January 1st - 2009

Sub-prime mortgages not responsible for world recession

The world economy is going down the drain because of some repossessed, boarded up, unsellable homes in Cleveland.

The world economy is going down the drain because of some repossessed, boarded up, unsellable homes in Cleveland.

If you believe a lot of what you hear and read in the financial media that’s what you’d think, according Jeff Rubin, Chief Economist, Chief Strategist and Managing Director CIBC World Markets, speaking at the Real Estate Forum in Toronto in December.

“We all understand how those mortgages were securitized” said Rubin, “and we all understand that when people send in the keys instead of a mortgage cheque those (mortgage-backed securities) couldn’t make the coupon payments that they said they were going to make. The value of those instruments fell. There were massive write offs in the financial sector. That is very clear…. But how does that bring down a 60 or 70 trillion dollar world economy is a whole other story.”

Rubin blames the global recession on the skyrocketing oil prices earlier in the year.

“Four of the last five recessions were caused by huge increases in oil prices,” said Rubin, precipitated in 1973 by the War in the Middle East, in 1979 by the Iranian Revolution, in 1991 by the first Iraqi War and today.

“In fact the 1998 Asian Meltdown is the only real global recession that didn’t have oil’s fingerprint all over it.”

First the good news

Rubin says the real oil story out there is supply destruction. Even before prices collapsed, oil supply had not grown from 2005 to 2008, he said.

“We may have a one- or two- or three-quarter decline in oil demand but in any economic recovery what we are really going to see is the supply destruction and that’s why I think oil prices are going to come back rapidly with any pick up in economic activity. We are looking to oil prices going back to $100 per barrel range within 12 months.”

And rising oil prices, says Rubin, is a good news story for Canada in the long run.

Now the bad news

Rubin expects the US housing crisis to moderate with housing prices there to stabilize by the end of the first quarter of 2009.

Where the US economy will have to deal with recession in 2009 is in vehicle sales, which will fall to 1982 sales levels, he predicts. Ninety per cent of all automobile sales have been financed and that financing has become increasingly problematic.

“The problem facing GM, Chrysler, Ford isn’t so much whether they are competitive with Honda or Toyota; the more fundamental problem is that the industry can build 15 to 20 million vehicle units a year in a market that will only be buying eight to 10 million units. And that is not a cyclical change. That is going to be a secular change, and one that is going to leave a huge imprint on the North American economy – on both sides of the border.”

The economic stimulus

Future taxpayers, says Rubin, will wish that we bit the bullet for two to three quarters, instead of “mortgaging their futures.” Rubin believes that Washington’s plan to stimulate the economy with an injection of hundreds of billions of dollars is an over-reaction, but added:

“Up here in Canada, that kind of response provides a unique opportunity for us to be freeloaders, because you cannot stimulate the US economy to that extent without that stimulus leaking into Canada,” particularly if that stimulus is going to be directed to integrated industries, like for example the auto industry, he said.

“If we were smart we would do nothing and let Washington do all the heavy lifting, and let US taxpayers pay for the stimulus in the future.”

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