Regulating banks: maybe bureaucrats aren't so bad after all -

Regulating banks: maybe bureaucrats aren’t so bad after all

A more robust Canadian supervisory ethos may be gaining ground


Among the trickier stories to follow in the aftermath of the 2008 financial markets meltdown has been the debate over banking regulation. Clearly, something went catastrophically wrong, especially in the U.S., but exactly what?

Proponents of a largely unbridled market have argued—not persuasively, to my mind—that the core problem wasn’t lax regulation and permissive oversight, but rather perverse signals from government. They blame, for instance, U.S. government policies aimed at promoting home ownership for having skewed the mortgage market.

But it’s hard to see how Washington’s interventions, clumsy though they might have been, invented mortgage-backed securities and credit-default swaps, or prodded banks to speculate wildly on them. No, at its root, the 2008 credit crisis and the resulting recession cannot be blamed on too much government rather than too little.

So the question is, what sort of beefed-up regulation is needed? Here the story takes on what must be by now for many readers a familiar Canadian twist. Canada’s banks held up nicely, thanks mainly to solid federal policy. The easy observation is that since the mid-1990s Ottawa has required banks to maintain better capital reserves and more conservative leverage ratios than their U.S. and British rivals.

Beyond those rules, however, there’s the matter of Canada’s assertive, intrusive, judgmental model for regulatory supervision. As I’ve written before, the key in not the rulebook, but the leeway given for the federal financial supervisor to get in the faces of bankers and tell them to fix emerging problems with their lending long before they get out of hand.

I revisit this topic mainly to note an interesting passage on the need for diligent enforcement—not just smart rules—in a New York Times story this morning about Paul Volcker, the former U.S. Federal Reserve Board chairman and Obama advisor, and avowed fan of the Canadian regulatory system.

Volcker has pushed for a rule in the new American banking legislation, already passed by the U.S. House and up for a vote in the Senate this week,  that would limit risky investments by banks in hedge funds or private equity. Here’s what he’s quoted as saying in the Times:

“The success of this approach is going to be heavily depending on how aggressively and intelligently it is implemented…  It is not just a question of defining what needs to be done, but carrying it out in practice, day by day, bank by bank.”

He is echoing what John Palmer, the former top Canadian financial regulator, and his current successor, Julie Dickson, have been arguing for months in the often arcane process of hammering out the coordinated international adoption of better banking rules and oversight.

Of course, Palmer and Dickson are the sort of supervisors who believe in their job. Ideology can and has prevented other public servants, especially in the U.S., from using their powers. Under Alan Greenspan, whose reputation hasn’t held up quite so well as Volcker’s, the Fed wasn’t inclined to intervene. “Rules are not enough,” wrote Jeff Madrik in a New York Review of Books essay on what went wrong. “Greenspan had been given the authority to examine the quality of mortgage lending by Congress in the 1990s, but simply did not use it, pleading free-market principles.”

There are hints that the more robust Canadian supervisory ethos is gaining ground over Greenspan’s discredited brand of reticence. The final communiqué after the G20’s recent Toronto summit declared that “stronger rules must be complemented with more effective oversight and supervision” and that supervisors should have “specific powers… to proactively indentify and address risks, including early intervention.”

This is an interesting development not only because it might ultimately prevent or at least lessen the damage done by a major banking crisis. We’ve come through a long era in which any suggestion that mere bureaucrats should be empowered to meddle in the affairs of business was to invite derision.

A more balanced perspective, closer to John Kenneth Galbraith’s idea of “countervailing powers,” seems to be taking hold again, at least when it comes to keeping a critical eye on the banks.


Regulating banks: maybe bureaucrats aren’t so bad after all

  1. I think a relevant analogue to "more banking regulation" is the imposition of the Sarbane-Oxley rules in the wake of the large U.S. corporate fraud/failures (i.e., Enron, Worldcom). The SOX rules are a dog's breakfast that appear to have accomplished nothing apart from imposing significant compliance costs on corporations worldwide. My view is the SEC and FASB already had more than sufficient authority to enforce greater disclosure and compliance if only they had had the bureaucratic will and sufficient political cover.

    Simply writing more and more complex banking regulations will allow the legislators to appear engaged in the issue, but absent their support for the bureaucrats charged with enforcement of even existing legislation, we'll be no better off.

  2. The problem at the heart of the global crisis is that we have 200 countries with 200 different systems, some good, some bad, all trying to trade with each other. And we ended up with chaos, shell games, outright theft, and massive mismanagement coming to light because of it.

    We need one global standard, one set of regulations and one oversight body with the power to intervene.

    Or as it says in the article 'hammering out the coordinated international adoption of better banking rules and oversight.'

    And we're running out of time, as politicians seek votes instead.

    • Yeah, good luck with that.

      • It'll happen.

        It just depends on how stubborn we want to be in the meantime.

      • I'm with you on this, Bob.

  3. "But it's hard to see how Washington's interventions, clumsy though they might have been, invented mortgage-backed securities and credit-default swaps, or prodded banks to speculate wildly on them."

    It's not that hard, if you actually look:

    Community Reinvestment Act, 1977 – "is a United States federal law designed to encourage commercial banks and savings associations to meet the needs of borrowers in all segments of their communities, including low- and moderate-income neighborhoods." Wiki

    Liar's Poker, Michael Lewis (1980s) – rise of Salomon Brothers through mortgage trading, when deregulation by the U.S. Congress suddenly allowed Savings and Loans managers to start selling mortgages as bonds (wiki)

    City-Journal, Howard Husock (1990s) – "The Clinton administration has turned the Community Reinvestment Act, a once-obscure and lightly enforced banking regulation law, into one of the most powerful mandates shaping American cities …. "

    Big Short, Michael Lewis (2000s) – "Lewis describes a financial industry conference in Las Vegas during the boom where Eisman hears of “a stripper with five separate home equity loans.'' Eisman also learns of a Mexican strawberry picker in California whose annual income was $14,000, yet he'd been approved for a $724,000 mortgage." Boston Globe, March, 2010

    There is plenty of blame to go around here – government, banks and Wall St all played a role in the fiasco that wiped off tens of billions $$$ of people's wealth. However, the financial crisis might also end the ceaseless rise of government because no one has money to lend anymore so that might be an upside.

    • Well the US has it's own internal problems, but they aren't the only ones who caused and continue to cause the global crisis.

    • Well, of course your examples are ridiculous. (I'm not arguing their validity, I'm just saying that's ridiculous)

      But here's something I wish we heard more about. How about individuals actually take responsibility for themselves a bit? The strawberry picker making $14,000 had to have known he couldn't afford a $724,000 mortgage and so hopefully didn't buy a house for anywhere near that amount.

      Yes, the banking regulations need to be there and the oversight and robust intervention.

      But let us also play up our freedom means we need to be responsible for ourselves, no matter or in spite of what the 'rules' say we can do.

      • "Well, of course your examples are ridiculous."

        Why? There is a reason why banks are offering strippers and illegal alien fruit pickers massive mortgages, and that's because they have been "encouraged" to do so by Fed government. And the banks weren't keen to be the only ones responsible for all these loans to dodgy people, so banks got Wall St to create mortgage bonds and the like to spread risk around.

        "How about individuals actually take responsibility for themselves a bit?"

        The illegal alien from Mexico probably lives in one room shack with his wife and seven kids, and one summer at work in California strawberry fields he's offered a $724,000 mortgage to buy a lovely home for his family …. Is it really all that hard to see why fruit picker probably took about .00001 of a second to decide if he would sign up for this deal?

        • "There is a reason why banks are offering strippers and illegal alien fruit pickers massive mortgages, and that's because they have been "encouraged" to do so by Fed government"

          Ah. Encouragment. It wasn't the cash bonuses offered to the brokers by the banks then?

          • In the worldview of the hard right there's nothing that cannot be blamed on people they consider to be lesser than them. And the government.

            Poor people + Government = everything that's wrong in the world

          • Nothing to do either with a strawberry-picker making $14K likely being an illiterate Mexican who couldn't speak English… and who made the fatal mistake of trusting the banker.

            Strippers are of course noted for their high levels of intelligence and education too.

            [rolls eyes]

          • I can provide random links as well

            "But the history is slightly more complicated than Krugman suggests. It's true, as he says, that Fan-Fred did not securitize much subprime directly in the early years of the bubble and lost market share to the private labels. They did, however, buy hundreds of billions of dollars worth of private-label subprime mortgage-backed securities for their own portfolios. These purchases, which began in earnest back in 2003, ultimately totaled more than $313 billion between the two entities ……….

            Indeed, few sectors of the U.S. economy have “benefited” from more government intervention than housing: Fannie and Freddie; the Federal Home Loan Bank Boards; the Federal Housing Administration; the Veterans Administration; Rural Housing loan guarantees; a raft of rental assistance plans in the Department of Housing and Urban Development; public housing; mortgage revenue bonds; the low-income housing tax credit; the mortgage interest deduction; favorable treatment of capital gains for home sales; Community Development Block Grants – and more." Washington Post, June 10

          • And yet not one of these things is forcing a bank CEO to allow bad loans. Any banker could have refused, because doing so would put his long-term shareholders at risk.

            Of course, refusing would also have meant much slower growth in the stock-market, and since CEOs and the like get paid primarily through stock options.. well.. not a lot of incentive there to value the actual health of the company over the next quarter's report, is there?

          • bergkamp, nothing in your link supports your assertion that the CRA or "big government" was behind the crisis.

            Freddie and Fannie contributed by eventually jumping on the bandwagon created by the private banks, but that's hardly due to their being "big government".

        • The banks themselves did not do due diligence, and have to take responsibility for poor risk management. However, Bergkamp is also partly right.

          The Community Reinvestment Act passed by Congress many years ago but given enhanced powers by the Clinton Administration placed the banks in a difficult position – either meet the requirements of the Act and make loans to borrowers who did not meet even minimum standards or flaunt the law. The banks thought they had found the answer to their dilemma by bundling mortgages and covering them off with default swaps. We now know that all those smart Wall Street advisers to local bank chairmen across the country did not know what they were talking about.

          Next time the bank chairmen should hire Wall Street advisers who have a few more years of actual experience in real life rather than betting their bank on economic models.

          • If the problem was just the CRA, then all we would have are some bad mortgages, upon which people defaulted. Banks would be able to repossess the homes in question, and would not suffer a total loss. Yet that is not what we had happen, and your answer alludes to the real story.

            The problem wasn't that people defaulted (in fact few people had done so by the time things went bust). The problem was that mortgages AND other assets were bundled into derivatives, which had been deregulated in 2000. Credit Default swaps were one of those kinds of derivatives. Essentially third parties guaranteed various investments, in the case that they went south. This turned badly rated investments into AAA ones (since the backing institutions were AAA), and so a lot of money poured into them.

            The problem was that firms like Lehman brothers (and Fannie and Freddie Mae, who specialized in mortgage securitization) had far more third party commitments than they could ever honour, should many investments go south (as would be likely in a downturn). In other words, your story REQUIRES the existence of credit default swaps (which were the result of deregulation in 2000) in order to work.

            I posit that the financial crisis was the result of credit default swaps. The CRA and the general craziness of American real estate law made it more likely that a real estate bubble would be how things would go down, but absent the CRA you would have had a bubble in something else. Why? Because:

            1. Reserve ratio requirements don't cover credit default swap contracts
            2. CDS's inflate the ratings of investments, and make it look like there are many more profitable opportunities out there
            3. High ratings push blue chip investors (eg. pension funds) into higher risk investments
            4. Nobody regulates credit ratings agencies
            5. There was not a lot of oversight of CDS's

            The US needs to watch CDS's carefully, impose something like a reserve ratio requirement on them, and regulate credit ratings agencies. All of this would be a LOT easier if the US banking structure looked more like Canada. There is a massive shadow banking industry out there, and we need to bring it into the light.

          • I dont disagree with your analysis. I was trying to keep it simple. But the bottom line is that securitization became popular with sub prime mortgages which ballooned as a result of Congressional pressures to give mortgages to everybody regardless of risk. Wall Street came up with the products such as CDSs..

            I completely agree that new reserve ratio requirements are needed which is why this is a high priority for the Basel process.

      • But American regulations speak directly to the issue of who defaults. In the United States it is possible to walk away from a mortgage. What is interesting is that the default rate by wealthy homeowners is actually two times that of lower income ones. This is a direct result of regulations that allow for strategic default. Now, I actually do think the US needs more regulation in some respects, but it may also benefit from less regulation in others. Banks are under-regulated, but real estate is over-regulated.

        • Are you telling me an American can just walk away with no penalty? (Other than losing the house, of course, but I mean no bankruptcy, credit rating in the dumpster, etc)

          Does it need to be pointed out that this is a bad way to do things? Egads, is common sense THAT scarce?

          • Thanks. Thanks a lot. :)

            I guess the good news is that I can still be shocked and appalled at the stupidity of the brainiacs running the world.

    • Keep pushing that CRA scapegoat, bergkamp, it’s not getting any more true with repetition.

  4. Spoken like a true Canuckistani

    • Whose economy is in better shape…..

  5. You are wrong. Canada's Banks are regulated yes, but a principal component of which was the lack of government using Banks as a social tool.

    The Democrats in the US took the position that owning a home was a "right" and passed banking legislation accordingly.

    If the US had an honest media rather than partisan leftists using the purported journalistic trade as a tool for leftist advocacy, the world would have been shown, over and over and over again how Republicans fought to repeal this legislation, warning of the dangers of a bust with so many owning homes who could not afford them.

    The ranking Democrats who controlled congress shot it down, and of course played the "we represent the downtrodden" card.

    I've seen the glaring footage, on the net of course. Those scenes from the House of Representatives will stay safely buried by today's leftist media.

    • Chet, Don't forget that Republicans seized control of Congress in 1994.

      I largely concur with the analysis regarding the fact that the Congress used the CRA as a social tool to coerce banks into offering mortgages for low income people who could not afford them. But the Republicans could have pushed harder on watering down the CRA if they had wanted to.

      I was living in Washington at the time and met many Republicans who were concerned about the dangers that the CRA was creating in the housing market. However, even Republicans knew that their voters liked the fact that it was juicing prices. My sense is they knew in their hearts it was wrong, but didn't want to spoil their constituents good times. Politicians, left and right, don't like taking tough decisions if it hurts the pocketbook.

  6. By the way, I credit the Martin (as Finance Minister….maybe one of the best FM's we've ever had btw – though Flaharty's is damn fine too), era.

    That was when the Liberals sought to fill the void left behind by a fractured right, and embraced fiscal conservatism and economic responsibility, and before the party was taken over by far leftist "progressives".

    • So sad that the powerhouses of Chretien and Martin (as finance minister), have been replaced by flakey, flowery academics who know precious little of the real world and far too much about progressive utopic recipes taken right out of standard intro humanities courses, where the worlds' problems are solved simply and easily with heavy doses of government power and corresponding taxpayer dollars.

  7. Q.What are: Apple, Berry Blue, Black Cherry, Bunch Berry, Cherry, Cherry Cracker, Cola, Eerie Orange, Frutas, Golden Nectar, Grape, Grapeberry Splash,Great Bluedini, Incrediberry, Kickin-Kiwi-Lime, Lemon-Lime, Lemonade,Man-o-Mangoberry, Mountainberry Punch, Oh-Yeah Orange-Pineapple, Orange, Pina-Pineapple, Pink Lemonade, Pink Swimmingo, Purplesaurus Rex, Rainbow Punch, Raspberry, Roarin' Raspberry Cranberry, Rock-a-dile Red, Rootbeer, Scary Black Cherry, Scary Blackberry, Sharkleberry Fin, Slammin' Strawberry-Kiwi, Soarin' Strawberry-Lemonade, Strawberry, Strawberry Falls Punch, Strawberry Split, Strawberry-Raspberry, Sunshine Punch, Surfin' Berry Punch, Tangerine, Tropical Punch, Watermelon-Cherry?

    A. Kool-Aid flavours.

    • I wonder what chet's favourite is?

  8. I'm socially left but centrist monetary policy. .Guess I'm a Red Tory, if I can use such a definition. The current CRAP party are free spenders now. They know they won't lose the majority of their 33% right wing ideological base no matter how in debt they put Canada. IMHO, the CRAP party's intention was always to totally gut all social programs. Now they'll say we have to get our fiscal house in order – we're good financial managers. CRAP is right.

    They're the ones who wanted to create a similar banking system as in the US and brought in 0/40 yr mtgs. and allowed CMHC (we taxpayers) to be on the hook for bankrupt homeowners. Good financial managers – gotta be kidding and they have the gall to pretend to the G20 that they were responsible our banks being solvent. It amazes me how stupid most people are. As well, how many financial reporters in the MSM, aside from Diane Francis, have spoken the truth. Didn't Flim Flam leave Ontario with a $6 billion debt while claiming all was in order. Pity we Canadians when we see our finances when the CRAP party lose. I hear the cost of the G8/20 is already 2B.

    • You are not a Red Tory, you are a pseudo-libertarian. Red Tories were "red" as in socialist, compared to their blue, as in "blue-blood" Bay Street counterparts. It was a different kind of leftist streak though – Red Tories liked big government more as a tool to stave off American influence and to preempt social disorder. David Orchard is probably the best contemporary example of a Red Tory.

      • What chaff and nonsense.

        There's nothing of the 'red' in Red Toryism. Those who ascribe to such are much as novagardener described: socially libertarian, fiscally prudent. More George Grant than, say, the red meat of a Barry Cooper or a Tom Flanagan (Both Americans). Grant was, is and will be the finest describer of Canadian values. Along with Frye, McLuhan and, to a certain extent, Charles Taylor, he designated a value-based, communitarian vision for the nation that is only now being seen for the brilliance that it was/is.

        • In Lament for a Nation, Grant argues that Canada has traditionally been less liberal than the United States (and repelling American influence is probably the raison d'etre of red toryism). Social libertarianism is inseparable from an individualistic perspective that is anathema to the red tory view of society as being organic. That doesn't necessarily mean that red tories are socially conservative, but an organic view of society certainly helps. If society is made up of complex inter-linkages, then social change is at least something to be watched carefully.
          George Grant, it is worth noting, was an inveterate foe of abortion.

          As for fiscal prudence, that is a weasel phrase. Everybody imagines their preferred ideology to be prudent – the real questions are those involving tradeoffs: taxes vs. spending, government vs. private enterprise. On that count Red Tories are more in favour of an expansive role for government than blue Tories. Charles Taylor, who you hold up as another example of a red tory, ran for the NDP. Diefenbaker, represented the Red Tory wing of the party (at least moreso than George Drew), was derided as a prairie radical.

  9. Canada has fewer large banks and so it is somewhat easier to regulate them; however, note that RBC is about to be sued. Lending regulations need to be enforced, not loosened.

    Derivitives and bundling of supposed" securities" (which were not secured by any real thing) have also contributed greatly to major problems.

    And, it should be noted that these days, a huge amount of trading is done solely by computer programs and is pretty much completely unregulated, because it occurs so quickly and computer programs, like many wall streed traders, have no ethical guidelines.

    Will there be another crisis? Absolutely, you can 'bank' on it..

  10. >But it's hard to see how Washington's interventions, clumsy though they might have been, invented mortgage-backed securities and credit-default swaps, or prodded banks to speculate wildly on them.

    It's not hard to see at all. The new financial instruments were a response to the risk of being forced, through legislative and political pressure ("more government"), to take on riskier loans without commensurate risk premiums or in which almost no reasonable risk pricing premium would have sufficed. Given the (again, legislated) requirements within which packages must be rated by particular agencies and some institutions are confined to buying only products of a certain grade, the ratings system is strongly at fault.

    >No, at its root, the 2008 credit crisis and the resulting recession cannot be blamed on too much government rather than too little.

    An accident rarely has one cause and is usually the consequence of a chain of events; this accident had at the root of most of its events a government-initiated factor.

    • The problem is not just a problem in real estate. The past 30 years have featured unusually high numbers of financial crises and bubbles. In the 80's there was a bubble in Savings and Loans (and real estate). In the 90's there was a bubble in dot com companies and Asian markets. In 2007 it was real estate again. The problem is that banks are underwriting dubious enterprises IN GENERAL.

      Moreover, defaults on subprime mortgages cannot explain the depth of this crisis alone. If it was just a matter of some poor people defaulting, the bank could at least repossess the homes. The problem is that many of these loans were securitized. This helps explain why such bad loans could be made in the first place – the loans were guaranteed by third parties. No guarantee, no loan. No deregulation, no derivatives. Your notion that banks must lend to people is off base, and not supported by the fact that the majority of sub-prime loans were from institutions not affected by the CRA (the default rate for high-value homes has been twice as high as that for cheaper homes).

      • People bought high-value homes because terms of lending became more relaxed (under government pressure), a widespread belief in rapid home equity growth ("bubble") was omnipresent, and interest rates were being held low. Inject funding into a market for something or reduce the cost of borrowing to buy into it (the latter really just a indirect driver of the former) , and what do you expect to happen to prices? What "entity" controls the underlying levers? It certainly wasn't the "invisible hand".

  11. So what we have here is an article arguing the value of judgment and yet we already have people blaming the left/right rather than reading the arguments presented in the article.