Financial markets turmoil stirs economists' memories of 1929 crash

By Julian Beltrame, The Canadian Press

OTTAWA - North American markets roiled and the Canadian dollar tumbled Monday in the wake of the sale of New York investment bank Bear Stearns for a fraction of its former value, with some economists tentatively drawing comparison to the 1929 stock market crash.

The volatility began overseas after the U.S. Federal Reserve held an emergency meeting on Sunday and cut its key rate by one-quarter of a point and said it was willing to back-stop institutions with urgent loans.

In Canada, banking stocks took it on the chin as concerns spread about their level of exposure to the U.S. subprime fiasco, with the sector dropping 2.8 per cent in early afternoon trading, and the Canadian Imperial Bank of Commerce (TSX: CM.TO) stock tumbled nearly five per cent.

CIBC is the Canadian bank that has been hit hardest by the credit crunch in the United States, with writedowns nearing $3 billion.

Overall, the TSX dropped tumbled by more than 400 points at one point Monday, and the Canadian dollar was down almost 1 1/2 cents US. Both recovered somewhat to close down 300.7 points and 1.33 cents US, respectively.

Finance Department spokesman David Gamble released a statement noting that Canada is not immune to global instability but assuring that its "banks and other financial institutions are sound and well capitalized."

The Fed's Sunday surprise was both directed at controlling the aftershock of Bear Stearns and to forestall a run on Lehman Brothers, another troubled investment bank whose shares slid Monday on rumours it might be the next to face a liquidity crisis. Lehman said its cash position was strong.

"The threat of contagion and wholesale breakdown on a scale of 1929 is real," said University of Maryland business professor Peter Morici.

"The real questions are - which of the big banks will be next to fail? How many more banks will fail? Will the whole system turn to panic if Citigroup (another troubled bank) unwinds?"

Harvard economist Martin Feldstein said the U.S. economy could suffer the worst recession since the Second World War.

Many economists now believe the U.S. economy has already slipped into negative territory, and Canada may also experience a negative first quarter this year, said TD Bank chief economist Don Drummond.

"I think we're flat, we're absolutely sideways in the first half," Drummond said.

"We can blame it all we want on the Americans, but the reality is - as great as the so-called domestic economy is - the exports are going to take a tumble and we've already seen that in automobile exports and a whole range of other things."

Drummond said the TD Bank is at the point of revising sharply downward the growth projection for Canada in 2008 from 1.8 per cent to 1.1 per cent.

BMO chief economist Sherry Cooper said she doubted that the world is on the verge of a 1929-style collapse, in part because Fed chairman Ben Bernanke has been willing to act swiftly and aggressively. But the situation is very serious, she cautioned.

"The Fed is now in the state of emergency," Cooper said. "They couldn't wait until Tuesday (the next scheduled policy announcement) because the wanted to make sure when Tokyo opened last night there was a definitive action already taken."

Meanwhile, Bank of England on Monday offered an extra five billion pounds - around US$10.1 billion - of reserves for short-term money markets because of the dire conditions.

And that may be the key difference between now and then, said Drummond, who noted that besides the stock market crash, 1929 also saw a "complete failure on the policy front" from governments, who reacted by imposing protectionist measures, among other policy fiascoes, that exacerbated the problem.

In response to the current turmoil, central banks around the world have reacted swiftly and aggressively to inject liquidity into the system.

Along these lines, the Fed is widely expected to cut interest rates by at least 100 basis points or a full percentage point on Tuesday, bringing its federal fund rate to two per cent - the lowest since 2004. Some economists say the U.S. central bank's key rate could dip below one per cent by year's end.

The Bank of Canada's next scheduled announcement on interest rates does not occur until April 22 - a lifetime given the volatility of markets - but Cooper said she would not be surprised if the bank jumped in sooner with perhaps a 50 basis point cut.

Bank of Canada spokesman Jeremy Harrison would not comment on what the institution would do, saying that it "is continuing to monitor financial market developments closely."

Not all the economic news was bad Monday. Canadian manufacturers started 2008 modestly on the positive side, with shipments rising 1.3 per cent in January after falling 3.7 per cent the last month of last year.

But Statistics Canada noted that manufacturing sales remained 7.1 per cent below the recent peak of $53.1 billion in March 2007, with the weakness continuing in autos and parts industry.