Why Didn’t Canada Have a Financial Crisis?

In looking back over this post and the ensuing comments, I realized that I’d been sloppy. I flipped back and forth between “blame” and “cause” without making distinctions. I don’t believe that you can assign blame for the financial crisis without considering fiduciary responsibility. I believe that the greatest degree of responsibility and hence blame lies with the Congress and, secondarily, with regulators, both those at the Fed and those working for the federal and state governments. Theirs is the responsibility for the system and, if the system fails, it’s their fault. Just that simple.

The behavior of bankers may have been a necessary cause of the financial crisis but they’re not responsible for the system, merely exploiting it. Their responsibilities are to their shareholders, their clients, their bosses, and their families. They do not have a primary (or, possibly, any) responsibility for the banking system. Unless there is specific wrongdoing, not just heedless profit-seeking, to my eye that takes bankers off the hook. Being arrogant and feckless is not the same as being culpable.

A similar line of reasoning applies to voters, consumers, and investors (regardless of where they live).

In my view the clear implication of this view is that attempting to spread blame as widely as possible without regard to considerations of responsibility is a distraction and, frankly, scurrilous. It’s a desperate attempt at avoiding the distinctions that are necessary for forging a prudent way ahead.

I do not believe that comparisons between countries or between cultures are useless but I do think that they need to be looked at skeptically. It requires discernment to identify what experience from another country might be applicable in your own and what would not. Different countries are simply different. Experience and preferences are different and what would be perfectly reasonable and tolerable in, say, Germany might be considered tyrannical and intolerable in the United States.

Since, unlike the United States, Britain, Ireland, Germany, France, Japan, and any number of other countries, Canada escaped the financial crisis relatively scot free, Canada forms a reasonable control for considering its causes. Why didn’t Canada have a financial crisis?

There’s a lengthy discussion of the differences between the U. S. and Canadian banking systems here. In summary, the structure and performance of financial systems are path dependent—that is, how you got to where you are now is significant. Canada’s banking system is substantially different from that of the U. S. and has been for nearly 200 years. Like Britain’s Canada’s banking system is oligopolistic and tightly regulated, a classic Fordist trade-off. By comparison the U. S. banking system is fragile, crisis-prone, and highly politically entrenched. The Canadian system did not experience a crisis in 2008. It also did not experience a crisis in 1930 or in 1907.

Canada’s system of housing finance is considerably different from that of the U. S.:

Canada has no Fannie Mae and no Freddie Mac. There is no mortgage interest tax deduction. There are no 30-year fixed-rate home loans that can be freely refinanced and prepaid. Mortgage lending is far more conservative, and Canadian mortgage lenders have a lot more recourse than American ones.

If Canadian homeowners default, their other assets and income are on the line, not just the property. Strategic defaulting is not an attractive option. There is more incentive to pay down mortgage debt because there is no tax deduction. Canadians mostly pay their mortgages electronically and automatically from their checking accounts — so extra effort must be made to actually miss a monthly payment. Canadian fixed-rate mortgages generally come with anti-refinancing prepayment penalties to protect lenders from interest rate drops, and the mortgage interest rates on these loans are fixed for a maximum of five years — an incentive to pay the debt down faster.

While these provisions aren’t so friendly for consumers, they have ensured that Canadian banks have (so far) survived the international financial crisis without requiring the taxpayer bailout. Furthermore, Canadian neighborhoods and individual homeowners have not been destroyed en masse by property bubbles burgeoning and bursting. Canada didn’t completely sidestep the recession, but home loan default rates are much lower than in the U.S., where one in 10 mortgages are in trouble.

Canada has a single consolidated financial regulator rather than the fragmented system of the U. S. The sovereignty of U. S. states is somewhat different than the sovereignty of Canada’s provinces.

Canada did not experience a housing bubble. Despite the foregoing I find the reasons for this elusive. I’m skeptical of the reasons presented for this: Canada’s system is quite similar to Britain’s and the UK did experience both a housing bubble and a financial crisis. IMO that alone is enough to rule out the superiority of Canada’s banking system as a cause of Canada’s relative financial stability, at least in the “necessary and sufficient” sense.

There are other differences between Canada and the U. S. and it’s hard for me to distinguish among those that are relevant and those that are irrelevant. Canada has only a handful of banks and the U. S. has on the order of 8,000. Since bureaucracy does not scale linearly that should cast at least some doubt on the applicability of the structure of Canada’s banking system to the United States. Canada’s population is a tenth that of the United States. Canada’s population has grown more slowly than that of the U. S. over the period of the last 20 years. Canada’s immigrant population tends to be more highly skilled than does that of the U. S. Are these relevant or not? I don’t know. It seems to me that a large increase in those who are relatively poor and unskilled is likely to cause political pressure for relief, particularly in housing. That in turn could introduce policies that put different stresses on the two countries.

And, then, the day ain’t over yet. Canada may yet have its own financial crisis:

Scotiabank analysts Derek Holt and Gorica Djeric note that housing prices in Canada are at all-time highs, despite the fact that Canadian household finances “are more stretched than ever before.” Within six months, Canadians will be more heavily indebted on average than Americans, who have been purging themselves of the debt that racked up before the recession. This leads Holt and Djeric to believe that the Canadian housing market will soften over the medium term.

In this post I’m not attempting to supply answers but to ask questions. Why didn’t Canada have a financial crisis? Why didn’t Canada have a housing bubble? If it’s a consequence of policy, what policies? If it’s a consequence of policies that are more like those of, say, the UK than they are like those of the U. S., why did Britain have a financial crisis and housing bubble?

75 comments… add one

  • PD Shaw

    Could you actually cite the regulation? Not all systems rely upon formal constraints.

  • DG

    Most Cdn mortgages are sold by the lender ie. the bank. Since they are lending their own money, credit quality is a factor in the mortgage officer’s compensation. In the US, mortgage brokers arrange loans from a variety of sources on a commission basis. This biases the deal to the highest mortgage amount and encourages fudged income numbers on the applicaiton.

    Second, the local loan requirements applied to US banks was threatened in Canada but not enacted. This has generated much of the sub-prime portfolio in the lower-income US neighbourhoods. That most of these mortgages end in default should not have surprised anyone, except the rosy-lensed Democrats who had the dumb idea in the first place.

    — Fewer foreclosure notices — a lot fewer. This is the most shocking stat of all. In the United States in 2008 a full 4.5% of mortgages are in 90-day arrears (i.e. the local sheriff is ready to move in and tack a notice to the door). In Canada, the figure was one 20th that level — just 0.27%. Amazingly, while the U.S. figure of 4.5% represents a doubling of the 2002 level of 2.2%, Canada’s 0.27% level reflects a halving from the (still low) level of 0.5% six years ago.

    – Less debt. In Canada, household liabilities as a percentage of assets sits at 20% — close to the stable, sustainable level it’s been at since the late 1980s. In the United States, the figure sits at 26%, after spiking radically upwards over the last decade

    — Less crappy mortgages. Canada’s subprime mortgage market (to the extent the bottom end of our mortgage market can even be called “subprime” in the American sense) represents only about one in every 20 mortgages. In the United States, the peak figure was about one in six. Astoundingly, up to a quarter of mortgages issued in the 2004-2006 period were in the subprime category.

    — Less debt, Part 2: In the United States, homeowners’ net equity as a percentage of home value has plummeted from around 65% to 45% over the last two decades. with more than half that drop coming since 2000. In Canada, on the other hand, this ratio has remained stable at between 65% and 70% since the 1980s. The phenomenon of mortgages going “underwater” — with homeowners owing the bank more than their homes are worth — is now tragically common in the United States. In Canada, it is virtually unknown.

    — Less off-balance-sheet mortgages. The frenzy of mortgage securitization that gripped the United States in recent years (famously explained/satirized in this comic strip) never really took off here. According to Scotiabank “The majority of mortgages are held on balance sheet in Canada, with only 24% having been securitized.” That’s huge, because it is the radioactive quality of these securities — many of which contain a tangled welter of mortgages of varying quality — that has really sunk the U.S. credit market: Since no one knows how much these complex instruments are really worth, they still haven’t established an equilibrium price level, thereby freezing the credit market for any entity that has a large number of them on their books. (What’s more, even those 24% have mostly been securitized through the CMHC, a Crown corp. with government backing.)

    — Smarter bankers, smarter standards. Finally, there is the fact that Canada simply has a different — and more prudent — banking culture: “Unlike many U.S. banks, Canada banks continue to apply prudent underwriting standards. In other words, they have always checked, and continue to check, incomes, verify job status, asks for sales contracts, etc., such that all those qursionts your banker asks in Canada have a purpose that somehow got lost on many American bankers. The no-income-no-job-no-asset (‘Ninja’) style, here-are-the-keys-to-your-brand-new-home lending just didn’t take hold in Canada.”

    — No bubble in the housing market: On average, Canadian home prices are roughly 200% what they were in 1989. In the United States, the corresponding ratio peaked at 260% before crashing down to 220%. In Canada, the more typical experience is that of my home, Toronto, which has witnessed steady increases in the 4-5% range every year, but none of the sudden surges and troughs that whipsawed homebuyers in U.S. markets such as Miami have witnessed.

    Read more: http://network.nationalpost.com/np/blogs/fullcomment/archive/2008/10/02/the-financial-crisis-for-dummies-why-canada-is-completely-immune-from-the-u-s-mortgage-meltdown-kind-of.aspx#ixzz1CXD8sIlm

  • john personna

    That was an easy trip to wikipedia, PD.

    “For example, banks and mortgage brokerages in Canada face restrictions on lending more than 80% of the property value; beyond this level, mortgage insurance is generally required.[7]”

    That’s all it takes, an 80% LTV requirement.

  • john personna

    (I hope no one is going to make a “freedom to play with matches” argument at this point. Some individual freedoms (to be stupid) come with high negative externalities.)

  • michael reynolds

    So why didn’t Canadian bankers influence their government to ease these regulations? You can’t argue that it didn’t occur to them, I’m sure they have the occasional trip to Manhattan to see their high-flying American counterparts.

    So either the Canadian government is less corrupt than ours, or Canadian bankers are less greedy than ours. Either answer points to a superior ethical and moral foundation to Canadian society as the essential ingredient.

  • So either the Canadian government is less corrupt than ours, or Canadian bankers are less greedy than ours. Either answer points to a superior ethical and moral foundation to Canadian society as the essential ingredient.

    Or, in this instance, a wiser foundation. I don’t know that there’s anything unethical about a mortgage deduction or lacking LTV requirements, to pick two examples. In hindsight, though, it sure seems like their might be disadvantages to these policies.

    And it’s also worth noting that the regulations worked both ways, and so a lot of these laws the Canadian banks wouldn’t want American law adopted up there. The ability to avoid prepayment penalties and the existence of non-recourse loans are pro-consumer/anti-bank policies, but both arguably assisted the Canadians in avoiding what shellacked us.

  • michael reynolds

    I have never liked the mortgage deduction simply because it’s one of these things which once extended can never be withdrawn, and because it distorts choices (rent vs. buy) on a premise that is questionable. Among other unintended consequences it ties the labor force down geographically at a point in history when mobility would be useful.

  • michael reynolds

    This goes back to core values. Our core political values are:

    1) Does it empower the rich to get still richer?
    2) Are there a few bones for the middle class so we can build political support?

    If so, then alrighty, we have ourselves a policy. Questions about unintended consequences, or the long-term benefits to society, or what we’re going to do if everything doesn’t magically go according to plan, or even basic morality or ethics never come into play. The goal is always the same: serve the rich while pandering to the voters.

  • No argument here, Michael, but there’s little questioning the deduction’s historic popularity.

  • PD Shaw

    jp, that isn’t evidence of a regulation. The banks are generally requiring something, they may be requiring it because of government regulation, or because oligarchal business practices means they don’t have to worry that the customer has anywhere meaningful to go.

  • PD Shaw

    Here is a Canadian Bank that will loan 95% of value:

    http://www.tdcanadatrust.com/mortgages/downpayment.jsp

  • or because oligarchal business practices means they don’t have to worry that the customer has anywhere meaningful to go.

    Or because they’ve determined, quite prudently, that people need to have more than 5% of the home’s value in savings.

  • john personna

    Trumwill, what happens to your moral accounting when you bundle 100% LTV (and esp. liar loans) into “AAA rated” securities?

    Basically, if we give each state of the pipeline an “amoral pass” we’re toast. This, or something like it, will happen again and again.

  • Basically, if we give each state of the pipeline an “amoral pass” we’re toast. This, or something like it, will happen again and again.

    John, I don’t disagree with that. Am I supposed to?

  • john personna

    PD, now you are just making a wiggle argument. That is, if I don’t want to spend my Sunday surfing Canadian law (“Could you actually cite the regulation?”) you think you wiggle free.

    The game is obvious to the reader.

    FWIW though, here is a Canadian’s eye view:

    http://www.cpc.gc.ca/feature-dossierspecial/sec-cce-eng.html

  • Regarding the LTV, the Wikipedia paragraph doesn’t say that loans with LTV of 80% cannot be done or are not done. It merely says that if you do it, you have to get mortgage insurance. That’s not very different from the United States, actually. If there is a difference, it’s that more banks either worked their way around it with piggy-back mortgages and/or simply paid the mortgage insurance (which collapsed under the weight of the housing crash).

  • PD Shaw

    Trumwill, the take-away from Dave’s first link is that in the U.S. system, if a bank maintained higher barriers to getting a mortgage, the customer would go find another bank, possibly even a bank that did not exist ten years ago. In Canada, there are essentially six banks, operating as a self-enforcing oligarchy. They can impose lending requirements without fear of market entrants.

    I’ll quote the graph from the article: “Deregulation tended to move the U.S. closer to the Canadian model.” That’s because deregulation tended to consolidate banking power and make it’s bankers closer and more influential in government. But obviously, we’re not there yet.

  • PD Shaw

    I’m not necessarily arguing for or against any given regulation. In a post on Canada, regulation appears to be a moot point. The primary feature appears to be oligarchy. Oligarchy tends to be stabilizing.

  • john personna

    What was the old joke? Deposits at 3, loans at 6, and golf by 3?

    Something like that. There was a saftey in it.

  • PD Shaw

    Here’s evidence of regulation: “the Canadian Government also forced new buyers to have at least 5% cash down and they can’t count on a 40 year amortization anymore.”

    But look at the graph of housing prices:

    http://www.thefinancialblogger.com/next-bubble-to-collapse-the-canadian-housing-market/

  • john personna

    From that we can assume that higher standards would have made them safer still.

    There is an obvious trade-off, right? Home availability versus financial stability.

    If you don’t want a housing crash, you don’t allow home loans.

  • tylerh

    A simple possible answer emerges if one Consides other national economies that mostly dodged this mess: Australia, bunch of smaller economies in Africa, and many Petro-states.

    These widely diverse economies had one thing in common: they are resource economies feeding the Chinese dragon. Just like gas, tar sands, and timber-rich Canada. and Texas.

    So here is an over-simplification to consider: Economies linked o US real estate have suffered (eg. European banks holding too much US real estate debt) Economies linked to Chinese commodity consumption, which is increasingly driven by real estate, haven’t suffered. Yet.

  • Drew

    As any regular readers will well know, I rarely agree with Sir Reynolds, but on this I think he is spot on:

    “I have never liked the mortgage deduction simply because it’s one of these things which once extended can never be withdrawn, and because it distorts choices (rent vs. buy) on a premise that is questionable. Among other unintended consequences it ties the labor force down geographically at a point in history when mobility would be useful.”

    My only admonishion would be that the deductions afforded rental property owners might in some way approximate those of home buyers and reduce the cost-to-consumer differential MR cites. But the bottom line pertains (to bastardize a phrase) – subsidy, always and everywhere, is a poor economic choice.

  • Geoff Belton

    I haven’t even read the whole article yet but right off the bat I need to point out a glaring error in this premise:

    “The behavior of bankers may have been a necessary cause of the financial crisis but they’re not responsible for the system, merely exploiting it.”

    The author must be ignoring many of the emerging facts which expose the powerful influence that the top men in the banks have over the top men in government.

    For at least the past 20 years the bankers have exercised their power upon legislators to put down any and all attempts to create better and safer regulations that would protect us all from their rampant profiteering. But of course the history of the rich exerting disproportionate influence on governments goes back further than any written accounts can relate. As ever though, they will only go so far as the people will let them.

    We must not let them get away with this nor go any further, which they still seem to be doing. This is not merely a matter for the American people and their bankers, this is a matter of international law that calls for a broad ranging investigation and prosecutions of those who acted fraudulently.

  • mikel

    This page came up second in my search so I thought maybe I’d comment from Canada.

    What is seldom discussed is WHY so many people in the US defaulted on mortgages. We’re told ‘they couldn’t afford the place’ in the first place, but that seems unsatisfactory. People WANT a home. I suspect they LOST their homes because of another cause-namely, the evaporation of manufacturing jobs and lack of growth in the ‘job economy’.

    In the maritimes of Canada you’ve essentially had stagnant to no growth for YEARS. In New Brunswick, the ONLY growth in GNP is due to the Irving family owned oil refinery. One third of the provincial budget of these provinces is paid directly by the federal government in the form of equalization payments. Take that away and you would have seen a collapse DECADES ago.

    As others have said, IF the economy stays solvent then homes can appreciate. In the prairies and maritimes, even ontario and quebec, you see housing prices staying afloat partially because of the mass exodus from rural areas.

    How long that lasts is another question. Ontario is the ‘engine of the east’, the manufacturing centre of Canada. The federal government immediately propped up the failing auto makers. Currently, like the US, the government simply has no idea how to sustain growth so it is mirroring the US in that spending on policing, security, and military is now skyrocketing in order to maintain jobs by a conservative government that doesn’t equate ‘safety’ with ‘government spending’. These priorities are VERY unpopular with canadians, but lack of opposition means the government can essentially do what it wants.

    As for regulation, that was mainly that oligarchic manouverings. The Prime Minister hated his Finance Minister, who propped up his deficit cutting on the backs of pension funds, and who wanted to deregulate banks. There was considerable protest, but again it was a majority government and the PM quashed bank deregulation but offering them the bone of purchasing lucrative insurance companies.

    Also, there are only five banks who have had a mafia like hold on ALL the savings of the entire country. This is partly the reason given for lack of productivity, which is FAR below US levels. Small business people have complained for DECADES about the service fees of banks. Canada, moreso than the US, is RUN by banks. While their investments have dropped, they essentially have the population of the country backing up their assets. And there are only four of them.

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