U.S. financials shock investors
The massive sell-off on Monday in North American stock markets that accompanied the filing for bankruptcy protection of American investment bank Lehman Bros. and the sale of Merrill Lynch — two of the largest and oldest financial firms on Wall Street — has left Canadian banks bruised but not beaten.
It also drew politicians on the campaign trail into the debate, with Prime Minister Stephen Harper maintaining “the Canadian economy’s fundamentals are solid,” while Liberal Leader Stephane Dion cautioned the “difficulties in the United States are something we worry about.”
That followed a rare move by the Bank of Canada in issuing a public reassurance that it is “closely monitoring global market developments,” which in turn prompted speculation the central bank may cut interest rates next month.
“I think you have to concede that there is a tangential impact on the Bank of Canada from these developments over the weekend,” said Eric Lascelles, chief economics strategist at TD Securities in Toronto. “The markets definitely believe so. They are convinced.”
The Toronto Stock Exchange’s benchmark index on Monday plunged 515 points, or four per cent, the biggest one-day drop in nearly eight months. South of the border, the Dow Jones indus- trial average fell 504.48 points, or 4.42 per cent. The Nasdaq shed 81.36 points, or 3.6 per cent. Markets around the world tumbled.
Robert Kavcic, an economic analyst for BMO Capital Markets in Toronto, said most investors realize Canadian banks are not at risk of suffering similar fates as seen in the U.S. because they have mostly not left themselves exposed to risky as- set-backed securities — such as U.S. subprime mortgages — as much as American institutions.
He added that Canadian banks tend to be more diversified across investment, mortgage and general retail operations, not concentrating on one particular area as U.S. banks tend to do.
He added that the retail-banking climate in Canada remains healthy.
The news of Lehman Bros. and Merrill Lynch, taken over by Bank of America for US$50 billion, follows developments about a week earlier that saw the U.S. federal government take over mortgage giants Freddie Mac and Fannie Mae. And in March, another large U.S investment bank, Bear Stearns, was bought out by JPMorgan Chase in a deal partly facilitated by the Federal Reserve.
Fred Ketchen, director of equity trading with ScotiaMcLeod in Toronto, said there is a bright side to what is happening, despite the pain investors were likely to feel and possibly for the short term.
“This is not, as far as I’m concerned, a disaster for (Canada),” he said.
Ketchen echoed the sentiment that Canadian banks are in much better shape than American ones. Also, he said the U.S. financial industry could be on stronger ground after recent developments, since the “weaker links” are being taken out of the field.
Harper told reporters in a campaign stop in Ottawa that Canada’s economic fundamentals, especially those in the financial system, remain solid.
“There are and will be difficulties in the world economy,” he said. “At the same time, Canada is not in the same situation as the United States. Our household sector, our government sector, and our financial institutions have solid economic fundamentals. The Canadian economy’s fundamentals are solid.”
Dion, for his part, said the “difficulties in the United States are something we worry about.”
He told reporters in St. John’s, N.L., that high-spending policies and “bad choices” of the Harper government have hurt the country, and resulted in slower economic growth in the last six months in Canada than in the United States.
Sherry Cooper, chief economist at BMO Capital Markets, said Harper has little choice but to highlight the country’s underlying economic strength. “If he were to do something, it would be interpreted as, ‘Geez, the economy must be worse than what he says.’ And secondly, what he is saying is correct.”
Meanwhile, Cooper said Tuesday’s rate decision by the U.S. Federal Reserve will determine what the Bank of Canada does next.
If the Fed moves to cut its benchmark rate, “it raises the likelihood of the Bank of Canada cutting rates. But it doesn’t necessarily mean it will do so,” she said. “Our economy is nowhere near as weak as the U.S.”