WHY THE CORONAVIRUS DOWNTURN MAY JUST BE A RECESSION, NOT A DEPRESSION
There are still decent odds that the pain will be short-lived, Kevin Carmichael writes.
The lessons of the financial crisis were starting to fade.
For instance, every major Canadian political party sought votes ahead of last year’s federal election by promising easier mortgage restrictions. Some of the biggest companies were issuing cheap debt and buying back shares instead of building up reserves and investing. Financial markets were frothy, and yet investors appeared more fearful of missing out on the boom than of getting wiped out by a bust.
But central bankers never forgot.
The major central banks and financial regulators kept working to make sure banks would be more resilient when the next storm hit. They also put considerable effort into thinking about which of their tools worked best during the financial crisis, and how they could be adjusted for future crises. They developed contingency plans so they wouldn’t be forced to create policy on the fly, as they often did during the autumn of 2008 and early 2009.
That work is now paying off. The new coronavirus recession will be brutal, but there are still decent odds that it will be short. If the economy is put on life support, then it should start up again once the threat to public health passes. The reason a quick reboot should be possible is that the banks were told the mistakes behind the financial crisis wouldn’t be repeated. Financial institutions were ordered to preserve enough capital to survive the toughest situations imaginable.
Banks grumbled that their new stress tests were unreasonably harsh. Thankfully, their regulators mostly ignored them. You will have heard stories of banks being difficult in recent weeks, as desperate companies collide with inflexible processes for loan approvals. But imagine what it would be like if financial institutions were in danger of bankruptcy like almost every other company? The stability of the banking industry is the reason we’re confronting a second Great Recession, and not a repeat of the Great Depression.
“In some ways, we are in better shape (than in 2008) because we aren’t destroying balance sheets,” Paul Boothe, an Ivey Business School academic who served in senior positions at Finance and Industry during the financial crisis, said in an interview.
“Luckily, it’s not a financial-market driven, or a financial-meltdown driven, shock,” he added. “That tells me that if we can get through this, and that’s the sort of the public health side, then I think we can come back fairly quickly and we don’t have to have the long rebuilding of balance sheets that we had post 2008-2009.”
The relative stability of the banking system has allowed the Bank of Canada to fight a guerrilla war, rather than relying on interest-rate cuts alone to offset the economic damage from the crisis.
Governor Stephen Poloz and his deputies slashed interest rates by a full percentage point in less than two weeks, dropping the benchmark rate to 0.75 per cent. Many analysts and investors predict Canada’s official rate is headed to at least 0.25 per cent, and maybe even zero, matching the U.S. Federal Reserve’s move earlier this month.
Those moves are likely. But one reason the Bank of Canada hasn’t had to rush to zero is that it has developed ways to calm specific markets that are showing signs of stress. The strategy allows policy-makers to save their biggest gun — the benchmark interest rate — for when things go really bad.
Earlier this week, after the Bank of Canada’s trading desk noticed unusual spikes in the market for short-term provincial debt, the central bank created the Provincial Money Market Purchase program, becoming a buyer of provincial treasury bills and promissory notes. On Wednesday, the Bank of Canada bought some $279 million worth of such assets, reducing the cost of credit for provincial governments, which are on the frontlines of the health emergency.
On Tuesday, the Bank of Canada bought $242 million of mortgage-backed securities, keeping a promise to purchase as much as $500 million of those securities per week to ensure a steady source of demand in a market that banks rely on to backstop their mortgage lending. The previous day, the central bank added $20 billion of banker’s acceptances to its portfolio through a separate program meant to keep cash flowing in a market that underpins a source of small-business finance.
In all, the Bank of Canada has established about a half-dozen of these sorts of programs with remarkable speed. That’s because policy-makers have spent the past decade getting ready for a scenario like this one. Many of the crisis fighters on the political side have drifted away, but many of the technocrats remain in place. For example, Carolyn Wilkins, a senior member of the Bank of Canada’s staff in 2008, is now the second in command.
“Those lessons were learned not just by the lenders, but they were learned by the policy-makers,” Poloz told reporters on March 18. “Personally, I have great comfort from the seasoned people who I’ve got around me who were living through that.”