TORONTO, ONTARIO - Nearly a year ago, buried near the bottom of this post, I presented Canadian economist Hugh Mackenzie's view that recovery from the 1991 recession was slower than from the deeper 1980 recession because factories were actually dismantled in the later recession, whereas workers could simply be called back in the earlier case. He predicted that because the 2008 recession was deep and factories were being dismantled and moved to China that recovery would be even slower than during the 1991 recession.
Place that view in the context of a recent article in Chemical and Engineering News (C&EN; this article is not available on-line). In the piece entitled "Vanishing Plants," staff writer Michael McCoy describes how various sectors, from manufacturers of auto hoses to safety gloves to pond liners, are no longer able to get needed component chemicals in North America because they are no longer made here. Plants closed because of the recession have ended the production of such basic chemicals as formic acid and such specialized ones as chlorosulfonated polyethylene (CSPE).
The bottom line for the affected manufacturers is that without a local source of these chemicals, they are placed at a disadvantage to competitors located closer to remaining chemical suppliers in the Middle East, Asia, or even Europe. Rather than being able to return to business as usual as the economy recovers, their costs will rise and they will recover more slowly, if they can compete with their overseas competitors at all. In some cases, as the article points out, the burden is even heavier, as changing suppliers means re-validating products if they are produced for regulated industries such as the safety gloves.
Why are the plants closing permanently? McCoy's C&EN article presents a lot of opinions similar to this one expressed by Stephen Fitzpatrick: "U.S. managers look at a declining market as something they don't want to be involved with. They tend to turn tail an run." Change the "U.S." to "western" and "managers" to "managers of publicly-traded companies" and I couldn't agree more with this view, based on what I've observed. In some cases, the "declining market" may even still be profitable, but the profits aren't as large as other sectors and hence the decision is made to stop production to avoid exposure to any further declines.
In fact, it's not that different than what's happened in a completely different industry, radio. Rather than accepting "lackluster" profits, even before the recession the radio industry was being decimated by corporate parents that demanded double-digit growth in profits and slashed talent at their radio station to improve their margins, in many cases making their products unlistenable. If a station didn't look like it could give that kind of growth, virtually its entire local staff would be fired and it would start running a satellite-fed format with no local content. Newspapers are another classic example of an industry that in many cases was profitable, but not profitable enough to satisfy its investors, ending up in a downward spiral.
The pressure of today's capitalism is so strong that nobody can justify something that makes only a small profit anymore, or that might take some time to recover in a recession. Instead, those fundamentally riskier things just aren't done, resulting in everything from the loss of local radio to the inability to make innovative new pool liners--and jobs and quality of life go away as a result.
Fundamentally, the incentive structures are messed up here--short-term returns are trumping long-term investment and quality of life. The solutions are not unknown and can even come from relatively small interventions in the market--changing the time scale of executive compensation to force them to think in longer terms and even taxing short-term profits that aren't re-invested at higher rates are things people talk about all the time, but there just isn't enough of a groundswell to actually make these things happen politically, both in government and on boards of directors.
Meanwhile, the market realities make a recovery even tougher to occur, and Mackenzie comes off looking like an optimist.
Showing posts with label Hugh Mackenzie. Show all posts
Showing posts with label Hugh Mackenzie. Show all posts
Thursday, October 1, 2009
Tuesday, December 9, 2008
Economics: Housing Market Differences
TORONTO, ONTARIO - National Public Radio's All Things Considered in the United States has been doing a series on the housing market in Las Vegas, Nevada. Some of the stories told in this series are a reminder of why the housing market in Canada is in much better condition than that in the United States, and offer some pointers for reform in the United States.
A variety of comparisons between the mortgage markets in the US and Canada have come out during the US crisis; one that does a reasonable job of balancing completeness and readability came from Marsha J. Courchane of Freddie Mac and Judith A. Giles of the University of Victoria. It would be futile to try to go in depth in a blog entry, but the basics can be covered here. The most striking difference is the median mortgage in each country. In the United States, the median mortgage has a 30-year term. In Canada, the median mortgage has a 5-year term. The US mortgage usually has a fixed rate for the full 30 years, the rate on longer mortgages in Canada generally shifts after a term no longer than five years and often as short as one year. In Canada, anything beyond a "conventional" mortgage of 20% down and a 25-year term (not fixed-rate) requires insurance, and which mortgages can be insured and under what terms are much more strictly regulated in Canada than they are in the United States (where insurance is often required, but on much less strict terms). The bottom line is that the risk falls much more strongly on the borrower than the bank in Canada as compared with the United States.
While much has been made of the NINJA (No Income, No Job or Assets) loan that existed in the United States not existing in Canada, it is possible to get what would be considered a sub-prime loan in Canada. However, because of all the regulation, those sub-prime mortgages amount to less than 5% of the Canadian market, as compared with 20% in the United States. Again, clearly the lender was taking on a lot more risk in order to create a mortgage in the US.
A further incentive to taking out a mortgage in the US is the mortgage tax deduction, in which the interest paid on a mortgage is deductible against income. That effectively reduces the cost of the mortgage, again allowing the borrower to become more indebted than would otherwise be practical.
All this might seem good for borrowers in the US, since they are shouldering less of the risk, but because of those more favorable terms, they are more like to over-extend themselves and default. Partially because of that possibility, more than half of mortgages in the United States are bundled together or otherwise securitized to effectively reduce risk for the bank. That amount is less than 20% in Canada. So, when the securitization process started to implode in United States, that had a much better bigger impact on the overall market.
What really came out in the NPR series, though, is the consequence of the reduced risk to the borrower. As up to half the homes in Las Vegas are now worth less than the remaining mortgage balance (they're "under water" in common parlance), a number of the borrowers are simply walking away from the residence and returning the keys to the lender. That's not legal in Canada. About the only way to get out of a mortgage in Canada is to declare bankruptcy. Again, the added burden on the borrower has led to a more stable market, and reduced crazy scenarios like abandoning a home.
If it is agreed that the greater stability of the Canadian housing market is desired in the United States--and that may be a big "if"--then it seems the principle of a solution is clear, if not the specifics. That principle is shifting the risk back to the borrower so they will only take loans they can actually handle.
Lest that seem like a recipe for reducing home ownership rates in the United States, recall that home ownership rates in Canada and the US are similar--in the mid-60% range. How can that be? Canada has tried to provide direct ownership incentives, working on the demand side of the equation by making more people able to afford a home, whereas the US has been effectively working the supply side by making homes cheaper through a mortgage tax deduction. It should be clear that these approaches are not equivalent.
Will the United States actually engage in such reform, phasing out the mortgage tax deductions in favor of direct incentives and making it illegal to walk away from a mortgage? It seems doubtful, but I leave the last word to Hugh Mackenzie, speaking last week: "If we don't see those two points addressed, then we have to assume they're not serious about solving the problem."
A variety of comparisons between the mortgage markets in the US and Canada have come out during the US crisis; one that does a reasonable job of balancing completeness and readability came from Marsha J. Courchane of Freddie Mac and Judith A. Giles of the University of Victoria. It would be futile to try to go in depth in a blog entry, but the basics can be covered here. The most striking difference is the median mortgage in each country. In the United States, the median mortgage has a 30-year term. In Canada, the median mortgage has a 5-year term. The US mortgage usually has a fixed rate for the full 30 years, the rate on longer mortgages in Canada generally shifts after a term no longer than five years and often as short as one year. In Canada, anything beyond a "conventional" mortgage of 20% down and a 25-year term (not fixed-rate) requires insurance, and which mortgages can be insured and under what terms are much more strictly regulated in Canada than they are in the United States (where insurance is often required, but on much less strict terms). The bottom line is that the risk falls much more strongly on the borrower than the bank in Canada as compared with the United States.
While much has been made of the NINJA (No Income, No Job or Assets) loan that existed in the United States not existing in Canada, it is possible to get what would be considered a sub-prime loan in Canada. However, because of all the regulation, those sub-prime mortgages amount to less than 5% of the Canadian market, as compared with 20% in the United States. Again, clearly the lender was taking on a lot more risk in order to create a mortgage in the US.
A further incentive to taking out a mortgage in the US is the mortgage tax deduction, in which the interest paid on a mortgage is deductible against income. That effectively reduces the cost of the mortgage, again allowing the borrower to become more indebted than would otherwise be practical.
All this might seem good for borrowers in the US, since they are shouldering less of the risk, but because of those more favorable terms, they are more like to over-extend themselves and default. Partially because of that possibility, more than half of mortgages in the United States are bundled together or otherwise securitized to effectively reduce risk for the bank. That amount is less than 20% in Canada. So, when the securitization process started to implode in United States, that had a much better bigger impact on the overall market.
What really came out in the NPR series, though, is the consequence of the reduced risk to the borrower. As up to half the homes in Las Vegas are now worth less than the remaining mortgage balance (they're "under water" in common parlance), a number of the borrowers are simply walking away from the residence and returning the keys to the lender. That's not legal in Canada. About the only way to get out of a mortgage in Canada is to declare bankruptcy. Again, the added burden on the borrower has led to a more stable market, and reduced crazy scenarios like abandoning a home.
If it is agreed that the greater stability of the Canadian housing market is desired in the United States--and that may be a big "if"--then it seems the principle of a solution is clear, if not the specifics. That principle is shifting the risk back to the borrower so they will only take loans they can actually handle.
Lest that seem like a recipe for reducing home ownership rates in the United States, recall that home ownership rates in Canada and the US are similar--in the mid-60% range. How can that be? Canada has tried to provide direct ownership incentives, working on the demand side of the equation by making more people able to afford a home, whereas the US has been effectively working the supply side by making homes cheaper through a mortgage tax deduction. It should be clear that these approaches are not equivalent.
Will the United States actually engage in such reform, phasing out the mortgage tax deductions in favor of direct incentives and making it illegal to walk away from a mortgage? It seems doubtful, but I leave the last word to Hugh Mackenzie, speaking last week: "If we don't see those two points addressed, then we have to assume they're not serious about solving the problem."
Thursday, December 4, 2008
Economics: Mackenzie On Why Canada Was Hit
TORONTO, ONTARIO - As fate would have it, the Education Committee of the local Parkdale-High Park New Democratic Party happened to schedule weeks in advance a session about the economy on a night when Prime Minister Stephen Harper and opposition leader Stéphane Dion both appeared on television to make their cases to the Canadian people. Neither of leaders gave a memorable speech or said anything new. The NDP event, on the other hand, featured economist Hugh Mackenzie's views on the current situation, some of which were very informative.
One thing I had never understood about the financial crisis was why, if Canada had a sound banking system unlike the US, there had been (and to some extent, continues to be) a liquidity problem for businesses. Mackenzie pointed that businesses in Canada, like their US counterparts, had long ago stopped relying on lines of credit from their banks for their day-to-day cash needs, and were also participating in the short-term paper market, in which they effectively traded short-term bonds as required overnight to maintain liquidity.
A compelling (at least at the time) reason to use the short-term paper market was that those loaning money could invest in structured investments--which contained other paper assets, which had come to include the bundled bad mortgages from the United States that have played such a central role in the crisis--in order to earn another 1%. When the crisis hit, nobody would buy the structured investments, not knowing what they might hold, and that meant money was no longer being exchanged; the liquidity had run right out of the market.
While the smoke has cleared somewhat, Mackenzie pointed out that the difference between the interbank rate--what banks charge each other for overnight loans--and the corporate loan rate has gone from 20 basis points before the crisis to 1600 points today. That's right, it used to be a 0.2% difference and now it's 16%! It's not hard to imagine how that makes things tough on businesses.
Probably the most amusing story of the night was Mackenzie's recounting of his encounter with the Quebec travel agent who gave away trips to the Caribbean if it snowed on a given day. It had snowed, so he had to provide the trips, but Mackenzie found out that the travel agent didn't care, since he had purchased insurance. What kind? A weather derivative. Mackenzie felt that pretty much proved the case that derivatives are not different than gambling.
People at the meeting were mostly looking for answers of what should be done now, and while Mackenzie did have some suggestions, his real bottom line was not reassuring. Fundamentally, the Canadian economy is too integrated with China's resource needs and the industrial needs of the US to recover on its own. The best that can be done in Canada is to try to be ready to capitalize on the next uptick in the economy when it eventually occurs. He pointed out that the 1981 recession, while deep, was recovered from in about four years because plants were largely kept intact and people laid off. The 1991 recession was not nearly as deep, but recovery took longer. Mackenzie believes that is in large part because plants were shutdown and dismantled. The 2008 recession may be deeper than the 1981 recession, and again plants are being permanently shut down.
In Hugh Mackenzie's opinion, it might be a very long path to recovery.
One thing I had never understood about the financial crisis was why, if Canada had a sound banking system unlike the US, there had been (and to some extent, continues to be) a liquidity problem for businesses. Mackenzie pointed that businesses in Canada, like their US counterparts, had long ago stopped relying on lines of credit from their banks for their day-to-day cash needs, and were also participating in the short-term paper market, in which they effectively traded short-term bonds as required overnight to maintain liquidity.
A compelling (at least at the time) reason to use the short-term paper market was that those loaning money could invest in structured investments--which contained other paper assets, which had come to include the bundled bad mortgages from the United States that have played such a central role in the crisis--in order to earn another 1%. When the crisis hit, nobody would buy the structured investments, not knowing what they might hold, and that meant money was no longer being exchanged; the liquidity had run right out of the market.
While the smoke has cleared somewhat, Mackenzie pointed out that the difference between the interbank rate--what banks charge each other for overnight loans--and the corporate loan rate has gone from 20 basis points before the crisis to 1600 points today. That's right, it used to be a 0.2% difference and now it's 16%! It's not hard to imagine how that makes things tough on businesses.
Probably the most amusing story of the night was Mackenzie's recounting of his encounter with the Quebec travel agent who gave away trips to the Caribbean if it snowed on a given day. It had snowed, so he had to provide the trips, but Mackenzie found out that the travel agent didn't care, since he had purchased insurance. What kind? A weather derivative. Mackenzie felt that pretty much proved the case that derivatives are not different than gambling.
People at the meeting were mostly looking for answers of what should be done now, and while Mackenzie did have some suggestions, his real bottom line was not reassuring. Fundamentally, the Canadian economy is too integrated with China's resource needs and the industrial needs of the US to recover on its own. The best that can be done in Canada is to try to be ready to capitalize on the next uptick in the economy when it eventually occurs. He pointed out that the 1981 recession, while deep, was recovered from in about four years because plants were largely kept intact and people laid off. The 1991 recession was not nearly as deep, but recovery took longer. Mackenzie believes that is in large part because plants were shutdown and dismantled. The 2008 recession may be deeper than the 1981 recession, and again plants are being permanently shut down.
In Hugh Mackenzie's opinion, it might be a very long path to recovery.
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