Banking Law

Last month, we discussed a column by Reuters' Rob Cox about how the Uinted States ought to look northward for a banking system that works, He thought consumers would be a lot better off in the US if we had a banking system more like Canada's, with a mere five gargantuan banks heavily regulated by the Canadian government.

Yesterday, the Miami Herald's Kevin G, Hall expanded on that theme.

Maybe Canada has something to teach the U.S. about housing finance.

One in four U.S. homes is thought to be worth less that the mortgage being paid on it. One in every 492 U.S. homes received a foreclosure notice in November. For the fourth year running, analysts are speculating on where the bottom is for U.S. real estate.

No such worries up here in Canada - yet its system of mortgage finance gets little attention in the U.S.

Not a single Canadian bank failed during the Great Depression, and not a single one failed during the recent U.S. crisis now dubbed the Great Recession. Less than 1 percent of all Canadian mortgages are in arrears.

Why? A smartass with officer of the Canadian Bacon Bankers Association boils it down to its simplest level.

"This sounds very simple, but one of our CEOs has said we are in the business of making loans to people who will pay them back," said Terry Campbell, vice president of policy for the Canadian Bankers Association in Ottawa.

I'd take that as a contention that Canadian bankers are smarter than US bankers, which may be true, except for the fact that, as Hall points out, "The Hosers" have no option to be "flexible" in their underwriting standards. Very conservative underwriting standards and loss reserves are mandated by law.

Other differences between the US and Canadian mortgage lending businesses that, in Hall's view, make the Canadian system preferable, are the following:

• No secondary market for mortgage loans (i.e., no Freddie, Fannie, or "private label" mortgage backed securities). Loans generally stay on the books of the bank that made them. Therefore, the banks tend to be much more conservative in underwriting, since they can't pass-off the risk to a chump buyer.
• No mortgage interest deduction (and, although Hall doesn't directly discuss it, no "tax free" gains on the sale of a primary residence, although homeowners get capital gains treatment on the sale of a home). Hall isn't clear about why this is better than having a mortgage deduction, although I think it's because of lost tax revenue, which our free-spending federal government needs and will need until hell freezes over and time (as we know it) ceases "to be."
• No 15- or 30-year fixed rate loans. Canadian loans are fixed interest for the first five years, then adjusted at five-year intervals. That puts more interest rate risk on borrowers.  It also incentivizes Canadian borrowers to pay their loans off more quickly, which is likely to be an accelerating trend once the bond markets finally make us pay for all the deficit spending we've been doing and world-wide interest rates take off for para-sectors of the universe where no man (or woman) has gone before.
• 20% down payments are the norm, and mortgage insurance is required for loan-to-value ratios that exceed 80% (which is still the case in the US for conventional loans, although Hall doesn't mention that).
• Canadian lenders remain blissfully ignorant of the concepts of "subprime," "low doc," "no doc," "option ARM," "Alt-A," and other US-concocted residential mortgage loan exotica.
• "Jingle Mail" is a tune not played in Canada. All loans are full recourse, and if you mail in the keys to the lender, you still have to "pay up" (or, I assume, file the Canadian equivalent of a bankruptcy proceeding). Thus, Canadian borrowers are motivated to pay their loans, while US borrowers are supposedly more apt to simply walk away when times get tough. What Hall fails to mention is that "jingle mail" doesn't work everywhere in the US, either, only in those states that have anti-deficiency statues. In Texas, for example, mailing in the keys might be a good way to get a cowboy boot up the nether regions, along with the epithet "Son, we don't cotton to ya'll here, so you might best be fixin' to move to Californ-ya."

Hall does mention a few distinguishing characteristics between Canada and the United States, which he admits make comparing Canada and the US an "apples to oranges" exercise, to a certain degree.

Canada's population last year was estimated at 34.3 million, while the U.S. population now exceeds 307 million. The U.S. economy is the world's biggest; Canada ranks ninth.

Canadian banks were recently named the best in the world by the World Economic Forum, but they're a much smaller universe of lenders - 71 that are federally regulated, compared with more than 8,000 U.S. lenders insured by the Federal Deposit Insurance Corp.

One bank for every 483,098 persons, compared to one for every 38,375 in the US. Only a relatively few federal (and no state or "provincial" banks) banks. A federal government that intrudes into everyday life to an extent that would be "uncomfortable" in the US. Tax rates so high that most US taxpayers would choke (46% highest marginal tax rate in Canada versus 35% in the US). Yeah, there are a few differences that make the comparison tricky.

The irony here is that before the federal government and Wall Street formed an unholy alliance to "encourage a greater participation in home ownership" in the US, US banks generally chose to as conservative as Canadian banks are required to be. Also, please remember that most the garbage originated in the latest "wilding" by mortgage lenders was originated by non-FDIC-insured institutions (with notable exceptions). In the aftermath of the subprime mortgage meltdown and the economic wreckage it left in its wake, both market and "de facto" regulatory pressures are likely to exert a return to the conservatism of the past without the necessity of drastically reducing the number of banks in the US or expanding the US government's bureaucracy into every fiber of the "business" of banking (although Dodd-Frank's made a great leap forward in doing just that).