Inasmuch as history books are full of examples of rapid and sharp recoveries following steep declines in the economy and in financial markets, many observers currently are predicting a repetition of a similar upturn. All but forgotten, however, are the stiff headwinds now confronting our economy this time. Circumstances are altogether different nowadays, which makes a recurrence very unrealistic.
Unlike the more recent business contractions the housing sector has suffered a severe shock, with prices tumbling at a rate similar to their collapse in the 1930s. That alone constitutes a serious threat to any prompt recovery. As a background, it should be noted that house prices rose precipitously in recent decades, sometimes as much as 300 per cent. The price structure in Canada did not experience that escalation, but nevertheless, house prices soared here as well. This house price inflation was based in part on buyers taking out mortgages way beyond their means. It will take years for any adjustment here to be completed.
Furthermore, aggravating the problem is the change in the population structure; aging baby boomer gradually are moving out of their houses as children leave, so there will be an additional glut of houses coming on the market.
The shock of collapsing house prices and a drastic decline in equity markets is reminiscent of events 70 years ago. It is difficult to imagine that anything is going to stabilize until we put a floor under house prices, which continue to decline.
Credit conditions are more worrisome than they have been in decades, but money is flowing again, and is more available than has been the case a year ago.
Potential borrowers still are burdened by overhanging debt. Banks are loaded with so-called toxic mortgages and all kinds of questionable financial instruments, such as derivatives and credit swaps. That makes banks’ ability to lend improbable, despite the much more conservative institutions in Canada. These factors will be a continuing drag on consumer spending.
The decline in the manufacturing industry accentuated by the abysmal conditions facing the automobile companies will entail job losses that will continue well into next year, even after business starts to recover. Inventories have been run down, so there will be some inventory restocking over coming months, and government spending on infrastructure too will help, but insufficiently to do more than stem the tide.
The triple blows of collapsing property values, equity wealth destruction, and ongoing unemployment totals, are huge hurdles for our economy to surmount. Also, asset-dependent households remain income short, overly indebted, and savings deficient.
This makes a mockery of the conventional wisdom forecasts of a prompt recovery.
Crowd psychology ignores true reality, apparently oblivious to the major obstacles facing us.