By market tradition, risk tolerance and fear are conflicting emotional states that govern our economic decision-making. As we re-examine our lives in the light of the COVID-19 outbreak, there are signs that risk may be losing some of its appeal.
When things are going right and we feel safe, it is reasonable that many of us throw caution to the wind and live a little closer to the edge.
But from Canadian investors redeeming $14B in mutual funds in March to our sudden urge to fill our homes with supplies of food and toilet paper, the risk-taking mood seems to have changed. As worries appear in the property sector and markets repeatedly soar and crash, the effect could be lasting.
“Consumer stockpiling in the face of the coronavirus outbreak can be viewed as unconventional inventory accumulation activity, mainly meant to minimize a perceived threat of loss,” Xiaodan Pan, an expert in supply chains at the Molson School of Business at Montreal’s Concordia University, told me in an email conversation.
Effectively, says Pan, behavioural economics tells us that squirreling away supplies is a natural human response to risk and uncertainty, where we are more afraid of losing what we have and less willing to strive for future gains.
Not feeling so safe
Suddenly, as the Alberta government investment fund loses billions of dollars on what was supposed to be a foolproof derivatives play, and people approaching retirement watch their nest eggs shrink, the world just doesn’t seem so safe anymore.
And it is by no means just a Canadian phenomenon. On Friday, there were reports that U.S. banks were becoming more cautious about lending to European businesses. Some governments are finding sources of lending tapped out.
According to an editorial in an influential business publication, the pandemic has taught companies they must adopt a reduced risk strategy by switching from “just in time” to “just in case.” But avoiding risk can be costly.
David Rosenberg, the market analyst who now runs his own research firm and has repeatedly warned that the boom would end one way or another, can now say “I told you so,” as boomers saving for retirement suffer a “huge negative wealth shock” which he says will encourage them to save more and spend less.
At the same time, the risk-reward nexus that has been a business justification for low taxes on investment gains is being turned on its head as taxpayer cash rushes to the aid of business and the economy.
But there are winners. The risk-averse who listened to Rosenberg’s gloomy advice in recent years, those who kept reserves of cash savings, bought houses they could afford and paid them off and who shunned debt now look like the smart ones.
But if others follow their lead, a growing trend to save and reduce risk rather than borrow and spend does not bode well for near-term economic growth. And it is not just consumers and investors who are wary.
Only last year, it seemed as if every visit to the bank resulted in offers of a little more consumer credit.
Now, despite the latest fall in interest rates, money isn’t so easy to get, and there are reports from mortgage brokers that banks are making more careful choices about the security risk of those they lend to.
More frugal, less risky
The new mood against risk may be the impetus that many have called for to make all Canadians, not just aging boomers, be more frugal.
As the CBC reported last week, for those who’ve kept their jobs, a decline in spending due to the lockdown is allowing some to save more, a trend that experts say may last after the economy begins to open up.
But Martin Boyer, professor of finance at University of Montreal’s Hautes Études Commerciales, says even if Canadians are now learning the wisdom of saving for future catastrophes, for those without jobs, those who own struggling businesses, those carrying crushing mortgages or are burdened with credit card debt, playing it safe won’t be so easy in a weak, post-COVID economy.
Meanwhile, he said, the savings of the consumers and businesses who did keep a cushion to tide them over what they saw as an eventual if unpredictable downturn, form a crucial core of economic stability. Boyer said those savings are part of what allows the government to borrow and bail out the risk-takers who assumed nothing bad would happen.
As in the fable of the self-denying ant and the self-indulgent grasshopper, Boyer said, the ants end up paying for the grasshoppers.
Boyer believe bailouts are reasonable for people who lost jobs through no fault of their own and those who had moderate levels of borrowing. But if the economic contraction continues, governments should not bail out those who took large risks in the expectation of large returns.
Must some speculators fail?
“The speculators should suffer,” said Boyer. Otherwise, “no one’s going to save, and everyone is going to expect someone else to bail them out.”
While a trend toward higher levels of saving may be good for the country in the longer term, Jennifer Robson, a specialist in poverty and inequality at Ottawa’s Carleton University, worries that a large number of people in the bottom half of the income spectrum simply don’t have assets to fall back on.
“I think one of the lessons from the 08-09 financial crisis was that households ended up in the situation where they took on a lot of credit risk,” said Robson.
But with borrowing now near record levels and roughly a third of households without enough savings to last a month, that may be hard to repeat this time around if lenders themselves become less risk-tolerant.
Follow Don on Twitter @don_pittis