I am intrigued by the issue of how our own cognitive foibles impacts our decision making processes as investors. Our behaviors have evolved for other reasons (primarily survival); Regular readers know I am especially interested in how our wetware fails us when applied to making risk decisions in capital markets.

It is exceedingly difficult to avoid these kinds of biases and cognitive errors in your own behavior, which is why smart investors develop rule based decision-making to help overcome these issues.

It is, however, a rather simple task to identify cognitive errors in other people. I find myself constantly playing pop cognitive therapist as I watch massive rationalizations occur. I see them deployed to explain why stocks are rallying, or why the economy hasn’t collapsed yet, or why a fit of under reported inflation will soon lead to $7000 gold (ignore the falling prices for now).

Probably the greatest example of bias is seen as some try to explain why the financial crisis occurred. Post bailout, the flailing, cognitive dissonance has been astounding. It is the underlying cause of the Big Lie.

I was reminded of this while reading a Real Time Economics post on Why Canada Can Avoid Banking Crises and U.S. Can’t. It discusses a new paper (and forthcoming book) by Charles Calomaris and Stephen Haber. The thesis is that Canada has a French legal history, which created a “highly-centralized federal government which controlled economic policy making and had built-in buffers for banker interests against populist forces” as the primary reason for its stability in banking.

Calomaris is an economics professor at Columbia University. My experience with him is he’s a really nice, really smart guy. At a conference somewhere in the Caribbean (I think Cayman Island), we had dinner with the wives after our respective presentations. I am often interested in what his thinking is about economic topics.

But it is his other role, as Co-Chair of AEI’s Financial Deregulation Project with Peter Wallison that raises questions in my mind.

Back to Canada: The legal backdrop is a fascinating concept, one I want to explore further. But I cannot help but wonder if this line of thinking came about to avoid the obvious issues in the US, namely, the crisis was driven in large part by the radical deregulation.

In Canada for example, there are other factors beyond the French legal history worthy of discussion. Note that in Canada, bankers cannot lobby regulators. Unlike the US, their Supreme Court does not think corporations are people. In Canada, money is not speech. There are explicit limitations on Corporate political donations. And where as we have a revolving door between government service and the private sector, the restrictions are much greater in Canada. All of this adds up to a much more intensely regulated banking system than in the America.

Which makes me wonder how this will get treated in their book.

It also raises important questions regarding academic objectivity. If your starting premise is that the financial system needs to be deregulated, how objective can any of your subsequent academic research be? If you spend time co-chairing AEI’s financial deregulation project, how much of your thought process is in part a rationalization of your own role in creating the crisis? (I’ll let someone else look into the issue of academic research being funded by deep-pocketed ideological Think Tanks). If your starting premise is deeply, fundamentally flawed, what happens to the academic theories built on top of that foundation?

By all means, we should be looking at all of the factors that drove the credit bubble and collapse. We just need to be especially aware of the framework our own biases create when we do so . . .

 

 

Previously:
Why is AEI Scrubbing Wallison’s Name From AEI’s Financial Deregulation Project?  (December 15th, 2010)

Source:
Why Canada Can Avoid Banking Crises and U.S. Can’t
Victoria McGrane
Real Time Economics, April 9, 2013
http://blogs.wsj.com/economics/2013/04/09/why-canada-can-avoid-banking-crises-and-u-s-cant/

Category: Bailouts, Psychology, Really, really bad calls, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

33 Responses to “Why Canada Avoids Banking Crises”

  1. Petey Wheatstraw says:

    Hmmm . . . “French,” you say.

    That explains it!

    True Americans (excluding George Washington), do not believe in the French, as they are defective socialists.

    In the US, we believe in the freedom to let mindless corporate “people” speak their minds, and money is the language they speak. In our system, money is the Lingua Franca — if you do not have enough, you are either incomprehensible, illiterate, or mush-mouthed.

    What would freedom mean, after all, if it did not carry with it the inherent potential for the subjugation and robbery of the general citizenry by those who have mastered their native tongue, by quantity or volume, better than the riff-raff who speak in the rank vernacular of uttered phrases?

    It doesn’t matter that the Canadians have a better system. They are the offspring of the socialist French, and they are doing it wrong!

  2. phasor says:

    Barry, there is no such thing as “objective” Economics.

    The production and consumption of goods and services among large groups of people in a society can only happen within a political context.

    Thus, Economics is just a branch of Politics.

    Of course, Economists are biased, they are by definition!

  3. jlj says:

    Nope, probably is the French legal system. Just look at Louisiana and how well they have done vs the other 49 states.

    • Roger Bigod says:

      As I have to explain to newcomers, Louisiana combines Anglo-Saxon charm with French efficiency.

  4. A says:

    As long as politicians can be purchased, the outcomes will never favor the people they were (supposedly) elected to ‘represent’.

  5. Moe says:

    Having worked on Toronto’s equivelant of Wall Street (Bay Street) for 8 years, I can also attest to the fact that Candians approach to business is much slower and methodical than ours. They tend to look at U.S. as gunslingers…”do it now and deal with the consequences late” – an approach they abhor.

  6. Gulfcoastm says:

    BR – I meant to ask after an article the other day. Do you have an updated chart on the US bank closures. You haven’t posted one for while. I love charts too…

  7. rd says:

    The French legal argument would never have come to my mind since most of Canada, including much of the Federal law, was developed based on British common law and the British parliamentary system.

    However, what both English and French Canadian cultures have developed over the past couple of hundred years is a widepspread concept of fairness and the government’s role to play in it. So, you see universal health care and other safety nets that are widely approved and viewed as a moral imperative. While Canada has a long, great tradition of military valor in WW I, WW II, and Korea, the past 50 years have been defined by its role within NATO and UN Peacekeeping which are fundamental mutual protection and fairness ideas. So you get the dichotomy of Canada having the highest casualty rate per deployed soldier of any of the NATO countries in Afghanistaqn while refusing to participate in the Iraq disaster because it was not a NATO or UN mission. Canada is currently in the throes of a lot of apologies to the indigenous “First Nations” people for the way they were treated over the past couple of centuries as another example of how fairness is incorporated.

    With respect to things like banking, Canada has a very Wild West attitude towards financial risk taking in sectors like mining where it is caveat emptor for investing in junior mining stocks, but views it as a societal duty to have a stable, low-risk banking sector. Even the bankers have bought into these separations! Similarly, the housing sector gets wild at times with various boom and bust problems, but mortgages are developed under different rules than in the US to better allocate the risk to the appropriate parties.

    Taxes are viewed as a fairness issue where in order to provide the services and safety nets that are required, taxes need to be paid and a progressive tax is viewed as generally appropriate. The country went through some difficulties in the 90s as it had to sort out budget issues, but part of that process included a discussion about the social contract between government and the population, what government’s role is, what levels of government should do what, and generally making sure that taxes are paid to the government level where the services are managed and delivered. Canada has generally avoided the vitriolic maker vs taker argument that grips the US these days.

  8. wally says:

    “Why Canada Avoids Banking Crises – So Far”

    Just a suggestion for a title. Nothing in economics or politics is forever.

  9. bbrune says:

    One view is that Canadians are just slow – we are only now getting around to real Reaganomics and Thatcherism – because we have just noticed how well that has worked out for you.

    If this theory holds, we should have our banking crisis on schedule in about ten years, after which we will elect a prime minister of color.

    My own opinion is that that the country is so small that the government can only be owned by one industry at a time, and currently it is owned by the oil industry.

  10. Chief Tomahawk says:

    Isn’t there just volumes of material for Sacha Baron Cohen to do a Borat (“Cultural Learnings of America for Make Benefit Glorious Nation of Kazakhstan”) sequel with? He could take the 2008 financial crisis (Wall St & DC cultural learnings) and take them back to Kazakhstan and run them by the people there!

  11. Old Rob says:

    Interesting ‘political’ article. Nice try with the reference to the Supreme Court, but it doesn’t wash.

    Congress and the Executive branch (both Bush the first and Clintons) destroyed things. The later-day Executives finished the job.

    It might be nice to fully restore Glass-Steagal and the other regulations that work, but don’t be fooled by this type of writing.

  12. Herman Frank says:

    RD wrote it so well: “Canada has a living, functioning social contract while the social contract in the US got torn up.” Perhaps British or French CULTURE has more to do with it than law. In an interview with Jens Weidmann (Pres Bundesbank) the interviewer raised the question “you’ve been all your career with the Bundesbank, why not take a private job after this one – pays much more?” Mr. Weidmann was simply aghast at the idea of rotating between government and private business. He thought it was simply “not done”. That is another example of a cultural aspect, not legal. Tony Blair may be raking in the big bucks with his world-wide consultancy firm, but he is absolutely vilified for it at home. “Abuse of former position” is the kindest evaluation.

    It all comes down to “what do you want your society to be?” What are your role models in business life? Your role models in political life? Who and what do you vote for? The biggest surprise came in a poll some time ago, when a majority of Americans actually favored the Swedish model of society. Only thing was that the interviewers never used the words socialist, support, social contract or the like.

    Tearing up the social contract will prove to have profound effects on the dynamics of society. It means that in another generation this will be a society of “haves and have-nots”.

  13. streeteye says:

    De-politicizing credit means… no banks relying on government backstop to reap big profits, take massive bailouts and socialize losses. Sounds OK to me.

  14. RW says:

    Just a couple observations:

    Agree that the title “Why Canada Avoids Banking Crises – So Far” might be better but also agree that banking regulation in Canada seems to be more strictly enforced with capital requirements to match so, even if there is a housing blowup, it seems less likely there will be a need for a large-scale bailout and more likely there will be prosecutions for regulatory misfeasance.

    I am not surprised AEI is ‘scrubbing’ Wallison and other aspects of its Financial Deregulation Project — that sort of thing appears to have become a rather standard response of agencies engaged in dishonest debate who realize the dishonesty has risen to the level of public awareness and can no longer be concealed — but in the case of AEI the problem Wallison presents is also one of virulence as well as exposure: He not only won’t keep his mouth shut he spouts with such venom that there is no longer even a pretense of analytic distance. For agencies such as AEI (and Heritage, Cato, etc) who provide intellectual and ‘research’ cover for conservative and reactionary policy initiatives, that is bad press and a weakening of brand.

    Can’t have that, these think tanks have a job to do and while they are paid to do it with conviction the pretense of analytic integrity and dispassion must be maintained. Wallison, and other actors in the Financial Deregulation Project, tore that veil.

  15. AHodge says:

    good guy calomiris, interesting topic
    canada had
    no housing bubble –down payment requirements
    not much subprime abuse
    cares about accounting more than us–Charlie gets how bad US bank accounting is
    oversight? just because they did not go the US route the last 20 years
    Of ” we dont need it anymore” ,
    doesnt mean they are Napoleonic. maybe the US changed more than Canada. australia also OK is not French”
    but i will read his argument
    only the US and europe have created dysfunctional credit systems, and bloated behemoths that used to be banks.
    Canadas banks are behemoth. but they are mostly real lending banks

  16. AHodge says:

    and also the supposedly highly regulated
    europe
    is now the biggest bank mess of all by far
    how that napoleonic regulation working for them?

  17. bully says:

    The notion that Canada’s banks are all so virtuous is such a load of bullshit. The difference here was that finance moved immediately and quietly to bail their asses out early on in the crisis. Here’s a link to the story that I saved for posterity: http://www.globalresearch.ca/canada-s-75-billion-dollar-bank-bailout/12007

  18. faulkner says:

    Re: Cognitive foibles – which I took to be more the motive for your piece than Canada. “Our behaviors have evolved for other reasons (primarily survival).” Time for tweak. It’s not survival, it’s reproduction – of self, kin and those that cooperate – in that order. Which lends more credence to your questions about self serving publications, ideological employment and academic capture. The logic can be flawless and the assumptions untested at the same time.

  19. Moe says:

    Barry – AEI has a posting on this same issue – with the spin you would expect…

  20. faulkner says:

    Re: Cognitive foibles – which I took to be more the motive for your piece than Canada. “Our behaviors have evolved for other reasons (primarily survival).” Time for tweak. It’s not survival, it’s reproduction – of self, kin and those that cooperate – in that order. Which lends more credence to your questions about self serving publications, ideological employment and academic capture. The logic can be flawless and the assumptions untested at the same time.

  21. brentnyitray says:

    Residential real estate bubbles are the Hurricane Katrinas of banking. Even highly regulated banking systems like Japan and Sweden blew up when their real estate bubbles burst.

    Canada median house price to median income ratio is around 5x. Pretty much the same place ours was when housing peaked.

    Our banking system looked peachy in 2006, too. Canada has a real estate bubble that hasn’t burst yet.

  22. Gestalt says:

    The motto in Canada is every major bank is Too Big To Fail something the federal government has insured stays that way. There are only 5, and if any of them were to fail the entire Canadian economy would go in the toilet. Sure in some regards they may be a bit better regulated, but let’s look at some numbers.

    Total Debt-to- GDP Ratio: (Source – McKinsey Global Institute Q2 2011)
    USA: 279%
    Canada: 276%

    Household Debt, % of Disposable Income
    USA Pre-crises peak: 128%
    Canada current: 160% and rising
    Source: http://www.economicreason.com/economiccrisisexplained/canadian-banking-system-exposed/

    So Canada is just as debt-gorged as the USA. Supposedly its safer, but the tax payer is on the hook for mortgages issued via the CMHC. Banks in Canada in many ways have immunity from consequences. With near 0% interest rates as well, a massive housing bubble is in the works.
    http://trendlines.ca/free/economics/RealtyBubblesMonitor/RealtyBubblesMonitor.htm

    I am not sure how any of the “french” logic is relevant. The word “yet” would be an apt addition to your title for this post.

  23. Estragon says:

    I must be having my own cognitive foible (brain fart). BR writes “The thesis is that Canada has a French legal history…”, but I can’t find that thesis stated anywhere in either the WSJ article, or the Calomiris article.

    The actual thesis, as I understand it, is the French population’s involvement in the history of Canada played a role in the evolution of Canadian political stuctures, and Canada’s banking structure evolved as a part of the political structure. Am I reading this wrong?

  24. donna says:

    I think they just watch what we do and do the opposite thing.

  25. cdwight says:

    I am an American who has been in Canada since 1994 and has worked in Banking most of the time since. One thing that struck me soon after arriving is that there are oligopolies in most large industries. I came to realize that this is because Canada has an inherent insecurity being right next to the largest super power in the world. As a result, there is a fear of being dominated by the use in many spheres including in business. To prevent this Canada has wanted to have Companies large enough to hold their own against US competitors. Give the size of Canada relative to the US (1/10th the size) the only way to do this is to create oligopolies. In banking, this has resulted in 5 large banks controlling 80% of the banking market in most areas (retail banking, investment banking, commercial bank). Unfortunately, oligopolies have a natural tendency to utilize their superior pricing power to extract more value from their customers (i.e. increase prices). This has created resentment among the banking consumers who recognize this behavior and causes them to lean further to the left and have a general distrust of business that is greater than in the US. This further results in pressure to keep a tighter rein on the banks than has been the case in the US.

    The other thing that struck me about regulation in Canada which applies to Securities law and banking law is that generally it is a violation of laws/regulations to violate the spirit of the law as well as the letter of the law. The US generally goes by the letter of the law, which encourages an attempts and structures designed to get around the law, which often results in additional changes to the law to close unforeseen loop holes. Just think about tax law in the US. In Canada, it is often a violation of rules to violate the spirit of the law. In other words, you might be able to come up with a contortion that will help get around a specific regulation, but that would still be a violation because it circumvents the intention of the rule/law.

    This causes the regulation to be tighter along with the control on lobbying discussed in other posts.

    Also, although Canada has a high debt to GDP ratio it does not have a subprime market like the US had before its collapse. That is there is generally proof of income and sufficient security to cover outstanding mortgages. Could there still be a collapse? It might be possible if there was a significant downturn in the economy or if interest rates rose dramatically in a short period, but I don’t see that happening at the moment. More likely, there will be a gradual lowering of debt to GDP through growth in the economy and perhaps stagnate home prices.

  26. formerlawyer says:

    I am commenting on the second last paragraph in Barry’s post.

    I am wary of academic papers that refer to themselves but this is “quick and dirty” so perhaps the forthcoming book will be more nuanced. Likewise cross-country comparisons are difficult, let alone global comparisons. For example how is a “banking crisis” defined in the paper? I note that most of the references to Canadian law and society date from the mid 1950′s!

    Of course ACORN shows up at page 32 in negative light. As does the CRA bogeyman which “It was, therefore, often in a bank’s interest to enter into an explicit partnership with an activist group in advance of a Fed merger hearing.” (33-34). The “number of agreements” under the CRA is listed at “376 agreements from 1977-2007, the insignificance is obvious given “[s]ince 1980, the structure of the U.S. banking industry has changed considerably, with over 10,000 mergers involving more than $7 trillion in acquired assets taking place. Furthermore, the number of institutions has declined dramatically over this period, and the concentration of assets held by the largest institutions has increased. There were 19,069 banks and thrifts operating in the U.S. in 1980 and 7,011 in 2010, a decline of over 60 percent. In 1980, the 10 largest banking organizations held only 13.5 percent of banking assets, increasing to 36 percent by 2000.2 By 2010, the 10 largest organizations held approximately 50 percent of banking assets.”
    from:http://www.federalreserve.gov/pubs/feds/2012/201251/201251pap.pdf

    Fannie and Freddie appear at 36-37 with no mention of rush for return etc You have gone through this ad nauseuem.

    Frankly given Professor Calomaris’s misapprehension of the US situation and what appears to be a cursory stereotypical view of Canadian economic history, give the new book a pass or borrow from your local library.

  27. cesar says:

    I don’t see any connection between French legal system and Canadian banking system.

    Canada”s banking industry is dominated by the big 5 banks. Its an oligopoly & competition is therefore less aggressive than the US with its numerous banks. Also, Canada’s historically more conservative culture extends to business i.e., banking. Luckily Canada’s major banks are regulated by one federal regulator (OSFI) but in other areas we are decentralized e.g. we still have no single securities regulator. Another point in our favour was a smaller underclass – subprime just wasn’t as big an opportunity.

    I wonder if the banks will face a crisis in the near future since canadian real estate is in a bubble in the major cities. The banks have been well managed but also lucky. The major 5 are too big to fail but no one talks about breaking them up & they continue with their investment banking operations. Some people seem to be forgetting that the Canadian banks were almost bankrupt in th 1980′s with massive exposure to Latin American sovereign debt. As the saying goes its better to be lucky than smart.

    I am Canadian & an ex-banker.

    • Boffin says:

      As a fellow Canadian, I support cesar’s comments.

      One of the reason’s the Canadian banking system didn’t suffer the same feat as the US and UK banks is due to the legislation passed during the 1990s by Prime Minister (PM) Jean Chretien (the same person who declined George W Bush’s request to send Canadian troops to Iraq). I recall the the current PM, Stephen Harper, calling for the deregulation of the Canadian banking system so that they could ‘better compete’ with the US and UK banks. Strange how he’s taken the credit for saving Canadian banks from a US like financial crisis. Then again, he’s a politician.

      As an outsider looking in, as long as the ruling that ‘a coporation has the same rights as an individual’ persists, the US is going to continue on a downward spiral for the foreseeable future.

  28. jonmaestro says:

    I worked at a Canadian bank during the crisis and I can tell you that Canadian banks fortunes are simply a matter of timing. Canadian banks take more time to analyze and impl;ement innovations and are less creative than their US counterparts. Therefore, when the US banks offered 100% LTV mortgages in 2004, it took Canadian banks to 2007 to begin offering those types of loans; right around the time the Bear Stearns mortgage funds blew up. I still recall posters all around banks in the financial district of Toronto offering “Now you can get 100% loan-to-value on your mortgage”.

    In my opinion, had the crisis taken longer to evolve, Canadian banks would have been in the thick of it, again to a lesser extent than US banks. Note also that we are not immune as Canadian banks dealt with a commercial paper crisis in 2007 – leverage funds using short-term CP market to fund credit investments, but I am unsure of the extent of this exposure on bank balance sheets (my recollection is that it was low – they only peddled the crap but did not invest much in it).

  29. [...] The Big Picture - Why doesn’t Canada have banking crises? [...]