Will Harper's superiority complex contribute to the next financial crisis?

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The mantra of the Harper government is that the Canada's banking sector is a bright star in the banking heavens. No public opportunity is lost to take credit for the resilience of Canadian banks during the 2008 financial crisis: "Without wanting to appear arrogant or vain, which would be quite un-Canadian," claimed our finance minster, Jim Flaherty. "While our system is not perfect, it has worked during this difficult time."

Sorry to break it to you, finance minister: there are some indications that this overconfidence may undermine the very qualities that helped the Canadian banking system to withstand the financial turbulence of 2008.

Why did the Canadian banking system get in less trouble than others? Are Canadian regulators that much smarter than their counterparts abroad? Are Canadian banks just inherently more prudent?

Let's not kid ourselves with this Canadian superiority shtick. A very particular set of circumstances pertained to 2008, and we cannot assume they will recur the next time a global financial meltdown threatens Canadian banks. Elsewhere, I have discussed what those special circumstances were, but out of them all, the key issue is fear.

Prior to the financial crisis, Canadian banks were not entirely sure that the government would smile upon them if they got involved in too much financial hocus-pocus. Sure, banks and their regulators are pretty cozy, but any one bank that got too far out of line might be punished if its risky bets failed. This uncertainty about how the government might react if a major Canadian bank was under pressure made banks more cautious. A little anxiety amongst bankers goes a long way to improving their behaviour.

Fast forward to 2011. Are banks still as worried that they will bear the consequences of their misadventures? I don't think so.

In the heat of the financial crisis in October 2008, the Canadian government sent out a message loud and clear: we will help our banks no matter what. Several avenues were quickly opened to help the banks borrow money from the government using a variety of financial assets as collateral.

Perhaps most eye-popping was the announcement that the Canadian Mortgage and Housing Corporation would provide $25-billion in cash to major financial institutions by buying CMHC-insured mortgage pools from them. As the crisis continued, the government kept increasing the upper limit of these purchases. The program finally allowed $125 billion in purchases by the time the crisis eased.

So what was happening there? It's not like these mortgage pools were posing a threat to the banks that held them (these mortgage pools are already insured up the yin-yang by the government ). The point of this exercise was to announce to financial markets that any and all mechanisms would be made available to make sure banks could get their hands on plenty of funds to withstand a financial panic. Even if the Canadian banks didn't need money, the government put on a show of demonstrating that financial institutions had only to ask and the spigots would be opened.

This precedent demonstrated that the government would think way outside the box to help banks. Before October 2008, no one dreamed that the mandate of the Canadian Mortgage and Housing Corporation included protecting Canadian banks from international financial crises. Then suddenly CMHC is able to funnel $125-billion to banks in the blink of a press conference? Talk about public policy improvisation on the fly. And banks drew the obvious conclusion: this government will do whatever is necessary to stand by us, regardless of the letter of the law.

So while Canadian banks made it through the crisis without outright bailouts, that doesn't mean they didn't have help. And the support they got in their moment of need has lingering effects on financial stability moving forward.

Today, Canadian banks can rest easier, knowing that they will not be allowed to fail. I don't suppose they will even be allowed to hurt very badly. And this de facto safety net provides an incentive for banks to get a lot more adventurous.

As the financial crisis knocks on in Europe, it is painfully apparent that banks that are viewed as "too big to fail" pose a significant threat to the public purse and the stability of the financial system. But the G-20 has mostly failed to solve the problem of implicit or explicit government safety nets for big banks. It is up to domestic regulators to try to make sure the biggest banks do not abuse the security of government support and merrily ratchet up the sorts of risk-taking that may well contribute to the next financial crisis.

Canada has a great opportunity to preempt these dangers. Every five years the Bank Act comes under review in Canada, and 2011 is the next scheduled review. And you'd think in the wake of a financial crisis, there would be some important questions to ask. Like, say, how are we going to prevent banks from exploiting the safety net that they know the government will make available if systemic banking stability is threatened?

Shamefully, it seems Canadians will be denied the opportunity to make the bank review a critical exercise. The upcoming Bank Act review is hardly whispered about publicly, except to say it will be confined to a narrow "technical" exercise. Decoded: little details can be tweaked, but no meaningful policy issues will be discussed. It would seem that the Harper government thinks that Canada's banking system is so fabulous that these hard questions don't even need to be asked.

No doubt the Harper government will fight the next election congratulating themselves on their banking smarts. It is ironic, and potentially tragic, that all of this bragging only masks the possibility that the Canadian regulatory landscape is losing the very qualities that made it resilient in the past.

Ellen Russell is a senior economist with the Canadian Centre of Policy Alternatives. This is the first of an ongoing monthly column.

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