Wall Street fallout shakes economy

The fallout from Monday's debacle on Wall Street could have major effects on the overall Canadian and American economies, experts say.

Fallout from Monday's turmoil on Wall Street could have a major impact on the overall North American economy, experts say.

That's because the financial problems faced by brokerage houses holding mountains of mortgage-backed paper debt will mean job cuts and monetary losses in other sectors, economists said Monday.

"It isn't the end of the world [but] there will be a substantial impact on the economy," said Sherry Cooper, chief economist at BMO Financial Group Inc.

On Monday, Lehman Brothers fell into bankruptcy and Merrill Lynch & Co. was purchased by Bank of America, moves that had investors selling stocks around the world and politicians grappling with what to do next to keep the ailing U.S. economy afloat.

The brokerage sector's woes stemmed from a collapse in the U.S. housing market that, in turn, depressed the value of commercial paper that had real estate as its backing asset.

Once the worth of those asset-backed investments dropped, so did the financial prospects of the firms owning the underlying debt.

Failing brokerage firms led to big stock market losses worldwide. ((Alastair Grant/Associated Press))

People who believe the crisis is Wall Street's problem alone, however, should think again, economists said.

Beyond brokerage

First of all, the damage is not limited to those few brokerage firms. 

Insurance giant American International Group Inc. is scrambling to secure $20 billion to $40 billion US to cover its outstanding mortgage-backed commercial paper.

And Washington Mutual Inc., the largest U.S. savings-and-loan company, saw its credit rating cut to less than investment grade last week and its stock lost one-third of its value in early trading Monday.

"The damage is widespread and not confined," Cooper said.

As more financing companies get swept up in the commercial paper tsunami, these firms will cut jobs and rein in their own lending to deal with their debt woes.

So far this year, Wall Street firms have chopped 10,000 jobs, or five per cent of their workforce, according to the New York Department of Labour. The total U.S. investment industry employed more than 850,000 people in 2008.

The overall economy is already chewing up jobs as growth slows. In August, the United States lost 342,000 jobs, compared with July.

As more companies approach the financial danger zone, that figure could continue to rise, experts said.

Too much real estate for sale

Commercial real estate could be next on the economic hit list because of Wall Street's falling fortunes.

U.S. and Canadian property firms, such as Brookfield Asset Management Inc., own many of the buildings in Manhattan and across the United States where the investment firms are housed.

Lehman's bankruptcy, for example, could result in more offices on the rental market in a time when the U.S. economy is demonstrably slowing.

That situation will hurt property management firms, Cooper said.

Worse still, for individual Americans, housing prices are sliding as they face increased problems securing low-cost money to cover mortgage payments. As a result, the value of the largest asset most people own — their main residence — slid in the first six months of the year.

In the first quarter of 2008, U.S. home prices fell 1.7 per cent from the previous quarter, the worst showing on record. The picture was only slightly brighter in the second three months of the year as prices slid 1.4 per cent.

As Americans watch the value of their homes decline, so does their ability to borrow to buy cars and make other major purchases. Banks sometimes use the deed to one's home as collateral for other borrowing.

Stock slide reduces wealth

Besides homes, many Americans — and Canadians — own a substantial portfolio of stocks and other paper investments. As North American stocks fall, however, so does overall wealth.

In 2005, for example, more than 50 per cent of American households and more than 90 million individuals owned some equities, or stocks.

With the Dow Jones industrial average off 21 per cent from its 52-week high, men and women in the United States basically are less wealthy and, as a result, are shopping less.

U.S. retail sales fell 0.3 per cent in August, or 0.7 per cent after subtracting vehicle purchases.

That represented the second consecutive month when retail sales dropped and might be an indication of American consumer thinking, according to economists.

Long before Monday's market turmoil, some experts said earlier this year that the U.S. economy was close to a recession.

"The economy is likely to experience an extended period of very weak growth, a rising unemployment rate and significant further Fed rate cuts," Lehman's chief U.S. economist Ethan Harris said in March.