Canadian Investment Review

Canadian Banks Got Bailed Out in 2008: Critics

Written by Scot Blythe on Friday, November 11th, 2011 at 12:16 pm

foreclosedAs Occupy TO or Occupy Bay Street takes its lead from Occupy Wall Street, it’s useful to ask whether Canada faces the same financial issues that have sparked protests in the U.S.

To be sure, Canada’s economic performance has been better than that of the U.S. since the onset of the Great Recession. Growth is higher, unemployment is lower, the housing market appears to be healthy. But that doesn’t mean Canada isn’t suffering through a post-recession hangover.

It’s just this time, it’s much weaker than the 1991-1992 or 1981-92 hangovers. Those times, we had to depend on the American consumer to buy our cars and timber. This time around, they’re not buying. They’re tapped out. But others are buying our oil and wheat

So why complain? Because, well, our banks weren’t virginal to the financial instruments that amplified the global financial crisis. The common view is that they were at least prudent in their counterparty relationships. Yet, many protestors and commentators put Canadian banks in the same financial policing lineups as the usual suspects: promiscuous U.S. thrifts and U.K. building societies, with such trustworthy names as Northern Rock or Washington Mutual.

Why the clamour against Canadian banks? Because the federal government, through the Canadian Mortgage and Housing Corporation, offered to trade the banks up to $125 billion in mortgage debt for  safe Canadian T-bills during the height of the financial crisis.

“Bailout,” both Bay Street and activists cried. Liquidity injection, the bankers retorted.

Said Murray Dobbin at Rabble.ca: “But call it what you will — the Canadian government borrowed and spent billions to backstop the banks lending during the recession and continues to do so. That borrowing is a cost to the taxpayer and many of the mortgages they bought up (starting with $75 billion in the fall of 2008 and then adding another $50 billion a few months later) could still go into default. If they do the taxpayer is still on the hook — not through the government but through the CMHC, a government backstopped crown corporation that had to be rescued by the taxpayer before.”

Wrote Mark McQueen, who runs private equity at Wellington Financial: “The federal government created a unique program through CMHC specifically targeted at allowing Canadian chartered banks to move tens of billions of dollars of assets off of their balance sheets. The reason? Canadian banks couldn’t raise sufficient and/or cost-effective funding from their traditional sources – primarily other global financial institutions – and needed Crown intervention to keep the wolf from the door. …

“There is only a subtle distinction between injecting capital into a bank and relieving it of assets so that it can avoid a capital injection. Kind of like your Dad temporarily buying your bike from you when you ran out on money in University, and then selling it back to you six months later when you were flush from a summer job. The notion that Canada’s ‘free market’ took care of itself over the past 15 months is poppycock.”

On the opposing side was Nancy Hughes Anthony, then head of the Canadian Banker’s Association. “Unlike other countries, not one bank in Canada went bankrupt or required a cent in taxpayer-funded bailouts.  The government of Canada bought insured mortgages from the banks when the global credit markets seized up to ensure that credit continued to flow to consumers and Canadian businesses. The government will make a profit on these transactions and it should be noted that these mortgages were already insured by the CMHC and therefore, create no additional risk for the government. “

So was it a bailout? In the U.S., the Treasury took toxic assets off the hands of the banks, much as the Resolution Trust Corporation took on the assets turned liabilities of the failing Savings and Loans even before the1991-92 recession. So taxpayers took a loss, lest the banking system collapse. Or the auto industry.

Did CMHC take toxic assets off the Canadian banks’ hands? (With the prices people are willing to pay for houses, surely there must be a lot out there.) Apparently not. Canadians are dutifully paying their mortgages, at least under the current low-interest rate regime (It probably helps that most Canadian mortgages are full-recourse: you can’t just hand in the keys and walk away on your flippers if you’re underwater.)

In the end, the Canadian banks only availed themselves of $69 billion in the IMPP facility, according to CHMC. And it turns out the federal government made a 1% profit.

How’s that? The Insured Mortgage Purchase Program involved the banks selling to CHMC pools of mortgages that CHMC had already insured. So there was no transfer of risk – or toxic assets. Yes, the Bank of Canada had to sell bonds  for CMHC to purchase those mortgage pools. But, in exchange for buying those mortgage pools, CHMC set a floor, through a reverse auction, so  that it would be compensated for its borrowing costs.

The result:  the banks offered somewhere between 86 and 100 basis points as their cost of (liquid) capital. Instead of paying Canadians to buy government debt at 50 basis points, CMHC was getting roughly 100 basis points for selling government debt. Not a bad deal, one would think, for buying assets where the risk of a long workout, as in the U.S., was minimal.

So no bailout. But was it economical? Did it increase liquidity? That’s hard to track, since the banks could have done anything they wanted with the dear money they had bought for loans that were already guaranteed, and for which the taxpayer was already on the hook, come what may.

According to Jean-François Nadeau, a Parliament of Canada researcher:

“It is true that there is no mechanism compelling the financial institutions to make the newly acquired cash available to households and businesses; they can use it for other purposes, such as improving their balance sheets. However, the data on available credit seem to indicate that the measure has helped financial institutions provide credit to households and businesses.

“In October, November and December 2008, the value of credit extended to households rose by $30 billion, including a $24 billion increase in mortgage credit. The figures on non-residential mortgages are less impressive: they show a rise of some $2.2 billion over the same period. Business credit as a whole rose $20.6 billion. In the fourth quarter of 2008, the combined increase was thus slightly more than $50 billion, twice as much as the value of the mortgages that CMHC purchased in its auctions in late December 2008.”

So it looks like debt-addicted Canadian consumers were bailed out, rather than the banks. The Canadian banks, unlike their American counterparts, weren’t knocking at the Grim Reaper’s door. They could have stopped lending for lack of funds. Or they could have passed on higher costs to consumers still seeking the ultimate “safe” return in leveraged real estate. The banks’ illiquidity could very well have become the consumers’ insolvency.

As the song goes: who’s bailing whom?

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