A change of heart?
Down south, there was an article from Mark Perry, a visiting scholar at the American Enterprises Institute, entitled Due North: Canada’s Marvelous Mortgage and Banking System. In the article, Perry pointed out some of the marvelous features of the Canadian banking system, which made it more stable.
I found it curious that a conservative think tank like the AEI would publish such a piece, particularly when conservative commentators have derided liberal commentators for comments like “Why can’t we be more like foreigners, like Denmark, or France…”
Now the AEI is publishing a piece that essentially says “Why can’t we be like Canada” ?!
Nothing in life is every free and choices have tradeoffs. In another era, the AEI would have been denouncing some of the anti-competitive practices of the Canadian system. Today, Mark Perry is extolling the Canadian banking system for its stability and points to the following reasons (comments in parenthesis are mine):
- Full Recourse Mortgages in Canada. (Agreed.)
- Shorter-Term Fixed Rates in Canada. (These are the equivalent of ARMs in the US, with terms of 1-5 years, though 7-10 year terms are available in Canada. Wasn’t the existence of low-rate teaser ARMs what got the US system in trouble in the first place?)
- Mortgage Insurance Is More Common in Canada than in the United States. (Agreed, though that just puts potential stress onto mortgage insurance. Remember that the CDS didn’t solve any problem, but exacerbated them.)
- No Tax Deductibility of Mortgage Interest in Canada. Home mortgage interest has never been tax-deductible in Canada, so there is no tax advantage to home ownership in Canada over renting. (In Canada, there is no capital gains tax on the sale of a principal residence. There are ways of making mortgage interest deductible. For example, if you fully owned your house and mortgaged it to make an investment, the interest is deductible.)
- Higher Prepayment Penalties in Canada. (Agreed.)
- Public Policy Differences for Low-Income Housing. To promote affordable housing for low-income households, the Canadian government has not used public policies like the Community Reinvestment Act in the United States. (The gap between rich and poor in Canada is far lower than the US. The impetus for legislation like the Community Reinvestment Act is therefore lower.)
- Differences in Canada’s Bank Concentration and Greater Diversification. (The tradeoff is oligopolistic practices. Banks are stodgy up here and act like the Post Office. Notwithstanding Paul Volcker’s remark about the only useful banking innovation is the ATM, Citi (NYSE:C) has a useful online credit card tool where you can generate a credit card number for one-time use, which is handy for internet transactions. I have never seen a Canadian bank come up with innovations like that.)
- A Few Other Differences that Contribute to Bank Safety in Canada. There is a much lower rate of loan originations by mortgage brokers in Canada (only 35 percent) than in the U.S. (70 percent), far less mortgage securitization in Canada than here, and a much smaller subprime mortgage market. Banks in Canada keep and service 68 percent of the mortgages on their own balance sheets that they originate and underwrite, which encourages prudent lending since banks are putting much of their own capital at risk. Finally, almost all mortgage payments in Canada are made electronically by an automatic payment arrangement, which minimizes late payments. (I am not sure the size of the benefits that electronic or automatic payment confer. However, during the boom years, conservative think tanks like the AEI would have been decrying the lack of imagination of Canadians in fully developing a mortgage securitization market.)
There is no free lunch
The Canadian banking system represents a low-beta system, whereas the US system is a higher beta system. It just so happens that the financial system underwent a shock - an environment where low-beta systems outperform. During the boom years, the AEI would have been celebrating the "innovative" nature of the higher beta US system.
Richard Nixon famously said “we are all Keynesians now.”
Disclosure: No positions