Need for stimulus spending in the U.S. might not be over

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The Gazette, Wedensday, July 7, 2010

In his runaway bestseller The Big Short, Michael Lewis perfectly describes the U.S. housing market bubble that burst in the summer of 2007, ultimately triggering the market meltdown and financial crisis in the fall of 2008, the aftershocks of which are still rippling through the global economy.

A migrant worker in California, who made $14,000 a year picking strawberries, was granted a $724,000 home mortgage with no down payment. Naturally, when interest rates moved, his mortgage payments went up and he lost a home he couldn't afford in the first place.

But the bank that made the loan didn't carry it on its books. It was bundled with other loans into collateralized debt obligations or derivatives, and sold to third parties, who sold them to someone else. Which is how banks in Iceland, some of them run by former fishing-boat captains, came to own houses in California, Arizona, and Florida. This is why Iceland's debt-to-GDP ratio is something like 850 per cent, and why people are blowing up cars to collect the insurance.

And when the reckoning came to America, did it ever. Millions of Americans lost homes they couldn't afford. Millions more lost their jobs. As for the investment and retail banks that were responsible for the mess, most of them got bailed out by Washington in the $700-billion Troubled Asset Relief Program (TARP) in the final months of the presidency of George W. Bush. They did so well in 2009 that they've paid back Washington most of the TARP money, posted huge profits, and paid themselves obscene compensation packages. And then they wonder why everyone hates Wall St.

Greed not being an exclusively American disease, but a contagious one that also infected Europe, many of their banks were also bailed out by government. And when the sovereign debt crisis struck Europe this spring, the healthy European countries led by Germany and France stepped up with a nearly $1-trillion bailout of their own, in a bid to boost lagging confidence in the euro.

In the U.S., the bank bailout was followed by an $800-billion stimulus program, passed February 2009 as the first major legislation under the new Obama administration. Meanwhile, the Federal Reserve has kept interest rates at record lows.

This is all in keeping with pledges made by G20 leaders at the Washington summit in November 2008. It was the Washington meeting that elevated the G20 from a finance ministers club to a heads of government one, the one that met in Toronto two weeks ago on the margins of protests that hijacked the actual meeting. The Washington summit was called at the height of the global financial crisis. The commitments made there -politicians promised stimulus and central bankers promised cheap money -might well have averted a global depression.

Two years later, there is another issue on economic and fiscal policy. No one wants to exit stimulus too early and provoke a double-dip recession, but neither can central banks keep printing money while their countries rack up deficits and debt as far as the eye can see.

This was the heart of the discussion at the G20, and the outcome was a kind of Canadian compromise. All countries would determine when to exit stimulus on their own, but they agreed to cut their deficits in half by 2013, with a view to returning to balance by 2016.

This is no problem for Canada because, as Stephen Harper noted at his G20 news conference, we are already on track to hit these numbers. The deficit, forecast in the budget to be $54 billion, will actually be only $47 billion for the last fiscal year, on its way to $27 billion in next year's 2011 budget, and is due to be in virtual balance by 2015. As for our banks, they never drew a nickel of $150 billion of standby credit in last year's budget. And in our housing market, you need to make a down payment, usually about 10 per cent, on your mortgage. Your bank not only carries the mortgage on its books, it keeps a very close eye on you.

In the U.S., it's a very different story. The current deficit of $1.6 trillion is about 11 per cent of GDP, compared to three per cent here. The housing market remains very shaky, notwithstanding the bailout of mortgage lenders Fannie Mae and Freddie Mac. The Fed stands by its cheap-money. policy. But the job numbers that came out last Friday were extremely discouraging -unemployment persists at 9.5 per cent, and 125,000 people lost their jobs as census workers finished theirs.

This is why Barack Obama made his point in Toronto about each government having the sovereign duty to determine its own exit path on stimulus spending.

In the short term, the U.S. economy might need more stimulus, not less. As for cheap money, it will continue to be in abundant supply. Correction: In Saturday's column I wrote that there were four francophone members of the Supreme Court, when the right number, of course, is three. My mistake, er, brain cramp.

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