Financial Contagion Hits Home in the Kootenays

HELMUT PASTRICK, Chief Economist, EKKCU

The financial crisis on Wall Street and in other global financial centres is having a negative impact on the economy, prompting policymakers into swift and unprecedented actions. While equity holders have taken a haircut and seen the losses on their statements, the impact of the crisis on the local and regional economy is less apparent but it nevertheless exists through several channels.

The Kootenays are far from Wall Street and the subprime mortgage mess but they are not insulated from the financial storm and its negative economic repercussions. Today’s globally integrated financial system and interwoven economies ensure that few parts of the world, if any, can escape fall-out from the worst financial crisis in decades.

The most direct channel is the cost and availability of credit. Credit markets in Canada are less disrupted and strained by the financial crisis than in the U.S. but the several billion dollar losses by Canadian financial institutions and others has an impact. Their balance sheets were hit leaving them less capital to lend or at a higher cost of capital when raised in the market. This pushed up lending rates higher than otherwise and caused lenders to ration more tightly their loans to borrowers.

A restricted flow of financing coupled with higher financing costs slows economic growth and when finance-dependent sectors such as real estate are already in trouble, it makes for a longer and more difficult recovery. Investment spending by companies is constrained by less available and more costly financing and their declining share price reduces the amount of capital raised in the equity market. Consumer borrowing and spending also slows down under these conditions.

The U.S. economy is struggling with recessions in housing and auto manufacturing along with slowing consumer and declining investment spending. Its main source of growth is exports thanks to a multi-year drop in the U.S. dollar and to a temporary surge in the past second quarter due to a large government stimulus package.

Cracks are emerging in Canada’s economic growth performance with its previously stalwart domestic side weakening due to the onset of a housing correction and slower consumer and business spending. Unlike the U.S., Canadian exports are in decline and the financial turmoil is contributing to a global economic growth slowdown and to lower commodity prices.

Decades-low lumber prices and low demand from American homebuilders coupled with the new Softwood Lumber Agreement, which imposes a 15% duty at the border, hits B.C. and Kootenay producers hard causing shutdowns, layoffs, and closure of some operations. No improvement should be expected until the U.S. housing market turns up likely later in 2009 or possibly not until 2010.

One bright industry sector in the Kootenays is coal mining. The recent global economic slowdown is taking pressure off prices but 2008 contract prices are the highest in years and the outlook for 2009 remains positive with still growing global demand and limited supply. There is potential for further production expansion in the East Kootenays and high prices are a necessary condition for new investment.

The region’s tourism sector grew at a double-digit pace for the second year in a row based on room revenue figures. A repeat of last year’s banner performance is in jeopardy this year with some slowing in Alberta’s economic growth materializing and the sharp increase in fuel costs discouraging some travelers. However, the region’s longer term expansion potential is substantial with numerous developments underway or planned. The recently expanded Cranbrook airport plays a vital role in fulfilling that potential.

Healthy markets for Kootenay exports are critical to the region’s economic vitality often making the difference between robust or sluggish economic growth. Financial crises reduce economic growth by restricting credit, outright job losses, heightened uncertainty, and higher risk levels. A region’s domestic economy can buffer against negative external conditions for a period of time but feedback effects take a toll.

Residential activity in the Kootenays is trending lower following a multi-year upturn. Sales turned down around mid-2007 when the subprime mortgage crisis came to the forefront and mortgage rates kept climbing higher. Potential purchasers may also have been deterred by the increasingly uncertain economic outlook, rising energy prices, and poor affordability for low equity buyers. Purchasers from outside the region are affected by the same external forces and may alter their spending.

Housing prices are reacting to fewer sales and more listings on the market. The record-high prices attained this year are leveling-out with each passing month, and barring a sales reversal, are poised to decline. However, lower mortgage rates are likely in the coming months and that is positive for the sales outlook.

This unfolding housing market correction, which is evident in all parts of the province, puts increasing emphasis on supply adjustment. Fewer listings coming onto the market and less new construction play out well into next year in order to achieve price stability and to better align supply with lower sales levels.

The financial crisis playing out in the U.S. is the most serious since the Depression era and no one knows how much longer it will last but the remarkable policy actions in September are necessary steps to its resolution.

The growth slowdown in the Kootenays, as in other parts of the province, is likely to extend well into next year and external events will influence the timing and magnitude of the eventual growth recovery phase.