Central banks around the world now have a better understanding of what happened when the sub-prime lending crisis in the United States sent shockwaves through global markets and what needs to be done to prevent it from happening again, Bank of Canada governor Mark Carney says.

"More than seven months on, the end is not yet in sight, although it is safe to say we have reached the end of the beginning of this turmoil," Carney told Toronto Board of Trade members.

"This is not because the dislocations in markets have eased; in fact, strains in the financial markets have intensified recently, but rather because we are entering a new phase where policy-makers and market participants have a better understanding of both the shortcomings in the current financial system and what needs to be done by both groups to address them."

Meanwhile, Carney says he will continue to monitor the situation and Canadian banks should be well positioned to weather the crisis.

Mark Carney

"Our banks are very well capitalized and have options in terms of how they deploy their consumer capital," he told reporters after his speech.

"The economic slowdown in the United States is likely to be more marked and more prolonged. Of those two adjectives, prolonged is probably more important.

"And we expect there will be some spillover of that economic slowdown into Canada," he added.

In his speech, Carney said while the current market turbulence was triggered by the sub-prime mortgage crisis, there was a wide range of other sources that could be blamed.

"Ultimately sowing the seeds of its own demise, market liquidity fed a supreme confidence in the ability to sell holdings at prices that matched mark-to-model valuations," said Carney.

"The second cause of current market disruptions has been the lack of transparency and inadequate disclosure that characterizes many highly structured financial products. These shortcomings were ignored when times were good to the extent that many investors did not actually understand the characteristics of the securities they owned," he said.

"This surprise, in turn, has prompted a broad re-evaluation of the structured products and, in some cases, indiscriminate selling. Even months later, the opacity of these structured products has made them harder to value, thus dramatically reducing secondary market liquidity," said Carney.

Carney said the third cause of market turmoil was "a series of misaligned incentives," or poor relationships between borrowers and lenders. Increasingly over-confident lenders let down their guard and allowed sloppy documentation or insufficient due diligence.

Days before arriving in Toronto, Carney made his first rate decision as governor and slashed the trendsetting overnight lending rate by 50 basis points, the biggest cut in six years when the markets struggled after the 9/11 terrorist attacks.

Some observers noted David Dodge made the same cut weeks after he was inaugurated as governor. "It is very similar to the press release we sent out at that time," bank spokesman Jeremy Harrison said, thumbing through a reply one of his colleagues had sent to his Blackberry in response to a question from Business Edge.

Across the country, most economists liked what they were seeing so far.

"It was the right thing to do when it comes to the impact on the real economy," TD senior deputy economist Craig Alexander said. "This should limit the impact of any credit crunch and keep the Canadian economy on track for at least a while.

"I suspect the next move will be to another half point," he said. "Things could change and it could also be a quarter-point rate cut, but right now I would say half a point."

Alexander said he believes Carney is doing well just over a month and a half into his term as governor and people shouldn't read too much into having a new face at the helm of the Bank of Canada.

"Given the circumstances, I believe David Dodge would have done the same thing in cutting the rate that much," he added.

BMO Financial Group deputy chief economist Doug Porter said his bank now believes the United States is headed into a moderate recession, but the effect on Canada will still be minimal. "We still believe there will be a moderate recovery in the second half of this year," he said in an interview.

"Mark Carney has done a good job so far and I think the effect in Canada will definitely not be as pronounced as it is in the U.S."

BMO executive vice-president Sherry Cooper told an Economic Club of Toronto breakfast meeting in early January that she didn't believe the United States would "technically" go through a recession in 2008.

But a few days later, Porter says, new economic data were released and the bank was forced to change its outlook.

Todd Hirsch, a senior economist with Alberta-based ATB Financial, said instability in the world markets, and especially in the U.S., should work itself out by this summer.

"The central bank making a cut of 50 basis points signalled that they are quite concerned. It was probably the right move, but they're hoping everything should work itself out," he said from Calgary.

Bank of Canada officials are scheduled to potentially announce a rate change on April 22.

(David Hatton can be reached at hatton@businessedge.ca)