[R-G] The gloom spreads north

[Anthony Fenton]

The gloom spreads north
http://www.theglobeandmail.com/servlet/story/RTGAM.20081004.weconomy04/BNStory/Business
By KONRAD YAKABUSKI , VIRGINIA GALT and GREG KEENAN AND NORVAL SCOTT

 From Saturday's Globe and Mail

October 4, 2008 at 1:37 AM EDT

MONTREAL, TORONTO AND CALGARY — Rick Lafleur is walking away from his  
home in Windsor, Ont., unable to renew his mortgage. Customers won't  
even talk to Newfoundland manufacturer Lorne Janes as their lenders  
tighten the screws. New Brunswick Finance Minister Victor Boudreau  
fears a budget deficit may be inevitable as a collapsing stock market  
whacks government pension funds and the province's export-driven  
economy falters further.

Across the country, even in the seemingly unsinkable resource towns of  
the Prairies, the grim prospect of a U.S.-led global recession and  
credit crunch has exited the abstract realm of the financial markets  
and landed with a thud on the kitchen tables of average Canadians.

In most parts of the country, house prices are flat or falling – they  
were down 6 per cent in the city of Toronto in September over the  
previous year – and down with them is the net worth of millions of  
debt-loaded consumers. They are in poor financial shape to weather an  
economic downturn that is already forcing some financial institutions  
to review the creditworthiness of existing borrowers.

Central Canada's manufacturing sector, already reeling from about  
400,000 job losses since 2003, is bracing for an even bloodier  
downturn than was expected only a few weeks ago. But it is hardly  
alone in its misery, as evidence mounted this week that the commodity  
price boom that has fuelled some provincial economies and filled  
government coffers is out of gas.

How bad it all gets depends largely on whether the $700-billion (U.S.)  
bailout package passed Friday by the U.S. Congress – which aims to  
take bad mortgage-related loans off bank balance sheets – meets its  
goal of getting financial institutions to start lending again. The  
deep integration of global financial markets – and particularly of  
Canadian and U.S. ones – means that it's not just the fate of the  
American economy, which lost 159,000 jobs last month, that hangs in  
the balance.

“Canadian banks are borrowing and lending in the same credit markets  
as U.S. banks, so if the credit markets seize up in the U.S., they're  
going to seize up in Canada, too,” McGill University economics  
professor Christopher Ragan explained.

Lender skittishness is a major worry for the Bank of Canada, which  
Friday massively boosted the amount of cash it plans to make available  
to the financial system to $20-billion from $8-billion, in a bid to  
unclog frozen money markets.

Still, there are no guarantees that its actions, along with similar  
moves by central banks around the world, will be enough to avert a  
protracted credit crunch. That would exacerbate the economic slowdown  
that had already been threatening Canadian jobs, Prof. Ragan added.  
“It will mean that the recession will be deeper. And any extension of  
a U.S. downturn is just an extension of the amount of time they're not  
buying Canadian wood and Canadian car parts.”

It's already too late for Mr. Lafleur, in Windsor, where auto-sector  
job losses pushed the unemployment rate to the highest of any Canadian  
city at 9.6 per cent in August. Although he and his wife have both  
found new jobs after losing their last ones at a Chrysler car  
dealership and General Motors plant, respectively, their house is now  
worth less than the mortgage on it.

Mr. Lafleur's lender, Xceed Mortgage Corp., has tightened its credit  
conditions and recently told Mr. Lafleur it would not renew the  
$155,000 mortgage on his modest 50-year-old bungalow because the  
property is now worth about 25 per cent less than that amount.

“I'm being told, no, they're not going to renew, because they are  
pulling out of Ontario and, secondly, because the loan-to-value was  
out of sync … because of the economy and Windsor is pretty bad,” Mr.  
Lafleur said.

It's a big switch from a few years ago when lenders were falling over  
themselves to offer a mortgage to almost any homeowner or buyer who  
asked for one. Indeed, Mr. Lafleur was not required to retain any  
equity in his property when he remortgaged it five years ago.

“I was getting married and I needed 100-per-cent financing. They said  
fine, no problem. Got the mortgage,” Mr. Lafleur said.

Xceed, meantime, has problems of its own and has tightened its credit  
after being caught up in the subprime mortgage crisis that has  
convulsed the United States housing market. Xceed and a handful of  
subprime mortgage lenders in Canada had used asset-backed commercial  
paper to fund their mortgage portfolios. Then the bottom fell out of  
the ABCP market, which is now being restructured.

“Xceed had to change its business model to where it no longer  
underwrites mortgages that do not qualify for the Canada Mortgage and  
Housing Corp. [insurance],” Xceed spokesman Richard Wertheim said.

In June, Finance Minster Jim Flaherty tightened the criteria for  
mortgage insurance provided by government-owned CMHC, requiring buyers  
to provide a down payment of at least 5 per cent. He also made the  
CMHC stop insuring mortgages amortized over a period of more than 35  
years, in effect killing the budding 40-year mortgage market that had  
been popular with first-time buyers seeking to keep their monthly  
payments to a minimum. Both moves were aimed at preventing the kind of  
housing bubble that has now burst south of the border, but they may  
have come too late to prevent a similar rash of mortgage defaults in  
Canada.

Many homeowners who got mortgages under the laxer rules that existed a  
few years ago could find themselves in trouble at renewal time. If  
they have not improved their financial situations to the point where  
they would qualify for a more traditional mortgage, Xceed for one is  
turning them down, Mr. Wertheim said.

Times aren't just getting tougher for homeowners. Home builders face  
bleaker prospects, too. Across Canada, jobs in the construction sector  
have accounted for virtually all – 99.4 per cent – of total employment  
growth so far this year, according to Statistics Canada data. One in  
12 Canadians is now directly employed in the sector, the largest share  
on record.

Residential activity, which constitutes about half of the total  
construction market, is already cooling after a decade of growth. Now,  
limited access to credit is threatening to curb the start of big new  
infrastructure and commercial projects.

Financing “at this point in time will be very tough, so they will  
definitely be impacted,” said Michael Clifford, Canadian tax leader  
for engineering and construction at PricewaterhouseCoopers. “The banks  
are being cautious, so the whole scenario leads to people waiting and  
seeing.”

For Canadian manufacturers, the credit crisis is the third stage of a  
triple whammy. They have already been battered by the surge in the  
value of the Canadian dollar and the spike in prices of such key  
commodities as steel and plastic.

Companies are hunkering down, scrapping expansion projects and cutting  
employees. The decline in the prices of some of Canada's key  
commodities, such as oil and fertilizer, could help ease their pain,  
since it has sent the Canadian dollar lower. But that might not matter  
much as a U.S. recession erodes demand for Canadian manufactured goods.

Mr. Janes, president of Newfoundland-based Continental Marble of  
Canada, is already getting the cold shoulder from his customers in  
Florida, Maryland and California. “The reply I'm getting now is,  
‘Lorne, save the phone call, don't call any more until this sorts  
out,'” said Mr. Janes, whose 12-employee company manufactures  
equipment to produce moulded stone countertops.

Across the country in Annaheim, Sask., Gurcan Kocdag has been feeling  
the pinch for more than a year. The U.S. downturn – new housing starts  
have fizzled – means fewer lumber trucks heading south, slowing demand  
for the trailers Mr. Kocdag's Doepker Industries makes. The 60-year- 
old company has already cut the work force at its three Saskatchewan  
plants by about 200 people to 325 in the past year.

“It's not just manufacturers,” Mr. Kocdag said. “Everybody who  
supplies services to the transportation industry – our customers, our  
customers' customers, their customers. Everybody in the value chain is  
significantly affected.”

Falling commodity prices – which have helped knock about 25 per cent  
off the Toronto Stock Exchange's benchmark index from its summer peak  
– have not yet eroded the confidence of Saskatchewan Premier Brad  
Wall. After all, despite dropping 50 per cent from its summer peak of  
$147, oil is still trading higher than it was a year ago.

“We are not going to be immune to what's happening around the world,”  
Mr. Wall said. “But even with the drop in oil, it brings it down to  
$94. Our government was only elected less than a year ago and it  
wasn't over $90.”

Across the border in Alberta, however, there are concerns that the  
U.S. downturn will be so severe that oil prices will fall further  
still. Together with spiralling costs for oil sands projects, it could  
make any new developments economically questionable, capping the  
province's boom.

The consortium behind the giant Fort Hills oil sands project revealed  
last month that its development costs had grown by more than 50 per  
cent in little more than a year. With the credit crunch, investors  
have assumed it will be hard for UTS Energy Corp., a junior partner in  
the consortium, to raise the cash to fund its 20-per-cent stake. The  
company's stock has dive-bombed to just over $1 from $6 a share in June.

But while some oil sands projects may be delayed or pulled, that would  
only slow the breakneck pace of Alberta's oil boom, rather than stop  
it. Companies plan their multibillion-dollar investments on long-term  
price projections that still support development.

The short-term picture looks bleaker for Alberta's natural gas sector.  
While larger companies – flush with cash from 2008's previously sky- 
high prices – say they'll be unaffected by any downturn, junior firms,  
which rely on raising funds through debt and equity, won't be able to  
easily find the cash they need to grow.

“Junior companies will not be able to get the cash to do drilling this  
year,” said Roger Soucy, president of the Petroleum Services  
Association of Canada. “At best, the forecast [for drilling next year]  
is flat, and it could drop.”

With neighbours losing homes or jobs, even consumers not directly  
affected by a downturn are likely to be rattled by what's happening  
around them.

“It's more likely than not that consumers are going to be more  
anxious, more concerned and less likely to spend going into the  
Christmas season,” said Kyle Murray, director of the school of  
retailing at the University of Alberta. “And if consumers, en masse,  
just hold off on buying those things like cars and houses, that also  
has a real negative impact on the economy in the short term. So none  
of that really bodes well.”

It all means finance ministers across the country will likely be  
facing lower revenues from income and sales taxes, while expenditures  
on unemployment and welfare benefits could balloon. That could push  
many governments – including Ottawa, which had a relatively slim $2.9- 
billion surplus in the first four months of the fiscal year – into the  
red.

“A deficit is something that's certainly in the cards right now [for  
New Brunswick],” Mr. Boudreau said in an interview Friday.

In its March budget, the government projected a tiny $19-million  
surplus, on spending of $7.2-billion, “so there's not a whole lot of  
cushion” if the economy slips into recession, he added. On top of  
that, government pension funds have been sideswiped by sliding stock  
prices, forcing the province to top up shortfalls with its own cash.

Each of the federal party leaders has insisted that he or she would  
not run a deficit if elected on Oct. 14, despite pledges of billions  
in new spending. But Prof. Ragan thinks their “no-deficit religion” is  
wrong-headed.

“The last thing you would want when the economy slows down is to  
intentionally raise taxes or cut spending just to stay out of a  
deficit,” he said. “It's bad economics and I suspect [the party  
leaders] know it.”

Ottawa's budget deficit exploded to $41-billion in 1992-93, in the  
wake of the last big recession, up from $28-billion in 1989-90. But  
subsequent moves to eliminate the deficit and pay down the federal  
debt – which now represents about 30 per cent of gross domestic  
product, down from a peak of 70 per cent – means Ottawa has room to  
prime the pump.

“One of the reasons it was so important to bring down the deficit and  
debt was so that in bad times you would have a little bit of fiscal  
room to manoeuvre,” Prof. Ragan said. “Well, the rainy day has arrived.”

With a report from Tavia Grant in Toronto