Many have sought to identify the factors that distinguished the Canadian banking system during the recent crisis. Among other factors, experts have cited the superior capitalization of Canada’s financial institutions, laws that effectively protect Canadian consumers, and the relative restraint of Canadian business culture. Reflecting the view that Canadian culture is less tolerant of greed, Matt Winkler, editor-in-chief of Bloomberg News, has stated that “Canadians are like hobbits. They are just not as rapacious as Americans.”
Yet these factors do not tell the whole story.
Indeed, in 2008, the huge U.S bank Wachovia failed with an equity/asset ratio of 16.9, as compared to the highest ratio of the big Canadian banks, Toronto-Dominion, at 5.7. Wachovia’s superior capitalization was therefore inadequate to prevent its failure.
Moreover, like Canadian banks, U.S. banks are subject to extensive consumer protection legislation, such as the Truth in Lending Act (TILA) of 1968, a federal law designed to protect U.S. consumers in credit transactions by requiring clear disclosure of key terms of the lending arrangement and of all associated costs.
Finally, there is scant empirical support for the suggestion that rapacity is less prevalent north of the border. Over the past 15 years, Canadian investors have repeatedly been the victims of chicanery on a spectacular scale, including that of the gold mining company, Bre-X Minerals, which at its peak had a market capitalization of US$4.4 billion, but whose purportedly large gold reserves were pure fiction. Around the same time that Bre-X collapsed, the Canadian corporation YBM Magnex raised nearly a billion dollars in a public securities offering, but collapsed within months when Canadian regulators belatedly discovered what apparently was already known to U.S. authorities — that YBM was little more than a money-laundering front for the Russian mob. And in late 2009, over two years after the $32 billion Asset-Backed Commercial Paper market ground to a halt in Canada, numerous of Canada’s leading financial institutions paid almost $140 million to settle allegations that they failed to make adequate disclosure to their clients of the risks associated with ABCP.
What is missing from the conventional wisdom about Canada’s performance during the financial crisis is the role of cheap money.
Alan Greenspan, once dubbed “the maestro” by celebrity journalist Bob Woodward, repeatedly drove down interest rates during his tenure as Fed Chairman in order to make stocks more attractive relative to fixed income investments. This came to be known as the “Greenspan put.”
Greenspan implemented his most aggressive put in response to the bursting in 2001/2002 of the U.S. technology bubble, which itself resulted largely from an earlier Greenspan put. From the first half of 2001 to the second half of 2002, the Dow Jones Industrial Average (DJIA) plummeted by approximately 30%. Greenspan then effected a drastic reduction in the federal funds rate, from approximately 6.5 % at the beginning of 2001 to a half-century low of 1 % in 2003, where the rate remained for another year. (The federal funds rate is the interest rate that U.S. banks charge each other for short-term loans; decreases in the federal funds lower the cost of the money that banks lend, and generate reductions in mortgage rates.)
Greenspan’s final and most audacious put caused the DJIA to soar by over 40% from September 2001 to late 2005, but it also resulted in a frenzy of mortgage lending, and a massive bubble in the U.S. real estate market.
During the same period, however, the Bank of Canada, then led by a highly effective and outspoken governor, David Dodge, did not lower interest rates as aggressively as the Fed. In 2004, the Bank of Canada’s official policy rate averaged approximately 2.5 %, and remained at or above 2 % for the entire year. Largely as a result, Canada avoided a US-style explosion in mortgage lending.
But only temporarily.
The International Currency War and the Explosion of Canadian Consumer Debt
Following the near collapse of the U.S banking system in late 2008, the Obama administration and the Federal Reserve, now led by Ben Bernanke, embarked upon an unprecedented course of action to prop up the US economy. Their extraordinary measures included a US$787 billion stimulus package, a federal funds rate even lower than the rate engineered by Greenspan following the destruction of the tech bubble, and the printing of vast quantities of dollars, described euphemistically by Bernanke as “quantitative easing.”
For a time, Obama and Bernanke claimed with some credibility that these and other measures had saved the U.S. economy from total collapse, and had generated “green shoots” in the wasteland of the U.S. financial industry’s excesses. But by mid-2010, the effects of these measures had begun to wear off, and fears of a double-dip recession began to roil U.S. stock markets.
Confronted by a U.S. Congress that had no appetite for further stimulus, the Obama administration and Bernanke elected the nuclear option – a wholesale debasement of the U.S. dollar. The debasement of the U.S. dollar was designed largely to monetize U.S. debt, and to enable the U.S. to export its way out of the great recession at the expense of economies that were heavily reliant upon exports to the United States, such as China, India, Brazil and Canada. The Fed has effected that debasement by making an extended commitment to virtually free credit, and by launching a second round of quantitative easing, or “QE2”.
Understandably, the leaders of some major economies have reacted strongly to the debasement of the U.S. dollar. In September 2010, by which time Brazil’s currency had reached a 10-month high against the U.S. dollar, the Brazilian Finance Minister stated publicly that the U.S. had launched an “international currency war” that threatened his country’s competitiveness. Since the Fed began conditioning the markets for the implementation of QE2 in md-2010, the leaders of China, Japan and the I.M.F. have also expressed alarm at the prospects of a global currency war.
In Canada, meanwhile, former Goldman Sachs banker Mark Carney, who now heads the Bank of Canada, has maintained Canadian interest rates at historically low levels largely in order to restrain the appreciation of the Canadian dollar versus the U.S. currency, which could have devastating effects on an economy that is arguably more dependent upon exports to the United States than any other. The unintended consequence of Carney’s ultra-low-interest policy, however, has been an explosion of mortgage debt in Canada.
Indeed, in December 2010, Carney admitted that Canada had entered “uncharted territory,” because the ratio of Canadian household debt-to-disposable income reached the highest on record in the third quarter of 2010, at 148.1 %. This constituted a 6.7 % increase in Canadian household obligations from a year earlier, and exceeded even the 147.2 % ratio in the United States.
The stark reality is that the Bank of Canada has been placed in a policy vice by the determination of Obama and Bernanke to debase the U.S. dollar. If the Bank of Canada raises interest rates, it risks causing a sharp appreciation in the Canadian dollar, and devastating the export-dependent Canadian economy, but if the Bank leaves interest rates at historically low levels much longer, then Canadian consumer debt is likely to rise to unmanageable levels, threatening the stability of Canada’s much-vaunted financial system when Canadian rates inevitably rise, and Canadian consumers inevitably drown in a sea of debt.
Despite the urgency of the crisis that the Fed’s dollar debasement policies have precipitated in Canada, both Carney and Canadian Finance Minister Jim Flaherty have done little more than jawbone Canadian consumers into exercising financial restraint, a course of action that has proved utterly ineffectual. Indeed, the longer that interest rates remain at unsustainably low levels, the more complacent that Canadian consumers are likely to become about the dangers of excessive household debt.
It is therefore time for Canada’s leaders to take the gloves off, and to declare publicly that it is grossly unfair for the United States to debase its currency at our expense. More than any other country, the United States is responsible for the global economic crisis, and America has no right to export its economic ills to other nations in order to mitigate the domestic impacts of its reckless neo-liberalism. Will Canada’s leaders have the courage to speak out?
Dimitri Lascaris is a a lawyer called to practice in the State of New York and the Province of Ontario, Canada. He currently represents investors in numerous securities class actions against public companies in Canada and the United States, and specializes in cases of financial fraud. Before becoming a plaintiffs’ class actions lawyer, Dimitri was a securities lawyer in the New York and Paris, France offices of a major Wall Street law firm.