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Contagion, bailout or liquidity support - the Canada version

Published:Friday | May 11, 2012 | 12:00 AM

Wilberne Persaud, Financial Gleaner Columnist

Last week's column suffered the misfortune of headline suggestive tyranny.

There was no attempt to sensationalise anything about Canadian banks' fortunes during the financial crisis. This column suggests a title but Financial Gleaner editors decide.

As submitted, the proposed title was, 'The dilemma: resolution, bankruptcy and too big to fail'. The idea of complexity in dilemma was suggested.

The published title portrays banks being 'shored up' - offering a different angle of vision, perspective and set of expectations.

The point about the headline, as marketing and communications experts emphasise, is that they do affect perception of content.

But the column reported research findings and published work of Canadian Centre for Policy Alternatives senior economist David MacDonald on support for Canadian banks during and immediately after the financial crisis of September 2008.

Canadian experience during that episode revealed an unexpected extent of support deemed necessary.

Another thing the Canadian banks' experience draws attention to is the fragility of all fractional reserve banking systems.

It underlined the plain futility thus far of attempts to eradicate the 'too big to fail' syndrome and most importantly, emphasised the potentially destructive force of contagion as counterparty failure spreads like untamed, wild antibiotic-resistant bacteria.

Indeed, it is from the public-health sphere that the concept derives. These issues are important and need to be dispassionately discussed.

So to my reader who instructs me to: "See Scotiabank's response in the Gleaner today ... which proves that you were talking utter rubbish in your silly and vindictive article. They should sue your a—" - I merely say, I think you've really overlooked the issues causing debate here. Scotiabank did not 'sue my a—' even though they obviously have the right and competence so to do. But you know what, Scotiabank is staffed by sensible people and has excellent Jamaican and Canadian lawyers both inhouse and otherwise at their disposal. They wouldn't want to provide my grandchildren with an unsolicited nest egg.

So let me restate, again, for emphasis, the comment from David Zaring that intervention by financial authorities "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)".

The US Federal Reserve and Canadian authorities intervened when markets were clogged and confidence had evaporated. Intervention support provided to the banks was deemed "liquidity support".

Had the authorities not acted, undoubtedly contagion and systemic failure would have resulted even if the banks were in a condition of "absolutely no fault".

No published details

What MacDonald appeared particularly concerned about is the fact that Canadian authorities did not, as opposed to their counterparts in the US, publish details of support provided to individual entities within the banking system.

From the perspective of confidence in a financial system, this is not usually a bad thing.

In the US, the accepted norm, backed by freedom of information legislation, is for publication at this greater level of detail. Not so in Canada. It is debatable, however, whether the latter policy is better than what obtains in the US. Controversy over details and their interpretation suggest that more information sharing might indeed be better.

So where are we? The comments have come aplenty, here's another: "I would like direct you to an article published by the Vancouver Sun, which I believe is a right-wing paper and has a leaning towards the Conservative government of Canada - But regardless of what the Vancouver Sun says, this Canadian government might find themselves in a pickle on Monday morning when they have to explain to the Parliament what the dickens was going on."

This article is in direct contradiction to MacDonald's. It states: "No Canadian bank was in danger of failing, the Bank of Canada lent banks money on market terms and the Canadian Mortgage and Housing Corporation bought safe, insured mortgages from the banks, all so that the banks could continue to lend to consumers and businesses to help the economy through the recession. Important programmes to be sure, but not a bailout."

Honestly, Terry Campbell could not mean what she says. The banks' problems were not recession-induced. They were confidence and contagion issues.

It is imperative that we appreciate the problem of contagion - an indirect result of too big to fail institutions.

Fact is, and with no sensationalist intent, without support Canadian banks would likely have failed. Invoking the divorce concept, call it 'no fault failure' if you wish.

The initiating too big to fail institutions were south of the border! Call it bailout; call it liquidity support - you choose.

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