Sound banking saved Canada

Canadian Ambassador Michael Wilson. Credit: http://www.canadainternational.gc.ca/washington

Follow Us On

Facebook

Follow @washtimes

Question of the Day

Who do you think has a better chance at the Republican nomination?

• Mitt Romney
• Rick Santorum
• Undecided
• Other

Login to Vote

View results

As the United States and European countries struggle to cope with mountains of debt accumulated through a series of market crises, massive bailouts and recession, one nation stands out for having avoided the sordid cycle of bailouts and debt.

Canada and its banks were barely touched by the epic 2008 financial crisis that nearly brought down the U.S. banking system and led to the biggest recession since the Great Depression. That has led the International Monetary Fund and World Economic Forum to showcase Canada for having the healthiest banking system in the world.

Despite the geographical proximity and cultural similarities to Canada, the U.S. Congress and Obama administration have largely shunned lessons that could be learned from the neighbor to the north.

The ingredients of Canada’s success are not secret or complicated: One is keeping conservative, even old-fashioned lending standards, such as requiring substantial down payments and proof of income for home loans. Canadian banks also set aside high levels of capital reserves — going beyond international banking standards — so they can weather losses on defaulting loans and recessionary storms from the south.

The IMF, in probing what made Canada’s mortgage lending system so resilient during the crisis, concluded that it was “boring” compared with the complicated, sophisticated and expensive financing system in the U.S., but nevertheless effective and safe.

Canadian bank losses were so low, and their cushion of reserves so high, that the banks managed to post profits for months in the aftermath of the 2008 crisis while major U.S. banks were teetering on the brink of insolvency and getting $250 billion in Treasury bailouts to cover burgeoning losses on bad mortgage loans.

Canada’s examples of lending principles were mostly shunned in the financial reform debate in Congress, despite the massive regulatory crackdowns on banks in House and Senate bills.

The Senate specifically rejected amendments aimed at imposing more disciplined and conservative lending standards like those in Canada, although it did adopt an amendment to impose higher capital requirements on the biggest banks, which the financial industry and Obama administration are expected to fight in House-Senate conference.

“The Canadian experience showed that more prudent lending and borrowing played a big part in preventing the housing bubble that proved the near-undoing of the American banking sector,” said Robert Elliott, a Canadian banking lawyer at Fasken Martineau.

Though major U.S. banks have been recapitalized by the government and are posting profits again, “all the fresh capital in the world may not prevent another cycle of misery down the road” unless the U.S. also adopts more prudent lending practices, he said.

Canada owes its success largely to the kind of solid lending practices that prevailed in the United States for decades, until the early 1990s, when banks typically required 20 percent down payments from borrowers seeking standard low-interest mortgage loans.

Borrowers in Canada typically make hefty down payments but can put down as little as 5 percent as long as they get mortgage insurance — a practice also followed in the U.S. for many years but abandoned on many loans during the housing bubble.

Because home loans in Canada generally are sound and profitable, Canadian banks hold on to most of the loans they make rather than selling them to investors, which was the prevailing practice in the U.S. during the housing boom.

Mr. Elliott said another key difference is that the Canadian government never promoted homeownership with lavish subsidies, such as those enacted by Congress since World War II.

In the U.S., housing is arguably the most government-favored sector of the economy. The government provides generous mortgage interest tax deductions for first and second home loans, real estate tax deductions and an array of subsidized loan programs for veterans, farmers and low-income citizens.

Story Continues →

© Copyright 2012 The Washington Times, LLC. Click here for reprint permission.