The Canadian Banking Fallacy

Peter Boone and Simon Johnson point out some potential limitations of the Canadian banking system in this post over at The Baseline Scenario.

16 replies on “The Canadian Banking Fallacy”

“Virtually all mortgages where the loan to value ratio is greater than 80% are guaranteed indirectly or directly by the Canadian Mortgage and Housing Corporation (i.e., the government takes the risk of the riskiest assets – nice deal if you can get it). The system works well for banks; they originate mortgages, then pass on the risk to government agencies. The US, 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.”

Alas, anecdotal evidence suggests that for some markets in Canada it is already too late. Still, no doubt the not-officially-called-subprime in Canada will be contained as the not-officially-called-subprime in Ireland was and the officially-called-subprime was in the US.

What’s in a name, eh?

If there are people out there saying Canadian banks were run better than every US bank, that’s probably not true. But at first glance there appears to be some cherrypicking of examples going on.

As for the statement “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.”

Well, let’s have a look:

“what the rule changes do require are the following:

Borrowers will need to have the resources to qualify for a five-year fixed-rate mortgage even if they decide on a lower-cost variable rate mortgage.

The maximum amount that can be withdrawn when borrowers refinance their mortgages (and draw out additional equity) will be 90 percent of the value of the home, down from 95 percent.

A minimum down payment of 20 percent will be required for insured mortgages tied to properties purchased as speculative housing investments not occupied by the owner.

These new rules come into force on April 19. The government says it has made these adjustments to its mortgage rules in an attempt to prevent a U.S.-style “housing bubble” in Canada. ”

That looks like the asset pool is going to get less, not more, risky.

@ Philip Lane,

It might not stack up to a complete economic analysis of Ireland, but I still stick to much of what I wrote in a recent blog entry.

I think that David McWilliams is correct also. It requires an awful lot of other professional classes, who are meant to do a certain job, to row in with the status quo to uphold a myth for as long as it was here in Ireland. But from my limited reading about the US situation, I believe there were regionalised versions of Ireland. I mean at state level. California’s housing market and parts of the mid west also, experience an enormous amount of asset inflation during the 2000s. (I scribbled down something this month on the blog, Sod buster’s cottage)I am reading slowly through Alan Greenspan’s latest paper, so that does give another perspective. BOH

Incidentally, I haven’t heard much analysis at all, here at Irish Economy blog site in relation to Ireland’s wealth. Where has it gone? Every newspaper and TV program only a couple of years ago spoke of that wealth. Someone I heard recently comment, that amounts of personal wealth on average across the entire UK population for instance, is several times higher than that in Ireland. Ireland does appear to have a heavily indebted population, but not necessarily a very wealthy population, even if you included for a small class of super rich. (Dermot O’Leary of Goodbody’s pointed to the indebtedness of Ireland’s population, and made the point that low ECB rates mostly passed on by Ireland’s banks post crisis 2008, has helped the overall interest bill for our population) I am reading some of the comments to Boone and Johnson’s recent piece about Ireland, and I come across some quotes like this, which really deserve more analysis by the Irish Economy (if at all possible). I think the way in which a population acquires its wealth, be in Germany, UK, US, Japan or Ireland (or emerging nations like China or India) over a no. of years influences a lot in politics. The trouble in Ireland was, instead of many getting moderately wealthy slowly, a few got super wealthy too quick.

There really is no parallel to the US. The US’s economy and wealth has been built up over generations, (and some would argue, buoyed by the status of the USD as the reserve currency and the currency for oil trading), in economic terms, the Irish economy was created in a blinking of an eye, the prosperity of the last decade was more an aberration that a natural condition. The US has a track record over generations of having an economy on a sound footing (the current situation is an aberration).

Discussing this with a Canadian freind recently, we came to the conclusion that the Canadian banks were very similar to the pre-bubble Irish domestic banks. They operated under an implicit Government guarantee which ran along the lines “we expect you to behave and not do anything really stupid – but if the wheels start to come off, we’ll be there”. All very mild-mannered and pragmatic in the land of “peace, order and good governance”. It appears that it was more by chance than fair shooting that the Canadian banks did not lose the run of themselves in contrast to their Irish counterparts who did.

I think Messrs Boone, Johnson & Kwak have a different fish to fry. They want to break up the US megabanks that are deemed TBTF. However, I suspect that these megabanks’ share of US banking system assets is far smaller than that of the big beasts in Canada.

Enforcing effective competition is hard work, but it’s probably the best solution.

I think the Baselinescenario boys brush over a rather key dynamic a bit too quickly, that the US “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”. I assume lending standards have not been maintained coincidentally in Canada and i don’t think its fair of them to just assume, based off US-experience rather than Canadian evidence, that these standards will eventually slip sharply. Be worries about it happening, fine, but they seem to be saying its definitely going to happen without really explaining why.

The whole post reads a bit snarky and with a tone of “i dont know why, but eventually the Candians will f*** it up somehow”…

The Canadian banking system, its regulation and its monitoring may or may not be sound & it is difficult for us to know. Questioning it now will put it to the test and might shake out some complacency from the system. Complacency in risk management can be a dangerous thing…..

Questioning the quality of risk management would probably do more good in good times as the losses will be smaller when times turn bad 😉

@ All,

What we can see evidence of in Ireland, if investigators choose to look (not something that is guaranteed to happen) and if one joins together a very few dots, is that Irish banks work extremely hard to undermine the supply lines of talent to the Irish financial regulatory and oversight bodies. The idea is to keep the oversight bodies of the banking system as stupid as possible. That seems to have worked beautifully for the Irish banks. As Boone and Johnson said, Ireland has to support a banking system which is way out of proportion to its needs as a country. Listening to Alan Dukes is a bit surreal, as he describes the vast sums required to provide a third banking force in addition to BOI and AIB. What we don’t need in Ireland is a re-branded Anglo (to employ his term). What we do need in Ireland is to do as Boone and Johnson suggested is done with US banks who are TBTF. In Ireland we need to break up BOI and AIB. They were originally parts that got put together to make monopoly sized banking forces in the first place. Anecdotal evidence suggests that AIB and BOI can employ 25 people for each task that would only require one in the real world. Banking in Ireland suffers from that distortion enormously. The other thing is, Irish banking employs huge bonus type of schemes to distinguish itself from public body jobs in finance and regulation. Which in turn, causes the public system to hand out too much to chief executives in regulator’s offices, and gold handshakes etc. This in turn, prevents the regulator from rocking the boat too much, because the cosy arrangement they have is too valuable to lose. I am frankly amazed the suggestion of fragmentation of AIB and BOI has not been put on the table yet. I don’t believe in the idea that AIB or BOI has a responsibility to its shareholders. AIB or BOI doesn’t give a damn about its shareholders, they are simple musket ball cover for the bondholders. Because of their size, as I outlined in my blog entries Talent Retention and The sacking of Athens, Irish banks engage in gross manipulation of the mortgage markets here. From both the commercial lending book, and mortgage loan book ends of the equation – to create ‘assets’ for themselves which are multiples of times of what GDP on this island can service. But this logical sensible discussion in Ireland, about this problem is not even happening. I strongly suggest, to re-adjust the economy in Ireland radically, we need to start by cutting all mortgage loan amounts by half. The land values have already halved. It is time for mortgages to do the same. Otherwise, this country is bankrupt, plain and simple. BOH.

The article is self serving and does not grasp the fundamentals of the Canadian goverment, regulatory and banking system. When the banks step out of line in Canada they are forcibly kicked back on course by the Minister of Finance and the Bank of Canada. For example when speculation in housing (flippers) reared its ugly head the Minister of Finance implemented a minimum down payment of 20% and affordability calculations based on 5 year term, not variable rate mortgages. In Canada the government is seen as being part of the solution as opposed to the US where governments are seen as being part of the problem. Canadians are ruthless at the polls where they can reduce the government from 170 seats in parliament to 8 seats overnight. Hence government has to be vigilant that it is not perceived to have been bought by any faction, that there is not the slightest evidence that it is incompetent or god forbid corrupt. Governors of the Bank of Canada wield enormous power even though they have no formal regulatory authority. They are expected to be forthright, front and centre concerning any threat to the banking system and the economy as a whole. Google David Dodge ex Governor who made 96 public speeches during his term and it will enable you to contrast the invisible Irishman with the voluble Canadian. It should be noted that the Governor of the B of C, Mark Carney is a first generation Canadian of Irish extraction. The Minister of Finance Jim Flaherty is also descended from Irish immigrants. Both of them are honest because they would be toast if there was the slightest hint of wrongdoing. Every country gets the type of government it votes for.

On the subject of wealth creation.

Another way to view the Irish situation would be as follows. Our tax take in Ireland at the moment is around €20 billion per annum. GDP is €30 billion. Heh, I’m no economist so correct me if I have to figures grossly out of proportion. But my basic point is, those are the kinds of basic numbers we have to deal with to serve any kind of debt, no matter what interest rates we can service our debt at. You look at commercial and non-commercial property lending in Ireland. It was huge relative to the numbers for GDP and tax revenue to fund the exchequer. A segment of Irish society became very, very wealthy on foot of the asset bubble, paid for in commercial and non-commercial property debt. In a society such as the United States, a large portion of the ‘wealthly class’ created as a result of all property related debts, would be recycled in order to drive growth of GDP and annual tax revenues to the state and federal systems. In Ireland, it appears as though we have created a wealthy class extremely quickly, and little or none of that wealth has recycled itself, into a position, where it can contribute the growth in Ireland. Isn’t that strange? I think, that is where Boone and Johnson do have a strong point, in the United States wealth had been created over a much, much longer time than it was in Ireland. Ireland started in the post war of independence days, without a pot to . . . BOH.

@ Mickey Hickey,

The article is self serving and does not grasp the fundamentals of the Canadian goverment, regulatory and banking system. When the banks step out of line in Canada they are forcibly kicked back on course by the Minister of Finance and the Bank of Canada. For example when speculation in housing (flippers) reared its ugly head the Minister of Finance implemented a minimum down payment of 20% and affordability calculations based on 5 year term, not variable rate mortgages.

That is my whole point. It was former Taoiseach Bertie Ahern in Ireland who saw it as his mandate in government to fast forward the creation of a solid wealthy class. He allowed the banks and the financial system an awful lot of ‘room’ to maneuver in that regard. For a while it appeared as though Ireland had done what no other country in the world had ever done. Ireland had gone in the space of a decade or less, from having very poor personal wealth resource per capita, to having the highest in Europe. Previously in history, every other country had taken centuries to achieve what Ireland had done in less than 10 years. This is the same problem that economists like Hernando De Soto have worked on. But former Taoiseach Ahern had somehow solved a problem, to do with ‘wealth creation’ which no one else could, anywhere in the world. At least commentators such as Chris Horn with the Innovation Task Force report, have put the discussion back onto sounder footing that where it was in 2006 in Ireland. Hopefully the wealthy classes in Ireland will henceforth look to ‘sinks of wealth’ other than property speculation. I think the cherry with property speculation in Ireland was the opportunity to turn €50k into €100k, €100k into €200k and so on, very quickly. Hence why you saw many people with modest deposit savings, wading into property speculation very deep indeed. Many of them, were only low paid civil servants, sucked in by the Bertie pipe dream. BOH.

Canadian banks have survived. So have Australian banks. House prices in Australia are the most expensive relative to income, in the world.
What policy on land use do these countries have?

The USA had the S&L crisis, showing just how much a kleptocracy it is and since there were virtually no consequences, it gave the green light to destroying the middle classes and the banking system. I understand that the Canadian system is dodgy but bot as dishonest as in the USA.
Is honesty a factor?

@Pat Donnelly
Commodity exporters have done quite well in the last few years as China stimulus (and to a certain degree US infrastructure stimulus) has kept demand up, even if prices were not as rich as they were.

Ireland was doing well also. But it has been taken away. Rich income means that the country can become a target.

The banking “system” is a weapon. For those who do not execrcise vigilance, it can steal away all production by means of interest due on loans.

This has been known for centuries. Thos Jefferson knew it.

Land use? Honesty? Or banking? Ireland made a choice. Learn to live with it!

You make it sound as if Bertie did this all on his own. It has been government policy for decades to get involved with banking. But the Irish lack understanding of banking. At all levels. I showed official connivance with Revenue by the banks. AIB said that Revenue had let them off the DIRT due.


The IFSC? I wonder what goes on there, knowing how clueless the Irish are about banking? Greedy little gombeens!

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