EU, Iceland, Canada Suffering Fall Out, Caused By US Crisis

EU leaders come up short on economic crisis plan

Oct. 4 2008

CTV News Staff

The leaders of Europe’s most powerful economies agreed Saturday to stave off potential financial peril by backstopping their weakened banking system, but they stopped short of announcing a sweeping, U.S.-style bailout package.

Still, Germany, Britain, France and Italy pledged to work together as shrinking financial stocks continued to hammer European markets and credit shortages threatened to freeze up businesses across the continent.

Optimism over the European Union pledge, however, was dimmed by news that a US$48 billion plan to save one of Germany’s top banking institutions had fallen apart Saturday.

Economic worries in Europe have been exacerbated by a difference of opinion on how best to combat the problems. Greece and Ireland have already broken with the rest of the EU and decided to shore up bank savings.

The leaders, who were in Paris Saturday at the behest of French President Nicolas Sarkozy, also called for an emergency meeting of the Group of Eight nations – which includes Canada – to coordinate a global response to what is now a worldwide crisis.

The urgent call for a G8 meeting underscores the growing threat of a deep global recession, but stands in stark contrast to comments by Conservative Leader Stephen Harper that Canada’s economy will weather the economic storm.

While Harper maintains that Canada’s banking system is secure, opposition leaders like the Liberals’ Stephane Dion have accused Harper of having no plan to deal with the mounting economic threat.

The European agreement – which includes German Chancellor Angela Merkel, French President Nicolas Sarkozy, British Prime Minister Gordon Brown, and Italian Premier Silvio Berlusconi – comes a day after U.S. President George Bush signed into law a bi-partisan, US$700 billion package that aims to thaw freezing credit markets and kick-start a sputtering economy.

“We have to make sure Europe takes its responsibilities like the United States,” said Dominique Strauss-Kahn, the head of the International Monetary Fund, on Saturday.

Over the past week alone, European countries have been forced to spend billions of dollars to ensure banks stay afloat.

Strauss-Kahn added that the financial plague, which began on Wall Street with toxic mortgage debt and has quickly spread to the world economy, amounts to “trial by fire” for Europe’s money markets, which have grown increasingly interrelated over the past decade.

Recently, worry that evaporating credit would leave European banks unable to shoulder their debts led to a drop in share prices that has forced governments from London to Berlin to intervene with aid packages.

Worse, many European countries were already facing an economic slowdown leading up to the current crisis.

Though France initially wanted to dump funds into a European Union reserve for struggling banks, Germany’s economic minister Michael Glos said in an interview with the Bild am Sonntag newspaper that banks themselves should take the lead in shoring up market confidence.

“In this situation, I don’t think it’s defensible to demand the state restore the trust that has been gambled away with large-scale debt write-offs using tax money,” he said.

Wall Street’s woes around the world

Meanwhile, British Prime Minister Gordon Brown has said that more attention should be given to the economy as a whole, including a US$21 billion contingency package for small businesses.

Still, Brown said at the Paris summit that creating stability should be paramount.

“People will be very clear that every country represented here today will want to do whatever is necessary to secure the stability of the system and to ensure the safety of hardworking families and businesses in each of our countries,” Brown said.

Wall Street’s troubles have also spread to Asia, where investors are reeling from falling stock prices and shrinking credit markets

In Hong Kong along for example, investments linked to Lehman Brothers, which filed for bankruptcy last month, were valued at around $2 billion.

In recent weeks, officials have fielded close to 4,000 calls from investors complaining about Lehman Brothers investments, The Associated Press reported.

Elaine Law, who dumped more than $70,000 of her family’s savings with Lehman Brothers, said she could lose all of it.

“We were very confident about the market,” said Law, 59.

“Who would have thought it would dive and a big bank like Lehman would collapse?”

With reports from The Associated Press


PhotoIceland’s Prime Minister Geir Haarde

Tiny island nation pays price for rapid growth

JANE WARDELL,  The Associated Press

LONDON — As the world suffers a hangover from the financial excesses of the past few years, the tiny island nation of Iceland has a bigger headache than most.The Nordic country was until recently lauded for its rapid generation of wealth despite its small size, as deregulation of domestic financial markets in the 1990s fuelled a stock market boom that underpinned an acquisition spree by cash-rich Icelandic banks and other companies.

But that success could become its downfall. The banking sector has grown to dwarf the rest of the economy with assets valued at nine times annual gross domestic product of €14-billion ($19 billion U.S.), leaving Iceland heavily exposed to the global credit squeeze.

A decision by the government this week to take over the country’s third-largest bank prompted major credit rating agencies to downgrade both Iceland’s government and its four major banks.

Iceland’s krona tumbled more than 20 per cent against the U.S. dollar this week, spurred partly by speculation that the central bank will struggle to bail out any more failing commercial banks after its rescue of Glitnir.

“Iceland is a standout case,” said Venla Sipila, a senior economist at Global Insight in London, which downgraded the country’s sovereign rating.

“The situation looks really volatile because it is so dependent on external developments now.”

With a population of just 320,000 people, the remote island nation between Europe and Canada has punched far above its weight in recent years, shifting from its mainstay fishing industry into an international investment force.

The Iceland Stock Exchange, or ICEX, was Europe’s top-performing market in 1994, leaving Icelandic companies with a large liquidity pool. Kaupthing, Iceland’s biggest bank, has doubled in size every year since 1996.

Another standout success was retailing investment group Baugur, which has expanded from one discount store in 1989 to a company that owns or has stakes in dozens of major retailers — including enough to make it Britain’s largest private company — and employs more than 50,000 people.

In Canada, HF Eimskipafelag Islands has done $1.1-billion (Canadian) in acquisitions in the cold-storage business in the past two years, buying the Atlas Cold Storage Income Trust and Versacold Income Fund, and also owns Dutch-based Daalimpex beheer, one of Europe’s biggest cold-storage operators.

But the qualities that made Iceland attractive to foreign investors and funded its expansion — essentially making it one big Viking hedge fund — are suddenly not as sought after.

A major concern is that some of Iceland’s banking liabilities will migrate on to the government’s balance sheet.

Part of problem is that Iceland’s tiny size has led to a high level of cross-ownership between banks and companies, which creates a house-of-cards scenario.

“There is still a number of cross-shareholdings … which increases the risk of contagion,” said Alexandre Birry, a director at Fitch Ratings in London.

Those worries were highlighted by the decision of investment firm Stodir, which has a major holding in Glitnir, to apply for temporary protection from creditors after the nationalization — and just before it had been due to take a 39 per cent stake in Baugur.

The risk that the crisis could spread like wildfire led to rumours this week that Baugur would be forced to sell overseas businesses to survive.

That prompted a rare public statement from the usually tight-lipped company, saying that while market conditions are tough “it is business as usual.”

The krona is also suffering from a withdrawal by a falloff in what are called carry trades — where investors borrow cheaply in a country with low rates, such as Japan, and invest in a country with higher returns — and often risks.

Prime Minister Geir Haarde has said that the Glitnir bailout is not the end of the banking crisis in Iceland, but he has so far shunned suggestions that Iceland join the euro currency, which analysts say could provide a measure of protection.

In the longer term, Iceland is putting faith in its growing hydroelectric and geothermal energy industries to carry it through the credit squeeze and back to growth — aluminum products are expected to overtake the traditional marine products industry in terms of revenue this year.

But with a current account deficit out of control, inflation running at more than 12 per cent and interest rates at a record 15.5 per cent, it first has to ride out a rocky patch.


The gloom spreads north


MONTREAL, TORONTO AND CALGARY — Rick Lafleur is walking away from his home in Windsor, Ont., unable to renew his mortgage. Customers won’t even talk to Newfoundland manufacturer Lorne Janes as their lenders tighten the screws. New Brunswick Finance Minister Victor Boudreau fears a budget deficit may be inevitable as a collapsing stock market whacks government pension funds and the province’s export-driven economy falters further.Across the country, even in the seemingly unsinkable resource towns of the Prairies, the grim prospect of a U.S.-led global recession and credit crunch has exited the abstract realm of the financial markets and landed with a thud on the kitchen tables of average Canadians.

In most parts of the country, house prices are flat or falling – they were down 6 per cent in the city of Toronto in September over the previous year – and down with them is the net worth of millions of debt-loaded consumers. They are in poor financial shape to weather an economic downturn that is already forcing some financial institutions to review the creditworthiness of existing borrowers.

Central Canada’s manufacturing sector, already reeling from about 400,000 job losses since 2003, is bracing for an even bloodier downturn than was expected only a few weeks ago. But it is hardly alone in its misery, as evidence mounted this week that the commodity price boom that has fuelled some provincial economies and filled government coffers is out of gas.

How bad it all gets depends largely on whether the $700-billion (U.S.) bailout package passed Friday by the U.S. Congress – which aims to take bad mortgage-related loans off bank balance sheets – meets its goal of getting financial institutions to start lending again. The deep integration of global financial markets – and particularly of Canadian and U.S. ones – means that it’s not just the fate of the American economy, which lost 159,000 jobs last month, that hangs in the balance.

“Canadian banks are borrowing and lending in the same credit markets as U.S. banks, so if the credit markets seize up in the U.S., they’re going to seize up in Canada, too,” McGill University economics professor Christopher Ragan explained.

Lender skittishness is a major worry for the Bank of Canada, which Friday massively boosted the amount of cash it plans to make available to the financial system to $20-billion from $8-billion, in a bid to unclog frozen money markets.

Still, there are no guarantees that its actions, along with similar moves by central banks around the world, will be enough to avert a protracted credit crunch. That would exacerbate the economic slowdown that had already been threatening Canadian jobs, Prof. Ragan added. “It will mean that the recession will be deeper. And any extension of a U.S. downturn is just an extension of the amount of time they’re not buying Canadian wood and Canadian car parts.”

It’s already too late for Mr. Lafleur, in Windsor, where auto-sector job losses pushed the unemployment rate to the highest of any Canadian city at 9.6 per cent in August. Although he and his wife have both found new jobs after losing their last ones at a Chrysler car dealership and General Motors plant, respectively, their house is now worth less than the mortgage on it.

Mr. Lafleur’s lender, Xceed Mortgage Corp., has tightened its credit conditions and recently told Mr. Lafleur it would not renew the $155,000 mortgage on his modest 50-year-old bungalow because the property is now worth about 25 per cent less than that amount.

“I’m being told, no, they’re not going to renew, because they are pulling out of Ontario and, secondly, because the loan-to-value was out of sync … because of the economy and Windsor is pretty bad,” Mr. Lafleur said.

It’s a big switch from a few years ago when lenders were falling over themselves to offer a mortgage to almost any homeowner or buyer who asked for one. Indeed, Mr. Lafleur was not required to retain any equity in his property when he remortgaged it five years ago.

“I was getting married and I needed 100-per-cent financing. They said fine, no problem. Got the mortgage,” Mr. Lafleur said.

Xceed, meantime, has problems of its own and has tightened its credit after being caught up in the subprime mortgage crisis that has convulsed the United States housing market. Xceed and a handful of subprime mortgage lenders in Canada had used asset-backed commercial paper to fund their mortgage portfolios. Then the bottom fell out of the ABCP market, which is now being restructured.

“Xceed had to change its business model to where it no longer underwrites mortgages that do not qualify for the Canada Mortgage and Housing Corp. [insurance],” Xceed spokesman Richard Wertheim said.

In June, Finance Minster Jim Flaherty tightened the criteria for mortgage insurance provided by government-owned CMHC, requiring buyers to provide a down payment of at least 5 per cent. He also made the CMHC stop insuring mortgages amortized over a period of more than 35 years, in effect killing the budding 40-year mortgage market that had been popular with first-time buyers seeking to keep their monthly payments to a minimum. Both moves were aimed at preventing the kind of housing bubble that has now burst south of the border, but they may have come too late to prevent a similar rash of mortgage defaults in Canada.

Many homeowners who got mortgages under the laxer rules that existed a few years ago could find themselves in trouble at renewal time. If they have not improved their financial situations to the point where they would qualify for a more traditional mortgage, Xceed for one is turning them down, Mr. Wertheim said.

Times aren’t just getting tougher for homeowners. Home builders face bleaker prospects, too. Across Canada, jobs in the construction sector have accounted for virtually all – 99.4 per cent – of total employment growth so far this year, according to Statistics Canada data. One in 12 Canadians is now directly employed in the sector, the largest share on record.

Residential activity, which constitutes about half of the total construction market, is already cooling after a decade of growth. Now, limited access to credit is threatening to curb the start of big new infrastructure and commercial projects.

Financing “at this point in time will be very tough, so they will definitely be impacted,” said Michael Clifford, Canadian tax leader for engineering and construction at PricewaterhouseCoopers. “The banks are being cautious, so the whole scenario leads to people waiting and seeing.”

For Canadian manufacturers, the credit crisis is the third stage of a triple whammy. They have already been battered by the surge in the value of the Canadian dollar and the spike in prices of such key commodities as steel and plastic.

Companies are hunkering down, scrapping expansion projects and cutting employees. The decline in the prices of some of Canada’s key commodities, such as oil and fertilizer, could help ease their pain, since it has sent the Canadian dollar lower. But that might not matter much as a U.S. recession erodes demand for Canadian manufactured goods.

Mr. Janes, president of Newfoundland-based Continental Marble of Canada, is already getting the cold shoulder from his customers in Florida, Maryland and California. “The reply I’m getting now is, ‘Lorne, save the phone call, don’t call any more until this sorts out,’” said Mr. Janes, whose 12-employee company manufactures equipment to produce moulded stone countertops.

Across the country in Annaheim, Sask., Gurcan Kocdag has been feeling the pinch for more than a year. The U.S. downturn – new housing starts have fizzled – means fewer lumber trucks heading south, slowing demand for the trailers Mr. Kocdag’s Doepker Industries makes. The 60-year-old company has already cut the work force at its three Saskatchewan plants by about 200 people to 325 in the past year.

“It’s not just manufacturers,” Mr. Kocdag said. “Everybody who supplies services to the transportation industry – our customers, our customers’ customers, their customers. Everybody in the value chain is significantly affected.”

Falling commodity prices – which have helped knock about 25 per cent off the Toronto Stock Exchange’s benchmark index from its summer peak – have not yet eroded the confidence of Saskatchewan Premier Brad Wall. After all, despite dropping 50 per cent from its summer peak of $147, oil is still trading higher than it was a year ago.

“We are not going to be immune to what’s happening around the world,” Mr. Wall said. “But even with the drop in oil, it brings it down to $94. Our government was only elected less than a year ago and it wasn’t over $90.”

Across the border in Alberta, however, there are concerns that the U.S. downturn will be so severe that oil prices will fall further still. Together with spiralling costs for oil sands projects, it could make any new developments economically questionable, capping the province’s boom.

The consortium behind the giant Fort Hills oil sands project revealed last month that its development costs had grown by more than 50 per cent in little more than a year. With the credit crunch, investors have assumed it will be hard for UTS Energy Corp., a junior partner in the consortium, to raise the cash to fund its 20-per-cent stake. The company’s stock has dive-bombed to just over $1 from $6 a share in June.

But while some oil sands projects may be delayed or pulled, that would only slow the breakneck pace of Alberta’s oil boom, rather than stop it. Companies plan their multibillion-dollar investments on long-term price projections that still support development.

The short-term picture looks bleaker for Alberta’s natural gas sector. While larger companies – flush with cash from 2008’s previously sky-high prices – say they’ll be unaffected by any downturn, junior firms, which rely on raising funds through debt and equity, won’t be able to easily find the cash they need to grow.

“Junior companies will not be able to get the cash to do drilling this year,” said Roger Soucy, president of the Petroleum Services Association of Canada. “At best, the forecast [for drilling next year] is flat, and it could drop.”

With neighbours losing homes or jobs, even consumers not directly affected by a downturn are likely to be rattled by what’s happening around them.

“It’s more likely than not that consumers are going to be more anxious, more concerned and less likely to spend going into the Christmas season,” said Kyle Murray, director of the school of retailing at the University of Alberta. “And if consumers, en masse, just hold off on buying those things like cars and houses, that also has a real negative impact on the economy in the short term. So none of that really bodes well.”

It all means finance ministers across the country will likely be facing lower revenues from income and sales taxes, while expenditures on unemployment and welfare benefits could balloon. That could push many governments – including Ottawa, which had a relatively slim $2.9-billion surplus in the first four months of the fiscal year – into the red.

“A deficit is something that’s certainly in the cards right now [for New Brunswick],” Mr. Boudreau said in an interview Friday.

In its March budget, the government projected a tiny $19-million surplus, on spending of $7.2-billion, “so there’s not a whole lot of cushion” if the economy slips into recession, he added. On top of that, government pension funds have been sideswiped by sliding stock prices, forcing the province to top up shortfalls with its own cash.

Each of the federal party leaders has insisted that he or she would not run a deficit if elected on Oct. 14, despite pledges of billions in new spending. But Prof. Ragan thinks their “no-deficit religion” is wrong-headed.

“The last thing you would want when the economy slows down is to intentionally raise taxes or cut spending just to stay out of a deficit,” he said. “It’s bad economics and I suspect [the party leaders] know it.”

Ottawa’s budget deficit exploded to $41-billion in 1992-93, in the wake of the last big recession, up from $28-billion in 1989-90. But subsequent moves to eliminate the deficit and pay down the federal debt – which now represents about 30 per cent of gross domestic product, down from a peak of 70 per cent – means Ottawa has room to prime the pump.

“One of the reasons it was so important to bring down the deficit and debt was so that in bad times you would have a little bit of fiscal room to manoeuvre,” Prof. Ragan said. “Well, the rainy day has arrived.”

With a report from Tavia Grant in Toronto


Published in: on October 5, 2008 at 9:02 am  Comments Off on EU, Iceland, Canada Suffering Fall Out, Caused By US Crisis  
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