As Canada’s economy slides into recession, how safe are the big banks?

Bank of America said it on the 1st of July, and TD said it on the 6th, but I knew that the economy was in a recession as soon as I heard federal Finance Minister Joe Oliver deny it way back in early June.

That would be the same Joe Oliver who “balanced” the budget with a whole host of lies, tricks, creative accounting, and the promise of future union-stomping. That surplus was a total fabrication, a clumsy election-year subterfuge designed to make the Cons look like responsible stewards of the economy.

Also that’s the same Joe Oliver who was forced to delay unveiling of that budget by several months because of “market volatility” (aka the tar sands getting kicked in the shins by the collapse in oil prices). Despite the total lack of improvement in the economy in the interim, Oliver was confident at the time the budget was released that things would get better – soon.

And that’s the same tune he was singing last week when BofA became the first of the big bank to project a recession following the release of stats for April showing the economy contracted for a fourth consecutive month. Oliver angrily denied that we’re in recession territory, and predicted strong, strong growth – right around the corner!

“We don’t have a recession. We don’t believe we will be in a recession,” Oliver said Friday in Toronto. “A recession is technically two consecutive negative quarters and we don’t have results from the second quarter.”

Statistics Canada reported this week that gross domestic product shrank by 0.1 percentin April, on the heels of a 0.6 percent annualized contraction in the first quarter.

However the finance minister sees indications that consumers and manufacturers are more optimistic. “There are, I think it’s fair to say, mixed signals at the moment,” Oliver said. “We’ll and wait and see what the numbers, in fact, will be.”

The federal budget, released in April, forecast annual GDP growth of 2 percent for the country, based on projections from private sector economists. Those projections haven’t been updated, Oliver said.

Of course the projections haven’t been updated – that would make the phony surplus Oliver worked so hard to engineer completely disappear! But in order to make good on those projections, the Canadian economy will have to grow at an annualized rate of roughly 4% in the second half of the year – a pace we haven’t seen in the last fifteen years.

Irrational exuberance from the Department of Finance notwithstanding, there’s a lot to be pessimistic about when it comes to the state of the Canadian economy. For one thing, the precipitous drop in the price of oil doesn’t look like it’s about to reverse itself.

Do you see a recovery anywhere in this chart? Cause I sure don’t. (Source:, obvi)

And when it comes to monetary policy (cue the yawns), we don’t exactly have a lot of room to maneuver:

After a string a disappointing economic indicators that strongly suggested the Canadian economy had contracted for a second straight quarter, financial markets and central-bank watchers are abuzz with will-he-or-won’t-he anticipation: Will Stephen Poloz, the central bank’s governor, decide to follow up January’s surprise rate cut with another quarter-percentage-point reduction, to throw a life preserver to an economy that may (or may not, depending on whom you ask) have already sunk into a small recession?

Note that the Globe is prematurely dismissing the recession as a “small” one. To be fair, the economy is barely into negative territory – but shrinkage (or “negative growth”, as expansionistically fixated economists insist on calling it) is shrinkage, and it’s not self-correcting.

Not when there’s so many things that could go wrong.

See, reducing the interest rate is, in theory, supposed to reduce the cost of borrowing for businesses and consumers like you ‘n me. But there’s two big problems with that.

One is that the Bank of Canada is already concerned that Canadians are in too much debt – and it’s not hard to see why. As the Financial Post notes, Canadians owe on average $1.64 for every $1 they earn, and Deutsche Bank estimates that our housing market is overvalued by as much as 63%. Giving Canadians cheaper access to credit so we can indebtedly spend our way back to marginal economic growth doesn’t seem like a good long-term strategy for success.

The second problem, though, is somewhat more insidious. The Globe made passing reference to Poloz’s surprise January announcement of a quarter-percentage-point reduction in the Bank of Canada’s interest rate, but surprisingly few economic commentators have noted what the ultimate impact of that rate cut was on consumer borrowing: absolutely none.

The reason is that the BofC doesn’t loan to people; it loans to commercial banks, who loan to people. All other things being equal, when the BofC’s interest rate goes down, commercial banks pass at least some of those savings on to their customers.

But this time, they didn’t.

As a single data point, it’s easy enough to dismiss – but when examined in the context of banks’ recent operational behaviour, it begins to look like a worrying trend. One wonders if they’re getting desperate for cash. They may well be, for reasons I’ll get into shortly. First, though, let’s look at some other signs of penny-pinching by the Big Banks.

In April, RBC announced that it was hiking fees for pretty much all of its customers, in some cases substantially. (Bank of Montreal snuck a similar fee increase past media attention in May; you can see the details here (PDF).) The move came several months after the bank shut down its struggling Caribbean operations, something that other major Canadian banks may be forced to do in the near future amid a deluge of bad loans and allegations of tax fraud and money laundering.

Late last year, Scotiabank announced it was firing 1500 employees and closing some of its branches in a bid to save $120 million a year. This January, CIBC followed suit, laying off over 500 employees. In April, TD said it too would lay off employees, although it refused to say how many.

Then there was Scotiabank CEO Brian Porter’s bizarre and desperate-sounding speech to bank shareholders this April, beseeching Canada’s policy-makers to ignore opposition from environmentalists and indigenous land defenders by pushing ahead with a slew of high-risk (and high-reward) tar sands-related infrastructure projects.

As I wrote last month, Porter tried to present himself as some kind of neutral expert in the speech, and that was the impression the business press broadcasted (the headline of the above-linked Toronto Star article was “Scotiabank CEO calls for end to bickering over energy infrastructure”, as though Porter was being the adult in the room). In fact, Porter has a glaring conflict of interest here: his bank is heavily invested in the tar sands, and a failure to implement these major infrastructure projects could cost his bank dearly. Hence the hard edge behind his lofty promises of jobs for everyone and profits all round – he’s likely feeling quite a bit of pressure lately, as the delays to all manner of pipelines keep mounting.

There’s a misconception in Canada that our big banks are safer than those of the United States, which needed extensive bailouts after the financial crisis of 2008. But I think that the conditions are right for the endangerment of at least some of Canada’s Big Five. In the midst of a deflating oil bubble and an ever-more-massive housing bubble, how overexposed are our big banks to bad debts that can never be repaid?

After all, they were far closer to collapse in 2008 than a lot of people realized:

If Canada’s banking regulations are not substantially toughened by the time the next global financial crisis hits — yes, there will be another crisis — our Big Five banks may very well find themselves in serious trouble. Again.

The public is almost entirely unaware that our banking system could go into a tailspin with just a couple of wrong moves or some bad luck. And when the next serious setback occurs, we could end up suffering even more than in 2008-10…

In fact, all of Canada’s five big banks (BMO, CIBC, Toronto-Dominion, Scotiabank, and the Royal Bank of Canada) faced serious financial problems in 2008, the Canadian Centre for Policy Alternatives (CCPA) found.

Our banks held far too many toxic United States sub-prime mortgages, the same mortgages that sank the U.S. economy. For a while, some of our Big Five were close to not being able to pay their debts.

All totalled, the five wrote down losses of $16.17 billion during the financial crisis, much of it due to losses on near-worthless bundled mortgages. What ensured the banks’ survival was massive relief, worth $114 billion, from three sources: the Central Mortgage and Housing Corporation, the U.S. Federal Reserve and the Bank of Canada.

That’s right, Canada’s banks got bailed out too! It got swept under the rug by Harper and Co, because it was an election year, and that kind of thing messes with the narrative of the Cons being responsible stewards of the economy. Now, you might argue that it was out of the government’s control, given the international origin of that crisis – but you would be wrong:

Looking back, people might wonder how Canada’s top five banks, with assets running into trillions of dollars, could nearly collapse with losses of only $16.17 billion.

It’s simple. The banks failed to have enough hard-cash reserve assets on hand to cover their losses when things started going south…

“Canadian banks were actually significantly more leveraged — and therefore more risky — than well-run American commercial banks,” wrote Peter Boone and Simon Johnson, two widely-read U.S. analysts. “For example JP Morgan was 13 times leveraged at the end of 2008, and Wells Fargo was 11 times leveraged. Canada’s five largest banks averaged 19 times leveraged, with the largest bank, Royal Bank of Canada, 23 times leveraged.”

In the U.S., banks are required to have cash assets valued at 10 per cent of their total investments and loans on hand, in case they have to cope with unforeseen losses. That wasn’t enough, as more than 120 U.S. banks, big and small, collapsed or had to be rescued.

Meanwhile, Canadian banks are required to hold only seven per cent of their outstanding debt in backup cash or cash equivalents. That will rise for Canada’s top banks to eight per cent by 2016 — still not enough to protect them during a severe crisis. [my bold]

So to sum up: our banks got caught holding onto bad mortgages – from another country – and even though their losses were tiny compared to the size of their assets, they had so little cash on hand that they came perilously close to collapse and had to be bailed out. Also, by international standards, our banks are atrociously over-levered. That means that even relatively small losses could cause them to come tumbling down. (Kudos to The Tyee’s Nick Fillmore, who did a fantastic six-part series on this issue back in 2013, which you should check out if you want to learn more.)

It’s not hard to see how similar problems with mortgages actually made and paid in Canada could lead to a far worse outcome. Here’s a scenario that’s maybe not too unlikely – see how it scans with you:

Second-quarter statistics show Canada to be in a slight recession, with shrinkage of less than 0.5% for the first half of the year. However, the numbers take a turn for the worse as over-indebted homeowners in Alberta (which boasts the highest levels of consumer debt in Canada) find themselves increasingly unable to make mortgage payments in the aftermath of energy industry job losses.

As the defaults increase, a sense of panic settles onto the Canadian real estate sector, and wealthy foreign investors who have been using Vancouver and Toronto condos as a store of wealth begin to pull out of the market. Increasingly, high-end units come onto the market without being able to find buyers, and the long-inflated property values in Canada’s two most expensive cities begin a rapid collapse.

Lending dries up, and as credit tightens, businesses stop hiring and start making layoffs. And so in a vicious cycle, the rate of default increases, and the range of the mortgage crisis spreads.

Highly-levered RBC, which holds 17% of all Canadian mortgages, more than any other bank, is the first to show signs of cracking, but all of the Big Five are in trouble at this point. Two-thirds of mortgages are owned by these five, and as the losses mount, it becomes increasingly clear that they will need to be bailed out, to the tune of tens or maybe hundreds of billions of dollars.

Now tell me, does that sound implausible?

I’m not saying that’s how it will happen. I’m saying that the short-term stability of Canada’s big banks isn’t something that we can take for granted, that the conditions are in place to cause a rapid cascading collapse. And we should be ready for that.

I mean that in the sense of personally preparing – I intend to move my account to a small credit union in the next few weeks, just to be on the safe side – as well as organizing against the type of bailouts we saw in the US several years back. The webcomic Saturday Morning Breakfast Cereal sums up the history beautifully. Go ahead, read it; I’ll wait here.

There are constructive alternatives to the bubble-enabling behaviour the US political class engaged in. We could consider nationalizing our banking industry and running it on a not-for-profit basis, for instance, or regulating it so heavily that reckless behaviour like the real estate bubble-blowing it’s been perpetrating would be impossible. We could break up the big banks entirely, and in the process diminish their influence on our political process. We could let them fail and bail out their customers instead. There’s any number of outcomes of a bank collapse that don’t involve an increased concentration of wealth and power in the hands of banks, and some are obviously much more viable than others.

The point is, these are complicated questions that need careful thought and study. If activists are forced to formulate a strategy in the midst of a banking crisis, their prospects of success will be much lower than if they come into that crisis prepared with a well-thought-through plan.

We know the banks are gonna be in trouble sooner or later. The time to start making that plan is now.

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