Our banking rules are smarter, not tighter

For all their growing closeness on other matters, such as global warming, Barack Obama and Stephen Harper could not be further apart on the issue of how to reform banking regulations, in the wake of the worst financial crisis in 75 years. A week after unveiling tough new rules that would limit the size and scope of banks’ activities—and two weeks after hitting them with a hefty new tax—the President took at least a dozen swipes at “banks” or “bankers” in his state of the union speech. Over and over again, he reminded his listeners of the banks’ part in the crisis, of how they had had to be bailed out at public expense, and of how, once the worst had passed, they had quickly reverted to their old ways.

The next day, Harper took the stage at the World Economic Forum in Davos, Switzerland, to deliver a very different message. While some reform was in order, he allowed, “Canada believes that financial sector regulation . . . must not be excessive.” He understood how, “in situations very different than Canada’s,” public anger over the failure and subsequent bailout of the banks had fuelled “demands for tough or even retaliatory measures.” But Canada “will not go down the path of excessive, arbitrary, or punitive regulation of its financial sector.” Canada would go its own way, its banking system would remain a haven of relative freedom, whatever certain other countries might choose to do.

The odd thing about this parting of the ways is that some of Obama’s closest advisers and acolytes seem to think they are copying the Canadian model. By forcing banks to get out of the riskier types of trading and capping their size, they imagine themselves to be replicating the safe, stolid commercial banks that have lately made Canada famous. The former chairman of the Federal Reserve, Paul Volcker, on whose recommendations the President’s reforms are based, has spoken of his fondness for the Canadian system, with its supposed focus on the traditional business of banks, taking deposits and making loans. The influential columnist Paul Krugman wrote this week in praise of Canada’s “boring” banks.

But in fact Obama’s reforms would make the two systems even less alike than they are now. Canada’s banks haven’t been kept small and dispersed: they’re massive, at least relative to their home market. And far from being restricted to plain-vanilla commercial banking, since the 1980s they have been permitted to enter most other areas of financial services, notably investment banking. We’re the exact opposite of the model Obama is pushing.

If Obama really wanted to copy the Canadian model—and there are many reasons he should—the first thing he’d have to do is consolidate financial regulation under a single, national regulator, in place of the hodgepodge of state and federal agencies that now make the rules. Depending on its composition, a U.S. financial conglomerate might find itself or its subsidiaries regulated by some or all of the Federal Reserve, the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the National Credit Union Administration and a couple of others besides—and that’s just at the federal level. Whereas Canada has OSFI: the federal Office of the Superintendent of Financial Institutions, with the power to regulate the whole entity, subsidiaries and all.

He’d have to abolish the Community Reinvestment Act, with its detailed instructions to banks on the proportion of mortgage loans that should be made available to lower-income borrowers. Likewise, he’d have to wind up Fannie Mae and Freddie Mac, the big national public-private enterprises, with their similar mandates to make home ownership more “affordable” through their activities in the secondary mortgage market. There is simply no equivalent for either in Canada: the mortgage insurance provided through the Canada Mortgage and Housing Corp. backstops the banks, not their customers.

Canada’s regulatory approach is undoubtedly simpler than America’s, and probably smarter. But it is not noticeably tighter. It sets limits on banks’ leverage ratios, requires them to be adequately capitalized, but avoids the sort of micromanaging in which U.S. federal and state governments have habitually indulged since the days of Andrew Jackson. Indeed, far from confining the banks, Canadian policy has erred on the side of coddling them, for example protecting them from foreign takeover bids, or even domestic ones, to the detriment of competition. Before Canada’s bankers became everybody’s heroes, they were the object of consistent criticism over their high costs and complacent business practices, and not without cause.

This isn’t to say the President’s proposals are without merit. On the contrary, there is a certain logic to them. If the purpose is to avoid making policy hostage to banks that are “too big to fail,” thus exposing the system to “moral hazard” (where banks, knowing they will be bailed out if they take on too much risk, are encouraged to do just that), there are two obvious ways to go about it: either prevent banks from becoming too big, or prevent them from failing. The President’s plan would do a bit of both, wrapping the larger deposit-taking institutions in a web of regulation while ensuring the riskier investment-banking sorts of institutions never become large enough that their failure would pose a systemic risk. (See: Lehman Brothers.)

But there are other ways of addressing this problem, and Canada’s is one of them.