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.

Montreal Gazette - - FINANCIAL POST -

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.”

JACK AT­LEY/BLOOMBERG FILES

The global econ­omy’s quick re­cov­ery from the COVID-19 cri­sis is pos­si­ble be­cause cen­tral banks and reg­u­la­tors have tried to en­sure that banks would sur­vive tough sit­u­a­tions and avoid the mis­takes from the fi­nan­cial cri­sis of 2008-09, says Kevin Carmichael.

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