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Problems With Your Banks, Eh?
by Robert Franco | 2009/02/15 |

It is kind of sad that we, the taxpayers, have to loan hundreds of billions of dollars to our banks to keep them from failing.  Last I checked, the banks were supposed to be loaning us money, not the other way around.  The first $350 billion in TARP funds has been handed out and our financial markets are still in turmoil.  Things aren't getting better. 

We hear that this a "global banking crisis," but is it?  Not every nation is facing the problems we have here.  Canada, for instance, has a thriving financial industry.  What have our friendly neighbors to the north done differently?


Source of Title Blog ::

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Unfortunately, in 1999, Congress repealed many of the provisions of the Glass-Steagal Act with the Gramm-Leach-Bliley Act.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



Categories: Banking & Finance, Legislation

1288 words | 2920 views | 9 comments | log in or register to post a comment

Mortgage interest deduction

I am not really a fan of the mortgage interest deduction.  Keep in mind that the general interest deduction was really for the benifit of business and farmers.  In the tax reform act of 1986, all other forms of consumer interest expenses were repealed.  Prior to then, all consumer interest was deductible.  The change in the code encouraged homeowners to take out equity loans rather than note loans, to take equity loans rather than financing a car.  I think it has contributied to the large number of upside down homeowner's we now see.

I would rather see us go back to allowing the deduction for all forms of consumer interest, or eliminating the mortage interest deduction.  It seems to be social engineering gone wrong.

by Douglas Gallant | 2009/02/15 | log in or register to post a reply

Yah Hey There

Well, how far do we need to go back to find the roots of this weed, Doug?  We have long had a thriving and stable housing market with the mortgage interest deduction included in the equation.  I agree with Robert as to the value of the deduction.  Responsible home ownership should be encouraged.  I would also like to see a deduction for all interest paid, but there's a difference.  The government uses taxes and tax breaks to encourage or discourage behavior.  It's the governments, way of controlling a free society.  If it has to be that way, I would rather see encouragement of the pride of ownership than the encouragement of general debt, which would validate Zakarias's argument regarding over consumption.

I agree with Zakaria in that over-consumption should not be encouraged with tax deductions, or by any other means, really.  Our consumption-based economy is not what made the USA the land of opportunity.  Our economy was successful when based on production.  Innovation was rewarded, and we sold to the world.  But I don't think the mortgage interest deduction encourages gluttany anymore than I think it has had much, if any, effect on the current state of our housing market.

by Patrick Scott | 2009/02/16 | log in or register to post a reply

Good point...

Doug makes a good point about home equity interest. To some degree the deductibility of home equity interest does encourage over-consumption.  People may be more willing to spend their equity because the interest is deductible.  It is almost like getting a discount on the purchases you make with a home equity loan.

However, there are limits in the Tax Code for deducting home equity interest.  First, there is cap on home equity indebtedness for which the interest is deductible - $100,000.  Second, the home equity indebtedness cannot exceed the fair market value of the home reduced by the amount of the acquisition indebtedness.  For example, if the home is worth $200,000 and you put 10% down, the acquisition indebtedness is $180,000.  That would mean that you could borrow $20,000 on a home equity loan and deduct the interest.  (Tax Code Sec. 163(h)(3)(C)).

For a while, many banks were loaning 110% or more loan to value on home equity loans.  So, if you took out one of these loans and borrowed $40,000 on a home equity loan, only half of the interest would be deductible. I don't know if many people are aware of these limitations, and many probably fully deducted the interest on their equity loans when the combination of acquisition indebtedness and home equity indebtedness exceeded the fair market value.

I'm not sure to what degree the deduction prompted Americans to borrow as much as they could on their homes and spend it frivolously... but it did happen.  To some extent, this behavior did contribute to our current problems.  Too many of us spent all of our equity and ended upside down on our mortgages when the value of our homes dropped over the past couple of years.  With very little or no equity in our homes, the mortgage market has stalled.


by Robert Franco | 2009/02/16 | log in or register to post a reply

Moral Hazzards

The repealing of the Glass-Steagal Act and the housing bubble probably are coincidence: a case of correlation not equaling causation.  The losses of banks in this country that need the bailout are due primarily to bad loans as a result of their own decision to dramatically loosen underwriting standards.  The same thing would have occurred if the Act were in place since nothing in the Act prevents banks from making bad business decisions in their main line of work - making loans.

Glass-Steagal doesn't prevent banks from engaging in a business model that favors a quick buck over long term investment.  There are plenty of smaller local banks that stuck to their underwriting standards, who didn't make bad loans, and who are not in need of a taxpayer bailout.  They (and we) are now stuck bailing out the banks who made the quick buck and are now crying that they are "too big to fail".  I've read in more than one place that these smaller banks are irate because they are now paying to subsidize their own competiton.  If the big banks were allowed to fail and the smaller banks were permitted fair competition, these smaller banks would be able to make the loans that the market wants and hire more people based on a much sounder business model.  Instead we are being set up for deja vu all over again.

If you want to make banks safer, we only need one regulation and that is to prohibit fractional reserve banking.  That is the main reason why these banks are able to over-leverage themselves so much.  Require 100% reserves and you eliminate the need for regulation, the FDIC, and all future bank bailouts.  Also, with regard to increasing regulation being the solution, Federal Credit Unions basically operate like banks but don't have all of the other regulations that banks have.  Very few, if any, are in trouble and it is because they have better business models.  More regulation in banking is like more regulation in the title business.  The good companies will suffer by obeying the rules and the bad companies will continue to either ignore them or find ways around them.  Letting bad banks fail is the best policy since it will keep them out of the market permanently - let the market regulate them out of business.

by David Jenkins | 2009/02/16 | log in or register to post a reply

Mortgage interest deduction

Hey Pat,

My initial reaction to just ax the mortgage interest deduction may have been a bit too blunt.  I agree that using tax breaks to encourage home ownership is a good policy for the government, but not in the current form.  I just read a policy paper from the Urban Brookings Tax Policy Center that makes sense to me.

You will see they just propose some concepts that would encourage home ownership via tax incentives, but do not really encourage over leveraging of a primary residence.  It is not completely on point with Fareed Zakaria's article, nor Robert's blog.  It does not address the foolish loans that the banks have made over the years.  But, it is a pretty cool read.

by Douglas Gallant | 2009/02/16 | log in or register to post a reply

Right on!

David, thanks for this breath of fresh air. I agree whole-heartedly that less, not more, regulation is the answer. Doing away with fractional reserves is just the ticket to enable this to happen.

Our local and regional banks are all doing fine in this economic climate. They stuck to sound, time-tested business and banking practices. And being smaller banks, they are much less leveraged than the national and multi-national behemoths. It's just common sense.

In computer programming, a solution to a problem that achieves a lot with very little in the way of lines of code is called "elegant". What we need in business and in finance, and even moreso in government, is more elegant solutions. Ending fractional reserves is one such move that is long overdue.

What prevents this from occurring? Only the resistance from those who stand to benefit with things the way they are now. Remove the resistance from the money- and power-elites, and common sense will prevail. Such courageous action on principle has happened before in our nation's history. Will it happen again, and soon? Time will tell...

by Jeff Herron | 2009/02/17 | log in or register to post a reply

I think you are missing the point...

David and Jeff,

I think you both agree that over-leveraging the banks is part of the problem we have.  Yet, you both oppose more regulation which would prevent much of it.  Repealing the Glass-Steagal Act allowed the commercial banks to get into the investment banking business.  Though the media doesn't ever specifically mention the companies that actually package up all of the Mortgage Backed Securities and Collateralized Debt Obligations, I would be willing to bet that those companies are owned or affiliated with the commercial banks.  The leverage problems resulted from carrying too much of this risky paper on the balance sheet.  Because of this common ownership or affiliation between the commercial banks and the investment banks, it was no problem for them to keep packaging and selling this near-worthless paper to show substantial assets that quickly vanished when the market collapsed.

I do not think that the collapse of the financial markets and the repeal of the Glass-Steagal Act was a coincidence.  It took less than a decade to ruin a strong market that existed since the 1940's.  A market that was made strong with many banking reforms like the Glass-Steagal Act.

by Robert Franco | 2009/02/18 | log in or register to post a reply

Sorry for the long post...


You’re giving into the false premises that (a) somehow the economy is totally ruined and that (b) the stock market of the last 70 years has been in some sort of perpetual boom.  The truth is that the stock market has gone through boom and bust cycles for the last 70 years and that about 80% of even its current value is mostly due to the inflation in the monetary supply not because of actual wealth creation.  Wealth has certainly been created, but what is happening now is that prices are readjusting back to pre-2000 levels before the Fed created the real estate bubble by lowering interest rates.  Even if it drops another 2,500 points it will merely be back to the level it was in 1995 before the dot-com bubble.


But let me explain why you are wrong about the Glass-Steagall Act not being a coincidence.  I realize you are starting with the premise of the author of the article that you read.  The problem is that he has given you bad information.  While it may be true that Canada has not repealed financial regulatons or its equivalent of the Glass-Steagall Act in the last 15 years, that is only so because it already did so in 1987.  Here is quote from a paper by Charles Freedman on the Canadian Banking System:


“The 1987 amendments - In this year, changes to the Bank Act and to Ontario legislation effectively eliminated the Canadian equivalent of the U.S. Glass-Steagall Act, which had previously kept banks out of much of the securities business”


He goes on to mention that one of the primary reasons Canada repealed its equivalent act is because most European countries did so even earlier and were out-competing the Canadian banks in the realm of global finance to the point where it looked like the Canadian firms would not be able to survive.  He worked at the Bank of Canada from 1974 to 2003, and was its Deputy Governor from 1988 to 2003.


If you want a good example of how ineffective Depression Era equivalents of the Glass-Steagall Act are, just look at a country which still had had its Glass-Steagall equivalent on the books since 1948.  That country had a seemingly great never-ending economic boom that culminated in a real estate bubble bursting followed by an 80% drop in its stock market.  This was all despite the firewall of separation between different types of financial firms.  All aspect of its financial industry suffered greatly when their real estate bubble burst and the stock market tanked.  That country is, of course, Japan and this all happened in 1990-1991 despite their strict financial regulation.  And their government’s solution sounds eerily familiar.  They did not let any bad financial firms fail, but instead dropped interest rates to zero, and pumped, at last count, $9 trillion into these institutions to keep them afloat as well as engaging in non-stop public works projects to "improve infrastructure."  The end result is that Japan is still in a recession after more than 15 years.


Here is a now ironic article published in 1990 explaining how Japanese banks were thriving under the regulation imposed by their Article 65:  The bubble burst shortly thereafter.  Article 65 (their Glass Steagall) was not repealed however until 1994 when all the damage had already been done.


So based on this research, which I’m fairly confident in, I can draw the opposite conclusion which is the that Glass-Steagall Act and its equivalent CAUSED the banking crisis in the U.S. because the world’s worst financial system (Japan) had their act in place when their economy tanked due to financial speculation and the second worst financial system (the U.S.) was too late in repealing it.  I’m no expert in how financial businesses are run, but I imagine that when Europe deregulated in the early 80s, they probably attracted a lot of MNCs and other companies that were interested in one-stop shopping for large-scale financing as well as any savings they could get by shopping under one roof.  When the U.S. firms got into the market, 20 years too late, they probably had to do what a lot of late participants do, which is either take on the firms as customers that the other banks didn’t want, or offer discounts to good firms they wanted to lure away from established banks with deals that were so low they were either not profitable or even lost money.  The U.S. firms may have even felt pressure to engage in more speculative, higher return investments in order to catch-up with the competition in terms of financial holdings.  There may have been an experience compenent missing in their decision making because they missed out on a 20-year competitive advantage that European banks already had.


I don’t necessarily believe that, but there seems to be a much stronger correlation between financial institutions failing and the existence of regulations such a Glass-Steagall.  I will therefore only return to my original premise which is these types of financial regulations are worthless and are neither the cause nor the solution to the problems.  No regulation can prevent a bank from making bad business decisions.  And no regulations can prevent people looking to make a fast buck from buying risky investments.  Let bad businesses fail and better, more soundly run companies will take over their assets and fill whatever demand the market has for them.  Let people who tried to get rich quick with untested financial products take their lumps and learn.  Keep them alive and pass a bunch of showboat legislation, and we will be in a permanent recession bailing out zombie financial firms conceivably forever.


Keep in mind also, that the same people calling for increased regulation now and who claim the sky is going to fall and that martial law would have been necesary if TARP didn’t happen post-haste—don’t ask any questions - were the same ones saying that the American economy was the strongest it has ever been two years ago.  They were wrong then and they are wrong now, but if they keep retelling the lie long enough through enough news outlets and media proxies, people will believe them because they will have effectively drowned out any different opinions.


by David Jenkins | 2009/02/18 | log in or register to post a reply

Stock Market

While I am a long writer too and can be quite winded at times, I will keep this one short as I didn't really read all of these replies.  I mostly scanned over it.

With that said.....The stock market is the biggest ponzi scam on the earth.  It was created by a bunch of cheating rich men that would manipulate it and then sell high and shaft the little guys that they conned into purchasing stock (long story short). 

I am not a stock expert by any means and the above is just my opinion.  I never saw any great benefit from it and if anything it has ruined our economy again and this time we may not recover.

Anyway, WOSU had a segment on the other night (3 a.m.) during one of my insomnia episodes.  I missed the beginning and would love to see it again from the start.  It is very interesting and might wake a few people up as to the true beginnings of the stock market.


by Clanci Nelson | 2009/02/19 | log in or register to post a reply
Source of Title Blog

Robert A. FrancoThe focus of this blog will be on sharing my thoughts and concerns related to the small title agents and abstractors. The industry has changed dramatically over the past ten years and I believe that we are just seeing the beginning. As the evolution continues, what will become of the many small independent title professionals who have long been the cornerstone of the industry?

Robert A. Franco



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