My personal favorite Nobel Prize winning economist has a take on why Canada came out of the recent banking disaster relatively unscathed, while the US economy and financial institutions took a major beat down. It all comes back to the regulatory environment. The US decided, or rather the captains of industry in banking and a bi-partisan group of Washington enablers decided, that stodgy,boring depression era banking regulation was cramping their style. They needed the freedom to innovate us right into a huge recession while capturing obscene compensation for essentially producing nothing but obscure financial instruments designed to hide risk in the most profitable way possible.
Over the past decade the United States and Canada faced the same global environment. Both were confronted with the same flood of cheap goods and cheap money from Asia. Economists in both countries cheerfully declared that the era of severe recessions was over.
But when things fell apart, the consequences were very different here and there. In the United States, mortgage defaults soared, some major financial institutions collapsed, and others survived only thanks to huge government bailouts. In Canada, none of that happened. What did the Canadians do differently?
It wasn’t interest rate policy. Many commentators have blamed the Federal Reserve for the financial crisis, claiming that the Fed created a disastrous bubble by keeping interest rates too low for too long. But Canadian interest rates have tracked U.S. rates quite closely, so it seems that low rates aren’t enough by themselves to produce a financial crisis.
Canada’s experience also seems to refute the view, forcefully pushed by Paul Volcker, the formidable former Fed chairman, that the roots of our crisis lay in the scale and scope of our financial institutions — in the existence of banks that were “too big to fail.” For in Canada essentially all the banks are too big to fail: just five banking groups dominate the financial scene.
On the other hand, Canada’s experience does seem to support the views of people like Elizabeth Warren, the head of the Congressional panel overseeing the bank bailout, who place much of the blame for the crisis on failure to protect consumers from deceptive lending. Canada has an independent Financial Consumer Agency, and it has sharply restricted subprime-type lending.
Above all, Canada’s experience seems to support those who say that the way to keep banking safe is to keep it boring — that is, to limit the extent to which banks can take on risk. The United States used to have a boring banking system, but Reagan-era deregulation made things dangerously interesting. Canada, by contrast, has maintained a happy tedium.
I’ve said this many times and it bears repeating, markets are only as good as the framework they operate within. They are not magic. They may produce efficient allocation of resources under a specific set of conditions, but are prone to manipulation by powerful players and are prey to many forms of market failure. They can be gamed and abused in ways that put the larger economy at risk. Our banking disaster is a case study in regulatory capture, where the industries to be regulated came to control the agencies designed to oversee them.
Since we still have Ben Bernanke at the Fed, Tim Geitner at Treasury and Larry Summers as director of the National Economic Council, we have apparently learned nothing. These are people who were directly part of the the failure and came from Wall Street or were part of the effort to deregulate banking that was the part of the reason we are where we are today. We are:
- Rewarding massive failures
- Failing to learn from past mistakes
- Listening to those who’s advice got us to where we are
Couple that with a recent political history of being institutionally incapable of making hard choices and the road ahead doesn’t look pretty. I’m not optimistic that we can do what’s necessary, particularly in light of the recent Supreme Court decision to strike down campaign finance laws designed to limit corporate influence in federal elections. Look for Wall Street to dump money into and provide advertising support for Congressional candidates who oppose new regulation on banks. They’ll probably use some Orwellian named astroturf front goups with names like “Citizens for Responsible Banking”. Candidates might mouth the right words in front of cameras, but who do you think they’ll listen to? The public or those who have the power to ensure they maintain their position of privilege and power in Washington?
Maybe there should be a truth in advertising law for front goups and the names they chose. Would you believe an ad if it was paid for by “Billionaires for Bank Failures” or “Citizens for Future Taxpayer Bank Bail Outs”? While we’re at it can we re-name the TARP (Toxic Asset Relief Program) and call it something more appropriate, like BARF (Bad Asset Relief Fund). That’s much more evocative of how it makes me feel.
