Our northern neighbor sometimes seems so similar to the United States that it's hard to tell where the USA ends and Canada begins. Here's one way: Canada is the place with healthy banks, taxpayers unscathed by megabillion-dollar bailouts and no need to overhaul financial regulation because it was done right the first time.
As U.S. officials scramble to prevent a crisis sequel, the ability of Canadian banks to navigate the current financial storm is earning global plaudits. The World Economic Forum in October ranked the country's financial institutions No. 1 in the world for solvency. U.S. banks came in 40th, two rungs behind Botswana.
Praise for the Canadian regulatory approach has come from former Federal Reserve Board chairman Paul Volcker as well as the head of the National Economic Council, Larry Summers. "Canada has come through this period with much less financial damage than we suffered. ... I think there are some lessons in financial regulation to be gained from what's happened in Canada," Summers told USA TODAY in a recent interview.
Indeed, Canada's experience is reflected in elements of the Obama administration's proposed revamp of financial industry regulation, the most sweeping set of changes since the 1930s. One example is an increase in the capital buffer required of financial institutions, especially those whose failure would threaten the entire system. Canadian banks must maintain high-quality capital reserves beyond international standards, thus limiting the banks' use of borrowed funds for investments. (Such leveraged financial bets magnify gains if they pay off — or losses if they don't.)
"The proposals the Obama administration have come up with are certainly along the lines of our thinking," says Mark Carney, governor of the Bank of Canada.
But the prospect of congressional turf battles prompted the administration to shy from tackling the fragmented U.S. regulatory system, meaning perhaps the greatest Canadian lesson is being ignored. The administration opted to leave in place multiple financial regulatory agencies rather than mimic Canada's most distinctive feature: a single powerful regulator, the Office of the Superintendent of Financial Institutions, with a mandate to roam across banks, insurance companies and pension plans.
"We see everything. ... If we see something that concerns us, we tell them to fix it," says Julie Dickson, OSFI superintendent.
Along with a consolidated regulatory system, Canada also boasts a more conservative executive-suite culture. Canadian bankers act less like Wall Street's masters of the universe and more like sedate, green-eyeshade types. Regulators aren't the enemy; they're an early-warning system that signals financial problems before they blossom into catastrophe.
In the U.S., some blame the financial debacle on the 1999 repeal of a Depression-era law that prohibited commercial banks from owning investment banks. But Canada notably allowed such mergers for more than a decade without incident before the U.S. scrapped its Glass-Steagall law. Conservative management made the difference.
In 2005, for example, Ed Clark, CEO of TD Bank Financial Group, which operates a U.S. retail subsidiary, grew increasingly worried about the complexity of some of the securities in the bank's portfolio.
Clark didn't fully understand how the derivatives would behave in different market environments, and he suspected no one else did either.
So he did something almost no one on Wall Street had the foresight to do: He ordered his traders to ditch the risky but highly profitable positions. Over the next nine months, TD gradually unwound its derivatives holdings at a cost of more than $200 million in write-offs, which looks like a bargain compared with the $2.2 trillion in losses that U.S.-originated derivatives are expected to incur this year and next, according to the International Monetary Fund.
Still, at the time it was a controversial move, even within TD's own ranks. "I actually said internally, 'I'm not going to be proven right in my career,' " Clark recalled. "I didn't see it blowing up that fast."
Clark is happy to take a little credit for getting a big call right. But he says far less dramatic factors at the core of financial industry operations also explain Canada's stability. Canada's Big 5 banks, which account for about 85% of industry assets, didn't make subprime loans to customers with weak or non-existent credit ratings. And rather than package their mortgages into securities for sale to other investors, as U.S. banks did, Canadian banks held onto the loans. Limits on the banks' use of borrowed money to goose their investment returns further insulated them from the woes suffered by their American counterparts.
While Canada has avoided the more than $1 trillion the U.S. has at risk in its financial industry rescue, it hasn't been able to dodge the economic fallout. Thanks to its close links to the U.S., unemployment is 8.4% and total output in April was 3% less than one year ago.