Tag Archives: canada

No Tea Party in Canada

By Marc Seltzer; originally published at care2.com on October 13, 2010
. . .
Democrats seem bewildered by the strength of the Tea Party movement.  Powerful incumbent Senators such as Boxer (CA) and Reid (NV), and numerous House Reps in leadership positions find themselves in difficult contests. Republicans are poised to gain significant numbers in the legislative branch in November’s mid-terms election.

Fighting back, Democrats and their supporters have gone after Tea Party-Republican candidates, focusing on their oddities, inconsistencies, and lack of coherent policies.  Rachel Maddow, among others, has exposed the remarkably poor caliber of some candidates propelled by the Tea Party to victory in the Republican primaries.

Be that as it may, the legitimate complaint of the Tea Party movement has not been effectively dealt with by Democrats.  The root groundswell of anti-government energy comes from fear and anger about deficit spending and debt.

Deficits matter.

In Canada, governments of the past decade worked hard to erase the substantial deficits of the 1990s.  When the 2008 financial crisis arrived, Canada was able to face the recession with sound economic fundamentals.   Increased public spending in 2009 and 2010 again created deficits, but helped Canada recover nearly all the jobs lost in 2008.  Embarking on a new deficit spending program did not faze the public, and Canadian leaders are now talking about returning to surplus budgets in the next 7 years.

There is no tea party movement in Canada.  National health care, yes.  Major tax protests, no.

For all the things wrong with aspects of the Tea Party movement, from blaming the Obama administration for current ills to dredging up misguided social views, the truth is that the U.S. would have braved the recession far more effectively if it had had a budget surplus.

In not addressing this aspect of the financial health of the nation directly from the start, with a coherent long-term plan, the Democrats have allowed the opposition to bundle legitimate disapproval of the government’s budget outlook with generalized anger at banks, unemployment, the Bush administration, Congress, taxes, and government spending.

It’s working for Republicans so far, and if this election looks bleak, imagine Sarah Palin filling a stadium near you in 2012.

(Marc Seltzer has been on paternity leave after the birth of his daughter in June.  Marc can also be heard reviewing U.S. Supreme Court cases at SupremePodcast.com)

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Are Republicans Lying About Financial Reform?

By Marc Seltzer; originally posted on April 20, 2010, at care2.com

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As the Senate moves towards consideration of financial industry reform, politics again threatens to overwhelm substance in the debate.  Conservatives have attacked Democratic legislation with the moniker “bailouts forever.”  Political writer Mark Halperin charged Republicans with “intentionally misreading the law,” echoing claims of angry Senate Dems.  Unlike with health care reform, where budget complexity defied evaluation without experts and CBO forecasts, the core principles of financial reform are fairly straight forward.

The following is what you need to know to make your own decision:

A.  Protections against risky behavior by financial institutions


1. Capital Requirements

Companies will be forced to keep more money available — “capitalization” or “capital reserves” — to protect themselves against losses so that typical companies will not be at risk of collapse in a downturn.  Sufficient capital could have eliminated the need for bailouts of financial institutions in 2008-2009.

2.  Leverage Restrictions
Financial companies will be limited in how much money they borrow and put at risk. Many institutions make money by investing and taking risk with borrowed funds.  This extends their gains in boom times, but threatens overwhelming losses in a bust.  Private companies are still allowed to place their bets, even risky bets, but they cannot do so using such high percentages of borrowed funds, creating a risk of nonpayment when their investments go bad.

Capital and Leverage rules are the key to protecting the economy from a 2008-style crisis. No longer would the great extent of irresponsible risk be tolerated.  With each individual company taking less risk, a severe downturn in the economy could drive some financial entities out of business, but would not threaten the entire financial industry and thus require government assistance.

Watch out for “too big to fail” arguments from the Left (“break up the banks”) or Right (“endless bailouts”). Canada has five of the largest banks in the world and none faltered.  Canada’s financial institutions are regulated with the same type of serious oversight included in current US proposals.  Capital requirements for Canadian banks were held at 7 percent going into this crisis, while the global average was closer to 4 percent. Canada’s chief financial regulator, OSFI Superintendent Julie Dickson, remarked in November 2008, “We have seen how strong capital cushions in Canada have paid off to the benefit of our institutions and overall financial system.” (My comparison of the U.S. administration’s proposals with the Canadian regulatory system)

The point is, capital, leverage and risk management are more important than size.  In fact, no one financial institution in the US was too big to fail as far as the effect on jobs, small business loans or the stock market.  The problem was that many separate but co-dependent entities were unable to handle a downturn and would have failed within a period of months, if not for government intervention.  Early in the Great Depression 5000 banks failed.  Making each bank smaller is irrelevant, if they all fail.

B.  Specifically dealing with failing companies.

1.  Closing companies down — “FDIC Resolution Authority”
The administration’s proposal is to use the FDIC (Federal Depository Insurance Corporation), which currently closes banks that are failing, to close all financial institutions, when they fall below financial operating requirements.  The FDIC is highly regarded for efficient and effective “weekend” bank closures.  FDIC agents take over Friday at 5:00 p.m., and Monday the bank is open for customers, but under FDIC supervision.  The FDIC locates a new buyer quickly and gets out of the way once new management takes over.  Previously, there was no law permitting FDIC action on failing financial institutions that were not technically chartered banks.  Thus, Bear Sterns, Lehman Brothers, Citi, etc., could not have been closed by the FDIC.

The alternative approach, proposed by critics of the FDIC model, is to allow failing financial institutions that are not banks to file for bankruptcy.  Advocates say that bankruptcy courts have more expertise than the FDIC at large complicated business structures.  However, bankruptcy does allow the management to continue through the failure and to propose corrective plans, using the bankruptcy court to deal with creditors.

In the 2008-2009 crisis, insurer AIG would have had to file bankruptcy, if the federal government did not bail it out.  In bankruptcy, AIG and its management would still have aimed to protect their own interests, despite the anticipated international catastrophe of its own making. (Many financial institutions had used AIG to insure themselves against losses; AIG’s collapse would have led to additional major collapses worldwide)

According to the proposed “FDIC resolution authority” model, the financial institution will be taken over and immediately managed by experts with the public’s interest in mind.  Presumably, the bankruptcy model would also protect the larger financial system, since higher capital and leverage standards, discussed above, would serve to lower the amount of damage that any one institution could cause in failure. However, the FDIC, as a banking regulator, has expertise in the financial system, while bankruptcy courts handle competing public and private interests in all types of businesses, and may not always have a view to protecting financial stability.  Remember, the purpose of the new law is to stop poor decision-making of a few entities from impacting the entire industry and the wider economy.

2.  Industry-Financed Disaster Fund
The Senate legislation plans for the financial institutions to contribute to a fund to be used if needed in closing companies.  The 50 billion dollar fund would shield taxpayers from having to pay for any costs incurred by failing financial institutions.  While the new law intends to avoid bailouts altogether, by making financial institutions less risky, more self-sufficient, and by closing them before they create systemic damage, it provides that any bailouts that do occur will be paid from a fund created with private financial company fees.

Should industry-financed bailouts be allowed? Imagine, for example, that a financial institution failure would cause a functioning private hospital to be shut down for a week while it sought new financing from another bank.  In that case, not because of a threat to the wider economy, but because of other public purposes, short-term bailout financing, using the institution-financed fund, might be deemed appropriate, at no cost to the tax payer.

The reason that Congress is rejecting the idea of outlawing any possibility of bailouts, is that it is possible that public purposes will be served by having a bailout option.  What is different here is that the government will not be forced into bailout because the new capital and leverage requirements will protect the wider economy.  Thus, Republican claims that bailouts using public funds will continue, do not take into account the fact that new capital and leverage requirements are the primary defense against systemic risk.  It is not by pledging, even through legislation, to avoid bailouts that we will be protected.  It is by stopping companies from taking so much risk that the entire system is put in danger of collapse.

C.  Consumer Protection

Fundamental consumer protections already exist to keep financial institutions from stealing or mismanaging their customers assets.  However, as the Madoff scandal illustrates, the government is not always effective in policing.  In addition, in the real estate market, many homebuyers obtained mortgages without fully comprehending the terms and consequences.  The new law aims to provide additional protection for consumers.  Krugman: Looters in Loafers

The financial industry is strongly against the consumer protection provisions, partly because they do not know how aggressive the new body will be in regulating business practices.  (Auto-finance example)  The current proposal puts a new consumer-protection agency under the authority of the Federal Reserve.  As the Federal Reserve traditionally regulates banks and manages monetary policy, including the interest rates that banks are charged to borrow funds for their business operations, the issue for the new consumer protection regulator will be how independent it remains from Fed regulators with different goals, and determining what level of protection balances business objectives with consumer rights.

These are the core ideas behind the administration’s plan, as spearheaded by Treasury Secretary Timothy Geithner and now incorporated into Democratic legislation.  As Congressional leaders posture about whether to support or oppose the plan and why, decide for yourself what’s politics and what’s substance.

More by Marc Seltzer:  Hate that Obama’s Near the Middle, Think Again!
Questioning Conventional Wisdom

Will Republicans return to power in November?  Listen to Marc Seltzer and Jessica Pieklo discuss political prospects at Redefining America:  Constitution and Leadership 2010

April 22, 2010 UPDATE: NY Times updates Dems efforts to push forward in the Senate and Republican opposition.

Hate That Obama’s Near the Middle? Think Again

(Photo:  Obama speaking in Europe, where his views are well received and highly regarded)

By Marc Seltzer; originally published on April 13, 2010, at care2.com

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Contrary to all the talk of disenchantment with the state of the nation, there is reason to be optimistic that President Obama is leading the government in exactly the right direction.  While his critics voice disappointment and outrage, calling on Mr. Obama to govern to the left and to the right, President Obama governs by judgment, not ideology.  This will always disappoint ideologues who see the world through conservative or liberal glasses, but do critics have credible political ideas behind them?

At the outset, a few things need to be set straight.  First, the biggest thing President Obama has done since taking office is not health care reform.  (Complete Story)

What can Canada teach us about banking regulation?

By Marc Seltzer and Leslie Schreiber; originally published as “Northern Light” on June 19, 2009, in Commonweal Magazine and at Commonwealmagazine.org.

US Regulatory Reform Follows Canadian Model

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Amid the greatest worldwide financial meltdown since the Great Depression, there have been few examples of sound financial management and regulation. Public authorities have had to provide billions of dollars to support ailing institutions and have acknowledged far-reaching gaps in public oversight. Responding to the disastrous bubble and bust, the Obama administration is calling for comprehensive reform. International leaders have even gone so far as to call for the creation of a world financial regulator.

U.S. Treasury Secretary Timothy Geithner, while not going that far, is asking Congress to grant the Treasury broad oversight authority for virtually all financial institutions, and a mandate to monitor systemic risk. Additional proposals seek to insure that financial instruments, such as credit-default swaps, are subject to federal regulation. While Congress will ultimately be responsible for crafting legislation, Geithner’s proposals provide a road map for a new financial order, in his words-“not modest repairs at the margin, but new rules of the game.”

The economic crisis has tested the stability of financial systems across the international community. The results differ widely, from Iceland’s near-bankruptcy to Canada’s remarkable financial health and insulation from risk. Beyond the private gains and losses, the crisis has revealed strengths and weaknesses of different regulatory environments. Remarkably, not a single major Canadian financial institution has needed a bailout. In March, the International Monetary Fund praised Canada’s banks for their “remarkable stability amid the global turbulence.” Howard Kaplow, an investment executive and director of financial services in Montreal, noted that Canadians “tend to be more conservative, but we also have a more restrictive financial authority with tougher rules to follow.” The IMF agrees, commending Canada’s “strong regulatory and supervisory framework.”

In this light one may ask how Secretary Geithner’s proposals for regulatory reform measure up against the Canadian model. Are the Obama administration’s efforts to monitor systemic risk and regulate all substantial financial entities and instruments in line with the Canadian approach?

In contrast to Canada’s conservatism, the U.S. system has gone through a period of “irrational exuberance.” Over the past twenty years, Congress deregulated financial industries in order to maximize business opportunity. New financial instruments, markets, and conglomerates were unleashed without oversight. In a recent debate over the causes of the crisis, New York University Professor Nouriel Roubini (nicknamed “Dr. Doom” for having predicted the current crisis) argued that, “deregulation occurred too fast and in ways that did not provide prudential regulation for provision of the financial system.”

The dominant political ethos was trust in free markets, competition, and modest regulation-even self-regulation. Where regulators did act, they followed a framework that called for distinct regulators in compartmentalized markets. The FDIC has been highly praised for its success at handling the closing of failed banks, but neither the FDIC nor the Federal Reserve had authority to intervene when an investment bank or insurer acted unwisely or teetered on the brink of bankruptcy.

In the end, the failures were systemic and pervasive. They could not be limited to one sector of the financial system, nor were they detected by any existing regulatory agency. In warning that the problems would not respond to a quick fix, President Barack Obama observed that the crisis “didn’t result from any one action or decision. It took many years and many failures to lead us here.”

New regulations were contemplated long before Secretary Geithner was confirmed. Former Treasury Secretary Henry Paulson and the General Accounting Office oversaw substantial groundwork in 2008, but it now falls to Geithner to finish the job. While Geithner is promoting a more comprehensive regulatory regime, the proposals have been developed by financial and market experts and insiders who believe in free-market capitalism. They do not wish to stifle financial innovation. Instead, the aim is to protect the overall system while allowing risk-taking activity to continue. This approach is in line with the Canadian system, where, despite strong regulatory authority, the financial sector has prospered. Today, five of the country’s banks are among the top fifty banks in the world. Ten years ago none of them was.

The lead financial regulatory authority in Canada is the Office of the Superintendent of Financial Institutions (OSFI), currently headed by Julie Dickson. She chairs the Financial Institutions Supervisory Committee, which has broad authority to monitor systemic risk and, for that purpose, brings together regulators who oversee market stability, risk-management, and business practices from across the financial economy. The OSFI mandate covers “all banks, along with federally regulated property, casualty, and life insurers, and trust and loan companies, plus about 10 percent of private pension plans” according to OSFI spokesman Jean Paul Duval. If any of the institutions “raise a red flag, the OSFI can implement a range of disciplinary measures, affecting everything from bank capitalization to controlling assets, and even getting directly involved in business planning.” Indirectly, this also includes securities firms, which are 70-percent bank-owned in Canada (for example, RBC Dominion Securities is part of the Royal Bank of Canada). The OSFI oversees 450 banks and insurers, and approximately 1,350 private pension plans. Its authority, while not reaching all financial institutions (hedge funds are not regulated by the OSFI), is fairly comprehensive and is foundational for the soundness of the Canadian system.

Secretary Geithner told Congress in March that the oversight he was proposing “would include bank and thrift holding companies and holding companies that control broker-dealers, insurance companies, and futures commission merchants, or any other financial firm posing substantial risk” (emphasis added). Not every financial entity reaches the size and significance to affect systemic risk, but Geithner wants to avoid a system where the legal form of an entity can be used to shield it from regulation. A key component of meaningful oversight is the ability of the regulator to set standards for institutional risk management. Geithner is asking Congress for authority to increase capital requirements, to restrict leverage ratios, and to enact additional prudential rules.

In Canada, the OSFI has substantial experience with such oversight. According to Duval, since its creation in 1987, the OSFI “has always been vigilant in the development of its risk-management practices.” Capital requirements for Canadian banks have been held at 7 percent, while the global average is closer to 4 percent. Similarly, Canada’s bank-leverage ratio has been kept under twenty-to-one, while international bank leverage ratios were thirty-to-one and even forty-to-one. OSFI Superintendent Dickson remarked in November 2008, “We have seen how strong capital cushions in Canada have paid off to the benefit of our institutions and overall financial system.”

Canadian institutions were not free from risk-taking or even from exposure to subprime loans from the United States, but strong capital and leverage standards kept the damage from overwhelming Canada’s banks, let alone destabilizing the economy. In addition, Canadian banks generally still maintain the mortgage portfolios of loans they originate, retaining direct knowledge and responsibility for their management. These conservative practices reinforce sound regulation, and vice versa.

Canadian regulators give special attention to larger, “too big to fail” organizations. Duval explains that “OSFI utilizes a risk-based methodology, where institutions that we believe are operating in a riskier manner are subject to increased supervision. That said, the larger institutions will be operating in larger parts of the market, so [they] would naturally receive greater attention…and can be subject to different supervisory requirements.”

Similarly, the U.S. federal regulator proposed by Geithner will have the power to step in and manage problems when institutions fail to meet prudential standards or find themselves in financial difficulty. Special consideration would be given to entities deemed “too big to fail.” Geithner is asking Congress for the flexibility to intervene where there is risk to the wider economy. He has already intervened with a few of the big banks. Recent “stress tests” resulted in some banks being required to raise capital, although banks could choose whether to seek private or public funds.

Critics have called for regulations that would cap the size or restrict the legal structure of financial institutions. However, noting that other countries have allowed hybrid entities such as Canada’s banking and securities conglomerates, Geithner appears to trust that oversight will protect the system, and that private decision making should be allowed as much leeway as possible. The changes he proposes will require legislation. Under his lead, the Obama administration should be pushing hard for a substantial increase in federal regulatory authority. What might have been politically impossible before the crisis is now high on the legislative agenda. In addition, the chairman of the Federal Reserve, Ben Bernanke, has spoken in concert with the administration. While Congress will take a significant role in designing new regulation and is not likely to rubber-stamp the administration’s proposals, momentum is strong for the creation of comprehensive financial reform. The success of the regulatory system across the border should inspire both humility and hope.