- The Washington Times - Monday, May 31, 2010

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.

Moreover, through community reinvestment laws, Congress pushed banks to make loans available to minorities who in earlier eras were less likely to own homes because they had less income or poorer credit records.

The U.S. housing crisis has magnified federal involvement. As a result of the meltdown of the private mortgage market and the federal takeover of Fannie Mae and Freddie Mac, the government now directly guarantees or insures nearly all home loans made today.

The cost of those subsidies runs into the hundreds of billions of dollars each year. Even though Canada does not promote homeownership the same way, the Canadian rate of homeownership — at 68.4 percent — is nearly identical to the homeownership rate in the U.S.

“For many Americans, owning one’s home … was transformed into a constitutional right,” Mr. Elliott said, and that contributed to the crisis.

Mortgage lenders aggressively pushed homeownership as a kind of “entitlement,” he said, rather than the reward for hard work, good credit and sound money management that it was in past eras and still is in Canada.

In conjunction with Wall Street investment houses, lenders created the increasingly risky loans designed to help Americans realize the dream of homeownership, giving birth to such questionable practices as no or minimal down payments, no income documentation and the deferral of principal and interest payments for years on many loans — making them unaffordable when they reset to reflect market realities.

“That was the genesis of this crisis. Americans were able to take out mortgages that they had no ability to pay back,” said Sen. Bob Corker, Tennessee Republican, who offered an amendment to the Senate reform bill that would have set into law minimum loan standards much like those in Canada.

“Canada just to the north of us didn’t have this crisis because most of the people there put down 15 percent on their home mortgages,” he said. His amendment requiring a minimum down payment of 5 percent was rejected, largely along party lines.

Mr. Corker cited the bill’s failure to address the problems with faulty underwriting standards that led to the crisis as a principal reason for voting against the legislation even though he helped Senate Banking, Housing and Urban Affairs Committee Chairman Christopher J. Dodd, Connecticut Democrat, write parts of the bill dealing with “too big to fail” banks.

“Interest in the Canadian model has never been as great as it is now,” Canadian Ambassador Michael Wilson, the country’s former finance minister, said in a recent address to the Woodrow Wilson Center. “I’ve been asked on numerous occasions — not just here in Washington — ‘What is it that you are doing right up north?’ “

He said Canada also has benefited from stable economic policies as well as a smaller and simpler banking system and a centralized approach to banking and securities regulation.

But perhaps the most critical difference from the “sophisticated” U.S. system stemming from Wall Street, he said, is Canada’s “culture of financial conservatism” among businesses and consumers.

“Canadian banks have few risky mortgages and negligible subprime exposure. They didn’t rely heavily on securitization for financing,” he said. “No explicit regulations prevented this. Rather, banks chose not to participate” because it looked too risky for them.

Standard & Poor’s, in a recent review of Canada’s banking system, found that the biggest source of loan problems are the result of Canadian lending and investments in the U.S., where businesses are experiencing deep losses because of the recession.

“As a result of relatively disciplined underwriting standards, the mortgage market in Canada has been comparatively more stable than in other countries,” said S&P credit analyst Lidia Parfeniuk.

The standout performance has given Canada boasting rights in international negotiations aimed at setting up a new global banking regime.

But it also has led to a clash between Canada and the U.S. and the European Union, which in Group of 20 meetings have been pushing for a worldwide system of new bank taxes to pay for future banking crises.

Canada rejected the tax idea, insisting that its banks are safe and should not have to shoulder such a burden.

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