When U.S. marshals put Bernie Madoff’s Long Island mansion on the block last month, few expected much action. Sales of luxury homes have been as dead as the lowly subprime market—and surely the oceanfront playground of a disgraced Ponzi fraudster would be hard to move. Then something astonishing happened. A furious bidding war erupted, and the house sold in mid-September for US$8.75 million in cash, well over the asking price. Madoff’s US$65-billion scam may have embodied all the lying, cheating and greed that got us into the Great Recession, but the frenzy for Bernie’s old digs shows that the froth is back, alive and well.
Evidence of reawakened exuberance is everywhere. Bidding wars are breaking out all over North America. In Costa Mesa, Calif., one 1,300-sq.-foot home drew 68 offers and sold for nearly US$100,000 above the asking price. In Vancouver, dozens of potential buyers reportedly drove the price of a tiny bungalow in the popular Kitsilano neighbourhood up $180,000 above the asking price, to $1.14 million. Condo projects that looked gaudy and excessive amid the new frugality of April are now back on the block as the latest must-haves. Toronto’s struggling 1 Bloor megaproject surged back to life last week with new developers. In Vancouver, the radio waves are ﬁlled with ads for home-equity loans and marble countertops, and luxury retailers are beating down the doors in Calgary. Next month Holt Renfrew will open a new store there, three times larger than its existing one, and featuring a boutique from French luxury giant Hermès, famous for its $7,000 Birkin bags. Conspicuous consumption didn’t die after all. It was just hibernating.
Barely six months after fretting about the end of the world, analysts and economists are suddenly transﬁxed by a more welcome ﬁnale: the end of the recession. Along with the housing market comeback, retail sales, a key measure of how the all-important American consumer is feeling, are on the rise. Most economists now forecast that, at least for the next few quarters, U.S. GDP will expand at a rate as high as four per cent, while Canada already saw a 0.1 per cent uptick in June. But the surest sign of euphoria can be seen in the raging markets. The S&P 500 has jumped a whopping 58 per cent since bottoming out in March; its counterpart in Toronto is up 53 per cent. Even if markets haven’t fully recovered from their recession lows, the surge in prices has suddenly made people feel a lot wealthier and more conﬁdent again, and that’s helped drive everything from auto to home sales. “We’re clearly out of a very dark hole,” says Glen Hodgson, chief economist with the Conference Board of Canada.
So why, then, does it all seem too good to be true? It’s hard to swallow the notion that “the worst crisis since the Great Depression,” as it was repeatedly described last winter, could, seemingly overnight, become little more than “the most inconvenient downturn since 1991.” The only truly substantive change has been the rebound in consumer confidence and investor sentiment. In other words, investors are driving the rally with their hearts, and not their heads.
Which is why some experts are warning there is still a lot more pain to come. In many cases, they were the same rare voices who accurately predicted the subprime mortgage collapse, credit crisis and recession. Just as the phenomenal rise in stock markets is built on hope, and not fundamentals, improvements in the economy are due almost entirely to the wheelbarrow loads of government stimulus money, and nothing more. A real, sustainable recovery is still ﬁve or 10 years away. Which means we should be preparing for America’s lost decade. What that means for Canada is painfully clear. We may have avoided the worst of the crisis—our banks are sound, unemployment is lower here and the housing market more stable—but Canada remains inextricably linked to the U.S. economy, and continued pain there threatens to drag this country’s economy down further.
“It’s not a case of being bullish or bearish, it’s being totally realistic about what happens after an epic US$14-trillion loss of household net worth,” says David Rosenberg, chief economist at Gluskin Sheff + Associates in Toronto. “It doesn’t mean we’re going back into a recession, it means that we’re going to have a period of stagnant U.S. economy that’s going to have an impact across the globe, including Canada.”
This past July, the U.S. government rolled out an incentive program called the Car Allowance Rebate System, better known as “cash for clunkers.” The idea was simple. Over the next four months, it would spend US$1 billion offering people as much as US$4,500 to turn in their beaters and buy new, fuel efﬁcient vehicles. So many jumped at the offer that, within a week, the money was gone. Another US$2 billion was added to the program. By late August, that was gone too, as nearly 700,000 cars were purchased with the help of Uncle Sam. Cash for clunkers, which single-handedly reversed years of auto industry ﬂoundering in less than 30 days, will likely go down as one of the most successful examples of government stimulus, ever.
The economic growth that has buoyed so many hopes of a turnaround has been driven—particularly in the U.S.—almost entirely by this kind of public spending. It’s brought key economic indicators like retail sales back to life, and forecasters have eagerly jumped on this as a sign the worst is over. But there are crucial elements integral to a healthy economy that are completely absent from this recovery picture, like the return of private investment and jobs. As successful as direct government handouts have been in the U.S, there’s little indication of progress on either front. “As long as the government is giving money away, people are going to spend it,” says Mike “Mish” Shedlock, of Sitka Paciﬁc Capital Management. “Those are not conditions that cause a sustainable recovery.”
Managing this kind of artiﬁcial growth presents a difﬁcult balancing act for governments, says the Conference Board’s Hodgson. If stimulus spending is shut down too early, it could quickly throw the economy straight back into recession (what’s known as a double-dip recession). Keep spending too long, and suddenly the government is competing with the private sector, overheating the economy as it drives up input prices and, eventually, interest rates. Jack Ablin, chief investment ofﬁcer at Harris Private Bank in Chicago, argues that stimulus spending is clearly working, and could pave the way for as many as four quarters of growth. But he likens this to someone running a marathon on a diet of crullers. “It’s hard to know how much of this recovery is real and how much is just fuelled by these doughnuts,” he says. “A year from now, we’re going to be at a crossroads.”