A lesson in economics... with today's news.

If you believe recent headlines, we are heading for the next depression. Now, I don't disagree that the markets are in a bit of a slump, but there are no real reasons for panicking in Canada except for the paranoia that has been created by various news media. There is no question that the housing market in the United States has plummeted. In Canada, recent job reports have been somewhat encouraging, so I don't see why the media is drawing parallels between the economies.

Granted, the US is our largest trading partner, so their economic troubles do have an impact on the success of the Canadian economy. That being said, our country is running, albeit small, a surplus, compared to the massive deficits created by President Bush. In addition, the US economy required a bailout package for its financing institutions due to their problems with the sub-prime mortgage crisis. In Canada, we have essentially provided our banks with an asset swap to help them out. We've given them now a total of $75 billion in the swap. I've been reading comments on news site and a lot of people are misstaking this for a bailout.

This is not a bailout. The Canadian government is providing cash to the banks to ease their liquidity problems. What does this mean?? Well, the banks have mortgages to individuals that they are expecting to collect over the next number of years. The banks are stretched to the point where they no longer have the cash to continue lending at current rates. The mortgages are still good, but they eat up the banks reserves. Banks can only lend so much money despite their abilities to make billion dollar profits.

I may make things more clear if I used an example. If I lent you (consumer)$1000 at a rate of 5% for one year, you would pay me $1050 in one year. As the lender (bank), I would make $50, but I lose my ability to loan another $1000 to someone else unless I can borrow another $1000. This is where the government can step in. The government can pay me (bank) $1025 for the ownership of the mortgage. The government will earn $25 when the loan matures, and I (bank) will earn $25 plus maybe another $50 from another loan that I could create.

The reason the government wants to do this is because these types of loans are critical for the success of our economy. First, the person that needs the first loan may be able to receive the needed cash to purchase a home. Next, if someone else needed money to start a business, they would not be able to acquire any cash. On a macro-level, a person would only be able to get the financing if they were willing to pay a higher interest rate. A lot of people may not want to get into business if they have to pay too high of an interest rate. The risk would be too great. By providing a mortgage swap, the Canadian government is assuring Canadians that they can borrow at low rates and be able to continue to stimulate the economy.

In my next post, I will discuss my outlook for the Canadian real estate market. I'll make a prediction for Ottawa, and when will the best time will be to get into the market. Obviously, I'm talking strictly from a investment point of view, dollars and cents. When purchasing a home for your own use, dollars and cents matters, but it is only a part of the overall satisfaction with living in your own particular home.