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Remebering 2008 and how little things have changed; World Economic Forum 2015


I have been taking in a fiew WEF disucssions and one I did enjoy was the Posen/ Martin Wolf interview, and can recommend this for anyone interested in nations and the worlds financial systems.  Wolf speaks of three key risks within the financial system which intestingly are precisely those same risks from 2008.

  • D/E (Debt to Equity) of banks which on average sits in real terms (disregarding risk weighted) in the range of 20 : 1 or 25: 1.  Wolf makes the point that at that ratio consider how much loss needs to occur in asset value before the bank is work less than nothing.
  •  Derivatives:  These sit still at $600 trillion + or 9 to 10 times the value of the world economy.
  • Stablity breeds instability (Minsky:  Minsky’s Financial Instability Hypothesis (FIH)) or as stated by Lawrence H. Meyer :

“a period of stability induces behavioral responses that erode margins of safety, reduce liquidity, raise cash flow commitments relative to income and profits, and raise the price of risky relative to safe assets–all combining to weaken the ability of the economy to withstand even modest adverse shocks.”

Relevance to Bankwatch:

Back in those heady days of 2007/2009 I blogged at length on bank equity levels, derivatives and yet we are still here. Wolf spoke of the Minsky point above which we admits regretting only having read recently, and how this could be the real risk underlying where we are today.

Rather than repeat all those arguments, here is the story of Wachovia and the speed with which it disappeared in hours and days back in 2008.  This is a stunning sotry bearing in mind Wachovia was the fourth largest bank in the US.  Wachovia had assets of $802 billion and liabilities of $720 billion (approx).  Equity base $72 billion Form 10K Feb 2008.

Written by Colin Henderson

January 25, 2015 at 12:51

Posted in Uncategorized

MF Global had over 10 times capital in off balance sheet derivative and short selling contracts


There are more than a few nervous people on Wall St, Threadneedle St, La Défense, Ōtemachi, and all the other financial centres of the world held their breath Friday when MF Global, a Prime Broker in New York announced they were in trouble and selling their assets.  That fell through over the weekend, and today MF Global are bankrupt. 

This is a big deal and might be another Oliver Stone movie in the future when we look back. 

http://dealbook.nytimes.com/2011/10/31/mf-global-files-for-bankruptcy/?hp

http://www.ft.com/intl/cms/s/0/138241f6-03dd-11e1-98bc-00144feabdc0.html#axzz1cOQ3SoMc

image

The bad part of this is how it could be allowed to happen.  MF were downgraded by the ratings agencies when, as reported in the NY Times:

The agencies said they were concerned that MF Global lacked a sufficient capital cushion if its $6.3 billion in European debt went bad.

Well, just is how much?  They are publicly traded so I looked up their balance sheet.  As usual it is horribly laid out, as is the case with all banks, and clearly designed to ensure basic items such as revenue, capital, liabilities and assets are as hard as possible to locate.

Anyhow, here is their fiscal year to Mar 2011 results:

Annual revenue:                                           $2.2 Bn

Gross revenue after transaction expenses   $1.0 Bn

Total Assets                                               $40.5 Bn

Equity                                                         $  1.4 Bn

So we can calculate Debt to Equity at 27.9:1 (39.1/ 1.4) so we are certainly in bank territory there.  To a traditional banker sense this company is unbankable.

Next and most important, being the thing that brought them to down, lets look at off-balance sheet items.  Again from their own financial statements here is their derivative position.  There are $1.1 Bn on the asset side, and $4.5Bn on the liability side or $3.4 Bn or two and a half times capital base.

image

Then on page 104 there are $5.1 Bn in stocks with the ubiquitous title of “Total Securities sold, not yet purchased” – this is perfectly legal ”short selling”. 

The ratings agencies marked MF down when they discovered $6.4 Bn in Euro derivative exposure.  So it seems that since March the company has become even more extended.  But lets stick with the Financial Statements amount.  The derivative liability and the short selling amount to $9.6 Bn.  If there is a 10% movement, they lose $1 Bn, 25% 2.4 Bn etc.  This potential for loss must be co-related to the capital base of $1.4 Bn or even total revenue at $2.2 Bn.

Relevance to Bankwatch:

This is a classic example of why banks make regulators make governments nervous.  The entire financial system (banks & brokers) is based on a set of liabilities which no one member of the financial system can manage and pay for alone.  In normal business, if one person or business goes bankrupt there is some disruption, but the ripple effect is very limited, and generally life carries on. 

When a bank or broker goes under the impact is felt across the entire financial system.  The good news, is that this one was allowed to go bankrupt.  The more interesting news is yet to be heard.  Financial markets are renowned for their lemming type behavior.  If MF were caught offside with too much derivative exposure against the Euro, how many others are in the same or similar category.  Clearly the ratings agencies are watching this very closely and are not going to get caught out as they were 4 years ago.

Written by Colin Henderson

October 31, 2011 at 16:23

Posted in Uncategorized

Dimon of JP Morgan makes a perverse argument for lower capital – no talk of innovation here


Jamie Dimon, who you will recall was seen here looking a little more contrite, bankersin Feb 2009 when they were being bailed out by TARP, is on a rampage to remove government control of banks. 

Lets face it, banks as they exist today, only exist because of close government co-operation.  This is carefully managed through the window of the central bank, the Federal Reserve, Bank of England, Bank of Canada, etc.

He is right in that all banks are not the same, but he is wrong in that all banks operate at debt to equity levels that would never survive in the ‘open market’ meaning without government provided deposit insurance and implicit government guarantee of the entire institution.

I refer to the 4th quarter results and this shows JP Morgan with debt to equity of 11.02 : 1 – in plain english shareholder equity represents 8.3% of total assets.  Consider GE at 5.0: 1, or Microsoft at 0.86 :1.  GE is on the traditional higher end of the scale when we are talking about ability to survive economically and weather good times and bad.  Microsoft is the traditional strong balance sheet. 

JP Morgan is in much stronger shape than most banks in the world. There are many European banks in the 20: 1 or worse range. 

Davos WEF 2011:  JP Morgan chief Jamie Dimon lashes out at bank critics | Telegraph

Today, he is quoted warning of a ‘nail in the coffin’ of banks and proposing a reduction in the capital that JP Morgan holds (they are at 9%)

Urging regulators to make a quick decision, he said the slow progress meant banks were already shrinking their balance sheets on the basis of “anger and the shrillness – and Switzerland says it’s got to be 19 per cent and people in the UK say it’s got to be 15 per cent.”

“If you think that’s helping growth, it’s not,” Mr Dimon said, adding that a 7 per cent capital ratio would be adequate.

Relevance to Bankwatch:

I am as sympathetic to banks as the next banker, but the arguments Dimon uses and the objectives he promotes are self serving.  Yes a company will be more economically efficient at a lower capital ratio, ergo return on equity will be higher with more assets employed to produce return.  But and this is the key …. but that lower capital ratio is only feasible with a government guarantee for your organisation. 

So, in effect Dimon is insisting on government support forever.  One is left to wonder who will benefit in the world he promotes and when he says higher capital ratio’s would hinder growth, is he actually referring to GDP or some other growth metric.  Lets not forget, JP Morgan paid out 7% of capital as bonuses in 2009.  It does not seem equitable for this to occur on the back of taxpayer support.  I cannot but but recall the words of Umair Haque about thin value, and how Dimon epitomises.

A final important note.  This shrillness against regulation is accompanied by a lack of anything about innovation or new business approaches that might actually be good for people and businesses.

 

Written by Colin Henderson

March 30, 2011 at 22:45

Posted in Uncategorized

BMO relies on rising stock prices to cover over the risk inherent in increasing debt


I really have to call out BMO for irresponsible commentary in this report on Canadian debt.  Basically the report says that despite even faster increases in debt of Canadians, that increases in the stock market cover the increase so overall its ok. Does anyone at BMO really believe that]?

Family debt rising but financial health improving | BMO

“Balance sheet repair is quietly underway among Canadian households thanks to a slight rise in savings and firmer equity markets, while debt growth is poised to slow amid the clear cooling in the housing market,” the report said. “A singular focus on debt portrays an overly negative picture of Canadian household finances, which have proven incredibly resilient this cycle and likely still have enough cushion to provide a soft landing for spending in the year ahead.”

What are they talking about?

  1. Fast increased debt supported by historically low interest rates is an accident waiting to happen.  When rates rise as they inevitably will, it is household income sufficient to make the payments.  Bank of Canada does not think so.
  2. When rates rise, what will the stock market do?  It will fall because that’s how it works.  So the supposed asset value coverage will disappear.  A higher proportion will have insufficient income to service the debt, and by the way, the stock value that could be sold to pay it off has gone.
  3. The report looks at averages.  Are the people with debt the same people that have asset value increases in stock values?

Relevance to Bankwatch:

Banks are worried.  They are worried that their franchise is being eroded because in a deleveraging environment, people reduce both Bank assets and liabilities which means reduced income for banks.  I get that, and the need to source alternative products and revenue sources is the order of the day.

However to make statements such as “A singular focus on debt portrays an overly negative picture of Canadian household finances” is to turn a blind eye to the lessons of the lasts 1,000 years.  Debt bubbles always end badly and are never resolved by asset bubbles.  Everything comes back to income and ability to service debt.  That’s why I introduced this uncharacteristically negative post on my own alma mater.

Written by Colin Henderson

December 1, 2010 at 20:53

Posted in economy

Basel 3 (Basel III) details released


For the record here is the detail on Basel 3 (Basel III).  It is a positive step but it still means banks have a debt to equity level of 8.5 :1

BIS Press release and pdf.

High level taken from the pdf.

basel 3 1

Detailed schedule taken from the pdf.

basel 3 detail

Written by Colin Henderson

September 13, 2010 at 16:00

Posted in regulation

The fragility of the banking system – the final 2 days in the life of Wachovia in 2008


There is a statement today …

Statement of John Corston, Acting Deputy Director, Complex Financial Institution Branch, Division of Supervision and Consumer Protection, Federal Deposit Insurance Corporation on Systemically Important Institutions and the Issue of "Too Big To Fail"

that contains some very interesting facts, and side from he bureaucratic commentary there is a real sense of incredulity that this is how big banks are managed.

The overall message is excruciating detail is one of rationalising insufficient regulatory oversight existed to permit the FDIC to adequately monitor the situation.  It describes the nature of onsite examiners at FI’s with greater that $10 Bn in assets (news to me) and how they were able to determine in 2008 with limited information that Wachovia was deteriorating do to increased bad debts but also doubts about derivatives which were being traded not as a hedge but for house benefit.

No surprises so far, and sounds like a regulator.  Then despite the bureaucracy no sooner than 11 + days before the demise of Wachovia, FDIC got excited that there was a problem despite earlier warnings.

In early September 2008, the FDIC became increasingly concerned with the liquidity condition of Wachovia. During the week of September 15th, following the Lehman bankruptcy, Wachovia experienced significant deposit outflows totaling approximately $8.3 billion, representing a mix of deposit types, but primarily large commercial accounts. On September 23rd, senior executives and staff of the FDIC met to discuss our elevated concerns with the institution, specifically noting liquidity concerns including considerable contingent funding risk and increasingly negative market views on the firm. The institution’s marginal and weakening financial condition made it vulnerable to this negative market perception.

This is the point where the detective work goes from years to minutes in detail.  Early September 2008, FDIC met with Wachovia executive regarding ‘elevated concerns’.

Liquidity pressures on Wachovia increased the evening of September 25th when two regular Wachovia counterparties declined to lend to the firm.2 Since the institution was a net seller of Federal Funds this signal was not viewed by the OCC as a catastrophic development. As discussed in the next section, the failure of WaMu was announced late in the evening on September 25th. As of the morning of Friday, September 26, the OCC indicated to the FDIC that Wachovia’s liquidity position remained manageable. During the day, however, market acceptance of Wachovia’s liabilities ceased as the company’s stock plunged, credit default swap spreads widened sharply, and many counterparties advised that they would require collateralization on any transactions with the bank.

So now over a 2 day period from Sept 23rd to Sept 25th Wachovia encounters counterparties to their commercial paper that will no longer lend to Wachovia, yet the OCC (Treasury) signaled all remains well.

Wachovia’s situation worsened as deposit outflows on Friday (26th) accelerated to approximately $5.7 billion, $1.1 billion in asset-back commercial paper and tri-party repurchase agreements could not be rolled over, and $3.2 billion in contingent funding was required on Variable Rate Demand Notes.

Then the final kicker.

On the morning of September 26th, before U.S. financial markets opened for the day, the FDIC Board approved both the systemic risk exception and the acquisition of Wachovia by Citigroup. This proposed acquisition included government assistance in the form of an asset guaranty on a portion of Wachovia’s assets in exchange for $12 billion in Citigroup preferred stock and warrants. The terms of the asset guaranty called for Citigroup to absorb the first $42 billion in losses on a $312 billion segment of Wachovia’s assets with the FDIC covering any additional losses above that amount.

… …

In the end, the Citigroup transaction was superseded by an unassisted bid by Wells Fargo to acquire Wachovia that was announced on Friday, October 3rd.

Relevance to Bankwatch:

The moral of this saga is the speed that a bank can disappear.  On September 23rd FDIC determined Wachovia was in serious trouble and September 26th Wachovia’s fate was sealed.  The speed of this is astounding and certainly speaks to the inability of the system to determine earlier that a problem was brewing.  But the FDIC already ranked Wachovia as being in trouble earlier in September (“FDIC became increasingly concerned with the liquidity condition”).  Surely some earlier activity could have occurred, especially since even this blog knew there was a systemic mortgage problem 18 months before Sept 2008!

For me this really speaks to the fragility of the banking system and the banks.  It also speaks to the lack of teeth that the regulators have, or are willing to exercise.  Its an obvious fact that banks operate at the convenience of government.  No legitimate enterprise could otherwise operate with debt to equity of 20 :1 +/- and survive. This occurs by virtue of the money markets and direct connection with the central bank who effectively manage the liquidity positions of banks. 

So long as that is the system there must be better co-ordination of information with the regulator so that banks are kept honest and do not get into the kind of house trading that made Wachovia a high risk market maker rather than a market participant.  This participation is high risk market activity not associated with basic banking is why Wachovia deserved to disappear.  The flip side is that banks create sufficient capital depth that they can operate independently.

Written by Colin Henderson

September 1, 2010 at 21:40

Too Big to Fail and How Little the Concept is Misunderstood


Sheila Blair Chair of the American FDIC (retail deposit guarantees) speaks clearly yet with words that are hardly reflective of US policy.

The first task is to scrap the “too big to fail” doctrine. To do this, we need to fix weaknesses in our regulatory system, and achieve global reform for effective resolution processes when large firms fail. With these steps, we can foster real market discipline and make international cooperation more successful.

Co-incidentally I watched the BBC World Debate earlier with an interesting group of contrasts (no video online yet)

BBC World Debate – Global Financial Crisis: Can we Afford the Future? (Opening plenary session of Program of Seminars) Speakers: Dominique Strauss-Kahn, Managing Director, IMF; Niall Ferguson, Professor, Harvard Business School; Christine Lagarde, Minister of Economic Affairs, Industry and Employment, France; Jim O’Neill, Chief Economist, Commodities and Strategy Research, Goldman Sachs; and Güler Sabancı, Chairperson,Sabancı Holding, Turkey

The study in contrast in the hour long debate was at its crispest when the facilitator asked Jim O’Neill no less than three or more times if Goldman was chastened by the whole government support, continued profits, and concern over billion dollar bonus thing, and he awkwardly and steadfastly bypassed the question. to which Niall leaped in to help out with the quote of the debate

Niall Ferguson: “you have got to be kidding … off course they are not chastened … They are absolutley gleeful! Their competitors have been knocked out [by government intervention and forced takeovers]”

It was a classic moment. The earlier context had been what lessons have been learned and does the answer lie in regulation. Ferguson had argued that regulation had created the problem through the creation of the Freddies which facilitated the mortgage crisis while operating as quasi government agencies with implicit 100% government guarantees that have since been exercised. Lets not forget that the Freddies accounted for $5.3 trillion in mortgages. That number is almost 50% of the US economy. This is consequential stuff, so to say more regulation is better is not appropriate. Better regulation at best might be acceptable, but not more.

Meantime back to the TBTF’s as Niall has named them. Just how strong are they after all the dust settles on the forced mergers to date. Here is a selection of the largest in US and UK. When looking at these numbers note that banks focus on capital base and on profits in public announcements. I choose to deliberately go back to basics and the debt to equity view – why? If it were not for the shortcomings in debt to equity, government intervention would not have been required by definition. Government assistance to banks is because they are unable to manage their debts – finance 101.

US $ billions

banks capital 2009

Relevance to Bankwatch:

Clearly I am innately pro-bank, otherwise I would not be bothering with this blog. What is really burning me more than anything though is the obvious refusal by the large banks, Canadian included, to openly recognise the role they play in the world economy, and the fundamental risk that is implicit in the pseudo state guarantee that has been in existence over the last 50 years, and that is now explicit. If I were a bank Chairman, what would keep me awake at night is the concern that the pro-state intervention meme that is exemplified in the benignly charming Christine Lagarde, will tomorrow reduce me to being a $50K per annum bureaucrat.

Going back to my earlier ramblings on the future of banking lying in two camps:

  1. financial utilities
  2. innovators

… I remain even more convinced of this evolution. At the moment, the majority or all of TBTF’s are or will be in the financial utility category based on their fiddle while Rome is burning approach.

Great_Fire_of_Rome

Banks as exemplified in the impotent Jim O’Neill at the BBC debate are not displaying the desire and action that suggests they apprehend the severity of the issue. Notwithstanding even Niall indicating that bonuses are symptomatic and not causal, they do reflect strategy. What about dividends? What of a Bank that eliminates dividends for 5 years to boost capital by definition, by 50%? Consider the stock impact on the appreciation of risk that would reflect, especially when we consider the coming credit card problem that few speak of.

For those that disagree with this, consider the size of the liabilities above, and the relative size of the money set aside in the back pocket (equity). Consider Barclays – they have $20 bn in outstanding credit cards. If 12% is bad, that is $2.4 Bn. This equates to 5% of the capital base. Not much in percentage terms, but that is just credit cards. There is the commercial lending portfolio, the investment banking portfolio, all of which are driven off the same retail consumer desire to buy.

It is just not clear at all from Bank announcements in the investor relations sections that they have altered their behaviour one iota to reflect potential economic hiccups going forward, which would affect countries and not just themselves.

Written by Colin Henderson

October 4, 2009 at 16:55

The power of positive thinking from Deutsche Bank


This is a very sensible article by Neil Hume at the FT.  He notes the extraordinary growth in bank stock prices since the infamous CitiBank memo in March, wherein he basically pronounced the worst as over, because he had removed the bad people, was instituting new processes, and working with Government.

What struck me is this quote from an analyst at DB (emphasis added)

On London: Banks’ rehabilitation could take time

Add it all up, and the reason banks have rallied is investors are no longer worried about nationalisation and are prepared to look through two years of rising bad debts and impairment charges to a recovery. “There is increased appetite from the market to accept 2009 and perhaps 2010 as lost years from a bank profit perspective and buy stocks for post-recession earnings,” says Jason Napier of Deutsche Bank.

Hmmm…  all I can say is I don’t think so.  Since when is the market willing to wait beyond 1 quarter, let alone 2 years?  Such thinking is precisely the kind of thing that pressed the exuberance of the last few years before this crisis – the ability to rationalise perverse events with thinking that sustains the perverse events.

As Neil points out there is much news still to come:

  • more stress test results
  • more economic events – just this week it has become clear that the projections on the economies of all advanced economies were overstated by orders of magnitude.
  • additional regulation – still to come

In my view, the impact of deleveraging has not yet hit the Banks’ of North America or UK.  Their capital bases are razor thin, with extraordinary levels of debt to equity.  Just one event can wipe that out.  It is painfully strange that the US Fed as again yesterday deferred the announements on the stress tests of the 19 banks’, 19 banks’ who as far as I can determine have yet to be named.  If the news was good one might assume the announcements would have come back in March?  The jury remains out.

Written by Colin Henderson

May 2, 2009 at 12:45

When will it all end? | the answer has to begin with smart banking regulation


I just finished a conversation with a colleague on the West Coast of the US who it turns out is a reader of this blog, so thank you for that.

The topic was the dire nature of the news, and in particular the emails from RBE (Nouriel Roubini) which are consistently bearish, and with the timing of those emails coming in late at night, this can contribute to sleep deprivation from worry.

Aside from the potential for re-scheduling the emails, it made me reflect on what is missing in all this economic crisis, and how it is different than what the memories of the majority have in their experience. 

When will it all end?  That is probably the best summary of the question on the minds of most, so a continual flow of negative information does not bode well in offering answers to that question.  At best some glimmer of good news such as an uptick in month over month car sales such as we saw in Canada today.  Of course that is meaningless, since the month in comparison was so low, it was hard to go lower.

Then I saw this leader in the Financial Times over lunch wherein Angela Merkel continues with her consistent refrain that we ought to focus on regulation.  It is notable that she said this the day after the US government announced a $1.2 trillion liquidity boost, which just sent investors scurrying for commodities, due to renewed concerns about inflation.

Merkels point is that the unintended consequences of government stimuli are worse than the problem that needs to be addressed.

“What we need is for [the April 2 G20 summit in London] to send a strong psychological signal. We should not be competing for the most unrealistic fiscal stimulus,” Ms Merkel told parliament before she travelled to Brussels for a European Union summit.

I believe she is right.  The missing element in all this is certainty.  Absolute certainty will never be achieved within financial markets but the current mess is getting worse, not better.  As Niall Ferguson points out repeatedly, this is a crisis of debt that we are experiencing.  That includes consumer debt, corporate debt, and financial institutional debt, the latter reflected in their unspeakably high debt to equity levels of 20 or 30 : 1. 

If we follow the logic flow those highly levered banks cannot deal with write downs on the highly levered consumers and corporates.  That stalemate produces inaction within the private sector, so the government jumps in.  However the government has jumped with both feet into the wrong swimming pool.  The current track of investment in financial markets to impose liquidity will simply be absorbed by the banks, and meantime, there is still no action on the debt problem.  And so in an attempt to restore confidence in markets, the government resorts to investment in bank equity, with no restrictions on the current bank management.  Again there is no clear apparent benefit to this and the only outcome expected now is that the banks will become wholly government owned, at least the large banks.

This underlying concern and worry can be characterised by questions about how the government will operate banks better than bankers will.  Nothing to date suggests and improvement, and in fact the concerns about bankers is systemic and global.  If everyone is running around stealing things, more police won’t fix it – firest people must know that stealing is wrong and brings penalties.

Returning to Merkel – her focus along with her lone colleague on this, Sarkoszy, is designed to provide a framework for certainty within the financial services industry.  For example (my example, not hers) …  the new regulation could require banks maintaining target leverage at no higher than say 4 : 1, with steps required each year to get there.  Incidentally would still be far higher than the Merchant Banks of the 1700’s but just say that was the target. 

First of all, every bank in the world today would be in contravention of that target, and some so far off that they cannot meet the steps.  You might see Governments stepping in with 100% administrative control of those banks to ensure stability and while they rework their balance sheets. 

After leverage regulation, next, derivatives should be made illegal.  The banks could either take on the asset associated with the derivative but only if those with liabilities take it on as debt.  Otherwise they just disappear and are ordered to be written off.  This would eliminate nearly $ 1 quadrillion (1,000 trillion) in world debt all of which is off balance sheet, and remains the smoking gun of this depression.  The result would be greater certainty and in theory limited impact on balance sheets, although their would be other consequences.

These two simple regulations would produce a dramatic shift and singular focus on strategy designed to break up large banks, sale and write-down of assets to develop a new base line from which to create a credible and believable capital base.  We would see a return to calm step by step back to basics banking.

Relevance to Bankwatch:

The point remains that regulation does not have to be burdensome – it has to be smart, clear and understandable, unlike the Basle Accords, which should be torn up.  The development of new regulation would produce rational business outcomes, instill confidence in those banks that get to target first, and generally produce a clear way ahead with a framework for others (consumers, corporate and governments) to understand how to plan.   Banks would also know how to plan and their strategies would be immediately measureable.

Then and only then would business certainty begin to return to the economy – it has to begin with the banks.  Then and only then the question, “when will it end” might have some answer, and allow my west coast friend to sleep at nights.

Written by Colin Henderson

March 20, 2009 at 14:11

Posted in Uncategorized

Memo to BofC | Canadian lesson ought to be benefit of early co-operative action – not “it began outside … “


I have to take issue with this statement by the Bank of Canada Deputy Governor made this morning to the House of Commons Standing Committee on Finance.  Without a full and proper understanding of the crisis, how can our leaders be exepcted to appropriately address it.  In particular this is central bank advice to the House of Commons.  Yes a global solution is required, but no it begain inside all countries borders, and here is the Canadian experience followed at this blog.

Opening statement by Pierre Duguay Deputy Governor of the Bank of Canada to the House of Commons Standing Committee on Finance

Because the crisis we are facing is global in nature and began outside our borders, most solutions must be found at the international level. …   I would note that there has been a great deal of interest worldwide in the resilience of Canada’s financial institutions in the face of the global economic crisis. Unlike their counterparts in other major economies, Canadian banks have not been materially affected by the financial crisis.

To state that the global problem began outside our (Canadian) borders is just incorrect.  I imagine his defense of that statement would be to make the point that the sub prime crisis was American. But that statement belies the now understood nature of the problem being derivatives and SIV’s that were assessed in mathematical terms with improper understanding nor accounting for risk.

The global problem of derivatives which are still over $600 trillion exists because those instruments were a result of real assets being dissected into different components and repackaged as new instruments that bore no resemblance of, nor clear line of sight to the original asset.  This is well known now, and to suggest that world market passed Canada by, is disingenuous at best.

All countries had banks participating in the international money market investing in securities they did not understand and Canada is not exempt from that fact.  Back when I started counting the extent of the problem when frankly few acknowledged it publicly (early 2007), Canadian banks were north of $6bn in write offs associated with sub prime and other very high risk investments, such as the 3/4 billion natural gas speculation at BMO.  CIBC though led the way with $3bn of sub prime losses at that point.  In July of 2008 Dundee Securities painted CIBC as a takeover candidate.  I have since lost track of the sub prime losses in Canada, but they have not gone down.

Then there was the Pan Canadian Investments arrangement orchestrated by Purdy Crawford on behalf of the Bank of Canada (yes, the place where Duguay works) and Government of Canada, whereby some $31 Bn in derivatives, involving secondary players in Canada, were removed  from the financial system and sheltered in an arrangement that ensured no immediate demand for payment on the Canadian banking system would occur.  This was a visionary move taking place in 2007, and before the extent of the world crisis was understood.  But those $31 bn do exist, and I believe Canada could have had its own “Lehman Brothers” crisis in 2008 had that action not occurred in 2007, and being wrapped up in January 2009.  Pages 1 & 2 of this pdf prepared by Pan Canadian and hosted on the E&Y site, highlights the direct involvement of the banks, including $21 bn of it relative to CDS (Credit Default Swaps).

So to say Canadian banks were not materially affected is something of a glossing of the facts.  A better approach for the speech would be to focus on Canadas natural conservative tendencies, early action to address problems,  foresight etc.

Canada took conservative and early action to prevent becoming embroiled in the fiasco being played out in US and UK particularly whereby even Lloyds, that bastion of risk adversity is on brink of full government ownership.  With Debt to Equity ratios ranging from the excellent TD at 14 :1 to CIBC at 25 :1 Canadian banks are on average in better shape now than many others around the world, assuming their bad debts allowances are reasonable and assets well valued, however at the lower end care and watchful eyes are required to ensure stability.

All this to say that Canada is not exempt from the roots as well as the woes of the crisis, and there are lessons to be learned from early action, and proactive work between the government, the central bank and the banks’ – lessons that the US could learn, rather than their naturally adverserial approach.  But lets not pretend we are being dragged into someone elses problem and unwillingly help to fix it.

Written by Colin Henderson

March 5, 2009 at 15:39

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