The Bank of Canada's Financial System Review

The Bank of Canada published its December 2008 Financial System Review yesterday. I spent a few hours reading it through (something I had never bothered to do in the past).

Some observations:

1. The large (25 page) first part (Risk Assessment and Macrofinancial Environment) is written by the Bank's own Governing Council (Governor plus Deputy Governors). They put their names to it; it's not just something written by a couple of junior economists. It is very good (as far as I can tell) in providing a clear and (as far as can be, in uncertain times) complete assessment of the risks. Lots of graphs. Lots of comparisons across countries and across time. And it needed to be done. (I would have liked to see something on CMHC losses, but there's not a lot of action we can take on that front now: the horse already bolted).

2. Some media reaction (TV especially, the print media were better) was daft. A lot of panicked journalists expressing shock. First, where have these journalists been hiding all these last months? Is this the first they've heard about the financial crisis? Did they think that Canada would escape unscathed and there couldn't be an increase in mortgage defaults and foreclosures? Second, their scenario is not what the Governing Council thinks will happen; it is their assessment of the risks of what might happen. They say this explicitly:

Against this background, the purpose of this assessment is not to focus on
the most likely outcome, but to identify and examine the main sources of risk
to the Canadian financial system and to highlight the policy actions taken to
mitigate those risks. (my emphasis added)

Perhaps it wasn't explicit enough. Message to Bank: next time use bold.

3. The purpose of a Report like this is to get a more realistic assessment of downside risks, and allay fears that we will all resort to barter and be hunting squirrels for food. (That's how it worked for me). But given some journalists' and public reaction, maybe it will just stoke those fears?

4. Most models of money and finance have multiple equilibria: if we think these bits of paper are/aren't money then they are/aren't money; if we think there will/won't be a run on the bank then there will/won't be a run; if we think there will be inflation/deflation at zero interest rates then there will be inflation/deflation; if we think an asset is liquid/illiquid then it will be liquid/illiquid; etc..

5. Because of 4, 3 matters.

6. Because of 4, and 5, it is very hard to present a realistic forecast of what will happen.

7. The Report doesn't worry me; 6 does.

8. I'm a country boy, and know how to hunt squirrels (but prefer rabbit).

9. Anyone got a ferret for sale?

Comments

[Yappa]

It was a good service of journalists to deliver a wake-up call. We've been hearing about the coming crisis for months but for a lot of people it's not real yet. Before they go into their annual Christmas debt, everyone should probably give thought to whether their job will survive long enough to pay it off.

[Nick Rowe]

I hadn't thought of it that way. Perhaps a lot of people are/were ignoring it. If so, then I take back what I said about journalists. Maybe they know their audience better than I do (as of course they should).

[Dee]

If you follow some of the financial floggers they've been saying the housing market is in fine shape in Canada. Can't waiver consumer confidence otherwise they won't spend.

Employment numbers for January should be interesting. Credit card defaults even more so.

Smoke and mirrors.

[Chris]

The mainstream media makes me angry these days. Stephen's post the other day about the Globe is a case in point (http://worthwhile.typepad.com/worthwhile_canadian_initi/2008/12/the-globe-and-mail-succumbs-to-irrational-panic.html)

My concern is that the fear mongering is having a further depressing effect on consumer confident, beyond what may be justified. We're better at spreading bad news today than at any point in history.

However, I'm a country boy too, and I just might have a friend in PEI with a ferret for sale...