First, a confession.
I stand by my argument, first made in The Home Game, an article on the Canadian financial services industry published back in October 2007, that the grip the Canadian banks maintain on Canada’s domestic market leads to less genuine competition among our banks. That leads to fewer financial products available at affordable cost to Canadian businesses and consumers. I also maintain that this is not a good thing for economic growth in Canada.
That said, two tumultuous years on, it’s clear the more conservative capital reserve requirements imposed on the Canadian banks have stood our economy in good stead as the current recession deepens. And now, those very lending practices could provide a model to help the U.S. financial sector get back on its feet without, necessarily, recourse to the Uber-Regulator or Global Regulator that U.S. Treasury Secretary Tim Geithner called for earlier today.
Currently making the rounds in Wall Street circles is a muttered refrain. “I hear your banks are doing okay,” says one exec. “I hear some of them are not even taking money from government financing,” says another.
It’s a message that’s percolated up to political circles. President Barack Obama heaped praise on our banks while he was on his brief visit up north. And Prime Minister Stephen Harper echoed the praise when he was in New York for a brief, characteristically low-key visit in early March.
This week, U.S. policymakers began to chart their way towards a new, more intelligent regulatory policy. So my question is: where are the Canadian banks, in all of this? Why aren’t our CEOs down here, meeting with Treasury Secretary Tim Geithner and the rest of the Obama Administration’s economic crew?
The Big Six’s chief executives might say they’ve got enough on their hands as it is a fair comment in these troubled times. But is strikes me there’s a real opportunity here for the Canadian banks to help U.S. policymakers establish prudent lending practices withoutregulating the life and soul out of the U.S. financial services sector. (The dictates of Buy American aside, they’d probably earn themselves some pretty spectacular government consultancy fees in the process.)
Earlier today, Tim Geithner testified (yet again) to Congress. This time, he was talking regulatory reform: a grand new plan that, he claims, will bring stability and more conservative lending practices back to America’s financial services industry.
This plan includes one single agency with responsibility for systemic stability over the major institutions and critical payment and settlement systems and activities. It would require Congressional approval. It did not, shall we say, elicit great enthusiasm from its immediate audience, the House Committee on Financial Services.
Key to Geithner’s efforts is a call for new powers over systemically important banks and other financial institutions. It’s an attempt to head off the Too Big To Fail problem that a bank, insurer or other institution become so big, its collapse would jeopardize the U.S. economy.
In recent years, this thinking goes, the notion of Too Big To Fail actually encouraged fund managers to take greater and greater risks. They did so in the assured knowledge that the U.S. Treasury would bail their institution out, should said institution find itself in dire financial straits.
Nobody guessed that almost all the major institutions in the U.S. financial services sector might come calling on the public purse at the same time. But last fall, that’s what happened. With this plan, Geithner is determined to prevent it from happening again.
Another important part of the Geithner plan: a global regulatory regime, of some fashion. Our hope is that we can work with Europeans on a global framework, a global infrastructure which has appropriate global oversight, so we dont have a balkanized system at the global level, like we had at the national level, Mr. Geithner said.
He was also asking for the right to supervise companies that currently escape most federal oversight insurance companies like A.I.G., and multibillion-dollar hedge funds like the Citadel Group and private equity firms like the Carlyle Groupor Kohlberg, Kravis & Roberts.
The litmus test in all of this, of course, would be whether a company had, indeed, become Too Big To Fail. If regulators deemed this to be the case, that company would be subject it to much stricter capital requirements than smaller rivals and much closer scrutiny of its borrowing levels and its trading partners, or counterparties.
Geithner didn’t go into detail on how this regulator, which one committee member dubbed the Uber-Regulator, would be structured. He indicated it might build on the model of the F.D.I.C. (The Federal Deposit Insurance Corporation, created during the Depression after a wave of bank failures, insures customers deposits and can put failing banks into receivership.)
However, the most striking new proposals would regulate private pools of capital hedge funds, private equity funds and venture capital funds and derivatives, including instruments like credit-default swaps.
Up till now, both markets have operated almost entirely outside the regulation of either the Securities and Exchange Commission or the Federal Reserve. This plan would require hedge fund, private equity and venture capital fund advisers to register with the S.E.C. for the first time. And fund managers would be required to provide the government on a confidential basis information on how much they borrow to leverage their investments as well as information about their investors and trading partners. The S.E.C. would then share those reports with the Uber-Regulator.
Hedge fund managers have questioned how necessary or fair this regulation is. But the more important question is the extent to which such regulation would further hamper liquidity which, presumably, isn’t what’s wanted, particularly when a government is attempting to get its economy and its financial services sector back in gear.
As Canadian readers can probably imagine, such an expansion of government power did not sit well with the committee. Representative E. Scott Garrett, a Republican from northern New Jersey, said government authority to take over failing institutions needed to be carefully structured to avoid a lot of unintended consequences.
So how can Canada’s banks help out in all of this? Canada is no paragon of financial service sector regulation this is the country, after all, that has yet to establish a single securities regulator.
But when it comes to regulating banks’ capital reserves, we practice another kind of regulation. And it’s one that might, in the long view, make more sense than attempting to establish either an Uber-Regulator or a Global Regulator (which, as Dani Rodrik argues most sensibly in a recent issue of the Economist , runs the risk of becoming the United Nations of financial service sector regulation. And we all know how effective the UN has been.)
The magic Canadian ingredient? Basic common sense.
Consider the arguments of Newsweekeditor Fareed Zakaria. In the February 7, 2009 U.S. editionof the magazine, he makes the following points:
Guess which country, alone in the industrialized world, has not faced a single bank failure. Yup, it’s Canada. 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 1compared 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.
In a special editionof the New York Times‘ Dealbook blog, Andrew Ross Sorkin puts an interesting question to Wall Street: Where’s the Plan? “In the last several months, Americans have looked to Washington to lead them,” he writes. “But where’s the leadership on Wall Street?”
Sorkin goes on to point out that right now represents an enormous opportunity for a C.E.O. to come forward with a plan to reform the financial system and pledge a change from business as usual. A reform driven not by populist anger, but by practicality and a sense of fairness. “After all,” Sorkin argues, “reasoned leadership may generate a reasonable response, helping the industry pre-empt what it fears most: additional government regulation.”
One simple answer? Look north of the border.