Financial FAQs Worth Reading

As the global financial crisis deepens, Report on Business writers examine and explain the turmoil in credit and stock markets. Here, we answer your questions daily, with the most recent at the top.

CENTRAL BANKS

What is a liquidity injection?

Central banks can use their financial clout to try to get money flowing to the banks and their customers. In a liquidity injection, they make money available for banks to borrow, although the financial institutions have to post securities as collateral to get it. Last week the Bank of Canada said it would make $20-billion available to Canadian banks, and on Monday it said it would let banks pledge their troubled asset-backed commercial paper assets as collateral. This will give some banks more flexibility. One problem, said TD Bank chief economist Don Drummond, is that the central bank's injection is just for the short term - Bank of Canada loans usually have to be repaid within 90 days. But the demand from customers is trending towards longer-term loans - especially from corporations who can't get money any other way - so the central bank money won't help much on that score.

Where do central banks get the money for a liquidity injection?

The Bank of Canada has billions of dollars in assets - about $56-billion at last count - mostly held in very safe securities such as bonds and treasury bills. In essence, when it makes money available to commercial banks, it is temporarily swapping its safe securities for the riskier ones the banks are putting up as collateral.

Do interest rate cuts actually help boost the stock market?

In theory, they should. If an investor is trying to make a decision between putting money into a bond or a stock, he or she will look at the difference between the yield on the bond and the possible return on the stock. Bond yields should fall when interest rates go down, making stocks more attractive. Essentially, for a stock to compete for an investor's money, it doesn't need to offer as high a rate of return. However, bond yields do not always follow central bank interest rate cuts, and they haven't this time. Some very high-quality corporate bonds, for example, are offering huge yields compared with the stock market. While lower interest rates should also make corporate borrowing easier and thus lower costs and finance growth, that hasn't been happening either in the current credit crunch. On top of all this, worries over a recession or panic over falling stocks can trump any minor tweaking of interest rates.

What will the co-ordinated rate cuts achieve?

Central banks around the world moved Wednesday morning to cut their benchmark interest rates by half a percentage point, marking the first co-ordinated action since the terrorist attacks of September, 2001. It was an extraordinary move to bolster markets and help ease clogged credit markets. Among the central banks were the Federal Reserve, the Bank of Canada, the European Central Bank and the central banks of Britain, Switzerland and Sweden. The Bank of Canada's key overnight rate falls to 2.5 per cent, while the Federal funds rate moves to 1.5 per cent.Economists cited the action as a positive and necessary step, but said there's still more to do. London-based Capital Economics, for example, said the move would provide "at least a temporary boost to confidence." Derek Holt, vice-president of economics at Scotia Capital Inc., cited the risk of 50 basis points not being enough and possibly not passing through to consumers and businesses. So far in Canada, major banks have cut their prime rates by just one-quarter of a percentage point. The Bank of Canada itself said the move does not preclude another rate cut at its next scheduled policy meeting on Oct. 21. Indeed, Toronto-Dominion Bank deputy chief economist Craig Alexander said the bank expects both the Federal Reserve and the Bank of Canada to cut another half-point at their next meetings, and the ECB and Bank of England to cut even deeper in the months ahead.

Don't interest rate cuts tend to fuel inflation?

In normal circumstances this is true, and that is one of the reasons the Fed has held rates steady for several months. But with oil prices dropping sharply, and commodity prices falling as well, the threat of inflation is taking a back seat to worries about credit and the functioning of the economy.

What was behind the Federal Reserve's Oct. 7 plan to buy up commercial paper?

The central bank is stepping in as a buyer of last resort in the $100-billion market for commercial paper. This is a form of short-term debt that thousands of companies use to finance their daily operations, including paying employees and buying supplies. The Fed hopes to kickstart this market and free up funds for corporations. The central bank said it was taking the action because money market mutual funds and other investors were loathe to buy commercial paper. Ian Stannard, a currency strategist at BNP Paribas in London, described the move as "probably the first piece of news we've had that starts to address the underlying problem in the financial system. This is a very proactive step and will be a huge help to getting things moving again.

What are the specifics of the plan?

Using Depression-era powers, the Fed will create a new temporary lending vehicle that eligible companies can tap for short-term cash (IOUs of less than three months). In return, the Fed will collect fees and interest, assuming the role of private investors, such as pension and money market funds, that have become too nervous to buy the paper.

How effective will the Fed's new measure be?

The historic move should unclog the market for these business IOUs, helping to insulate the real economy from the credit crunch. The hope is that, over time, private investors will feel confident enough to return to the market, allowing the Fed to withdraw. The catch is that the commercial paper market is just one piece of a massive and interconnected credit system that is no longer functioning, and the Fed can't possibly nationalize it all. Credit markets saw some slight easing Tuesday after the announcement, described by some observers as the most effective measure to date. Douglas Porter, deputy chief economist at BMO Nesbitt Burns, said the central bank is putting itself even more into the "credit creation process" and taking on more risk as a result. Will it work? "This welcome step should alleviate some of the pressure on companies which were finding even day-to-day operations difficult to manage ... Still the problems besetting the credit markets are so multi-dimensional that no move will be a single fix," Mr. Porter said, noting the Fed wants to use every measure possible before cutting its benchmark Federal funds rate.

CREDIT MARKETS AND CRISIS

What is the "money market," and why does it matter if it freezes?

The money market is made up short-term loans (generally of less than one year), such as certificates of deposit, commercial paper, banker's acceptances, and 30-day treasury bills. If the money market freezes up - in other words, no one wants to make short-term loans because they are worried about borrowers defaulting - companies cannot get the cash they need to pay staff, buy supplies or pay rent. Often companies need to borrow this money because they are waiting for revenue that may not arrive for a few days or weeks. But if they can't get short-term cash from the money markets, it can make day-to-day operations very difficult.

What is a credit default swap?

These were originally set up as a kind of insurance against bad debts. A holder would pay a series of "premiums," and in return would get a payout if a specified organization failed. It's the same idea as paying a life insurance premium, where the beneficiary gets a payout only if the specified person dies. Like life insurance, everything is in balance unless there is an epidemic and people start dying left and right. With more companies going under, or threatening to do so, firms that issued swaps are themselves in trouble. That's what happened to insurer AIG, which sold credit default swaps that protected investors against bond defaults. When bonds started defaulting, AIG itself was left vulnerable.

What is counterparty risk?

When you lend $20 to a friend, the counterparty risk is the chance that he or she won't pay you back. And it works the same way with corporations or financial institutions, although their measurement of risk is a little more sophisticated. If the counterparty risk is high, traders and banks won't lend money unless they get some solid collateral or loan guarantees, or they might just say "forget it."

Commercial paper is normally issued only by the most credit-worthy companies, providing them with short-term cash to run their day-to-day operations. Issuers almost always need to have a credit rating on their commercial paper, because the buyers want assurance that their money is very safe, and will be paid back quickly. But getting a credit rating is an expensive and time-consuming process that is conducted by bond-rating agencies. As a result, most commercial paper is issued only by large, stable companies, or entities such as utilities.

What other measures could the U.S. take if the bailout package and interest rate cuts don't stabilize markets and the economy?

The U.S. government and Federal Reserve have used two of the key tools in its toolkit to try to stem panic and stabilize the financial system: The $700-billion bailout of the problem assets at the big banks, and an interest rate cut. But there are other tools as well that have not come into play yet. They could try to stimulate the weak economy by cutting taxes to individuals, they could beef up spending on federal infrastructure to create jobs, or they could give specific tax incentives, for home purchases for example. And while the U.S. government has already boosted insurance on bank deposits to $250,000 from $100,000, it could follow the lead of some European countries and move to unlimited insurance. And if things get even worse at any of the major financial institutions, the government could take direct equity stakes. That seems an unlikely move, but the current situation is unprecedented.

Where will the $700-billion (U.S.) in the Wall Street bailout package go and how will prices be determined?

The money will be paid to Wall Street firms, banks, pension funds and other companies that hold bad mortgages and other toxic assets. The values aren't known at this point, and the amount paid will be decided in a reverse auction, in which the sellers of the assets compete with each other and decide how cheaply they will sell the toxic debts. The government, through the newly appointed Office of Financial Stability, then pays the lowest price offered.

Will the money ever be recovered?

The U.S. Treasury Department has said there is a good chance it will recover some if not all of the money, although observers are not so certain. Previous rescue efforts have actually turned a profit, although others have cost billions.

Who wins and who loses?

While it's theoretical at this point, financial institutions could win out by having their toxic assets bought by the government at what is effectively a premium. While banks can dispose of some of these assets now, they would be doing so at firesale prices if buyers are found. In an ideal world, the U.S. government would hold on to the troubled assets until maturity, when hopefully the real estate market will have recovered, and then dispose of them at at least breakeven. But it is a long-term process, and thus it is too early to tell how the taxpayer makes out.

ECONOMY

Everybody keeps talking about a recession, but when will we know if we're really in one?

The classic definition of a recession is a period when the economy shrinks for two consecutive quarters. But that is considered very rough and imprecise by most economists.

By that measure we won't know whether Canada or the United States is in recession now until well into next year. The third-quarter gross domestic product (GDP) numbers are due at the end of November, and the fourth-quarter stats will be out at the end of February. In the second quarter, both economies grew.

One of the problems with the simple definition of recession is that it doesn't take into account swings in the economy. If GDP shrinks in one quarter by 2 per cent, rises in the next by 0.5 per cent, then shrinks in the third by another 2 per cent, then the country is not in recession under the definition, although it very likely is, in reality.

On the other hand, two consecutive 0.2-per-cent drops would mean we're in recession, even if there was strong growth in earlier quarters. That's not very realistic either.

GDP numbers can also be skewed by population growth, which can disguise a possible recession. And they are often revised months after the fact, so that what initially looked like a recession might not actually have been one.

"We've had situations in history where a recession has been revised away, two years later," says Dale Orr, chief economist at Global Insight Canada.

Is there a better way to define recession?

Many economists prefer to do a much more complex analysis to determine whether a country is in a recession. What needs to be added into the equation, says Mr. Orr, is data on industrial production, consumer spending and labour markets.

In the United States, the National Bureau of Economic Research (NBER) takes these and other numbers into account to officially declare whether a recession has happened.

The NBER (or more specifically, the NBER's "business cycle dating committee") says that a recession is the period that begins just after the economy reaches a peak of activity, and ends as the economy reaches its trough. Sometimes NBER data show there is a recession, even if GDP hasn't declined for two quarters. That was the case in 2001, when the U.S. was deemed to be in recession even though there were no successive quarterly GDP declines. (Later revisions showed there were GDP declines in the first three quarters of 2001.)

So is Canada in recession? Is the U.S. in recession?

Mr. Orr says Global Insight's view is that Canada is not in a recession. While the economy is pretty much stalled, with little or no GDP growth expected this year, "the labour market is moving along at a pretty good pace."

At the same time, consumer spending appears to be holding up, although some analysts are projecting a very weak fourth quarter.

The Conference Board of Canada weighed in yesterday, saying it thinks Canada will likely avoid a recession.

In the United States, however, all the signs suggest a recession is already under way. Estimates indicate the U.S. economy shrank in the third quarter, and will fall again sharply in the fourth, and again in the first quarter of 2009. Employment also has been falling since the start of the year and there is a definite decline in consumer spending. "There is a wide range of people who are feeling a lot of pain; a lot more than in Canada," Mr. Orr said.

If I lose my job, that puts me personally in a recession, doesn't it?

There is an old joke (recently retold in the Economist) that says that when your neighbour loses her job, it is called an economic slowdown. When you lose your job, it is a recession. But when an economist loses his job, it becomes a depression.

What is a depression, anyway?

There doesn't seem to be any formal definition of a depression. But economists say it would involve a sharp drop in economic activity, as measured by GDP, over a prolonged period of more than two years. That shrinkage would also be accompanied by a rapidly rising unemployment rate and a severe drop in personal consumption. During the most bleak stretch of the Great Depression between August, 1929, and March, 1933, the U.S. economy shrank by 27 per cent, about 10 times as much as during the worst postwar recession.

EUROPE

Why are European banks having more trouble than those in Canada?

European banks are in trouble because their leverage - their assets to equity ratio - is typically much higher than those of their Canadian and U.S. counterparts. In North America, the average leverage ratio is about 20. In Europe, it's close to 40. At the end of June, the top dozen European banks had a leverage range from, at the low end, 18.8 (Royal Bank of Scotland) to, at the high end, 61.3 (Barclays). The European banks' sheer size makes them vulnerable too, in the sense that they may be too big to save. For example, the total assets of Deutsche Bank, Germany's biggest lender, are almost €2-trillion. That's more than 85 per cent of the country's GDP. Political squabbling also has the potential to hurt the European banks. If a big bank with operations scattered across the continent, like Italy's UniCredit or ING of the Netherlands, needs a bailout, who pays? The home country or all the countries where the bank has major subisidiaries?

What did the British government do to bolster the banking sector?

The British government partially nationalized its financial institutions by offering to buy up to £50-billion in preference shares from at least eight of the country's biggest banks and building societies. These include HBOS PLC, Barclays and Royal Bank of Scotland. The move by the Treasury would give taxpayers a stake in Britain's major banks. Treasury chief Alistair Darling stressed Britain was not trying to take control of the banks or attempt to run them. But the government also warned it would not be hands off, saying it would look at the dividend policies and executive compensation schemes of the banks and also wanted a firm commitment to support lending to small business and home buyers.The government also promised to guarantee £250-billion of bank loans. British bank stocks surged on the announcement.

Why is Britain taking a leading role?


As the world's foremost banking centre, Britain has more than most at stake in repairing a system that has so rapidly disintegrated.

"We regard ourselves as leaders in global finance and I think government has really sought to protect that, to protect the city as a global leader in finance," said Charles Davis, economist at the Centre for Economics and Business Research Ltd.

Much of the motivation stems from the role of the country's financial services sector, which represents a higher-than-average chunk of the country's economic activity. Britain was the first country in the world to put together a policy package that addressed the different dimensions of the banking crisis, says economist Margaret Bray at the London School of Economics. Other countries have tackled those problems on a piecemeal basis, but Britain was the first to tackle the issues comprehensively, she said.

Will recent measures fix things?

British policy responses, in conjunction with global efforts to repair the financial crisis, are giving investors reason for optimism.

"It's premature to argue that this is the end of the credit crunch but certainly the pervasive lack of confidence and fraught atmosphere is starting to dissipate somewhat," said Mr. Davis of the Centre for Economics and Business Research.

Government assurances Monday were "exactly what was needed because clearly the markets weren't going to come up with a solution to the systemic problems that the credit crunch created," he added.

The spectacular bounce in stock markets Monday was "encouraging," though it will take more time to see whether interbank lending recovers. Recapitalizing banks and guaranteeing debt will go a long way toward restoring confidence.

Economic challenges remain, though. "We may be getting past the worst of the financial crisis but you still have the economic crisis to deal with next year in terms of the effects on the real economy," Mr. Davis said.

What is Mr. Brown proposing now?

British Prime Minister Gordon Brown wants reforms to the international financial system. His London speech Monday outlined five principles that should govern any overhaul.

First, transparency and the adoption of internationally agreed-upon accounting standards. Second, integrity and closer focus on conflicts of interest. "This includes a system of remuneration founded on long-term success, not short-term irresponsibility," he said.

Third, responsibility and ensuring boards are effectively managing risks. Fourth, closer regulations and supervision of banks. This should also help to "prevent speculative bubbles when markets are rising and to cushion the impact of shocks when they are falling."

Fifth, a new Bretton Woods agreement (established in 1944 and which set up the International Monetary Fund and the World Bank) that would build a new global financial framework for the years ahead. "Sometimes it takes a crisis for people to agree that what is obvious and should have been done years ago can no longer be postponed."

Iceland's president said his country could face "national bankruptcy" because of the credit crisis. Can a country actually go bankrupt?

Countries can't go bankrupt in the same way that companies do - closing their doors, sending everyone home, and having their remaining assets seized. But they can become insolvent if they default on their loans and don't repay the interest or principal.This has happened many times over the years, particularly among small developing nations. But in those cases the creditors were not able to seize assets - that would have meant an invasion and takeover of the country. In most cases, world bodies such as the International Monetary Fund work to reschedule or restructure debt so that creditors get some of their money back eventually. At the depths of Latin American debt crisis in 1990, more than four dozen countries were close to bankruptcy because they were unable to pay what they owed. Some were brought back from the brink by the creation of "Brady bonds" - a repackaging of defaulted loans that were backed by U.S. collateral.

FINANCIAL SYSTEM

Are bank deposits safe?

Bank deposits in this country - GICs or other deposits that mature in five years or less - are insured by the Canada Deposit Insurance Corp., a government agency. But the limit is $100,000 per person per institution. and not all financial institutions are members. Depending on the type of account in question, more than one account may be covered to $100,000 at a given bank. In Europe, some countries have recently removed any limits, to make sure that there is no rush of worried customers taking their money out and stuffing it under their mattresses. In Canada there has been no move to change the limit. The CDIC points out on its web site that banks in Canada don't fail often, but "it has happened and it could happen again." In fact, 43 CDIC members - mostly small ones - have collapsed since it was formed in 1967.

What is interbank lending?

Banks normally lend each other cash and short-term securities to help balance out their everyday activities. But lately, banks around the world have been extraordinarily cautious about this lending - partly because they are worried about getting repaid - and this is driving up the interest they have to pay when they want to borrow. This also makes the banks much more cautious about lending out the money they receive in deposits, thus making it harder - and more expensive - for homeowners, small businesses or corporations to borrow. The standard interest rate for interbank loans is Libor, an acronym for the London Interbank Offered Rate. Libor is an average of interbank rates offered by more than a dozen banks, and is calculated every day. The difference between Libor and government bond yields has been growing recently, and that's important because corporate loans, mortgages and student loans are all based on Libor.

Don't banks usually get the money they loan from deposits?

That is usually the case, but the balance is never perfect, and that's why banks lend money to each other. Currently, there is a lot of demand for loans from corporations, which until recently haven't needed much money because they've been so profitable. With little cash available, rates have increased.

Where is the U.S. government getting the money to buy shares in the country's financial firms?

The $250-billion will be part of the $700-billion set aside to help bail out the financial sector. That bigger pot of money, authorized by the U.S. Congress, is likely to be borrowed from the public, corporations and perhaps other national governments, by issuing bonds and Treasury bills.

Of the $250-billion, about half will be used to buy preferred shares and common stock warrants from several of the country's largest banks. Those banks have also agreed to place some limits on executive pay, including a ban on "golden parachutes" during the period that the government holds its stake. The other half will go to thousands of small and mid-sized banks.

The U.S. government will earn an annual dividend of 5 per cent for the first five years and 9 per cent after that. But Washington's holdings will be non-voting.

The banks will be able to buy back the shares from the government when volatility has cooled down and they can raise capital from private investors.

President George Bush also said the government will insure all deposits in non-interest bearing bank accounts, to help businesses worried because their payroll and checking accounts exceed the limits backed by the Federal Deposit Insurance Corp. The government will also back most new bank debt, a change designed to spur more lending between banks.

Why is the U.S. government investing in healthy banks as well as struggling ones?

The government said it didn't want there to be a stigma in accepting the government cash, so it is giving it to both strong banks and weak ones. President Bush said the new capital will help healthy banks continue to make loans to consumers and businesses, while it will help struggling ones "fill the hole created by losses during the financial crisis, so they can resume lending and help spur job creation and economic growth."

Is this the first time the U.S. government has taken equity stakes in private companies?

By no means. Despite the free-enterprise culture of the United States, Washington has often intervened to take ownership of private business. During the First World War the U.S. government took over the railways to make sure that arms and troops were efficiently transported. The trains were returned to private ownership in the 1920s.

The railways were nationalized again during World War II, along with coal mines. The government has also taken direct ownership of banks before. In 1984, when Continental Illinois National Bank and Trust was on the verge of failure after a run on its deposits, a huge rescue package was put in place that resulted in Washington owning an 80-per-cent stake for a decade. In 1994 Continental was finally sold to Bank of America.

Has the Canadian government ever owned shares in our commercial banks?

The Canadian government has avoided any direct investments in Canadian banks, and has tried not to get directly involved in rescuing troubled financial institutions, says Duncan McDowall, a historian at Ottawa's Carleton University.

"The pattern in Canada has consistently been that when commercial banks got in trouble, the federal government allowed them to collapse, or more likely, to fall into the arms of another bank that took its assets and its employees," Prof. McDowall said.

An example: In 1906, the Ontario Bank collapsed, but the federal and provincial governments and other commercial banks arranged to have Bank of Montreal take over its assets and operations.

The only active federal government involvement in banking, Prof. McDowall said, was Canada Post's ownership of the mainly rural Post Office Savings Bank, which had almost 1,500 branches but was shut down in the late 1960s after 100 years in existence.

Aside from that, "there's always been a complete arm's length relationship" between the federal government and the banks, he said. It also helps that the Bank Act is updated every decade or so, "which allows it to be attuned to changes in the market."

Interestingly, the federal government didn't even own the Bank of Canada when it was first established in 1935. For the first few years it was held by private investors, including the commercial banks. But in 1938 the central bank was nationalized and has been in Ottawa's hands since then.

What should be done differently in a new Bretton Woods?

Bretton Woods was formulated more than half a century ago when the world was a different place. Mr. Brown's proposal calls for more co-ordination among national regulators and a focus on global money flows. A new agreement would need to be much more inclusive, said Peter Chowla, London-based policy officer at the Bretton Woods Project, which monitors the World Bank and International Monetary Fund. "We need to involve more people in the discussion. We shouldn't presume one country from a region is going to represent the whole region."


What is Tier 1 capital and what does it tell you about a bank's health?

Tier 1 capital includes a bank's common equity - the value of the shares it has sold to the public - plus the value of its non-cumulative preferred shares, and its retained earnings. These are instruments that can't easily be redeemed by holders, so they are considered permanent.

Tier 1 capital, as a proportion of a bank's overall assets, is a key measure of its financial strength. There are international standards, set by the Swiss-based Bank for International Settlements, for this Tier 1 capital ratio. In Canada, the Office of the Superintendent for Financial Institutions sets the minimums.

Most Canadian banks have Tier 1 capital ratios of around 10 per cent (meaning that Tier 1 capital represents about one-10th of overall assets), well above the OSFI minimum of 7 per cent. The banks also measure second level, or Tier 2, capital which includes not-quite-so-permanent items such as reserves, loan loss provisions, and subordinated debt.

What is the TED spread?

The TED spread is a measure of how much premium banks have to pay when they borrow from each other, and it is a reflection of worries over possible defaults.

Originally, the TED spread was the difference in interest rates between three-month U.S. treasury bill contracts (the "T") and three-month Eurodollar contracts (the "ED").

Now, it usually represents the spread between risk-free three month T-bills and not-so-risk-free three-month LIBOR (the London inter-bank offered rate that banks use for interbank borrowing).

When the TED spread goes up, that suggests bank lenders are worried their counterparties on interbank loans might default. In today's paranoid environment, the TED spread has increased to more than 400 basis points (a basis point is one-hundredth of a percentage point) from "normal" levels of around 30 basis points.

How exactly is the American taxpayer going to pay, directly or indirectly, for the $700-billion bailout package?

The U.S. government's treasury will likely borrow the $700-billion from the public, corporations and perhaps other national governments, by issuing bonds and treasury bills. They will then use this money to buy, at a discount, the distressed assets from the financial institutions that are in trouble. The hope is that when these assets are eventually sold, they could bring in a substantial return to the government, and possibly even make a profit. If it works out as planned, the process should not cost the taxpayer anywhere near $700-billion. Because the process of selling the assets will take time, there should be no impact on the U.S. budget deficit in the short term. If the government eventually takes a loss on the assets it is buying, then it will deepen the deficit down the road.

MORTGAGES AND MORTGAGE INSTITUTIONS

This whole downward spiral seemed to start with U.S. subprime mortgages. What exactly are they?

Subprime mortgages are home loans made to people who would not, under normal circumstances, be ideal candidates to get a mortgage - thus they are "subprime." These are individuals who have a higher risk of defaulting on their loan, such as those who have been delinquent in making payments in the past, or people with a bankruptcy on their credit record, or those who simply don't have a credit history.

Starting around 2005, U.S. lenders loosened their rules and began granting mortgages to borrowers who provided very little evidence of their income and ability to repay. Many of these mortgages had very low initial interest rates, for the first six months to three years, but when that period ended the payments jumped sharply. Borrowers were led to believe that they would be able to refinance their homes at this point because the value of the property would have increased. But the slump in the housing market meant that didn't happen. As a result many people - especially those who had not been completely frank about their income levels - defaulted on their mortgages and lost their homes.

What are Fannie Mae and Freddie Mac? Why the cute names?

Fannie Mae is the nickname of the Federal National Mortgage Association, while Freddie Mac is the Federal Home Loan Mortgage Corp. Fannie Mae is the older of the two. It was created as a government agency in 1938 under U.S. president Franklin Roosevelt's New Deal. The idea was to give local banks federal money to finance home mortgages, since private lenders were leery of lending money. The government wanted to help more people buy homes, and encourage the building of affordable housing. In 1968 it became a private company. Freddie Mac was set up in 1970 to expand the secondary mortgage market, and ensure there was competition with Fannie Mae's monopoly. Both companies buy loans from banks or mortgage firms, and re-sell these as mortgage-backed securities. Together they own or guarantee about half of U.S. mortgages. The two were put under "conservatorship" by the U.S. Federal Housing Finance Agency on Sept. 7 - essentially a takeover by the government.

Who owns Canada Mortgage and Housing Corp. and can it go under?

CMHC was set up by the federal government just after the Second World War to help deal with a housing shortage exacerbated by the huge number of soldiers returning home. It helped finance home construction and provided funds for low-income housing. In the 1950s, when banks got into mortgage lending, CMHC started insuring "high-ratio" mortgages where home buyers initially made only a small down payment. This summer CMHC stopped insuring mortgages with zero down payment or 40 year amortizations.

CMHC also subsidizes aboriginal housing, provides loans and grants for certain kinds of renovations, and gathers statistics on the housing market. It also buys mortgages from financial institutions, and repackages them as mortgage-backed securities, which it sells to investors.

Because CMHC is a Crown corporation - unlike Fannie Mae and Freddie Mac which were private companies - it is backed by Ottawa and could not really "go under."

PERSONAL FINANCE

Do the interest rate cuts mean my mortgage rate or credit card interest rate will go down?

On Wednesday several banks lowered their prime rates by just a quarter of a percentage point, instead of matching the half-point cut in the Bank of Canada's benchmark overnight rate. One bank said it couldn't afford a steeper cut because it is paying so much these days to fund its own borrowing through global credit markets. You will see that quarter-point cut in interest rates if you have a variable-rate mortgage that is tied directly to prime. Other short-term loan rates - certain car loans, for example - that are measured off prime will also go down. But other rates - for five year mortgages, for example - are set based on bond yields, which have been rising sharply, so don't expect any relief. Credit card rates are a function of credit risk, and won't likely see any decline because of the drop in the prime rate.




Why are Saudi Arabia and other OPEC countries allowing the price of crude oil to fall so dramatically? Can they not control the price of oil by adjusting production?

OPEC (the Organization of Petroleum Exporting Countries) does have significant control over production, but it is not an instantaneous process and changes don't always have an immediate effect. In early September the cartel said it would cut production by about 520,000 barrels a day, and OPEC is set to meet Oct. 24 to talk about possible further action. (On Thursday it shifted the meeting forward from Nov. 18.)

Still, as University of Alberta business professor Joseph Doucet points out, OPEC has no direct control over prices, but can merely control the quantity of its production, which has an indirect influence on prices. Other factors - such as the level of crude and gasoline supplies in the United States - can have a greater impact. In addition, Prof. Doucet says, oil prices have been shifting quickly in the past few weeks and production changes take some time to put into place.

The internal politics of OPEC account for yet another complicating factor. "Saudi Arabia has the largest reserves of any OPEC country and is the 'patient' one - the country with the longest view," Prof. Doucet said. "They have an interest in a moderate oil price [because] they want to be able to sell oil for a long time. Countries with shorter views, say Nigeria, have more pressing needs for cash flow ... and thus worry less about long term oil substitution."

And even when OPEC sets quotas, not every country in the organization always respects them.
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