Mon | Aug 2, 2021

New report suggests Scotiabank, CIBC shored up by gov't support during crisis

Published:Friday | May 4, 2012 | 12:00 AM

Wilberne Persaud, Financial Gleaner Columnist

A reader writes: "Who says Scotiabank and CIBC were solid as a rock? Did you know they actually went under three years ago but was brought up by the Canadian government? News just came out today that the gov't of Canada bailed out four banks totalling CDN$114 billion including these two...Scotiabank and CIBC were bailed our for a sum worth more than their net worth...This means they actually failed...If they were not bailed out, these banks would be history by now."

Why now, why was my correspondent commenting on this topic? Was he remarking on the view Jamaicans held in the mid-1990s about the strength and stability of those foreign banks during our crisis? So I checked - where else - the Internet machine, of course.

I learned immediately that on April 30, 2012 the Canadian Centre for Policy Alternatives (CCPA) published in Ottawa, its estimate of the secret extent of extraordinary support required by Canada's banks during the financial crisis that ensued after September 2008.

The study, undertaken by CCPA Senior Economist David MacDonald, estimated support for Canadian banks reached CDN$114 billion at its peak. He was led to investigate the issue because assistance given to Canadian banks by the US Federal Reserve was made public as early as November 2008 - all five of the big Canadian banks were involved.

No published numbers were available for Canadian government support for these banks. MacDonald's report describes his methods of estimation and suggests that at "some point during the crisis, three of Canada's banks -CIBC, BMO, and Scotiabank - were completely under water, with government support exceeding the market value of the company".

In effect, given their market capitalisation, it would have been cheaper for the Canadian government to take over the banks and do a restructuring. He estimates that the support amounted to CDN$3,400 for every man, woman, and child in Canada.

Proper analysis

In an interview Macdonald, when asked whether he thought making these details public would be counterproductive, merely leading to anxiety or panic with no real benefit to the society, said that with full disclosure, the data would allow proper analysis of failure that could lead to better arrangements in the future.

So here is the dilemma, when banks are about to fail, the biggest problem regulators, policymakers, commercial interests and governments face is what has come to be known as contagion.

A company selling automobiles or construction steel can file for bankruptcy with no generalised effect, except perhaps positive, on its competitors or indeed, its entire market segment. Not so for banks. So the Bank of Canada and its government prefer to keep the extent of their support secret, describing it merely as 'liquidity support'. Generally too, prior to publication of this report, Canadian banks were considered not to have had the broad exposure and solvency issues of their counterparts to the south.

Only the entirely uninitiated would have believed this scenario, yet the extent and magnitude of rescue operations, while perhaps reassuring, is indeed troubling.

Title II of the USA's Dodd-Frank Act, is entitled 'Orderly Liquidation Authority' or OLA. It grapples with the potentially catastrophic impact of "too big to fail" financial entities by setting up criteria for a new insolvency - bankruptcy - regime for large, interconnected financial companies, inclusive of broker-dealers, whose failure poses a significant risk to the financial system of the United States.

The Federal Deposit Insurance Corporation (FDIC) would act as receiver upon filing proceedings to deal with qualifying financial companies.

That this legislation is complex is an understatement. It creates a new breed of law with genetic inputs from the act that created the FDIC, the US Bankruptcy Code and elsewhere. It involves extensive input and control by the FDIC and other government authorities, including the board of governors, the treasury secretary, congress and the president. It includes tough measures that themselves guarantee they might only be used in the grimmest of circumstances.

Senators Dodd and Frank set out to mitigate risk, to conquer the 'too big to fail' syndrome, end bailouts forever and in so doing protect taxpayer funds. This notion - the end of bailouts - can have no meaning unless and until either one of too things happen: either too big to fail financial institutions are broken up and no longer allowed to exist legally, or we create humans, for whom we can legislate good sense, prudence and morality, to run such institutions.

Although there is no compelling economic justification of the enormous size of these entities, the first outcome seems impossible, and the second? That's mentioned purely for its absurdity. We shall therefore be left with the task of creating 'Resolution Institutions' that are palatable.

Here's a neat description of this beast by David Zaring.

"Resolution authority is the polite term for seizing failing financial institutions and either shutting them down or selling them off for the best possible price. Resolution is meant to be implemented before contagion sets in and the institutions' counterparties, including customers, traders, and even competitors, also fail, either through panic (which is not the fault of the counterparties) or poor risk management (which is, but still may exacerbate a crisis). It is a particular kind of instant bankruptcy, destroying the interests of some creditors quickly and unmercifully, while giving others, especially the bank's depositors, a fresh and happy start."

Do we recognise this beast?

Wilberne Persaud is author of 'Jamaica Meltdown: Indigenous Financial Sector Crash 1996'.