Tuesday, April 13, 2010

Canada Points Way for USA Bank Reform



It is not too surprising that US bank reform is looking to emulate the Canadian banking system.  After all it is the only man standing among the major developed economies.  This article looks at two approaches and discusses some of the pros and cons.
I have a few comments.  Too big to fail is a strong argument for breaking up of any business on some form of rational basis.  In Canada, this could be easily done on a geographic basis with resultant improvements.  In the USA, it would be strongly opposed by the New York centric nature of these businesses.  Yet I think creating additional money centers throughout the USA would be good for everyone.
The idea of centralization is profoundly attractive to participants but unsupported by historical evidence.  The capacity to finance the largest loan in history is great, except that it leads immediately to the largest bad loan in history because of a simple lack of product and too much money.  It is better to force regional money centers to syndicate and compete instead.
The original post 1929 reforms centered on separating the lenders from the brokers.  Do I need to explain after the past decade why that was a good idea?  I thought that this was common knowledge, which explains my surprise when they repealed all those laws in the dying moments of the Clinton administration.
There is still a lot of merit in having a lot of large banks.  Canada has six who are ultimately outright integral to the Canadian financial system.  And yes one could fail and be immediately absorbed by the other five.  It would then be replaced quickly by one of several other rising institutions.
The USA needs ten times as many of similar size with sound branch systems and geographically distributed.  This is possibly best accomplished by establishing State owned banks in the more populous States.  In combination with other regional banks we have a cadre of institutionally important banks that can be regulated properly in times of excessive enthusiasm.
The Canadian banking system and regulatory regime is no accident at all.  A banking fiasco a couple of decades before 1929 similar to the 1929 disaster made clear the need for this form of regulatory oversight.  As a result, Canada also passed through the 1929 disaster with its banking system largely intact.  The ensuing global lack of credit brought about the rise of alternative lending in Western Canada.  The important result of all this was an institutional memory that resisted recklessness in the banking industry.

Canada points the way in U.S. banking reform

Why bust up Wall Street megabanks when Canada’s Big Five have thrived?

Published On Mon Apr 12 2010

David OliveBusiness Columnist


The question is whether Canadian bankerly prudence can be transplanted stateside.
As banking reform gears up in the U.S., the attention of American reformers increasingly turns to Canada.
The reformers have essentially lined up between two solutions.
One is to break up big American financial institutions deemed “too big to fail,” whose possible collapse is a “systemic” risk to the entire system.
The other approach is to maintain the megabanks but simply regulate them as well as they were before the era of deregulation that began in the late 1970s.
At this relatively early stage of the debate, the Canadian model seems to be winning out. Canada’s megabanks, also “too big to fail,” were alone in the G-7 nations in not requiring a government bailout. Australia’s Big Four banks also came through the crisis with flying colours.
U.S. reformers intent on busting up America’s biggest banks lack confidence in the character of American financiers. U.S. economist Robert Reich wants America’s megabanks dismantled because no amount of new regulation, he believes, will stop the more avaricious and morally deficient operators from finding a way around them.
“The giant banks already hire fleets of lawyers, accountants, and financial entrepreneurs to find loopholes in every existing regulation,” says Reich, who insists that a megabank is dangerous by definition.
For pro-breakup reformer Dean Baker, co-director of the U.S. Center for Economic and Policy Research, the Canadian model doesn’t work because it would require a transplant of Canadian banking values stateside. And that isn’t going to happen.
“There is a level of independence and integrity on the part of the regulators in Canada that does not exist in the United States,” Baker says.
But Nobel laureate economist Paul Krugman, on the other side of the debate, has what I consider the winning argument.
To be sure, Krugman also notes that “Canada – whose financial system is dominated by a handful of big banks, but which maintained effective regulation – has weathered the current crisis notably well.”
But Krugman draws a different lesson from the Canadian experience.
Krugman and his ilk have more faith in the good conduct of U.S. bankers. And they should. America has more than 7,000 independent commercial and community banks. Less than a dozen poorly supervised mega-institutions triggered the global crisis with their reckless short-term profit-seeking.
Americans have a tendency to “over-solve” problems, as with the creation of the largely dysfunctional Department of Homeland Security in the aftermath of the Sept. 11, 2001, terrorist attacks.
It’s plain today, two years after the outset of the financial crisis, that the deployment of any one of three existing failsafe devices would have prevented the disaster.
The U.S. Federal Reserve Board could have made a quick end, circa 2003-04, to its policy of historically low borrowing costs. That policy spurred an unprecedented U.S. housing bubble.
Existing U.S. financial regulators could have required banks to pull back on their overzealous lending, and stay within a reserve ratio of $20 of loans per $1 of underlying capital. The ratio reached 30 to 1 at the peak of the housing bubble. Canadian regulators have imposed this requirement repeatedly during past times of over-exuberance.
Finally, the sudden proliferation of Triple A packages of subprime, or junk, mortgages should have alerted authorities to the role that the oligopoly of U.S. credit-rating agencies played in rubber-stamping toxic assets as investment grade.
Again, that simple step alone would have prevented the crisis. Deutsche Bank, the Harvard University endowment fund, and the managers of California public employees’ retirement savings would not have touched those toxic assets had they borne the accurate junk-rating they merited.
None of those reforms would require substantial changes to the U.S. system.
“Breaking up big financial institutions wouldn’t prevent future crises,” Krugman asserts. Why not simply allow Uncle Sam to seize the rogue operations, or “shadow banks,” within existing megabanks should they go awry? The U.S. Federal Deposit Insurance Corp. has long had the authority to seize failing conventional banks. And why not get strict about leverage ratios, as the Canadians do?
John Kenneth Galbraith was never sanguine about the motives, means and morals of Big Business. Yet he had to acknowledge, when he was FDR’s wage-and-price control czar during the Second World War, that it was a lot easier imposing edicts on the five oligarchs controlling the steel or rubber industries than on America’s thousands of housing contractors and scrap-metal dealers.
As the Canadian and Australian models have proved, it’s actually easier to ensure financial-markets stability when you have only a handful of mega-players to supervise. Or, to repeat Mark Twain’s maxim, place all your eggs in one basket – and watch that basket.


No comments: