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The Bank of Canada intervened in the money market more heavily than usual Thursday amid continued turbulence in Canadian and U.S. stock markets.
The turmoil worsened after word that a French commercial bank has been burned by the meltdown of the U.S. subprime – or high-risk – mortgage market, along with a Wall Street Journal report that a second hedge fund operated by high-flying U.S. investment bank Goldman Sachs Group Inc. is now in subprime trouble.
Canada's central bank took the rare step of publicly reassuring investors that it will help provide stability to financial markets and the domestic financial system.
“In light of current market conditions, the Bank of Canada would like to assure financial market participants and the public that it will provide liquidity to support the stability of the Canadian financial system and the continued functioning of financial markets,” the central bank said in a brief statement issued at about 10.45 a.m. (EDT) Thursday, although it emphasized that this is standard operating procedure.
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“The Bank is closely monitoring developments, and will deal with issues as they arise.”
The bank's website indicates that the last time it issued this sort of public reassurance was following the Sept. 11, 2001, terrorist attacks in New York and Washington.
Reached in Ottawa, bank spokesman Jeremy Harrison said it had taken the unusual move of doing so again Thursday after receiving many inquiries from both financial market players and the media. “The bank felt it was best to issue a statement at the same time to inform everybody what [its] normal operating responses are,” he said.
The statement came in the wake of news that the European Central Bank (ECB) lent about $130-billion (U.S.) to banks at low rates to allow them to inject more cash into money markets.
This followed a revelation by France's BNP Paribas that it has frozen three hedge funds that have been hit by the U.S. sub-prime crisis, just weeks after U.S. investment bank Bear Sterns Cos. shut down two similar funds after they bled away $1.6-billion in investors' capital.
Mr. Harrison would not say whether Canada's central bank has already injected extra funds.
However, information on its website shows that by about 2:30 p.m. Thursday, it had made $1.64-billion available to Canadian banks at its regular target interest rate, considerably more than recent daily infusions.
The Bank of Canada's intervention is “a large number but not all that unusual,” Bank of Montreal deputy chief economist Douglas Porter said when reached in Toronto.
“For instance, just a couple of days ago, they injected about $410-million, and there was a day last week when they injected $660-million,” he said. “So it's not completely out of bounds and it's nothing compared with what the ECB had to do.”
Ted Carmichael, chief economist at J.P. Morgan Securities Canada Inc., called the size of the ECB injection “fairly stunning.
“It was a pretty major action,” he said in a telephone interview.
Mr. Carmichael also said that as part of its regularly scheduled provisions of liquidity to overnight lending markets, the U.S. Federal Reserve Board Wednesday night provided the system with a higher-than-normal $24-billion injection.
As for the Bank of Canada, Mr. Carmichael and several other economists said its main goal in issuing its statement is “to indicate to the markets that it stands ready to act if it needs to,” he said.
This view is shared by Patricia Croft, chief economist at Phillips Hager & North Investment Management Ltd., in Toronto.
“It's just meant to calm the jittery nerves of the market today,” she said in a telephone interview. “Liquidity, of course, is the fuel for the markets, it greases the wheels. And [the central bank's] job is to reassure investors that there is plenty of liquidity out there.”
Although no Canadian hedge funds are known to have blown up because of U.S. subprime woes, concerns about potential exposure to the debacle is one reason Canadian financial stocks have been taking a bit of a beating lately, Ms. Croft said.
Andrew Pyle, a former senior economist at Bank of Nova Scotia and now an investment adviser with the bank, said there is “good reason” for the Bank of Canada's heightened concern.
“If credit is being rationed globally, at a time when China is hinting at using its foreign reserves as a defensive weapon against U.S. trade initiatives, the contagion from subprime to private equity will spread to other segments of the global economy (business lending, consumer lending, and overall spending),” he said in a note to clients.
The bank's statement at first appeared to have succeeded in settling down Canadian investors.
The benchmark S&P/TSX composite index, which opened down just over 200 points at 13,558.27, bounced back to 13.758.19 by about 11 a.m.
However, by about 2 p.m it had yo-yoed back down to 13,579.34, off 1.3 per cent.
South of the border, the Dow Jones industrial average was down 190.46 points or 1.39 per cent at 13,467.4, while the S&P 500 was off more than 1.7 per cent and the Nasdaq had given up 1.27 per cent.
There is a lesson in the hedge funds' troubles, according to National Bank Financial chief economist Clément Gignac.
“As some investors are beginning to realize, many hedge funds have invested in different risky and sometimes illiquid financial instruments (like subprime mortgages) in order to deliver higher returns,” he said in a Thursday note to clients.
Observing that, fuelled by investor optimism, the lightly regulated hedge fund industry has grown by five times since 2000 to exceed $1.7-trillion assets under management without really experimenting a full-fledged credit or business cycle, Mr. Gignac said human nature has not changed and that risk perception can quickly change from greed to fear.
“After spreading the risk everywhere through securitization, banks and brokers are now facing some difficult choices: step in to buy back risk and provide market liquidity on some assets, or stay on the sidelines and proceed with further margin calls, with the risk of exacerbating market turmoil,” Mr. Gignac said.
“ Bottom-line: Credit risk may have been passed along, but it has not evaporated. What goes around eventually comes around!”
With a file from reporter Heather Scoffield in Ottawa
