The Canadian ‘good banks’ myth

By Murray Dobbin
Murray Dobbin's Blog

The sorry spectacle of Conservative cabinet ministers flying around the world defending banks from a tax to cover their next, inevitable, meltdown is bad enough. What is perhaps worse is that it is being largely justified by the perpetuation of the myth that Canada did not have to bail out its banks.

Wrong.

We are, according to the IMF, actually the third worst of the G7 countries, behind the US and Britain, in terms of financial stabilization costs.

First, we put up $70 billion to buy up iffy mortgages from the big five banks, through the Canadian Mortgage and Housing Corporation, taking them off the banks’ balance sheets. That is almost the exact equivalent the US bailout – it spent ten times as much, $700 billion, and its economy is about 10 times as large.

Secondly, the Harper government established a fund of $200 billion to backstop the banks – money they could borrow if they needed it. The government had to borrow billions – mostly from the banks! – to do it. It’s euphemistically called the Emergency Financing Framework – implying that our impeccable banks might actually face an emergency. It is effectively a line of low-interest credit and while it has not all been accessed, it’s there to be used. Could it help explain why credit has not dried up here as much as it has in the US?

Third, the government now insures 100% of virtually all mortgages through CMHC eliminating risk for the banks – and opening the door to the ridiculous flood of housing loans we have seen over the past few years. The result: housing has become unaffordable for tens of thousands of Canadians and new rental housing has dried up.

Why all this extraordinary effort?

If Canadian banks are such paragons of conservative virtue and prudent behaviour why did the federal government have to relieve them of mortgages that, presumably, were all carefully vetted and the borrowers scrutinized?

And why is Mr Flaherty not making any connection between the growing housing bubble (which he now reluctantly acknowledges) and the banks which lend virtually all the money (backed by CMHC) that is growing that bubble?

One of the reasons that Canadians (and international commentators, other finance ministers and global financial institutions) buy this Canadian banking fairy tale is the way the government accounts for the money borrowed to support the banks.

As Bruce Campbell of the Canadian Centre for Policy Alternatives explained in 2009:

“These measures are considered ‘non-budgetary’ or ‘off book.’ They do not show up as expenditures, which increase the federal deficit and debt. Rather, they appear on the books of CMHC and the Bank of Canada. But they have increased the government’s borrowing from $13.6 billion in 2007-08 to $89.5 billion in 2008-09, or double the fiscal deficit now projected for 2009.”

Not only has the Harper government felt it necessary to prop up Canadian banks it was this same government which created financial system risk in the first place. In 2007 the Harper government allowed US competition into Canada which prompted the CMHC to dramatically change its rules in order to compete: it dropped the down payment requirement to zero per cent and extended the amortization period to 40 years. In August 2008 Flaherty moderated those rules in response to the US mortgage meltdown. CMHC then “securitized” an increasing number of its loans into bond-like investments (if you have a typical Canadian mutual fund, you’ve got some.)

At the end of 2007 there were $138 billion in securitized pools outstanding and guaranteed by CMHC –17.8 per cent of all outstanding mortgages. By June 30, 2009, that figure was $290 billion and by the end of 2010 it was $500 billion.

In an effort to prop up the real estate market in 2008 (when affordability nose-dived), the Harper government directed the CMHC to approve as many high-risk borrowers as possible to keep credit flowing. CMHC described these risky loans as “high ratio homeowner units approved to address less-served markets and/or to serve specific government priorities.” The approval rate for these risky loans went from 33 per cent in 2007 to 42 per cent in 2008. By mid-2007, average equity as a share of home value was down to six per cent — from 48 per cent in 2003. At the peak of the U.S. housing bubble, just before it burst, house prices were five times the average American income; in Canada in late 2009 that ratio was 7.4:1 — almost 50 per cent higher.

While it was CMHC that insured these loans it was still the banks that put up the money. And they knew they were effectively sub-prime. How do we know? Because they avoided direct risk like the plague - in the two years from the beginning of 2007 to January 2009, the banks themselves took on virtually no new risk. According to CMHC numbers Canadian banks increased their total mortgage credit outstanding by only 0.01 per cent. But they were happy to put Canadian taxpayers at risk by lending to high-risk borrowers knowing their money was protected by CMHC.

Conservative? Prudent? Responsible? In a pig’s eye.