Global Agenda: Some people never learn

The Canadian and Israeli real estate booms show that prudence doesn’t always stand up to temptation.

February 18, 2011 06:32
4 minute read.



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One of the best – and certainly the least painful – ways of learning about anything is by observing the mistakes made by others. If you are smart, you can observe other people doing things in a stupid or inefficient way and actually avoid getting into trouble by making the major blunders that they are making. If you are less smart, you can at least learn from your own past mistakes. Failing all of these, you can avoid serious trouble just by sheer good luck.

These pearls of wisdom apply to almost every field of activity, but let’s home in on economics and finance – and let’s be specific. There was a huge bubble in the real estate and mortgage sectors of several countries in the decade from 1997-2007. This was the result of bad economic policies, very lax supervision of the banks and incredibly poor decision-making by the banks themselves. There were other factors involved as well, with the specific mix varying from one country to another.

But the result of these policy mistakes, incompetence, stupidity and a large dose of criminal activity as well was a huge real estate crash – the bigger the bubbles come, the harder they pop and crash. In most of the countries involved, the entire banking system was made insolvent by their excessive exposure to real estate and mortgages.

However, there were a few countries in the developed world that managed to get through the crash of 2008 without serious trouble.

A good example is Canada, which had run a very sound and sensible economic policy since the mid-1990s, and whose banks were hailed during and after the crash of 2008 as being solid, prudent and largely clean. In other words, the government, the banking system and the general population had succeeded in avoiding the fate of their large neighbor, the US; of their former mother country, the UK; and of Ireland.

This success was achieved by learning from their own mistakes in the past (such as running up a huge budget deficit) and from avoiding the obvious idiocies of others. No doubt, a measure of luck was involved as well, but luck often serves those who are well-prepared to take advantage of it. In the wake of this singular achievement of having avoided the worst crisis in eighty years, you might think that the Canadians would be not only proud of themselves, but extra careful to keep their economic policy and banking system on the straight and narrow.

In reality, things are working out rather differently. The Canadians cut their interest rates sharply in 2008-09 along with the rest of the developed countries, and have kept them at historically low levels. Meanwhile, their economy has bounced back quickly, because of its underlying strengths – and also because of the country’s wealth of natural resources, which have benefited from the global commodity boom.

The country’s currency has risen strongly, having benefited from its economic performance and its clear superiority to the American dollar.

Cheap money and strong growth have triggered a housing and mortgage boom in Canada. The banks – the same ones being hefted for their conservative attitude and solid performance a few years ago – have been pumping out mortgage loans as hard and fast as they can, so that the strength of their balance sheets is rapidly being diluted.

They are in no immediate danger, but if and when interest rates rise and their borrowers find their repayments jumping whilst the value of their properties falls, they will suffer losses. If things carry on their present path for much longer, the potential danger will shift from being one of a bad year or two to a systemic crisis with massive implications for the whole economy.

To the onlooker, this is remarkable, because it shows how easy it is to subvert supposedly intelligent people.

Instead of drawing the lesson that it pays to be prudent, the Canadian banks and their clients have been seduced by the siren song of cheap money and a speculative boom in which “everyone” is “getting rich” quickly and easily. The fact that very recently the same scenario ended in major disaster in nearby countries makes no difference. The herd is up and running and nothing can stand in its way.

The Canadian story is not only remarkable in itself – it also sounds eerily familiar.

Israel, another country that came through the crisis with flying colors, is charging down the same path. The same devil’s brew of cheap money and rising prices is fuelling a mortgage and house price boom here, with people loading up on floating- rate mortgages that are currently very attractive.

Indeed, substitute Israel for Canada in the previous paragraphs and almost the entire description is still valid.

That this process will end badly is not open to question – the evidence from historical precedents is overwhelming.

The longer it goes on, the worse the final outcome.

So far, the efforts of the Bank of Israel to stem the tide of speculation have failed.

But after this week’s shocking GDP figures – which were not wonderful but terrible, showing an economy rapidly overheating and racing in the wrong direction – those efforts will have to be redoubled.

The Israeli consumption and real estate boom will have to be derailed, before it goes over the cliff, taking the banking system with it.

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