Finance Committee on March 26th, 2009

[Glen Hodgson]

We're marking it down right now. It'll be much closer to 2%.

[John McCallum, Liberal, Markham—Unionville, ON]

I beg your pardon?

[Glen Hodgson]

It'll be closer to a 2% contraction of the real economy than our previous forecast suggested, simply because we're looking at the investment numbers across the economy and you're seeing a rout in investment plans. I think Ted confirmed that bottom-up analysis from your members. You're seeing people really pulling back on their investment intentions.

[John McCallum, Liberal, Markham—Unionville, ON]

So you're converging on Don Drummond, in a sense?

[A voice]

He's still not low enough.

[John McCallum, Liberal, Markham—Unionville, ON]

Can you give us the order of magnitude of your two-year deficit? We have the government at $64 billion; we have TD Bank at $82 billion; we have the Parliamentary Budget Officer at $73 billion. Can you tell us where in that range you would like to find yourself—not necessarily to the closest billion?

[Glen Hodgson]

I can't even tell you to the billion. We use very different tools to get there. Don gave you a pretty nice snapshot of how they do it. We actually crank up our model and do the national forecast. We then do a separate fiscal forecast. We use a model-based forecast. As a portable think tank, we can't do that for free, unfortunately. Part of the reason we have a contractual relationship with the Department of Finance is that we give them this advice on a regular basis. At one point, going back two or three years, we actually had a similar relationship with this committee. So I can't give you a single number, but based on the logic that Don walked you through, it's clearly going to be a deeper deficit over the next two years.

[John McCallum, Liberal, Markham—Unionville, ON]

Thank you.

[The Chair, Conservative, James Rajotte]

Mr. Bernier, please.

[Maxime Bernier, Conservative, Beauce, QC]

Thank you, Mr. Chairman.

I agree with you: the crisis we are currently experiencing in Canada did indeed originate in the United States. However, I would like to ask you a question concerning a witness we heard from last Monday. That witness targeted the persons responsible for the current economic crisis. He said that those responsible for the crisis that we are currently experiencing around the world were the American politicians, both Democrats and Republicans. I will explain his argument and I would like to hear your comment on what he said.

He said that, in the early 2000s, American politicians had a very noble objective of enabling all Americans to have access to home ownership. In so doing, they asked Fannie Mae and Freddie Mac to guarantee mortgage loans that Americans otherwise would have been unable to obtain as they were unable to make a downpayment or were simply unable to get a mortgage loan in the private sector. By asking Fannie Mae and Freddie Mac to guarantee high-risk mortgage loans, they led the banks and the private sector to agree to do the same as they were, since they were sharing the risk. The crisis originated in the early 2000s, and we have seen that those loans were securitized and bought by certain international financial institutions. As a result, the financial crisis was transformed into an economic crisis. In his view, the nasty capitalists aren't at the origin of the crisis; it's the fault of American politicians instead.

I'd like to know what you think of that.

[Finn Poschmann]

If I may, Mr. Chairman, I believe everything the member reported is roughly correct, except the history is longer. If you go back to the Community Reinvestment Act in the United States, we have a much longer history going back to the beginning of the 1990s, and even earlier in different incarnations, where Congress and legislators pushed mortgage lenders to put money back into low-income communities specifically because they thought banks weren't lending as much as they should to people near the edge of creditworthiness. The pressure emerged from Congress, from the House financial services committee in particular, and also from the White House, and in 1998 President Clinton pushed hard on Fannie Mae and Freddie Mac to broaden their lending activities. And what Franklin Raines said at the time was that too many homeowners were just a notch below creditworthiness and they wanted to reach out to them with our lending programs.

And guess what? He was right, they were just a notch below creditworthiness, but that we didn't know for sure until very recently.

The program, yes, it was broadly expanded by President Bush, who carried on with the mandate of extending home ownership to low-income communities. Lots of indicators show what you saw: ownership at the bottom end of the price range, at the entry-level price range, boost up relative to other income ranges over this particular period, and you saw debt accumulation among those households build up at an unusual rate in response to the incentives created by the mortgage lenders.

[The Chair, Conservative, James Rajotte]

There's about a minute left.

Mr. Drummond.

[Don Drummond]

I agree that the government has its share of responsibility, but it's too simple to limit oneself to that. I also blame the people responsible for regulation.

As I said, I don't agree with Alan Greenspan when he says that high-risk mortgages were acceptable in 2000 and 2001. There were such obvious problems that there would have been grounds for changing the regulations in 2005 and 2006. I also blame investors. Why did they buy batches of high-risk mortgages when returns were so low, with risk both high and absolutely unknown? I have no sympathy for them. They made a serious mistake. Perhaps the government can correct that mistake, but they are adults; they used risk analysts who could have led them to make a different decision.

I also blame the population of the United States. Why did a family in California or Florida take out a $400,000 mortgage to buy a house worth $400,000 without making any downpayment? The banks that granted the mortgage did not even request proof of their income. After granting the mortgage, they did the checks and found that these people who had reported an income of $100,000 had none. They had not even had a job in the previous six months. Should we have sympathy for them? Should we just blame the government? No. A society can't rely solely on regulation and think that the government is always responsible for everything. Yes, the government had its share of responsibility. It made a mistake by encouraging too many people to take out mortgages without making downpayments. They made a mistake in the area of regulation, but everyone made a mistake: the people who granted the mortgages, the investors who made the mortgages and the public, citizens who took out the mortgages.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Bernier.

Mr. Mulcair.

[Thomas Mulcair, NDP, Outremont, QC]

Mr. Chairman, I would like to continue asking questions of Mr. Drummond, who is on a roll here.

Today in the United States, they're going to propose another raft of measures, they say, to provide a better framework for the situation. I am taking the liberty of suggesting that certain things that were done in the wake of the Enron scandal regarding accounting rules—because walls had to be built—were part of the problem.

Earlier it was said that mark-to-market was one of the challenges. Certain things that were done in response to the very real crisis will cause real problems for us in the longer term. For example, currently they're talking—and I'm going to say it literally—about $10 trillion in the United States, somewhat like what happened during the Vietnam War. The only way to repay the debt from the Vietnam War was through heavy inflation in the 1970s. The war ended in 1975 and there was heavy inflation in the late 1970s and early 1980s.

Aren't we running a real risk of inflation by printing $10 billion? Réal Caouette and Camil Samson—I apologize for citing Mr. Bernier's heroes—are no doubt looking at this with big smiles on their faces. Newsweek recently published the following headline: “We are all socialists now.” I would dare say that we are all social creditors now. Aren't there any other challenges, other problems that are concealed with that orientation?

[Don Drummond]

As I said earlier in response to a question, I believe that the challenges are enormous in the medium term. In view of the burden of their debt, the United States will have to do what Canada did in 1995 and 1996. However, I doubt it's capable of doing so. At that time, it was the Liberals who did it in Canada, and they had a very strong majority. In the United States, considerable importance is attached to the voice of minorities. I really doubt that, to reduce the growth rate... Even the growth rate influences the level of spending in the United States. The banks need to accumulate capital, not only in the short term, but also to replace the capital provided by the government. They have to replace the entire system of shadow banking, which has disappeared. I don't think it's returned in force in the United States. That's a responsibility of the banks; they would be capable of doing it.

Next, it must never be forgotten that the real problem with the global economy stems from the fact that the United States was spending too much when the savings rates in other countries were very high. We are in exactly the same situation. In the United States, it's the government that's spending too much, not consumers.

At first, we thought that a slowdown in U.S. economic growth would be beneficial, that it would lower [Inaudible - Editor]. We saw that kind of thing in the private economy, but we simply saw that consumer spending was being replaced by government spending. We're in exactly the same situation; we're seeing the same trend in the world, probably worse. I'm sure that—

[Thomas Mulcair, NDP, Outremont, QC]

Do you think there will be inflationary pressures in the medium term, over a five- to 10-year horizon, let's say?

[Don Drummond]

That's a risk, but it would be a mistake by the central banks. Everyone talks about the basic expansion of money in the United States. They can control that in a few months, if they want. The risk is keeping interest rates too low for too long, as Alan Greenspan did. That was a serious mistake on his part. Personally, I think that it will make the same mistake. I firmly believe that the inflation rate will still be 2% in two or three years. The problem is more fiscal than monetary.

[Thomas Mulcair, NDP, Outremont, QC]

Since today's subject is access to credit and the stability of Canada's financial system, I'll take the liberty of asking one final question on that subject.

Certain chartered banks—not yours—currently want a mortgage market at a rate of 2% or 2.5%. That's not unusual in Montreal.

The Mouvement Desjardins' rate is now below 2%, 1.5%. I don't entirely agree with you that interest rates won't stay at that level for a long time. The 1.5% rate at Desjardins isn't a fixed rate, but a variable rate. It's like a game on a computer screen: someone sends you something and it moves every time you try to click on it. Try to fix that mortgage at 1.5% for five years and they'll start talking to you about 5%, 6% or 7%.

As soon as rates start to rise, shouldn't someone assess what's happening with those mortgages? We're creating demand. People still think they can pay by the month, not the total value. Shouldn't that be subject to greater oversight?

[Don Drummond]

There are remarkable situations on both sides. The Bank of Canada rate is 0.5% and mortgages are extremely low. In addition, bank margins are extremely low, probably the lowest ever seen. The banks will be trying to restore their margins to normal levels. I'm convinced we'll see an economic recovery, but we'll have to wait until early next year.

The Federal Reserve, the Bank of Canada and the Bank of England will raise interest rates quickly, but they won't be 10%. The Bank of Canada's normal rate is probably between 3.5% and 4.5%. Those interest rates will have to go into effect as soon as possible. I don't think they will before mid-2010; they'll wait for the economy to recover. I'm worried about inflation, but, to avoid that problem, they'll have to start raising interest rates as soon as the economy is stronger.

[The Chair, Conservative, James Rajotte]

Merci.

I have Ms. Hall Findlay. I'm advised that I have to get the consent of the committee because there are four members. Do I have the consent of the committee for Ms. Hall Findlay to ask a question?

[Some hon. members]

Agreed.

[The Chair, Conservative, James Rajotte]

Ms. Hall Findlay, please.

[Martha Hall Findlay, Liberal, Willowdale, ON]

Thank you, Mr. Chair, and thank you very much, colleagues, for your gentlemanly behaviour today.

I have a quick question for Mr. Hodgson. You mentioned earlier that you have revised forecasts in terms of GDP--although not published yet--and you mentioned some contraction, some numbers. Because of the bit of confusion in the discussion we've had so far, can you repeat for me what your forecasts are now for the next number of quarters in terms of GDP?

[Glen Hodgson]

That's a painful exercise, but I'll go through it.

We saw the economy contracting. The forecast we did just before Christmas--we do it on a quarterly cycle, when the national accounts come down, which is when we run the model--saw a contraction of about 0.5% for the country for the year, with growth returning in the third quarter and strengthening in the fourth quarter. The profile will be more or less the same, but it's going to be down a notch. So you're going to see a really bad first quarter. I think there's a consensus among everybody who does forecasts. Some have talked about a contraction of 9%. I think that's too high, but you're going to see a 5% or 6% contraction.