Gimme shelter
Banks profit in good times and in bad, we all share the pain
Ellen Russell
Photography by Reuters: Mark Avery
“Poor Canada—so far from God and so close to the United States.” Although this quotation is recycled from the 19th-century Mexican dictator Porfirio Díaz, the sentiment still applies as U.S. financial turbulence threatens to do serious collateral damage in Canada. And while the financial institutions that made this mess profited handsomely in the good times, in the bad times we all share the pain.
This latest financial carnage has been years in the making. In the early 2000s the U.S. was looking shaky: the 1990s tech boom had collapsed, Enron and other baddies were discrediting corporate America, U.S. businesses were nervous of global competition and, well, 9/11 came along.
Alan Greenspan—U.S. Federal Reserve chairman and patron saint of the financial elite—stepped in. He lubricated the economy by printing money, which made a tricky situation a lot less tricky—at least for a while.
Plentiful money ignited a home-buying spree that pushed up the price of housing by 53 percent between 2002 and 2007. Homeowners whose paycheques weren’t stretching far enough could borrow against their appreciating homes. Americans went shopping, which stimulated the economy, but left households deeply in debt.
Always game for profitable hocus-pocus, financial institutions salivated over rising house prices. In a hot housing market, thousands of mortgages could be bundled together, and slices of this bundle could be sold off as securities that could trade like stocks and bonds—a process called “securitization.” The profits they made reselling those securitized mortgages funded yet more mortgages. With mortgages so cheap and easily available, the housing market skyrocketed, and a bubble was born.
Bubbles encourage risk-taking, and financial institutions sought out more dubious activities. They encouraged people who probably couldn’t afford it to purchase homes (at teaser intro interest rates set to rise later) and voilà: the subprime housing market took off. Banks assumed that appreciating house prices and falling interest rates could more than cushion subprime homebuyers’ shaky financial situations.
Sound familiar? In the 1970s, banks pressured third-world countries to take loans—whether or not the countries could realistically repay them once interest rates climbed. Back then it was called “loan pushing” (like drug pushing, only the pusher creates a long-term debt impoverishment instead of drug addiction). Many poor countries still haven’t recovered from that mess.
Already perched on a knife-edge, subprime borrowers fell into default as their interest payments “reset” at higher rates, they lost their jobs or other problems pushed them over the edge. In January of this year, 233,000 Americans received foreclosure notices—up 60 percent from January 2007.
Investors soured on securitized assets as mortgages underlying them appeared increasingly risky. The slicing and dicing involved in securitization means that no one is clear who is holding these now toxic securities. Financial institutions started running scared.
The problems in financial markets can morph into a general economic nosedive. Huge losses on bad mortgages make banks cut their lending. This slows economic activity as even credit-worthy businesses and individuals find their bankers hunkered under their desks rather than lending money. Spooked homeowners with hefty credit-card bills fear for their jobs and cut back on their spending, further slowing the economy.
While financial institutions are free-market boosters in good times, in bad times they want government help. The same blind faith that led America into Iraq drove excess confidence in housing prices and speculative finance. Millions of homeowners, mortgage lenders, banks and Wall Street are now trapped in an expensive asset-meltdown quagmire. Regulation will have to change, trillions will be lost. Government and private costs are high and rising.
How is Canada affected by all of this? Of course when the U.S. economy slows, Canadian exports are hit. But the impact of globalized financial markets is a wild card.
For starters, Canadian financial institutions got into the subprime craze (and other bubble shenanigans) via adventures in asset-backed commercial paper and other financial exotica. No one knows how much toxic waste is buried in their “structured investment vehicles” (causing the irreverent to label the financiers “SIV-positive”).
We also have to worry about a conventional recession spilling over. According to the International Monetary Fund, financial conditions are now “the largest source of U.S. spillovers to Canada.” And as our financial institutions wobble, we risk a Canadian credit crunch that will drag down our economy.
Since the God Señor Díaz referred to is not forthcoming about how to handle this mess, perhaps it’s time to start asking some tough questions about a system that privatizes the profits and socializes the costs.
