Outlook 2008/09 Life In the Aftermath of the Great Global Credit Crisis May 8 th, 2008 Presented by: Patricia Croft, Vice President & Chief Economist Phillips, Hager & North Investment Management Limited Est. 1964
Rare Events Have Become the Norm Worst U.S. housing market recession since the 1930s U.S. dollar at record low Record oil, gold, rice prices Global credit crisis run on banks in U.S. and U.K. U.S. T-bill yields fell to 1950 levels unprecedented response by the Fed What s next??
The Greatest Credit Bubble of All Time 1. Liquidity too much and too cheap 2. Trend to deregulation By 2006 an estimated 75% of lending in the U.S. was outside the jurisdiction of regulators* 3. Boom in securitization Democratized credit provision but disconnected lender and borrower 4. Overconfidence in financial models Rating agencies, banks and others put too much faith in financial models that cratered when faced with fat tails * Source: The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash by Charles R. Morris
Double Bubble Bubble in Housing and Securitization % change year-over-year 25 20 15 10 5 0-5 -10 S&P/Case-Shiller U.S. Home Price Index U.S.$ billions Securitized Residential Mortgages Outstanding Quarterly change at annual rates 600 500 400 300 200 100 0-100 -200-15 87 89 91 93 95 97 99 01 03 05 07 Source: MacroMarkets LLC -300 90 92 94 96 98 00 02 04 06 08 Source: Federal Reserve, NBF Financial
Third Banking Crisis Since 1930s 600 U.S. Bank and Thrift Failures 500 S&L Crisis 400 Today 300 200 100 Great Depression 0 1934 1942 1950 1958 1966 1974 1982 1990 1998 2006 Source: Federal Deposit Insurance Corp., The Mortgage Lender Implode-O-Meter.com
Are We There Yet? More than seven months on, the end is not in sight, although it is safe to say that we have reached the end of the beginning of the turmoil. Mark Carney, Governor of the Bank of Canada March 13 th 2008
Subprime s Tangled Web Housing/ Economy Banks Bond Insurers Hedge Funds SUBPRIME Regulators Rating Agencies Private Equity Commercial Paper Market
U.S. in Recession Now What? 1. How long and how deep? 2. What will the recovery look like? 3. What are the consequences for the rest of the world?
Single Biggest Risk Still Housing Index 160 140 120 100 80 60 40 US Housing Affordability Index 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 Source: US National Association of Realtors Months' supply 13.0 12.0 11.0 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 US Unsold New Housing Inventory (months' supply at current selling rates) 1963 1968 1973 1978 1983 Source: US Census Bureau 1988 1993 LR average 1998 2003 2008 % change year-over-year 25 20 15 10 5 0-5 -10-15 -20 S&P/Case-Shiller US Home Price Index 1987 1989 1991 1993 1995 1997 Source: MacroMarkets LLC 1999 2001 2003 2005 2007 Index 120 US Consumer Confidence 110 100 90 80 70 60 50 40 1980 1985 1990 1995 2000 2005 Source: University of Michigan
Aggressive Federal Reserve Action 6 5 4 Central bank policy interest rates Bank of Canada U.S. Federal Reserve Monetary Policy: Federal Reserve has responded to economic risks (%) 3 2 1 Market pricing in Fed tightening later this year Inflation figures vastly different 0 2003 2004 2005 2006 2007 2008
Not Your Average Credit Cycle Diffusion Index 90 70 50 30 10 Banks Tightening Lending Standards Commercial & Industrial Loans Mortgages* Credit card loans All other consumer loans Commercial real estate loans -10 Shaded areas indicate U.S. recessions -30 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: Federal Reserve Senior Loan Officer Opinion Survey *2007 Q2 onward calculated by PH&N
Falling Homeowners Equity = Skewed Incentives 90 US Owner's Equity, % of Household Real Estate 85 80 Banks & lenders own more of the average American house than owner does! 75 % 70 65 60 55 50 45 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 Source: Federal Reserve Flow of Funds
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Housing: A Tale of Two Markets Annual % change, 3-mth avg Existing House Prices, Canada & U.S. 20 15 10 5 0-5 % of Total Loans Size of Subprime Mortgage Lending Market 25% 22% 20% 15% 10% 5% 5% -10 1995 1997 1999 2001 2003 2005 2007 Source: Can. Real Estate Assoc., National Assoc. of Realtors 0% Canada United States Source: CIBC World Markets
Canada s s Housing Market Not Overvalued 35 30 House price gap (%) 25 20 15 10 5 0-5 -10 Ireland Netherlands UK Australia France Norway Denmark Belgium Spain Sweden Italy Japan U.S. Finland Germany Canada Austria Source: International Monetary Fund, National Bank Financial April 2008
A Tale of Two Consumers % Household Liabilities, % of Net Worth 25 24 23 22 21 20 19 18 17 16 15 1990 1994 1998 2002 2006 % Household Net Worth, % of Disposable Income 700 650 600 550 500 450 400 1990 1994 1998 2002 2006 Source: Federal Reserve Flow of Funds, Statistics Canada National Balance Sheet Accounts
Canada Tied to U.S. Like Maple Syrup to Pancakes Country U.S. Exports (% of GDP) Country U.S. Exports (% of GDP) 1. Venezuela 26.1 2. Canada 25.5 3. Mexico 23.8 4. China 10.9 5. Saudi Arabia 8.8 6. Chile 6.3 7. Korea 5.5 8. Sweden 3.9 9. Switzerland 3.6 10. Belgium 3.5 11. Germany 3.0 12. Japan 3.0 13. Brazil 2.8 14. Argentina 2.5 Source: Merrill Lynch, Sept. 2006
The Long and The Short of the C$ Net Long Non-Commercial C$ Positions 100,000 80,000 60,000 40,000 20,000 0-20,000 Cents U.S. 110 105 100 95 90 85 80 Canada- U.S. Exchange Rate Actual Purchasing Power Parity* 98.8 81.4-40,000-60,000-80,000 Data to Jan 22 2008-100,000 1993 1997 2001 2005 2007 Source: U.S. Commodity Futures Trading Commission 75 70 65 60 1970 1978 1986 1994 2002 2006 Source: Bank of Canada, OECD
Gisele Wants to Be Paid In Euros 150 U.S. Dollar Trade-Weighted Index 140 130 120 Index 110 100 90 80 70 Major currency index Broad index 60 1973 1979 1985 1991 1997 2003 2006 Source: U.S. Federal Reserve
Mixed Picture Outside of North America European economy slowing ECB reluctant to cut rates Bank of England weighing growth/inflation tradeoff house prices weakening Japan s economy fragile India slowing somewhat China challenged Pace of Global Growth Set to Slow
IMF Puts 25% Probability on World Recession 8 World Real GDP Growth 7 6 Strongest 4-year period in 30 years 5 % 4 3 2 1 0 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Recession Source: IMF World Economic Outlook
50 Commodities Detach From Near- Term Reality Global Trade and Commodity Futures 600 Global Commodity Derivative Trading Contract Turnover 40 Global Trade (3 month avg.) CRB Commodity Futures Index 500 Percent year-over-year 30 20 10 0 Number of Contracts 400 300 200-10 100-20 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Source: Commodity Research Bureau, IMF, Datastream 0 1994 1995 1996 1997 1993 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: Bank for International Settlements
2008/09 Risky Business 1. U.S. recession 2. Further fall out from sub prime crisis contagion to commercial real estate, credit card and auto loans, bank failures 3. Stagflation in Europe 4. China stumbles global recession 5. Geopolitical factors/protectionism/u.s. election 6. Inflation led by soaring food prices