File this one under “Impending Economic Crisis” – a file that’s looking pretty stuffed lately.
Earlier this week Bloomberg reported on a disturbing trend: Canadian pension plans are increasingly investing in high-risk securitized loans in the United States, loans that new American regulations prevent domestic banks from touching.
The headline, “Shadow Banking Draws Canadians Where U.S. Banks Are Warned Away“, strikes an appropriately dire tone, and the details are pretty frightening:
Public Sector Pension Investment Board, Canada’s fifth-largest pension plan, said last month it intends to open a loan-origination business in New York by year-end. That follows the Canada Pension Plan Investment Board’s $12 billion deal to acquire General Electric Co.’s business that lends to smaller companies.
The Canadians are part of a wave of institutions unencumbered by U.S. regulation searching for higher returns in the market for risky loans to American companies. Bank supervisors there are pressuring the biggest lenders to pull back from deals that load up companies with too much debt, seeking to avoid a credit bubble that could damage the U.S. economy…
The Canadian funds, which have pioneered the strategy of using alternative investments in pensions, are joining private-equity giants KKR & Co. and Apollo Global Management LLC and other nonbank firms in seeking to profit from high-yield credit as central banks around the world suppress interest rates. Canada’s biggest private-equity firm, Onex Corp., has also moved deeper into the U.S. market, ramping up its business packaging the debt as securities with an eye to doubling that unit’s assets in two years.
That’s some serious investing, man! Like wow!
The PE funds are being drawn by the allure of high returns, but of course, with high returns comes high risk. And indeed, the very fact that this market is being flooded with billions of dollars only increases the risk, as it further inflates an already dangerous bubble.
Many people in the United States found out just how risky these kinds of investments by pensions funds can be, at great personal cost, during the financial crisis of 2008. Globally, pension assets lost about 20% of their value in just under a year, and the US was especially hard-hit. Compounding the loss of retirement funds was a collapse in housing prices and a spike in unemployment, leading to the impoverishment of millions of older workers who thought they were set for retirement. All of this was made even worse when the US federal government bailed out the banks who engaged in the high-risk behaviour which caused the crisis while slashing “safety-net” programs like unemployment insurance and food stamps.
Now compare the situation then and there with the situation here and now. That we are in the midst of a housing bubble is hard to deny – as I wrote last week, it’s only a matter of time before prices come crashing down. We’re also dealing with another bubble, an oil bubble, which is already in the painful process of popping, dragging our economy into what politicians and central bankers are still insisting is just “technically” a recession. Bloomberg is predicting that some companies operating out of the tar sands will soon run out of operating funds, and writes:
Renewed declines in oil prices, which this week touched a six-month low as they fell below $50 per barrel, are already being felt in the part of the debt markets that Canada’s neediest companies depend on for cash. Borrowing costs for junk-rated Canadian firms in the U.S. climbed this week to 723 basis points more than ultra-safe government debt, the highest since February, according to Bank of America Merrill Lynch data.
That could make it harder for cash-strapped resource firms to re-finance their debt as it comes due and avoid default.
Already, Calgary is posting a higher jobless rate than London, Ontario, something that hasn’t been true in over a decade. And, as I’ve noted before, Albertans are the most indebted Canadians, making high unemployment in that province a likely trigger for widespread defaults on debts, including mortgage debts. With the big banks already heavily leveraged and heavily invested in both mortgages and the tar sands, a sudden downturn in both fields could prove devastating.
Here’s a scenario that’s maybe not too unlikely – see how it scans with you:
Second-quarter statistics show Canada to be in a slight recession, with shrinkage of less than 0.5% for the first half of the year. However, the numbers take a turn for the worse as over-indebted homeowners in Alberta (which boasts the highest levels of consumer debt in Canada) find themselves increasingly unable to make mortgage payments in the aftermath of energy industry job losses.
As the defaults increase, a sense of panic settles onto the Canadian real estate sector, and wealthy foreign investors who have been using Vancouver and Toronto condos as a store of wealth begin to pull out of the market. Increasingly, high-end units come onto the market without being able to find buyers, and the long-inflated property values in Canada’s two most expensive cities begin a rapid collapse.
Lending dries up, and as credit tightens, businesses stop hiring and start making layoffs. And so in a vicious cycle, the rate of default increases, and the range of the mortgage crisis spreads.
Highly-levered RBC, which holds 17% of all Canadian mortgages, more than any other bank, is the first to show signs of cracking, but all of the Big Five are in trouble at this point. Two-thirds of mortgages are owned by these five, and as the losses mount, it becomes increasingly clear that they will need to be bailed out, to the tune of tens or maybe hundreds of billions of dollars.
Now tell me, does that sound implausible?
I’m not saying that’s how it will happen. I’m saying that the short-term stability of Canada’s big banks isn’t something that we can take for granted, that the conditions are in place to cause a rapid cascading collapse. And we should be ready for that.
If you factor into this the exposed vulnerability of major Canadian pension funds and hedge funds to sudden and severe economic downturns outside of Canada, you now have three potential triggers for a major financial crisis in this country.
At this point, it seems inevitable that bank bailouts are going to be on the table sometime in the next few years – which is why progressives and radicals need to start working now towards a strategy for resisting the kind of outcome we saw in the United States in 2008, which merely strengthened the power of the too-big-to-fail/jail banks while screwing over the folks who were most affected by financial recklessness/fraud/stupidity.