Canadian Banking Is Not the Answer – Unfortunately ;-)

With pathetically uninformed questions from Senators – & equally opaque, evasive answers from the perpetrators – Tuesday’s “Goldman Sachs Day” in the Senate was a pretty big bust,

the reasons for which will be the subject of a Featured Analysis in coming days.

With pathetically uninformed questions from Senators – & equally opaque, evasive answers from the perpetrators – Tuesday’s “Goldman Sachs Day” in the Senate was a pretty big bust,

the reasons for which will be the subject of a Featured Analysis in coming days.

With pathetically uninformed questions from Senators – & equally opaque, evasive answers from the perpetrators – Tuesday’s “Goldman Sachs Day” in the Senate was a pretty big bust,

the reasons for which will be the subject of a Featured Analysis in coming days.

But in its wake, it did churn up at least SOME important questions, one of which focuses on the surprising financial stability of the US’ neighbor to the North – Canada –

which, South Park aside, has created far less monetary turmoil, both domestically and globally, than its lumbering giant of a neighbor to the south. [br]

While we wholeheartedly endorse the high medical standards and sterling economic efficiency of Canada’s single-payer health system,

both in regard to the mess we’ve got now, as well as the mystery of whatever Obamacare turns out to be 😉 ,

we DO, sadly, have some reservations about the ways in which the Canadian banking system somehow managed to “weather the storm,” expressed most clearly in this New York Times Economix piece

by Peter Boone, a Canadian, and chairman of the charity Effective Intervention and a research associate at the Center for Economic Performance at the London School of Economics,

and Simon Johnson, former chief economist at the International Monetary Fund, co-author of 13 Bankers, and lead writer for one of our favorite blogs, the baseline scenario.

Despite supposedly tougher regulation and similar leverage limits on paper, Canadian banks were actually significantly more leveraged — and therefore more risky — than well-run American commercial banks.

For example, JPMorgan Chase was 13 times leveraged at the end of 2008, and Wells Fargo was 11 times leveraged.  Canada’s five largest banks averaged 19 times leveraged, with the largest bank, Royal Bank of Canada, 23 times leveraged.  

It is a similar story for  Tier One capital (with a higher number being safer):  JPMorgan Chase had 10.9 percent at the end of 2008 while Royal Bank of Canada had 9 percent.  JPMorgan Chase and other American banks also typically had more tangible common equity — another measure of the buffer against losses — than did Canadian banks.

If Canadian banks were more leveraged and less capitalized, did something else make their assets safer? 

The answer is yes: guarantees provided by the government of Canada. [br]

Today over half of Canadian mortgages are effectively guaranteed by the government, with banks paying a low price to insure the mortgages. 

Virtually all mortgages where the loan-to-value ratio is greater than 80 percent are guaranteed indirectly or directly by the Canadian Mortgage and Housing Corporation.

The system works well for banks; they originate mortgages, then pass on the risk to government agencies. 

The United States, of course, had Fannie Mae and Freddie Mac, but lending standards slipped and those agencies could not resist a plunge into assets more risky than prime mortgages. 

Let’s see how long Canada resists that temptation.

The other systemic strength of the Canadian system is camaraderie among the regulators, the Bank of Canada and the individual banks.

This oligopoly means banks can make profits in rough times — they can charge higher prices to customers and can raise funds more cheaply,

in part because of the knowledge that no politician would dare bankrupt them …

In other words:  Don’t bother looking at how dumb or smart we are.

The Canadian government is there to make sure creditors never lose a cent.

With such ready access to taxpayer bailouts, Canadian banks need little capital, they naturally make large profit margins, and they can raise money even if they act badly.

Proposing a Canadian-type model to create stability in the United States is, to be blunt, nonsense …

With a handful of new “hyper-megabanks,” we’d have to count on the political system to prevent banks from going wild;

Canada may be able to do this (in our view, the jury is still out), but what are the odds this would work in Washington? 

This would require an enormous leap of faith in the regulatory system immediately after it managed to fail repeatedly and spectacularly over 30 years.

Who can be confident that powerful corporate lobbies, hired politicians and captured regulators can become so Canadian so soon?

The stakes would be even greater with these megabanks.

When such large banks collapse they can take down the finances of entire nations.  We don’t need to look far to see how “Canadian-type systems” eventually fail. 

Britain’s largest bank, the Royal Bank of Scotland, grew to control assets equal to around 1.7 times British gross domestic product before it spectacularly fell apart and required nearly complete nationalization in 2008-9. 

In Ireland the three largest banks’ assets combined reached roughly 2.5 times Ireland’s gross domestic product before they collapsed. 

Today all the major Canadian banks have ambitious international expansion plans — let’s see how long their historically safe system survives the new hubris of its managers.

There’s no doubt that during the coming months many people will advocate some form of a Canadian banking system in America. 

The largest banks and their lobbyists on Capitol Hill will love the idea. 

For some desperate politicians it may become a miracle drug:  a new “safer” system that will lend to homeowners and provide financing to Washington, while permitting politicians and regulators to avoid tough steps.

Let’s hope this elixir doesn’t gain traction.

Smaller banks with a lot more capital — and with an ability to fail when they act stupidly — are what American  citizens and taxpayers really need.