Carpe Diem

Why the US banking system is so dysfunctional vs. Canada’s

The WSJ reports on a fascinating new paper by Columbia University finance professor Charles Calomiris (“The Political Foundations of Scarce and Unstable Credit“), which is based on a forthcoming book he’s co-authored with Stephen Haber. Here are some excerpts from the WSJ article “Why Canada Can Avoid Banking Crises and U.S. Can’t“:

Since 1790, the United States has suffered 16 banking crises. Canada has experienced zero — not even during the Great Depression. It turns out Canada can thank the French for their stable system.

That anti-populist political system — known in political science as liberal constitutionalism or liberal democracy — is a key ingredient in Canada’s stable banking track record. That’s because this kind of political system makes it difficult for political majorities to gain control of the banking system for their own purposes.

Populist democracies like the U.S., on the other hand, tend to create dysfunctional banking systems because a majority of citizens gain control over banking regulation that steers credit to themselves and to their friends at the expense of the citizens that are excluded from the banking system, he said. The contrast between the U.S. and Canada was part of Mr. Calomiris broader argument that dysfunctional banking systems — which are by far the norm rather than the exception around the world — are the result of political factors.

“Whether societies have dysfunctional banking systems is really not a technical issue at all. It’s a political issue,” Mr. Calomiris said, introducing his premise as “we do know how to avoid dysfunctional banking but that we make political choices – you might even say consciously” not to have functional banking systems for most of the modern era in most countries of the world.

The history of the U.S. banking system is one in which the government forms partnerships with different interest groups at different points in history, and those coalitions jointly influenced the way the banking system was regulated.

For example, a coalition emerged in the US during the 1990s of government, big banks, and activist consumer groups that helped fuel the housing crisis. Regulatory changes opened the door to a wave of mergers and acquisitions that created today’s megabanks. But banks still had to get approval – usually from the Federal Reserve – to complete those mergers and outside groups were able to weigh in on the wisdom of the deal as part of the Fed’s decision-making process.

Community groups, with the Clinton administration’s encouragement, used the Fed’s approval process to extract binding concessions from banks to loosen underwriting standards for poor, urban communities – concessions to which the Fed agreed, Mr. Calomiris argues. The banks had to apply the looser standards to everyone. That helped fuel an explosion in poorly underwritten mortgages that contributed to the depth and severity of the housing crisis, he contends.

All in all, Mr. Calomiris’ theory is a bleak one for the ability of financial reform efforts to make much of a difference.

29 thoughts on “Why the US banking system is so dysfunctional vs. Canada’s

  1. “Community groups, with the Clinton administration’s encouragement, used the Fed’s approval process to extract binding concessions from banks to loosen underwriting standards for poor, urban communities – concessions to which the Fed agreed, Mr. Calomiris argues. The banks had to apply the looser standards to everyone. That helped fuel an explosion in poorly underwritten mortgages that contributed to the depth and severity of the housing crisis, he contends.”

    But, but, George W Bush!. Banksters! Barry Ritholtz!

  2. Excellent posting. The great danger is through presumably “neutral” regulation steering financial business from one set of favorites to another. History is rich with examples of how government directed credit always comes a cropper, because it always misprices (as in underprices) risk. We are witnessing that with student lending today, which has enormous government interference and is therefore clearly out of balance. We can see the same thing with proposals like the “Volcker Rule” which under the rubric of “limiting risk” is just a means of government steering more lending into government securities and government encouraged enterprises.

    • and let us not forget the wonderfully circular flow of perpetual motion capital currently running between the banks and the treasury.

      freddy and fannie (now the treasury) buy a loan from wells fargo. (and they are buying 80% of the market). this gives WF $1. they then can lever that dollar 20X and buy government bonds. that bond money gets used by the treasury to buy more mortgages. lather, rinse, repeat.

      the fed is buying mbs’s, the treasury is buying mortgages, and leverage is high in us bonds whose rates and curve slopes are being manipulated by the fed.

      i mean, what could go wrong?

  3. “Since 1790, the United States has suffered 16 banking crises. Canada has experienced zero.”

    It can be summed up this way: Americans sometimes take too much risk, while Canadians always play it safe. If it weren’t for Americans, Canadians would be living in even smaller houses or saving until they’re even older to buy a house.

    • I totally disagree with this statement. I think you need to learn history and know what is happening elsewhere and the history of other places. Better yet you should live in the other countries for 10 to 20 years and then you will know the answer.

    • My, a deep bow to you sir. What would become of us if we couldn’t imitate your entire. Then we can look forward to our asylum being run by the lunatics shortly as well?

    • That is not true. The trouble is that US governments at all levels have meddled more with the smaller banks while the well connected Wall Street outfits have been given the assurance that no matter how badly they screw up the government and the Fed will be there to bail them out.

      That said, Canadians should not be complacent. With an idiot being in charge in Alberta, Ontario being bankrupt, and Quebec a mess the country’s banks could be facing some serious problems. While they are not as ‘broke’ as their US counterparts they still seem broke to me.

    • Banks and their regulators tend to be powerful I’m what in ever society they operate. It appears that in the US they buy regulators and manipulate the rules to the banks’ management’s short term advantage. In Canada they manipulate the regulators to obtain monopoly pricing (there only 5 big banks in Canada which control over 90% of the market). The result is a very stable, very expensive banking system. The Canadian banks make up for their monopoly prices with poor service!

  4. If Canadian banks are so safe, why did they just pass a law saying they can raid private bank and savings accounts in said banks in Canada. No they are not safe, and they know it. All the big banks and governments know the world is on the edge of a big blowup and they intend to take all savings they can get to restart or try to save the system. Canada may have been better in the past but their actions tell us it is no longer true!

  5. Correction to comment in response
    What would become of us if we couldn’t imitate your entire system? Then we can look forward to our asylum being run by the lunatics shortly as well?

  6. Peak Trader…”get over yourself”…you display a typical American attitude of arrogance which not only Canadians…but the rest of the world is tired of.

    As far as the article is concerned:

    The assumption that Canadian Banks are solid is erroneous…

    go to this link and scroll down to the slide show at the bottom of the page to find out how stable our banks are…

    Canada Bank Bailout: Yes, There Was One, And Here’s Why It’s Important To Remember That

    http://www.huffingtonpost.ca/2012/04/30/canada-bank-bailout_n_1466219.html#slide=918810

  7. PeakTrader – not sure how you link Canadians playing it safe with Americans and bigger homes for Canadians being available to us at a younger age? Speaking for only myself – I have bought and sold 4 properties as an adult living here in Canada (still own two of them). I was 40 years old when I bought my first with 25 % cash down – which I had saved up for that purpose! We also can not deduct morgage interest cost here in Canada – so we view our homes as that HOME – not as investments to be flipped to the next greater fool for a quick profit! And our Banks actually hold the Mortgage they issue, they do not parcel it out to the next greater fool for a quick profit! You will note I used the word fool and quick profit twice – which basically describes your US bankster system – which produces criminals both political and financial. And a greedy foolish public. I guess that sums up the major differencies between Canada and the US …which system seems to work better?

  8. Prof Calomaris is incorrect about the mortgage crisis causes. The Community Reinvestment Act incentives applied primarily to commercial/business loans, not residential. Residential incentives were trivial.

    Most damage was cause by the overuse of subprime and Pay Option ARMs, that were terribly misrepresented to borrowers. Those loans were motivated by greed, pure and simple. Lenders found that those loans could be securitized and sold for huge profits.

    Fannie/Freddie did talk a lot about housing affordability. But, as detailed thoroughly by Morgenson & Rosner in Reckless Endangerment, the talk was just leverage to maintain their volume and the executive bonuses that depended on that volume.

    So in the end, the mortgage crisis was caused by greed.

  9. The reality is Canadian houses are much smaller than American houses, and Canadians homebuyers are much older.

    Canadian banks benefit much more at the expense of Canadian home buyers/owners.

    So, of course, that strengthens the Canadian banking system.

    • PeakTrader you state the following…The reality is Canadian houses are much smaller than American houses, and Canadians homebuyers are much older.
      Canadian banks benefit much more at the expense of Canadian home buyers/owners. So, of course, that strengthens the Canadian banking system…

      I am not so sure about the bigger part- we have very similar home designs here in Canada – I know, I have family in the US…and I am not so sure about the age of first time buyers being that much different either! – the point I was making was clear…rent seeking, quick profit – money grabbing -criminality is at the heart of the US Banking and political system. Very simply -that is nothing to be proud of, or repeated here in Canada. We do however, have over paid Banksters here too…its just that they have not bought off the political class here as yet…they have a monoply already so they do not need to.

  10. The article is absolutely incorrect – it present false logic
    linking liberal democracy and banking.
    It has nothing to do with each other.

    I lived in Russia, USA, UK and Canada and can compare the systems.

    The true reason Canadian banks are “stable” is due to the Canadian character being “complacent” and a huge countryside mentality. That is even in Toronto which is financial center of Canada. I am an accountant and Candaian have an odd hiring culture : do you have designation? No? Get out of here. US and UK ask if you can do the job, only then if you have designation.

    In general, US and UK are extremely aggressive in persuing “the new” thing whatever it be and ripping benefict “now” . That’s why the only Canadian bank that was affected by 2008 crisis was CIBC – their CEO was as aggressive as US counterparts.

    In addition, there only 5 large banks in Canada , and they want to keep it that way by lobbying their governament not to create any more large instritution, and not allow any sizeable foreign capital in the banks. Who pays for that? Consimer, of course. Ttheir system is as corript as the US, or UK, but they are too simply half-hibernating all their lives while US is trying to rip the short-term benefit of whatever they find in front of them.

  11. Banking in its modern sense evolved in the 14th century in the rich cities of Renaissance Italy but in many ways was a continuation of ideas and concepts of credit and lending that had its roots in the ancient world. In the history of banking, a number of banking dynasties have played a central role over many centuries. .`.,

    Current post produced by our personal blog
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  12. [email protected] |

    Canadian banks are subject to the same credit system as US Banks. They are all leveraged beyond any kind of what we could call safety?
    If mortgage rates go from 3% to 6% quickly, over 50% of homeowners are underwater and cannot pay their mortgages. Canadian banks have 50% of their loans outstanding in mortgages, but their capital is less than 10% of what is loaned out. So we are all underwater.It is incredible the population does not understand the banks have no money.
    You cannot own more than 10% of a Canadian bank, so this is good.

    • There is a lot of merit to what you say. But there is a huge difference. Unlike in the US, Canadian homeowners cannot easily walk away and discharge their liabilities. They will have to keep making payments even if they leave their homes. This makes it far more likely that Canadian homeowners will keep paying mortgages and will do all that they can to stay solvent even if other spending has to be cut to the bone.

      • Charles you are obviously Canadian so debating you on the US banksters vs Canadian banksters would be pointless. Key to the Canadian Mortgage system is that Canadian Banks hold the paper -so they are very keen to lend only to those who can pay. Recent Government rule changes make the banks stress test the borrower…in the event interest rates go up. Canadians put more down initially as well and cannot deduct the interest costs. Canadians treat home buying differently then Americans. Thus the Banks here work a bit differently then the US but I see the US banks now are tightening up.

  13. Not one of these 22 commenters has mentioned the fundamental difference between the U.S. and Canadian Banking Systems: the major difference is Regulatory Authority. In Canada, there is but one Authority that regulates all financial institutions : Banks, Credit Unions, Investment Bankers, S&L’s, Insurance Companies, etc.etc. It is Federal: The Office of The Superintendent of Financial Institutions. And this Authority regulates all such institutions, both Federal, State, Regional, Local and Private. The U.S. Financial system is fractured and so is it’s regulation, creating a huge opportunity for opportunistic manipulations. Canada’s Financial system is heavily concentrated (6 major banks with multi country-wide branches), and so is it’s resultantly powerful Financial Regulation.

    • David, you maybe right about one regulator as a source of stability in the Canadian Banking system – however other countries have had one regulator systems and have not faired as well. Which brings us back to the greed and criminal factor. If the culture is criminal and greedy and I truly believe the US system from the very top to the (EBT using / abusing) citizen are criminal and greedy. There is a cultural difference between the US and Canada I know a lot of people will not agree but the proof is right in front of us. Canadians have more guns per capita then the Americans yet we don’t have the same level of gun related crime on a per capita bases. Canadian banks aren’t paying billions in fines for past criminal activity like HSBC or JPMorgan Chase etc. In any case the next year, or so will see the US and European Banking systems see some very interesting situations. If I were a US bank customer I would keep as much of my money (as I could) OUT of their control and diversify out of US dollars.

      • I could not agree with you more then I do! There is a vast cultural difference between the U.S. and Canada, and it’s been widening! I can’t see the trend changing, given the characteristics you so accurately described. “Greed” is a devastating destroyer of honor, truth and justice.
        Thanks for your thoughts.
        David
        p.s. As an aside, the Cdn Regulatory Body (OSFI) has been more effective then other countries single regulators because of good funding, more then adequate staff, both in numbers and training, and a lack of meaningful political interference. I’ve had dealings with them in my other life!

        • Mark thanks for keeping me honest – Canada has according to the small arms survey 9,950,000 guns. The RCMP has told me because many of the firearms in Canada are not registered and don’t have to be ie. shot guns, long rifles etc., that there is over 11 million guns in Canada real number based on the number of adult owners in Canada they estimated 11 guns per owner

        • Mark thanks for keeping me honest – Canada has according to the small arms survey 9,950,000 guns. The RCMP has told me because many of the firearms in Canada are not registered and don’t have to be ie. shot guns, long rifles etc., that there is over 11 million guns in Canada real number based on the number of adult owners in Canada they estimated 11 guns per owner

        • Mark, thanks for keeping me honest – Canada has according to the Small Arms Survey 9,950,000 guns. The RCMP has told me because many of the firearms in Canada are not registered and don’t have to be ie. shot guns, long rifles etc., that there is over 11 million guns in Canada real numbers based on the number of adult owners in Canada – they estimated 11 guns per owner, here in Canada – I myself own 14. The US has 270 million Civilian guns – which puts it around 9 guns on average per gun owner. Thank you for the correction.

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