With 2008 now drawn to a welcome end, certainly as far as financial markets are concerned, and for many the affairs of state in Ottawa, we can look back to it as annus horribulus. With what amounts to an almost break down of confidence and trust in financial markets and institutions, we have witnessed the demise of brand name investment banks and bailouts in the US and Europe that are in the trillions and almost defy imagination! Karl Marx and his followers have to be saying “we told you so.”
While we on Main Street should be mad as hell that the financial system of the world almost collapsed, we should also recognize that we played are own small part too in benefitting from the cheap money credit gravy train and enjoying the bubble of equity and housing values. There is a law of gravity to financial markets and while we were at one time in 2007 flirting with a TSX of 15000, as I write this commentary, we are not sure if we can maintain a bottom of 9000! Other stock markets have also seen significant declines so there is no decoupling here.
What started as a credit crisis moved to liquidity and solvency crisis on a global scale and what is worrying for economic growth, a loss of consumer confidence. When the data on the traditional Christmas spending spree come in we will know more, but the signs are not good with the November sales figures down (except for Wall Mart). Some retail chains have filed for bankruptcy (e.g. Woolworths in the UK) and there were lots of pre Christmas sales! The OECD and many politicians have now used the R word and as it has been confirmed for the USA it is only a matter of time for Canada to be included.
While this wholesale slide into what is now uncharted financial territory began in August 2007, if we look back to those almost halycon days, the global economy was still showing signs of robust growth and inflation concerns were leading to further interest rate tightening. However, to use a Winston Churchilian term, the Storm Clouds were gathering. This was evident in 2006 with the US housing boom coming to an end and with it spelling the demise of the business case for subprime mortgages and their securitized aunts and cousins. In early 2007 there were clear signs of trouble in both the U.S. and Europe with write downs and failures of financial institutions particularly in the U.S.
As a result of these signs I wrote a column in July, 2007, for the Halifax Daily News in which I discussed the potential for a financial tsunami. While I cannot claim any real forecasting ability, these earlier pre- shocks were leading almost inevitably to a financial earthquake, perhaps on a Richter scale level of 7. Serious, but not enough to lay waste to all of the system. The aftershocks that came in September and October of this year in particular did almost that making this crisis like no other, certainly in the last 70 years or even more. They hit the very core of the financial system causing panic and a global loss of confidence not just among investors/savers, but among banks as the interbank market has still seized up and many prime borrowers in Canada are still finding difficulty obtaining loans, even from their primary bankers.
In a subsequent piece in September 2007, I posed the question as to whether a fatal flaw existed in the financial architecture of what is often referred to as the Anglo American system or was it the usual plain old greed and stupidity? Now I think we can add fraud to the list. Given that many banks in Europe, including the usually very conservative Swiss and Germans are caught up with holding subprime securitized debt and its consequences, we can probably conclude that if there is flaw it is more prevalent – not exactly a recipe for a good night’s sleep!
One is prompted to ask the question “do we retain any memory of recent history never mind the bubbles and crashes of history?” The dot com bubble was a case in point where investors willingly flocked to IPO’s of any new IT idea. Some financial analysts enthused about the new economy and how the IT sector was rewriting the fundamentals of stock valuation. Of course this whole episode imploded and we reverted to the standard and well tested textbook models of how value is created and destroyed. Our economies survived the trauma including 9/11 that followed and apart from the NSADAQ , the broader stock market indices not only recovered, but reached new heights. We will survive this on too but there will be a lot of turbulence as our economies slowly recover and financial markets claw their way back to the heights we once enjoyed.
As we look forward in 2009 we can be assured that recession woes will continue, at least into the 3rd and 4th quarters. While we can expect some selective buying of some of the blue chips that are severely depressed, it will take a series of positive earnings coming from the broader corporate sector for the financial markets to have a sustained and positive reaction. While there is a lot of cash out there right now waiting to be ploughed into the market, investors are more cautious now than they were after Black Friday/Monday in October 1987. It took 22 months for the TSE index as it was then to fully recover. This would seem a very unlikely timeline for what faces us today.
Another necessary condition for a full recovery is to fix the regulatory gaps that exist both within countries and cross border. This will need a coordinated response on the lines of a Bretton Woods Mark 2 which will set a prudential, ex ante regulatory framework that will not stifle innovation, but provide more effective control of institutions and markets. Simultaneously we will need surveillance systems that can provide early warnings and trigger policy makers’ responses to emerging shocks and insolvencies. Finally we will need an ex post response if markets and institutional failures occur. This is a tall order to achieve. The world of 2009 is very different to that of 1944 that produced the institutional foundations of our post WW 11 monetary and trade system, namely the IMF, World Bank and what is now the WTO.
Capitalism thrives on the concept of greed and it is very difficult to legislate its control. It is clear from this crisis and the Enron, Dot Com et al events that we have seen in our recent past, that if the leaders of financial institutions, the corporate sector and rating agencies cannot be relied upon to maintain standards of integrity and ethics that we on Main Street should expect from them, then we can expect a roll back of the liberalization of regulatory controls that took place progressively from the 1970’s onwards that lead to a greater reliance on self regulation. We would all lose from this, but as excesses can have negative outcomes, and this crisis has been no exception, then the pendulum will swing to greater state and global regulation/control.
J. Colin Dodds, President
St. Mary's University
Halifax, Nova Scotia