Sunday, October 21, 2012

The Canadian Bank Bailout

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This will come as no surprise to regular readers, but in the chance that you happened to find this post via Google or some other search engine, allow me to describe as plainly as possible the hows and whys of the 2008 Canadian bank bailout.

“It is true, we have the only banks in the western world that are not looking at bailouts or anything like that.” — Prime Minister Stephen Harper

Politicians always lie; this is no exception. A number of policies were initiated to keep Canadian banks "liquid" during the financial crisis of '08. Whether this constitutes a bailout boils down to semantics. True, Canadian banks didn't receive direct money from taxpayers, like their US counterparts. And the federal government's intervention didn't go through Parliament, unlike the Congressional vote on TARP. But certain actions were taken by the federal government to keep the Canadian banks solvent. This is what happened:

The Canadian banks expanded credit well beyond their assets, supported and even encouraged by the setting of low interest rates by the central bank, the Bank of Canada. This credit found its way into the economy by increased borrowing for capital projects, such as housing. Projects which never would have been started, or started at a later date, now became profitable. However, because these projects were funded by artificial credit (rather than legitimate savings), they constituted a malinvestment. They increased demand for production materials and for labour and caused prices to rise. This then caused an increase of prices of consumption goods.

But banks can't increase credit forever. All resources are scarce, the means of production and labour which are diverted into housing have to be taken away from other sectors. There is no additional capital or labour, only credit and debt. Eventually a clash over resources becomes inevitable.

The American banks and Federal Reserve pursued the same reckless policies and in 2008 it became a crisis. As people were spending money on consumption goods, capital investors found their projects to be unsustainable. Banks then asked their borrowers for payment and credit conditions started to deteriorate. The capital good industries, like housing construction, found their investments to be in error. What they thought was profitable suffered from a lack of demand. Particular types of investments were revealed to be "wrong" from the perspective of the long-term financial sustainability of the market. This was due to the distortion of price signals via the expansion of credit into the markets.

The USA suffered a huge meltdown. Canada got off relatively easy, but government intervention was used to prevent any sort of correction.

The Canadian Bankers Association (CBA) claims that in 2008, “due to the crisis of confidence in global credit markets, some funding sources that banks normally relied upon became unavailable.” To prevent a US-style catastrophe, the Canadian Mortgage Housing Corporation (owned by the federal government) bought $69 billion worth of mortgages off the Chartered Banks.

The left-wing Canadian Centre for Policy Alternatives released a report earlier this year that found the Canadian banks  receiving, "$114 billion in cash and loan support between September 2008 and August 2010. They were double-dipping in not only two but three separate support programs, one of them American." Both the Bank of Canada and the US Federal Reserve (as well as the Canadian federal government) were involved in what Harper called "liquidity support" but not a bailout.

The CBA claims it wasn't a bailout because it wasn't a solvency issue, like with the US banks. But this is faulty logic, as Daniel Tencer of the Huffington Post writes,

Those who say this wasn’t a bailout argue Canadian banks had a “liquidity” problem, not a “solvency” problem like the U.S. banks. What this means is that Canadian banks had the collateral needed to get loans to pay their bills, something the U.S. banks didn’t have. But if the problem was that no one wanted to lend to Canadian banks, as the banks themselves say, then they would have had to sell assets to pay their bills, and pretty soon the banks’ “liquidity” problem would have become a “solvency” problem, just like the U.S. banks.
Without the bailout, the Canadian banks wouldn’t have been able to pay their bills. It’s as simple as that.

According to the Canadian Centre for Policy Alternatives, the TD Bank received a $26 billion bailout, 69 per cent of the bank's value at the time. Scotiabank got $25 billion, 100 per cent of the bank's value at the time. RBC received $25 billion, 63 per cent of the bank's value at the time. CIBC got $21 billion, an astonishing 148 per cent of the bank's value at the time. And BMO received $17 billion in bailout money, 118 per cent of the bank's value at the time. Lew Rockwell put it best when he wrote, “Good liquidity needs to be based on savings and capital, and it cannot be created by decree. Decrees end up creating money out of thin air, which ends up overriding market preferences and generating inflation. Everything officials do to fix the crisis ends up prolonging it.”

Bankruptcy is a necessary component of capitalism. It separates the losers from the winners. In a free society, banks wouldn't have to be "chartered," nor could they form an oligopoly. Competition would weed out the inefficient from the efficient and consumers would have a greater variety of services. A free banking system would lead to greater economic freedom. It would mark the end of the Bank of Canada's monopoly of currency. A collapse of the Canadian financial sector may have been a precursor to this vision. Instead, malinvestments haven't been liquidated, interest rates are still manipulated by central planners and propaganda about Canada's "resilient" financial system has reached absurd proportions.

Last Monday Statistics Canada reported that the debt-to-income ratio rose to 163.4% this year. They reported household credit market debt to be $1.61 trillion. It's clear that there is a Canadian housing bubble and when the inevitable becomes obvious, the Canadian banks will most likely require another bailout to keep from collapsing.

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