Why Canada's banks are better than US banks right now

[Darth Wong]

NEW YORK — Jean Chrétien is smiling.

Ten years ago this fall, after his government rejected a pair of proposed bank mergers, the financial community was awash in dire prophesy: Canadian banks were too small to compete with their bulked-up neighbours to the south, the critics complained.

They were too insulated to remain relevant in a global economy characterized by lightning change and mind-bendingly complex products.

Yet today, amid the worst financial crisis in a generation, those predictions have been turned squarely on their head. While Wall Street titans succumb to a credit meltdown, spreading their contagion to Europe, the Canadian banking system has emerged as the most stable and best performing in the world.

Three Canadian banks are now in the top 10 in North America by market value, and the remaining two are not far behind.

Mr. Chrétien, who faced considerable Bay Street backlash for his stance on the banks, now credits his government's policy with helping to ward off the financial meltdown currently gripping much of the G8.

“While everybody's in turmoil, Canada is not in turmoil,” Mr. Chrétien explained in a brief interview.

“And the two big reasons are that we balanced the books in '95, and we said no to the merger of the banks.”

Of course, it's impossible to say with any certainty whether the decision to quash two mergers – one between Royal Bank of Canada and Bank of Montreal, the other between Toronto-Dominion Bank and Canadian Imperial Bank of Commerce – shielded the Canadian industry from the mortgage-fuelled fallout that has ravaged Wall Street.

One school of thought is that if the Canadian banks gained scale through mergers in 1998, they would have made bolder moves south of the border, and perhaps become entangled in the same toxic lending activities that have prompted the collapse of several major U.S. banks.

Indeed, sources said that had RBC and BMO joined forces, one of their first acquisition targets would have been Wachovia Corp., the North Carolina bank that has been hobbled by soured mortgages, and is now the subject of a takeover battle between Citigroup Inc. and Wells Fargo.

“It was a crazy race they were in,” Mr. Chrétien said of the U.S. banks, which were expanding frantically in the belief that bigger was better.

“Our guys were not in that race because they claimed they were too regulated.”

Charles Baillie, the former head of TD, believes that had the Canadian banks merged, they would have been able to resist the temptation of reckless lending that consumed Wall Street, and might be in a better position now to participate in an industry-wide buying frenzy.

Yet he acknowledges it's no sure thing, and said that the current health of the banking sector probably nullifies any appetite for industry mergers.

“If we had been allowed to merge, we might have thought that we were big characters and played more aggressively,” he said. “But I think it's more likely we would have played by the same lending standards we have now.”

RBC, TD, and BMO have each established a presence in the U.S. market, albeit not in the transformative way they may have imagined when they lobbied for mergers. And CIBC's painful experience in investment banking there in the late 1990s proved that a bank can find trouble through foreign expansion regardless of whether they first tie the knot with a domestic partner.

Yet while the impact of merger policy is debatable, the issue of culture isn't: indeed, it is one of the main reasons why the Canadian industry has remained stable in the face of a global banking mess.

Canadian banks have historically been more cautious lenders than their U.S. peers, preferring to hang on to most loans they underwrite rather than package them off in complex securities to third parties.

The numbers bear this out: As of the end of last year, only 23 per cent of mortgage loans in Canada had been securitized, with the remainder sitting on the balance sheets of federally regulated institutions. In the U.S. market, by contrast, 51 per cent of mortgage debt had been moved off balance sheets through securitization, much of it Byzantine.

Ian de Verteuil, a BMO Nesbitt Burns analyst who compiled the numbers in a recent research report, noted that there are several problems with such a heavy reliance on securitizations. Underwriting standards become less stringent (if you're not keeping a loan on your books, there's less reason to be picky); the complexity of the securities backed by these mortgages require more reliance on rating agencies, which have shown themselves to be sorely lacking; and the fact that many of these securities are held by unregulated entities like hedge funds makes central bank interventions less effective.

“We believe the fundamental difference between the Canadian and the U.S. banking systems is that Canada still effectively runs an on-balance-sheet banking system, while the U.S. does not,” Mr. de Verteuil wrote in his report.

This is not to say there haven't been problems: several of the banks have had exposure to subprime mortgages and faltering bond insurers.

CIBC, the worst hit, suffered almost $7-billion in writedowns.

Even so, the capital position of these banks remains very strong, and investors noticed have this. Although the index of Canadian banks has fallen about 10 per cent this year, that is far less than the U.S. industry (25 per cent), Europe (38 per cent) or Asia (37 per cent). And this relative strength has catapulted RBC to the number four ranking among North America's big banks – a big leap, considering its planned merger with BMO in 1998 would have made the combined company a distant 10th.

Instead of being devoured, the Canadian banks might do some devouring of their own. Chief executives of the Big Five are being pitched daily on potential acquisitions in the U.S. sector, and most believe they will find some bargains to fuel their expansion.

I personally suspect the culture issue had more to do with it. There are those of us in Canada who have envied America's free-wheeling spirit in the past, but the more level-headed among us always knew that this carefree attitude was going to bite you in the ass eventually.

[Darth Wong]

On a related note:
http://gold.globeinvestor.com/servlet/A ... ck_url=yes (subscription site; sorry)

So, where do they get the money?
HEATHER SCOFFIELD

OTTAWA — Central banks around the world have pumped hundreds of billions of dollars into gummed-up credit markets over the past two weeks. On Tuesday alone, the U.S. Federal Reserve Board said it would find the financing to actually buy up commercial paper, a move that could cost up to $1-trillion (U.S.) more.

What the central banks are doing is a modern version of the old-fashioned role of monetary authorities, one that dates back to the 18th century, says David Laidler, a retired economics professor at the University of Western Ontario who has advised the Bank of Canada. They're printing money.

“When the banking system gets nervous, they tend to hold their cash. The classic response of central banks is to provide more,” Mr. Laidler said in an interview from London, Ont. “Simply put, they print it.”

An extreme example is the famous image of Germans pushing around wheelbarrows full of banknotes in the 1920s, trying to deal with hyperinflation. That's not the case this time around, economists say.

This credit crunch, in fact, is mainly deflationary. When companies and households can't borrow as they wish, and spend accordingly, economic activity contracts and prices can fall. So the central banks' money machines are trying to counteract that deflationary force.

If the global economy were running smoothly, and money were easy to get, the liquidity operations of central banks would indeed be inflationary, economists say.

But now, the supply of readily available money is insufficient to meet demand. So central banks are not indulging in oversupplying markets with money. Rather, they're trying to increase the supply merely to a point where it can meet demand.

“Concern about inflation can be put aside for the moment,” said Edwin Truman, a senior fellow at the Peterson Institute for International Economics in Washington, and long-time senior Fed official for international affairs.

Plus, the central banks are not dishing money out for free. In most cases, they are lending the money out, and taking collateral in return. Their balance sheets are holding up.

“I think the central banks, as I understand it in general, are being reasonably careful,” said Mr. Truman. “The risk of a substantial loss at a central bank is minimal.”

When central banks issue extra cash for money markets, they keep their balance sheets in good shape by taking collateral from borrowers in return. The collateral is marked down by a prescribed “haircut” decided upon by the central bank.

The central bank does not normally just hang on to the collateral. It holds it for only a short time – long enough to help the markets fund their daily operations.

It is possible, but unlikely, that the central bank could actually lose money if the value of the collateral collapses while the central bank is holding it, Mr. Truman said.

Not everyone agrees. Some fear that the financial crisis is so out of control that the Fed and other central banks don't have a hope of counteracting it with their own funds alone.

“The Federal Reserve balance sheet is about $1.2-trillion,” David Shulman, senior economist at the UCLA Anderson Forecast, told the Washington Post this week. “But we have an $11-trillion mortgage market, a $5-trillion credit-default-swaps market. The central banks are nowhere near large enough to handle this problem right now.”

Concerns about fiscal health weigh heavily, as well.

It's hard to know how much of the $700-billion rescue plan passed last week by the U.S. Congress will have to be funded by U.S. taxpayers. But pressure is growing in the United States and in Europe for governments to pledge their own money to back up banks and their troubled customers.

On Tuesday, the International Monetary Fund urged governments to inject capital, buttress troubled assets, and use their funds to prevent a “fire sale” of problem banks and their holdings.

At their meeting last weekend in Paris, the leaders of France, Germany, Italy and Britain agreed that European rules limiting government deficits and state aid should be applied flexibly given the exceptional circumstances.

And in Canada, former tough talk about deficits from political leaders has softened in the past couple of days.

But most economists say that even if Ottawa needs to come to the economy's rescue just as its revenues are diminishing because of falling commodity prices, the country can afford to run a small deficit.

“There is ample room to run deficits … and Canada has lots of room for lender-of-last-resort liquidity operations,” Mr. Laidler said.

The U.S. fiscal situation is another question, however. Already carrying a large debt, more stimulus packages and bailouts will take a toll, he said.

“The U.S. is extraordinarily vulnerable.”

[Solauren]

So, a culture of 'from the top down' fiscal responsibility has made a smaller country more economically stable then a much larger country with a culture of 'from the top down' fiscal irresponsibility?

Who would have 'thunk it?

I'm just amazed it was something Jean Chrietian's liberals did.

Man, if the Liberals were smart, they would so spin this right now. Oh well.

[J]

With regards to the second article, there's a couple key points which are blatantly false, at least in the case of the US system. The US Fed has a pretty sorry balance sheet these days, in fact they have more credit and IOUs on their books than actual hard cash, as can be seen on the Fed H.4.1 release. Most of their balance is in various credit facilities & loans as opposed to Treasury bills & notes (cash).

The other point has to do with collateral, and how they're "unlikely" to take a loss on it. This is the table (PDF) used for doing the "haircuts" on loan collateral, it's not much of a haircut at all. Any collateral taken last week would already be worth less than the "haircut" price, meaning the Federal Reserve Bank has already taken a loss in the span of a week.

On a related note, I'm somewhat concerned that the Bank of Canada governor, Mark Carney, is a former Goldman-Sachs employee given how former GS employees in the US have run their entire economy into the ground. Maybe I should set aside my tinfoil hat...

[Uraniun235]

What happens when the Federal Reserve goes bankrupt?

[CaptainChewbacca]

What happens when the Federal Reserve goes bankrupt?

Everything goes. Everything. I'm pretty sure without the Federal Reserve, you can't guarantee bank deposits, which means banks go and then...

Then Lord Humungus shows up.

[J]

What happens when the Federal Reserve goes bankrupt?

Then it obtains more money from Treasury which either prints up the bills and inflates and/or bills it to the taxpayers.

I'm pretty sure without the Federal Reserve, you can't guarantee bank deposits, which means banks go and then...

The FDIC guarantees deposits, not the Federal Reserve. But like the Fed, if the FDIC goes broke it borrows from Treasury which then fires up the presses and charges the tab to you. In effect, you end up paying to insure your own money.

[Stuart Mackey]

Similar situation for NZ and Australia to Canada, with some of the best banks in the world. In the case of NZ, we also have plenty of headroom with our officail cash rate to go down, to cushion the blow. For the smaller nations, the problem comes after the lager nations economies fall over, whom will buy our products if the larger nations cannot?
Nothing like fiscal prudence to get one through a recession, but only to a a degree.

[Ekiqa]

Also, Canadian bankers have been labeled as boring by the Americans.

And the regulations that were put in place post 1929 were not removed, as they were in the USA.

[Enigma]

I may have misunderstood my teachers in high school but I understood that they way that the Canadian banks are structured made them more stable than the U.S. banks. I guess it is the reason you don't see Mom and Pop banks in each province except the large banks that have branches throughout the country.

[Ekiqa]

I may have misunderstood my teachers in high school but I understood that they way that the Canadian banks are structured made them more stable than the U.S. banks. I guess it is the reason you don't see Mom and Pop banks in each province except the large banks that have branches throughout the country.

We have 5 big banks. The US has 9,000 banks for less than 10 times the population.
There has always been lots of regulations on the banking industry here, probably a lot more than in the US.

[Braedley]

Many Canadians saw the financial crisis in the US from a mile away. Included in this were the banks, which did not over extend their lending and expectations for repayment of the more risky loans. I don't know where the Americans would be today if their banks did the same, but I'd bet they'd be at least in a slightly better place than they are now.

I wish I could remember more of my intro econ course, because we talked about how appropriate lending actually improves lending for everyone. I have a feeling that many of the US banks didn't follow all of these practices.

[J]

Oh hell. And now we follow the US down the road to ruin. Fucking Conservatives.

Bloomberg link

Canada Agrees to Buy C$25 Billion in Mortgages (Update3)

By Frederic Tomesco and Andrew Barden

Oct. 10 (Bloomberg) -- The Canadian government shored up the nation's banks by taking on some of their mortgages in a bid to ease soaring borrowing costs that have crippled lending.

Canada Mortgage and Housing Corp., a government-run agency, will buy as much as C$25 billion ($21.6 billion) in mortgages from the banks, Finance Minister Jim Flaherty said today in Ottawa. The lenders will get cash, giving them more money to lend to consumers and businesses.

``This transaction is simply a market intervention,'' Prime Minister Stephen Harper told reporters today. ``It's a market transaction to ensure our credit markets are functioning strongly.''

Borrowing costs for Royal Bank of Canada and other lenders have soared as the global credit crisis spreads. Canadian banks have become less willing to lend to each other, let alone to customers. The difference in yield between Canada's three-month treasury bill and the three-month dollar London Interbank Offered Rate rose to the highest since at least 1990 this week.

Canadian banks are ``reluctant to lend to any other bank,'' said Ian Nakamoto, director of research at MacDougall MacDougall & MacTier Inc. in Toronto, which owns bank shares. ``Canada is obviously not an island unto itself. We rely on the funding costs that any other bank in the world would rely on.''

Most Canadian bank shares were mixed amid a global stocks rout. Royal Bank, the country's biggest lender, climbed 98 cents to C$42.38 at 10:44 a.m. trading on the Toronto Stock Exchange, while Toronto-Dominion Bank dropped C$1.29 cents to C$51.21.

No Comments

Spokespeople at Royal Bank, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada weren't immediately available to comment.

The mortgage buybacks may allow commercial banks to lower their prime lending rate by about a quarter percentage point, Flaherty said. The measure won't cost taxpayers any money, and the housing agency isn't taking on troubled assets, Flaherty said. He added that no banks in Canada are at risk.

``Our mortgage system is sound,'' Flaherty said. ``Canadian households have smaller mortgages relative both to the value of their homes and to their disposable incomes, than is the case in the United States.''

Borrowing costs have risen so much that commercial banks this week failed to match the Bank of Canada rate cut for the first time in 11 years. The lenders lowered their prime rate, offered to their best customers, by 25 basis points, or a quarter percentage point, short of the half-point cut by the central bank.

Less Subprime

Canada's stock of residential mortgages amounts to about C$773 billion, according to the country's finance department. Subprime mortgages represent less than 5 percent of all outstanding mortgages in the country compared with about 20 percent in the U.S., the finance department said.

Nakamoto said he expects Canadian banks to match the central bank's rate cut.

``It would look quite bad to the public if they remained at a quarter point, yet they're being perceived as being helped out by the government,'' he said.

Canada Mortgage will make its first purchase of mortgages next week, Flaherty said. The Ottawa-based housing agency insures home loans and sells mortgage-backed securities to help keep mortgage costs low for consumers.

Flaherty also said he approved a request by state-owned Export Development Canada to increase its borrowing by 50 percent to C$6 billion, adding that he's prepared to take ``other measures as necessary.'' The move will help Canadian exporters secure financing, he said.

Election Campaign

Flaherty announced the bank aid four days before national elections as support for his Conservative Party weakens over the government's handling of the economic crisis.

Support for the Liberals, the largest opposition bloc in Parliament, rose after leader Stephane Dion announced in a televised leaders' debate last week that he would put together a 30-day plan to revive confidence in the economy.

The meeting today of finance ministers and officials from the Group of Seven industrialized nations in Washington is a chance to discuss a further ``coordinated response'' to the credit crisis, Flaherty said.

[Stuart Mackey]

Oh hell. And now we follow the US down the road to ruin. Fucking Conservatives.

Err, Canadian does not have a subprime issue and its banks are sound, you do have a situation where no one is lending and borrowing costs are up, which is not a good thing, hence the intervention, so what's the issue? You didn't think that Canada was immune?

[J]

No one is immune. The problem is Canada is going about this backwards just like the US, we're just a year & half or so behind. If money is going to be put into the system, it has to be done in a way which stabilizes mortgages and prevents foreclosures, this would involve mortgage workouts where the banks work with the borrowers to ensure to the best of their abilities that the loans are sustainable going forward and will not default. Renegotiate the terms of the mortgages as needed, rework interest & principal, take the losses and use the rescue money to fill the hole. This makes the mortgages whole going forward and greatly reduces defaults.

But instead they're going to throw money in from the top and buyout mortgages, this is the toss money into a fire & pray model. It fixes nothing.

[Stuart Mackey]

No one is immune. The problem is Canada is going about this backwards just like the US, we're just a year & half or so behind. If money is going to be put into the system, it has to be done in a way which stabilizes mortgages and prevents foreclosures, this would involve mortgage workouts where the banks work with the borrowers to ensure to the best of their abilities that the loans are sustainable going forward and will not default. Renegotiate the terms of the mortgages as needed, rework interest & principal, take the losses and use the rescue money to fill the hole. This makes the mortgages whole going forward and greatly reduces defaults.

But instead they're going to throw money in from the top and buyout mortgages, this is the toss money into a fire & pray model. It fixes nothing.

Hang on, since when does Canada have a mortgage problem? the article you posted did not seem to think this (sic), it did say there was a confidence in credit issue, not the same thing.
It seems to me that Canada's issue, like NZ and Aus, is the inability to get others, like the US or the UK whose economies are a bit sick, to buy your exports, which will have a direct effect on jobs and the ability to pay mortgages, and you are not their yet.

[Ekiqa]

The reason Harper is doing this is because he is getting hit in the polls for doing nothing except saying that there are good deals in the market now.

With only 4 days till the election, he needed to do something. This however, is the wrong something.

[Phantasee]

The reason Harper is doing this is because he is getting hit in the polls for doing nothing except saying that there are good deals in the market now.

With only 4 days till the election, he needed to do something. This however, is the wrong something.

Wrong or not, I cannot tell you. But I have to tell you this: I laughed when he said it was "simply a market intervention." A Conservative telling me it's nothing but a simple market intervention is comedy gold.

[Ekiqa]

Wrong or not, I cannot tell you. But I have to tell you this: I laughed when he said it was "simply a market intervention." A Conservative telling me it's nothing but a simple market intervention is comedy gold.

The thing most Canadians dont realise, is that Harper isn't really a Conservative, or even a small "c" conservative.

He's a neoconservative, who follows Bush and the Friedman theories.

[aerius]

Hang on, since when does Canada have a mortgage problem? the article you posted did not seem to think this (sic), it did say there was a confidence in credit issue, not the same thing.
It seems to me that Canada's issue, like NZ and Aus, is the inability to get others, like the US or the UK whose economies are a bit sick, to buy your exports, which will have a direct effect on jobs and the ability to pay mortgages, and you are not their yet.

We don't have a mortgage problem yet, but we will. We don't really have the subprime and Alt-A crap that the US does, or at least in our case it's a relatively minor problem, but a lot of our "prime" mortgages aren't prime. The traditional definition of Prime is 20% downpayment, fixed rate, and a maximum debt to income ration of 36%. This puts equity in the home and keeps the monthly payments down such that it takes a nasty recession before a significant number of people default. Even in the 1970's stagflation or late 80's market crash, very few people defaulted on their homes.

The problem now is our "prime" mortgages are more like 5% down, 50% DTI, and not always fixed rate. This has been going on for at least the last 5-10 years in Canada, those mortgages aren't nearly as default-proof as a true prime mortgage. This is going to be a problem for us when housing prices here start heading downward. We're 18 months or so behind the US in our housing issues, so sometime next year our housing market is going to have a big crash. That's going to take down our "prime" mortgages and hurt our banks, and we'll be where the US was last fall.

[ray245]

No matter how much better Canada's banks may be, when the US screwed up, Canada's banks will still be dragged down with it.

Now, if only the US decides to allow proxy voting, and allow parents who has children born in the US have a right to vote...

[Phantasee]

The problem now is our "prime" mortgages are more like 5% down, 50% DTI, and not always fixed rate. This has been going on for at least the last 5-10 years in Canada, those mortgages aren't nearly as default-proof as a true prime mortgage. This is going to be a problem for us when housing prices here start heading downward. We're 18 months or so behind the US in our housing issues, so sometime next year our housing market is going to have a big crash. That's going to take down our "prime" mortgages and hurt our banks, and we'll be where the US was last fall.

Hah! That's hilarious (in a dark way). I never really wondered too much about the actual definition of "prime" mortgages until now. Thanks for clearing that up.

I'm wondering how I got such a sweet mortgage on my condo, though. My parents cosigned for it, of course, because I have practically no credit, never mind good credit (which is to be expected at 19-20 years of age). But I got prime +1% with 10% down!

[Ekiqa]

Hah! That's hilarious (in a dark way). I never really wondered too much about the actual definition of "prime" mortgages until now. Thanks for clearing that up.

I'm wondering how I got such a sweet mortgage on my condo, though. My parents cosigned for it, of course, because I have practically no credit, never mind good credit (which is to be expected at 19-20 years of age). But I got prime +1% with 10% down!

I take it you had a good paying job at the time?

Could be one reason they gave you the deal.

[Stuart Mackey]

Hang on, since when does Canada have a mortgage problem? the article you posted did not seem to think this (sic), it did say there was a confidence in credit issue, not the same thing.
It seems to me that Canada's issue, like NZ and Aus, is the inability to get others, like the US or the UK whose economies are a bit sick, to buy your exports, which will have a direct effect on jobs and the ability to pay mortgages, and you are not their yet.

We don't have a mortgage problem yet, but we will. We don't really have the subprime and Alt-A crap that the US does, or at least in our case it's a relatively minor problem, but a lot of our "prime" mortgages aren't prime. The traditional definition of Prime is 20% downpayment, fixed rate, and a maximum debt to income ration of 36%. This puts equity in the home and keeps the monthly payments down such that it takes a nasty recession before a significant number of people default. Even in the 1970's stagflation or late 80's market crash, very few people defaulted on their homes.

The problem now is our "prime" mortgages are more like 5% down, 50% DTI, and not always fixed rate. This has been going on for at least the last 5-10 years in Canada, those mortgages aren't nearly as default-proof as a true prime mortgage. This is going to be a problem for us when housing prices here start heading downward. We're 18 months or so behind the US in our housing issues, so sometime next year our housing market is going to have a big crash. That's going to take down our "prime" mortgages and hurt our banks, and we'll be where the US was last fall.

Regardless of your definition of 'prime', its the ability to pay that mortgage, and that's going to be the issue.
No job, no income no homes, thats the effect it will have on those of us who have sound banks, but who's nations are export dependent, as when those export markets dry up, as they will, that's when it really hits as people loose their jobs.
So it wont be house prices, it will be if you have a job or not.