(Globe & Mail)
The following article was written by Thomas Homer-Dixon, the author of The Upside of Down: Catastrophe, Creativity, and the Renewal of Civilization, for “globeandmail.com”. Mr. Homer-Dixon is the keynote speaker at the CSCB Annual Conference in October.
There has been something deeply disconcerting about the negotiations of the past few days in Washington to bail out the U.S. financial system: The best and brightest of policy and economic elites have seemed out of their depth.
Congressional leaders, senior administration officials, top bankers and economists, even the Chairman of the Federal Reserve admit they don’t fully understand what’s happening or what to do. As the financial crisis deepened over the past year, most of these people consistently underestimated its severity. The responses by the Federal Reserve and the U.S. Treasury - interest-rate cuts, injections of enormous amounts of liquidity into the financial sector, outright nationalization of troubled firms - haven’t reversed the slide. On the contrary, they have seemed increasingly desperate and ad hoc, sometimes veering from one extreme to another in a matter of days.
Such developments feed a deep existential fear of the unknown and the uncontrolled. Most of us want to believe that our institutions are rational, durable and fair, directed by experts who have a grip on bedrock reality and understand how things work, who will take care of severe problems when they arise. The possibility that no one knows enough to protect us is terrifying, almost unthinkable.
Now, as we’ve watched the deal-making in Washington, we’ve looked into the abyss of the unthinkable. The corporate titans, bond and derivative traders, the investment managers who inhabit the imposing towers in the hearts of our financial capitals - supposedly among the world’s smartest people - have led us into terra incognita. And the experts in Washington who are supposed to rescue us turn out to be mere mortals. Despite yesterday’s announcement of a deal in principle, in reality, it’s not clear they know the route out.
This terra incognita does, in fact, have a name: unbounded uncertainty.
Many commentators say the latest financial crisis has its roots in the implosion of the U.S. housing market, or in near-fraudulent asset rating by companies like Standard & Poor’s, or in lax oversight by regulators.
All of these factors have played key roles. But just as important are the financial innovations made possible by the combination of modern computer power, lightning-fast data communication and sophisticated mathematics, some originally developed to solve problems in physics. Financial firms have used these advances to create new types of securities of mind-numbing complexity. Take the example of collateralized debt obligations, which bundle small amounts of debt (such as individual mortgages) into packages, which are then sliced into pieces sold as bonds. Credit default swaps allow holders of assets, such as mortgage-backed bonds or standard corporate bonds, to pay someone else to assume the risk that the bond’s issuer might default. These devices are like insurance, except the firm or individual that’s paid to assume the risk - to provide insurance against default - isn’t legally obliged to have enough money on hand to cover default. They’re also bought and sold like regular securities and have become a way for speculators to bet on the demise of companies.
Both these devices progressively separate lenders from the risk associated with lending, and by doing so cause risk to be underestimated - “mispriced,” in business parlance. In the old days, a bank that lent money for a particular mortgage would have an ongoing relationship with the homeowner, and both the incentive and ability to track the homeowner’s performance in meeting his or her obligations. In other words, the bank could track the risk associated with the asset on its books. But in recent years, the bank may have sold the mortgage to a firm that packaged it into a CDO [Collateralized Debt Obligations]. The CDO’s bonds were then bought and sold again and again. Along the way, buyers purchased credit default swaps that allowed yet other parties to assume the risk on the underlying mortgage.
At the end of the day, no one really has a clear incentive - or even the ability - to determine the quality of the original mortgage. Because risk has been so fragmented and attenuated, investors are lulled into overconfidence in the value of debt and debt-related securities, which in reality are sometimes very insecure.
Here’s where lax regulation comes in. In 2004, the U.S. Securities and Exchange Commission loosened the rules governing the amount of debt major investment banks could assume in their trading activities.
Firms such as Lehman Brothers then borrowed staggering quantities of money to bet on these new types of securities, because the firms’ executives, managers, and traders - people with great technical intelligence but too little wisdom - believed their mathematical risk models were infallible.
And so, what once seemed like manageable risk has mutated into unbounded uncertainty. Corporate balance sheets far and wide are riddled with debt-related assets of unknown value. It’s virtually impossible to determine which firms, banks and investment funds are vulnerable to default, so lenders are holding on to their money. The credit meant to provide the oxygen for investment and growth has largely evaporated.
Because of deposit insurance, we’re not going to see a 1930s-style economic implosion, in which banks collapse and people lose their life savings overnight. But we may well see a slow-motion contraction of breathtaking proportions, as assets throughout our economies are repriced and wealth vanishes. People on fixed incomes derived from dividends are most vulnerable, but we’ll all feel the effects.
Next time, maybe we won’t be so eager to rely on experts to take care of us.
October 1, 2008
Economy Suddenly Tops Election Campaign Issues
(The Hill Times – Simon Doyle)
As the U.S. braces for what’s being described as the worst financial crisis since the Great Depression, economists say a federal deficit could be on the way if Canada faces an economic downturn and at the same time a need to put up cash for bailouts or economic stimulus.
Although economists for now say that Canada’s banks have not borrowed excessively, are in a relatively good position, and don’t appear to need financial support, the government won’t have much room to offer economic stimulus packages for specific sectors of the economy if the need arises.
“I do think that the government is going to be at the line in terms of running a deficit. If it did run a deficit of a few billion dollars, it would not be the end of the world, given that we’ve made so much progress,” Jack Mintz, fiscal policy expert at the School of Policy Studies at the University of Calgary, said in an interview. But he acknowledged: “It’s hard for a government, politically, to basically come out and say, ‘We’re going to run a deficit.’“
Economists now describe a host of ways that a U.S. economic slowdown can impact the Canadian economy, from sliding commodity prices to closely linked Canadian and American financial markets. An American recession will impact Canada’s exports, especially in the way of lumber and automobiles, say economists, partly because Americans are buying fewer big-ticket items such as cars and houses. Slower growth in the U.S. will also impact Canada’s commodities exports, including oil and minerals, which will in turn affect employment in Canada.
“We’ve already had a sharp slowdown in Ontario and the auto industry. The worry is that the ongoing uncertainty in the U.S. economy is going to hurt business and consumer confidence,” Kip Beckman, an economist at the Conference Board of Canada, said in an interview last week. “That’s going to hurt our exports. If Americans are going to buy fewer cars, which they’re already doing, obviously that hurts Ontario, and Canada.”
Prof. Mintz added that Canada could potentially see the bankruptcy of a major North American auto company. “I think there’s more bad news to come out,” he said, indirectly referring to steady losses at GM, Chrysler and Ford. “You could potentially see a major bankruptcy of an auto company down the road.”
Mr. Beckman said that the Conference Board’s current outlook, released this month before the major credit crisis in the U.S., said Canada can avoid a recession, which is technically defined as two consecutive quarters of decline. Avoiding that is still possible, he said, and he continues to predict government surpluses – albeit smaller ones. Still, that may not leave much room in the way of funds for economic stimulus, for ailing auto or forestry sectors, for example.
Following on the U.S. government’s $700-billion bailout for the financial industry last week, the Canadian economy became a top campaign issue, as party leaders attacked one another on who has shown better financial stewardship. The Liberals have been going after the Tories for increasing spending and tax cuts, and for effectively eroding the kind of $13-billion surpluses the Liberals had managed.
At a campaign stop in Quebec, Que., Liberal Leader Stéphane Dion (Saint-Laurent-Cartierville, Que.) called Prime Minister Stephen Harper (Calgary Southwest, Alta.) an “economic incompetent,” referring to sliding productivity and Canada’s economic record as the worst among the G8.
“He has allowed our economy to hit a brick wall,” Mr. Dion said. “Canadians have to ask themselves. Do we really want more of this? Can Canadians afford more of this?” Mr. Dion went on to say, “by the way, it’s the economy, Stephen.”
Mr. Harper downplayed serious economic impacts in Canada, saying the Canadian incomes and employment levels remain healthy and that inflation is fairing well against the rates of other western economies. Canada’s banking sector also remains healthy, he said.
“This will continue to be a slow, and a tense, and a somewhat difficult period,” Mr. Harper said. “My own suspicion is that not all the shoes have necessarily dropped in financial markets, but on the other hand we do see the government of the United States and others with a plan to deal with those things.” Mr. Harper added: “Yes, we’ve seen a slowdown in Canada, but we have not seen a recession.”
Merrill Lynch Canada released a report last week that suggested Canada is headed for a housing and mortgage crash similar to the U.S., but other economists have disputed the notion. A TD Economics report last week also said that Canada’s strong job market and financial sector fundamentals are being hurt by the U.S. economy.
“Over the next 12 months, home prices will have bottomed, the cost of funds to financial institutions will have fallen, the worst in institutional failures will be in the rear view mirror, and the process of recapitalizing the financial system will be well underway,” said the report.
Thomas Homer Dixon, an international affairs professor at the University of Waterloo, said in an interview last week that the Tories have worn down the government’s tax base with a two-point cut to the GST, and that lost revenue – about $10-billion per year – could come in handy at the time of a potential recession.
“There’s less capacity to use government fiscal policy to compensate for a downturn in the economy,” he said. “That surplus would be a nice thing to have right now, but it was substantially reduced, and to virtually no benefit, except some short-term political benefit.”
He said the Liberals under Jean Chrétien balanced the budget, but to be fair, the Liberals were able to do so because the Mulroney Tories before them introduced the GST. Prof. Homer Dixon said Canada will see a drop in housing prices, but not on the same scale as the U.S. He said the problem now is that it’s hard to determine the value of credit investment vehicles, that financial markets are now driven by fear and there’s been a “debilitating loss of confidence” in credit markets.
“People are left with nothing to turn to. It’s like looking into the abyss. Every few days it comes back, then there’s a wave of fear, panic, and a crisis atmosphere among policy makers. Then it stabilizes, then it comes back,” he said. Read the complete article.
As the U.S. braces for what’s being described as the worst financial crisis since the Great Depression, economists say a federal deficit could be on the way if Canada faces an economic downturn and at the same time a need to put up cash for bailouts or economic stimulus.
Although economists for now say that Canada’s banks have not borrowed excessively, are in a relatively good position, and don’t appear to need financial support, the government won’t have much room to offer economic stimulus packages for specific sectors of the economy if the need arises.
“I do think that the government is going to be at the line in terms of running a deficit. If it did run a deficit of a few billion dollars, it would not be the end of the world, given that we’ve made so much progress,” Jack Mintz, fiscal policy expert at the School of Policy Studies at the University of Calgary, said in an interview. But he acknowledged: “It’s hard for a government, politically, to basically come out and say, ‘We’re going to run a deficit.’“
Economists now describe a host of ways that a U.S. economic slowdown can impact the Canadian economy, from sliding commodity prices to closely linked Canadian and American financial markets. An American recession will impact Canada’s exports, especially in the way of lumber and automobiles, say economists, partly because Americans are buying fewer big-ticket items such as cars and houses. Slower growth in the U.S. will also impact Canada’s commodities exports, including oil and minerals, which will in turn affect employment in Canada.
“We’ve already had a sharp slowdown in Ontario and the auto industry. The worry is that the ongoing uncertainty in the U.S. economy is going to hurt business and consumer confidence,” Kip Beckman, an economist at the Conference Board of Canada, said in an interview last week. “That’s going to hurt our exports. If Americans are going to buy fewer cars, which they’re already doing, obviously that hurts Ontario, and Canada.”
Prof. Mintz added that Canada could potentially see the bankruptcy of a major North American auto company. “I think there’s more bad news to come out,” he said, indirectly referring to steady losses at GM, Chrysler and Ford. “You could potentially see a major bankruptcy of an auto company down the road.”
Mr. Beckman said that the Conference Board’s current outlook, released this month before the major credit crisis in the U.S., said Canada can avoid a recession, which is technically defined as two consecutive quarters of decline. Avoiding that is still possible, he said, and he continues to predict government surpluses – albeit smaller ones. Still, that may not leave much room in the way of funds for economic stimulus, for ailing auto or forestry sectors, for example.
Following on the U.S. government’s $700-billion bailout for the financial industry last week, the Canadian economy became a top campaign issue, as party leaders attacked one another on who has shown better financial stewardship. The Liberals have been going after the Tories for increasing spending and tax cuts, and for effectively eroding the kind of $13-billion surpluses the Liberals had managed.
At a campaign stop in Quebec, Que., Liberal Leader Stéphane Dion (Saint-Laurent-Cartierville, Que.) called Prime Minister Stephen Harper (Calgary Southwest, Alta.) an “economic incompetent,” referring to sliding productivity and Canada’s economic record as the worst among the G8.
“He has allowed our economy to hit a brick wall,” Mr. Dion said. “Canadians have to ask themselves. Do we really want more of this? Can Canadians afford more of this?” Mr. Dion went on to say, “by the way, it’s the economy, Stephen.”
Mr. Harper downplayed serious economic impacts in Canada, saying the Canadian incomes and employment levels remain healthy and that inflation is fairing well against the rates of other western economies. Canada’s banking sector also remains healthy, he said.
“This will continue to be a slow, and a tense, and a somewhat difficult period,” Mr. Harper said. “My own suspicion is that not all the shoes have necessarily dropped in financial markets, but on the other hand we do see the government of the United States and others with a plan to deal with those things.” Mr. Harper added: “Yes, we’ve seen a slowdown in Canada, but we have not seen a recession.”
Merrill Lynch Canada released a report last week that suggested Canada is headed for a housing and mortgage crash similar to the U.S., but other economists have disputed the notion. A TD Economics report last week also said that Canada’s strong job market and financial sector fundamentals are being hurt by the U.S. economy.
“Over the next 12 months, home prices will have bottomed, the cost of funds to financial institutions will have fallen, the worst in institutional failures will be in the rear view mirror, and the process of recapitalizing the financial system will be well underway,” said the report.
Thomas Homer Dixon, an international affairs professor at the University of Waterloo, said in an interview last week that the Tories have worn down the government’s tax base with a two-point cut to the GST, and that lost revenue – about $10-billion per year – could come in handy at the time of a potential recession.
“There’s less capacity to use government fiscal policy to compensate for a downturn in the economy,” he said. “That surplus would be a nice thing to have right now, but it was substantially reduced, and to virtually no benefit, except some short-term political benefit.”
He said the Liberals under Jean Chrétien balanced the budget, but to be fair, the Liberals were able to do so because the Mulroney Tories before them introduced the GST. Prof. Homer Dixon said Canada will see a drop in housing prices, but not on the same scale as the U.S. He said the problem now is that it’s hard to determine the value of credit investment vehicles, that financial markets are now driven by fear and there’s been a “debilitating loss of confidence” in credit markets.
“People are left with nothing to turn to. It’s like looking into the abyss. Every few days it comes back, then there’s a wave of fear, panic, and a crisis atmosphere among policy makers. Then it stabilizes, then it comes back,” he said. Read the complete article.
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