FAQ's Of Our Market Turmoil From all Angles

How European interest rates compare to others

Thursday, November 06, 2008

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.

Why have European interest rates been so much higher than those in North America in recent months?

In Europe, as in every other developed economy, the central banks generally set interest rates to spur economic growth (by moving rates down) and to control inflation (by moving them up).

Until recently, inflation has been a much bigger concern in Europe than in North America, so rates there were set higher to try to keep upward price pressures in check. In the United States, growth has been sub-par for several years, so the Fed has already moved rates down to try to stimulate the economy.

In addition, Europeans tend to be even more concerned about inflation than North Americans, said Toronto-Dominion Bank senior economist Richard Kelly, because in Europe many wages are indexed to inflation. As a result, a jump in inflation in a country can almost immediately accelerate wage costs and damage the economy.

Now, the focus in Europe has shifted to economic growth, as the consequences of the implosion of U.S. financial markets spread around the world. Inflation is much less of a worry, so we're seeing big interest rate cuts to try to curb shrinking European economies.

CENTRAL BANKS

What is the difference between the U.S. Federal Reserve Board and the Department of the Treasury?

The Federal Reserve Board, often called the Fed, is the central bank of the United States. It has a similar role to the Bank of Canada, in that it sets interest rates and lends money to member banks.

It also regulates banks, a job that in Canada is performed mainly by the Office of the Superintendent of Financial Institutions. The Fed also manages the United States' cheque clearing system.

The Department of the Treasury is the arm of government that manages finances, much like Canada's Finance Department.

It collects taxes (a role performed in Canada by the Canada Revenue Agency), pays government bills, and manages federal government debt. The Treasury also prints paper currency and mints coins.

What is the purpose of countries having foreign currency reserves?

Foreign reserves usually include cash held in foreign currency, along with gold, and reserves set aside for the International Monetary Fund.

Holding foreign reserves gives a country flexibility in influencing the exchange rate of its own currency. If Japan wants to prop up the value of the yen, for example, it can sell some of its vast foreign reserve holdings to buy yen, a move that effectively increases demand for the currency, which will tend to increase its value.

(In recent years, the Japanese have been doing exactly the opposite. They have purchased billions of U.S. dollars and sold yen to try to slow the appreciation of the yen, which was hurting Japan's exports.)

What is "currency intervention?"

When a country doesn't think its currency has the right value compared with that of another nation, its government or central bank can make large purchases or sales of currency to try to right the imbalance.

For example, if country A wants to see its currency lower relative to country B, it will sell its own currency and buy large amounts of country B's currency. That would increase supply of the domestic currency and drive down demand, likely depressing its value.

If a number of countries work together, they can have an even bigger impact on currency value?

There has been speculation that the largest industrial nations might attempt to intervene in currency markets in the near future, to try to trim the value of the Japanese yen, which is near a 13-year high compared with the U.S. dollar. The finance ministers of the G7 countries said Monday that they will monitor markets closely and "co-operate as appropriate" because they are concerned about the volatility in the yen.

In the past, the Japanese have been among the most active countries in using currency intervention to shift the value of the yen. Several times since the mid-1970s the Japanese government purchased billions of U.S. dollars and sold yen to try to slow the appreciation of the yen, which was hurting Japan's exports.

The last major multinational intervention was in September, 2000, when central banks in Europe, the United States and Japan sold massive amounts of U.S. dollars and bought euros in order to prop up the European currency, which had fallen about 30 per cent since its launch in January, 1999.

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.

COMMODITIES

Have oil prices, which have fallen more than 50 per cent since mid-July, ever dropped this fast before?

In early 1986, oil fell sharply over about three months from about $26 (U.S.) a barrel at the start of the year to just over $10 by the end of March, a price that had not been seen since the mid-1970s. The blame for the price drop was placed on increased production by Saudi Arabia and other OPEC countries, a move that caused a glut on world markets.

Again in the late 1990s there was a plunge, from over $22 in the fall of 1997 to below $11 about a year later. That was the lowest price oil had traded at in more than a decade.

Again, the Organization of Petroleum Exporting Countries got the blame, because it could not agree on production cuts.

A decline in demand - particularly in Asia, where the economy had weakened - also exacerbated the downward price pressure.

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.

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

I read that Saudi Arabia is already one of the largest contributors to the International Monetary Fund. How much does it give?

Saudi Arabia is indeed one of the largest contributors to the IMF, and as such it has a large number of votes at the organization. Saudi Arabia's "quota" — or the amount of credit it provides to the IMF — is just over $10-billion (U.S.), slightly more than Canada's quota of about $9.5-billion.

Since votes at the IMF are proportional to quota, that means Saudi Arabia has about 3.2 per cent of the votes, compared with Canada's 2.9 per cent.

That makes Saudi Arabia the sixth most powerful country within the 185 members of the IMF, beaten out only by the United States, Britain, Japan, Italy and France. The United States has the biggest quota (about $55-billion) and the largest number of votes (about 17 per cent of the total).

Member countries keep the bulk of their IMF commitments in their own reserves at home, but they may be called on to provide cash when troubled members seek help.

With the economic downturn, is Canada's unemployment rate anywhere near a record high?

The unemployment rate may rise in the coming months, but at the moment it is very low in historical terms. The current rate, at 6.1 per cent, is not far above the 33-year low of 5.8 per cent that was hit in the early months of this year. Economists are expecting the rate to rise to 6.2 per cent when the new labour force numbers for October are released later in November.

We have had much higher unemployment rates at several times in the past. During the depth of the Depression, in 1933, the rate peaked at about 25 per cent. By the end of the Second World War there was virtually no unemployment, and for the next three decades the rate stayed below 7 per cent. Then in the early 1980s and again in the early 1990s there were spikes when unemployment rose above the 11-per-cent mark, but it has been trending downward since then.

When the Canadian dollar took its recent dip, did it come close to its lowest point ever relative to the U.S. dollar?

The Canadian dollar bottomed out at 61.75 cents (U.S.) in January, 2002, so the fall to 77.59 cents on Oct. 27 was quite a way from that point. What was more unusual about the recent drop was the speed with which it occurred. The dollar tumbled more than 19 cents in the space of a month.

The recovery has also been quick, however. The dollar was up more than 7 cents in the five trading days since it hit the trough a week ago.

The Canadian dollar's highest point compared with the U.S. dollar, at least in modern times, came just last November, when it briefly nudged above $1.10. Way back, during the U.S. Civil War in the 1860s, the Canadian dollar reached $2.78.

Why do economists always say that the consumer is 70% of the economy? Isn't the consumer really 100% of the economy, since all business is just an intermediary activity that ultimately sells to the consumer?

In a broad sense, you are right that individual consumers ultimately make up the entire economy, said Doug Porter, deputy chief economist at BMO Nesbitt Burns. But the way economic activity is measured, there are different categories that make up the overall picture, he said. This includes government spending, residential construction, domestic business purchases and exports, along with consumer spending.

But Mr. Porter notes that the 70-per-cent number you are referring to actually applies only to the United States, "which is the real outlier compared to most of the rest of the world." Elsewhere, consumer spending makes up a much smaller proportion of the economy.

In Canada, consumer spending is about 55 per cent of the economy. The big difference between us and the Americans is that health care purchases are mainly made by government here, while in the United States most of that spending comes under the consumer category, because individuals write the cheques.

Government consumption makes up almost 20 per cent of the economy in Canada.

What provinces have run deficits in recent years?

Most provinces have had balanced budgets or surpluses for several years. The only exception is Prince Edward Island, which had a small deficit of $37-million in its 2007-08 fiscal year, and projected a $35-million shortfall for 2008-09.

The days of almost-universal provincial surpluses may be gone, however, because of the gloomy economic outlook. Ontario said Wednesday that it will now have a $500-million deficit in the current fiscal year because it does not want to cut health or education spending, even though its revenue is declining. That's a change in direction after three years of surpluses.

Alberta has been running surpluses for the longest period - it hasn't had a budget deficit in 15 years, thanks to its blossoming oil revenue. And Alberta is also the only province that has managed to completely eliminate its accumulated debt. That happened in 2004.

The international financial summit set for November has been called Bretton Woods II. What was the first Bretton Woods conference?

Bretton Woods is the informal name for the United Nations Monetary and Financial Conference held in Bretton Woods, N.H., in July, 1944. Officials from 44 countries attended. The central agreement hammered out there said each country would maintain a fixed exchange rate - a policy that has long since collapsed - in order to help encourage the flow of capital across borders. The International Monetary Fund and the World Bank and the World Trade Organization trace their origins to the meeting. The coming summit is likely to be held in New York after the Nov. 4 U.S. election.

Several countries are now lining up for assistance from the International Monetary fund. What is the IMF?

The IMF, established at the 1944 Bretton Woods conference, provides financial help to countries in serious economic trouble. It uses money gleaned from its 185 member countries.

Those funds, called quotas, vary depending on each country's size and strength. The U.S. has the biggest quota, at $58-billion. Canada's quota is about $10-billion. Countries keep the bulk of their IMF commitments in their own reserves at home, but they may be called on to provide cash when troubled members seek help.

Voting rights in the fund are proportional to quota. Rich nations also contribute to a separate emergency fund. The total quotas now amount to more than $350-billion, and the fund has about $20-billion in outstanding loans to more than 60 countries.

The IMF makes money on the spread between what it earns on its loans and what it pays in interest to countries that provide the funds. It uses that cash to pay administration costs.

Why would a recession push the Canadian government into a deficit position?

A recession would likely cut into Ottawa's revenue at a time when it is not expecting a very big surplus. If there is no economic growth, the government will take in less personal income tax, corporate tax and GST.

At the same time, employment insurance benefits could rise if more people are out of work, and there will be pressure to stimulate the economy with government spending.

Unless the government actually cuts spending, it could be forced into a deficit position. The same would apply for any individual province.

Isn't there a "buffer" to take up some of this slack?

When Paul Martin was finance minister, he usually included a "reserve for economic prudence" to protect against the economy being weaker than forecast, and a "contingency fund" to protect against other unforeseen problems, says Dale Orr, chief economist at Global Insight Canada.

However, in its 2008 budget the Conservative government did not set aside either of those reserves, and that might force it to take extraordinary actions to avoid a deficit.

Iceland may become the first western nation in 32 years to get a loan from the International Monetary Fund. Which was the last one?

In 1976 Britain received a loan of more than $4-billion (U.S.) from the IMF after inflation leapt to record levels and the pound fell sharply. In return, the IMF demanded that Chancellor of the Exchequer Denis Healey cut spending and implement other austere economic measures. Reports Monday said Iceland is expected to get about $1-billion from the IMF, as part of a $6-billion rescue package that includes funds from central banks in Scandinavia and Japan. Iceland's government was recently forced to take over the country's major banks after their liquidity plunged and the country's currency lost more than half its value.

What is deficit financing?

It is the concept, first promoted by British economist John Maynard Keynes in the 1930s, that governments should be prepared to run deficits during tough times in order to stimulate the economy by increasing spending. It was not enough to let market forces deal with high unemployment, he said.

The idea was that budgets would be balanced over the course of an entire business cycle, as revenues would increase - and surpluses would replenish government coffers - when the good times returned.

The concept fell out of favour in the 1970s and 1980s, when many governments began to run large deficits on a regular basis and cumulative debt spiralled out of control. There was no Keynesian solution to "stagflation" - prolonged periods of inflation, low economic growth and high unemployment.

Why could a recession push the federal government into a deficit position?

A recession would likely cut into Ottawa's revenue at a time when it is not expecting a very big surplus. If there is no economic growth, the government will take in less personal income tax, corporate tax and GST. At the same time, employment insurance benefits could rise if more people are out of work, and there will be pressure to stimulate the economy with government spending. Unless the government actually cuts spending, it could be forced into a deficit position.

Isn't there a "buffer" to take up some of this slack?

When Paul Martin was finance minister, he usually included a "reserve for economic prudence" to protect against the economy being weaker than forecast, and a "contingency fund" to protect against other unforeseen problems, says Dale Orr, chief economist at Global Insight Canada.

However, in its 2008 budget the Conservative government did not set aside either of those reserves, and that might force it to take extraordinary actions to avoid a deficit. Mr. Orr thinks there will be likely be a budget deficit in the 2009-2010 fiscal year because the surplus forecast was so small - about $1.8-billion.

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

What are the differences in the regulation of investment banks in Canada compared with the United States? Were U.S. brokers really unregulated?

Independent U.S. investment banks were not completely unregulated, because they were governed by the rules of the Securities and Exchange Commission. But they had far less regulation than commercial banks, which came under the supervision of the Federal Reserve Board.

In September, however, the last two major investment dealers — Goldman Sachs and Morgan Stanley — became bank holding companies and thus moved under the purview of the Fed. As a result, they will have the same kind of capital requirements as banks, and will not be able to use borrowed money to leverage profits as they have in the past. The SEC will continue to supervise their brokerage activities.

This move puts the U.S. investment banks in a similar position to Canadian dealers. Here, the Office of the Superintendent of Financial Institutions sets the rules for banks' capital ratios and risk management activities on a consolidated basis, so the bank-owned brokerages fall under that umbrella. Canadian brokerage activities are also subject to supervision by provincial securities commissions, or foreign securities regulators if they have activities outside the country.

We keep hearing that Canadian banks are the most sound in the world. Who says so?

That verdict came from the World Economic Forum - the Swiss-based organization that runs the annual conference of big thinkers in Davos - in its 2008-2009 Global Competitiveness Report released early in October. It ranked 134 countries around the world on a wide range of issues related to their ability to attract business investment. Canada was 10th over all (the United States was first, followed by Switzerland and Denmark), but we came first in some of the dozens of individual measures.

Canada was not only ranked first for the soundness of its banks, it was also top dog when it comes to the ease of starting a business, the number of personal computers per capita, and the low incidence of malaria.

We also ranked in the top 10 on investor protection, number of Internet users, quality of scientific research organizations, quality of management schools, and telephone infrastructure.

The biggest problems in doing business in Canada, according to the study, are our tax rates and regulations.

If Canada's banks are so healthy, why do they need the new program, launched by the finance minister in October, to support their borrowing?

Many other countries are putting in place some kind of backstop for the wholesale debt market, and that has prompted worries that Canadian banks would be uncompetitive when they tried to borrow money outside the country. It is possible that lenders will prefer to do deals with banks that are backed by their national governments, and that might mean Canadian banks would have to pay higher interest rates, which would likely be passed on to customers.

The new program is essentially a form of insurance, which the banks can opt for if they want it.

But they will have to pay - it will cost them a fee of up to 1.85 per cent of the value of the insured loan, depending on their credit rating, and even more if the loans are denominated in currencies other than the Canadian dollar. Several banks have said this is too costly and they won't be opting for the insurance.

We keep hearing that the financial regulatory system is "tighter" in Canada than in the U.S., and that's why our banks are healthier. What are some of the differences in regulation?

For one thing, the Canadian Bankers Association says, there are fewer bank regulators in Canada, so rules are a bit more streamlined. Here, the Office of the Superintendent of Financial Institutions sets the rules on capital levels, etc., while the Financial Consumer Agency of Canada tells them how they have to conduct themselves in the marketplace.

In the U.S., banks are governed by many regulators, including the Federal Reserve Board, the Office of the Controller of the Currency, and the Office of Thrift Supervision.

Another key difference is that the Canadian Bank Act says that anyone who borrows money to buy a home must get mortgage insurance if their mortgage is more than 80 per cent of the value of the home. That, along with a tendency to give out fewer subprime loans to borrowers with dubious credit history, has kept the banks here in better shape.

Canada's banks also benefit from the fact that regulations encourage them to operate nationally. That means they can move capital from one region to another, and when risk in the eastern manufacturing sector is higher, it can be offset by lower risk among western oil and gas customers, for instance.

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.

INVESTING AND MARKETS

Does the TSX have "circuit breakers" to stop precipitous falls in the market, similar to those at the New York Stock Exchange?

The TSX has linked its circuit breakers with those of the NYSE. So if the New York market is suspended, trading in Toronto will also stop.

There's a good reason for this, says Michael Prior, vice-president of market surveillance at the Investment Industry Regulatory Organization of Canada (the body that sets these rules). About two-thirds of the volume of trades on the TSX is in stocks interlisted with U.S. exchanges, he said. So it would cause big problems, and not be very effective, if trading on one of the exchanges were to be halted while the other remained open.

The U.S. circuit breakers are a bit complex. The three levels are set at the beginning of each quarter at 10 per cent, 20 per cent and 30 per cent of the average closing price of the Dow Jones industrial index for the preceding month, rounded to the nearest 50.

That means the current levels are 1,100 points, 2,200 points and 3,350 points. These thresholds will likely move downward sharply when they are reset at the beginning of the next quarter in January.

If the Dow drops by one of those values, the markets will shut temporarily, or for the rest of the day, depending on the level and the time of day that it occurs.

The only exception to the link between the NYSE and the TSX is on days when Canadian markets are open and U.S. markets closed. (If July 4 falls on a weekday, for example).

Then, the TSX has its own thresholds (currently 1,250 points, 2,500 points and 3,750 points). These kick in the same way as the U.S. circuit breakers.

IIROC executives can also halt TSX trading on an ad hoc basis if there is a made-in-Canada emergency. This was considered a possibility during the Quebec referendum in 1995, but it has never happened.

The whole circuit-breaker system was set up after the market crash of October, 1987. Initially it was designed to kick in after specific point drops, but the thresholds were changed to the percentage system late in 1997.

The only time the equity circuit breakers have tripped, so far, was on Oct. 27, 1997, when the Dow fell 554 points, or 7.2 per cent. That was enough to stop trading at the levels set at the time.

Are companies allowed to have closed-door meetings with analysts and high net worth investors that others never get to hear about?

A decade ago it was common for companies to hold meetings and conference calls with analysts that no one else was allowed to listen to. This practice has been curtailed, partly because regulations now explicitly say any material information must be disclosed broadly.

Securities legislation makes it crystal clear that it is illegal for companies to reveal material information unless it is "generally disclosed." But regulators have also issued "best practice" guidelines to more specifically deal with conference calls and analyst meetings. They say conference calls and investor conferences should be open to allow anyone to listen, in order to reduce the risk of selective disclosure.

Companies can hold private meetings with analysts, the guidelines say, but these can involve only non-material data, or information that has already been disclosed to the public. For instance, firms can't give new earnings forecasts in these meetings, but they can discuss long-term strategy or the business environment.

What are principal-protected notes, and why are they now an issue in the global financial crisis?

Principal-protected notes, or PPNs, are complex instruments that guarantee an investor will get his or her principal back at maturity, but also offer the potential for a far greater return if certain indexes, commodities, mutual funds or baskets of stocks appreciate in value. They are usually sold through financial planners.

Some are causing problems for the issuers because the stocks, funds or indexes have taken such a fall in recent weeks. A simpler form of PPN is the "market-linked" or "market-growth" guaranteed investment certificate (GIC). These GICs are sold to retail investors by many of the big banks and are less complex, but the idea is the same. You are guaranteed to get your money back, usually after a three- or five-year term, and you'll get more - usually up to a capped amount - if a specific stock index increases in value. GICs are also guaranteed by Canada Deposit Insurance Corp., while PPNs are not.

Am I going to lose money on the PPNs or market-linked GICs that I hold?

If you hold these instruments to maturity, you will get all your principal back. But if the instruments to which they are linked happen to fall over the term of the holding, you may not get a penny more. In effect your money hasn't appreciated at all - but at least you haven't lost anything.

Is there any way to build my own principal-protected note (PPN) so I don't have to pay the built-in fees on the ones sold by insurance companies and investment dealers? I also don't want to be subjected to a "protection event" that will kill off any potential for future gains.

It is possible to create a kind of do-it-yourself PPN, which will guarantee principal and still allow some exposure to market gains (if we ever get any). Here's one suggestion from reader Graeme Tweedie in Halifax. If you have $100,000 to invest, for example, you could buy a stripped bond with a face value of $100,000. It will cost you less than $100,000 - the bond's "present value" - but you will receive the full amount at maturity. The balance from your $100,000 nest egg could then be used to buy an exchange traded fund linked to the performance of the S&P/TSX composite index. If the value of the ETF rises by the time the stripped bond matures, you'll have earned an extra gain related to the market performance.

MORTGAGES AND MORTGAGE INSTITUTIONS

What is the difference between a residential mortgage that is recourse, and one that is non-recourse. Is it true that most mortgages in the United States are non-recourse but in Canada mortgages are of the recourse variety?

If someone who borrowed money to buy a house fails to make the payments, the lender can seize the property. If the mortgage was non-recourse, that's all that can be taken.

In a recourse loan, however, the lender can go after the homeowner's other assets, if the value of the house isn't high enough to pay back the loan.

In the United States most mortgage loans are non-recourse. That's why so many people have just walked away from houses that have dropped substantially in value. The lender can take possession of the undervalued home, but they can't try to get any more money back to make up the difference between that value and the mortgage loan.

In most Canadian provinces mortgages are recourse, which allows lenders to go after other assets. The exceptions are Saskatchewan and Alberta (although in Alberta high-ratio mortgages are recourse).

This has not been a widespread issue in Canada because our housing market has been much stronger than in the United States, and we haven't seen people trying to walk away from homes that have dropped sharply below the value of their mortgages. That did happen back in the 1980s in Alberta, when the housing market there collapsed.

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

Just how badly did the markets fare in October. Was it a record decline in Canada and the United States?

October was actually nowhere near the worst decline for the main Canadian and U.S. indexes. The S&P/TSX composite fell about 17 per cent in the month, far less than the decline of almost 23 per cent in October, 1987. The Dow dropped about 14 per cent in the month, again far less than its record fall of just under 23 per cent, also in October, 1987.

What made this autumn so remarkable were the back-to-back declines in September and October. While September, 1987, wasn't a great month, both the U.S. and Canadian markets fell by less than 3 per cent. September of this year was much worse, so the combined two-month decline in 2008 was devastating.

The S&P/TSX dropped by more than 4,000 points, or 29 per cent, over the two months to Oct. 31. The Dow fell by more than 2,200 points, or 19 per cent, over that period.

Averaged over the past 50 years or so, October has actually delivered positive performance on the stock market, unlike September, which has generated negative returns over all.

What is a margin call?

A margin call occurs when a brokerage tells an investor that he or she has to pony up more money, because the stocks purchased with borrowed cash have fallen in value.

In order to come up with the money to meet the call, the investor may have to sell some of the stocks - often at a loss.

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.

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