that this administration will be any more successful than the previous one. “Geithner offered no specifics on the implementation process needed to identify and value the toxic assets, compel banks to disgorge them and incentivize private capital to acquire them,” observes the BCA Research report. “In short, many of the hurdles that befell the original [Troubled Assets Relief Program] plan remain in place.”
A report by New York-based Oppenheimer & Co. Inc. appears to agree: “The new proposals, primarily aimed to entice private capital into the market, lacked sufficient detail to get excited about yet.” The report also expresses support for the idea of reviving consumer lending by boosting the securitization market.
“However, as yet, details have been slim and execution remains unproven,” the report continues. “Our key concern, however, is that nothing the government can do is capable of altering the unavoidable reality that fewer American businesses and consumers will have access to prior levels of credit.”
Rising risk aversion on the part of banks is constraining their lending. And with the economy deteriorating, unemployment rising and credit quality declining, banks are rightly worried that they may face large losses in the year ahead. So, hoarding capital to accommodate those losses, not lending it out, is the priority.
“Years worth of loans were underwritten with ‘bad math’ assumptions or too optimistic underlying economic forecasts,” the Oppenheimer report says. “Short of becoming a direct lender to businesses and consumers, there is little the government can do to change lenders from pulling back from years worth of lending to borrowers with a proven track record of not paying back.”
The UBS report also anticipates rising credit losses and capital needs for banks in the year ahead. “We are skeptical that private capital can be relied upon to recapitalize banks at this stage,” it says. The report concludes that the latest proposals probably won’t be enough to turn around the financial system: “We expect additional measures to follow in the future and cannot exclude [the possibility] that the government will be forced to resort to full-blown nationalization of individual banks.”
All of this leaves policymakers in Canada and elsewhere in a tough spot. Having done almost all they can on the monetary and fiscal policy fronts in their own backyards, they are left to hope that other governments will have the wisdom and the resources to save the global financial system and allow recovery to take hold. IE
Waiting for the world to catch up
Canadian banks are strong but still hampered by other countries’ problems
- By: James Langton
- February 25, 2009 February 25, 2009
- 09:22