Fareed Zakaria has written a fascinating article about the Canadian economy, Worthwhile Canadian Initiative.
In 2008, the World Economic Forum ranked Canada's banking system the healthiest in the world. America's ranked 40th, Britain's 44th.
Canada has done more than survive this financial crisis. The country is positively thriving in it. Canadian banks are well capitalized and poised to take advantage of opportunities that American and European banks cannot seize. The Toronto Dominion Bank, for example, was the 15th-largest bank in North America one year ago. Now it is the fifth-largest. It hasn't grown in size; the others have all shrunk.
So what accounts for the genius of the Canadians? Common sense. Over the past 15 years, as the United States and Europe loosened regulations on their financial industries, the Canadians refused to follow suit, seeing the old rules as useful shock absorbers. Canadian banks are typically leveraged at 18 to 1—compared with U.S. banks at 26 to 1 and European banks at a frightening 61 to 1. Partly this reflects Canada's more risk-averse business culture, but it is also a product of old-fashioned rules on banking.
The United States has made some bad judgments when it comes to banking legislation. After the Great Depression, nearly 5,000 banks failed. In response, Congress passed the Glass-Steagal Act, which separated banks that hold deposits and make commercial loans from those that underwrite securities and set up corporate mergers and acquisitions. This seemed to work well - it removed the more risky, speculative investment banking activities from the domain of the ordinary deposit institutions.
Unfortunately, in 1999, Congress repealed many of the provisions of the Glass-Steagal Act with the Gramm-Leach-Bliley Act. It expressly allowed bank holding companies to own other financial companies and it permitted affiliations between banks, security firms, and insurance companies. Less than a decade later, the financial industry saw another wave of bank failures and costly government bailouts. Is that just coincidence?
As Zakaria pointed out, the Canadians didn't loosen the regulations on their banks and they are thriving.
American banks were working over-time making bad loans and packaging them up as fancy investments that they could leverage to make more loans to people who couldn't afford them. You would think that the home-ownership rate in this country would be much higher than it is in Canada - but you would be wrong. It's virtually the same - 68%.
When our financial markets began to crumble, housing prices dropped by about 25%, according to Zakaria, but the Canadian housing prices fell only half as much. He hypothesizes that is due to a U.S. Tax Code that encourages over-consumption by making mortgage interest deductible and the use of non-recourse financing. On these points, I tend to disagree.
First, I believe that the deductibility on mortgage interest is good public policy. We should be encouraging and rewarding home-ownership. The problem, however, is that while we encourage people to buy homes, we aren't encouraging them to own them. By this, I mean that we have allowed people to buy homes with very little or no down payment. With virtually no equity in the home, and nothing of their own invested in the home after the purchase, they really don't have any sense of ownership. I like the mortgage interest deduction, but we need get back to sound lending practices that require a significant down payment.
Second, I think Zakaria over-estimates the use of non-recourse financing in the United States. Non-recourse basically means that if you default, the bank can foreclose on your home, but they can't collect from you personally for any deficiency after the sheriff's sale. In California, mortgage loans are non-recourse, but they are not in Ohio. But, I would agree that the less people are held personally responsible, the more likely they are to walk away from their homes... and their obligations.
Nonetheless, Zakaria makes a very good point - you don't have to run your banking system into the ground to have a stable housing market. And, you don't need to eliminate strict regulation to make your banks stronger. We need more banking regulations... not less. The financial markets are too important to allow the big banks to gamble with our money. We knew that once; and, we had good, sound regulations in place. Unfortunately, Congress let the banking lobby get the best of them.
Maybe Geitner should make a trip up north and get a little fresh advice. I can hear that meeting in my head.... "So, you're having problems with your banks, eh?"
Robert A. Franco
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