Friday, February 21, 2014

Canada's Crisis (part 3) –The Banking Crisis

“Bail-in policies are appearing in multiple countries in direct relation to 'Too big to Fail' (T.B.T.F) banks to convert the funds of ‘unsecured creditors’ into capital; and those creditors, it turns out, include ordinary depositors. Even ‘secured’ creditors, including state and local governments, may be at risk.  Derivatives have ‘super-priority’ status in bankruptcy, and Dodd Frank precludes further taxpayer bailouts. In a big derivatives bust, there may be no collateral left for the creditors who are next in line.  ‘Too big to fail’ now trumps all.  Rather than banks being put into bankruptcy to salvage the deposits of their customers, the customers will be put into bankruptcy to save the banks.  The big risk behind all this is the massive derivatives boondoggle managed by banks. Derivatives are sold as a kind of insurance for managing profits and risk; but they actually increase risk to the system as a whole” (The Derivatives boondoggle is explained in SIDE NOTE 3 down below in this article)

“The CEOs of Canada’s five banks work literally within a few hundred meters of each other in downtown Toronto.  This makes it easy to monitor banks.  They also have smart-sounding requirements imposed by the government:  if you take out a loan over 80% of a home’s value, then you must take out mortgage insurance.  The banks were required to keep at least 7% tier one capital, and they had a leverage restriction so that total assets relative to equity (and capital) was limited.  But is it really true that such constraints necessarily make banks safer, even in Canada? Despite supposedly tougher regulation and similar leverage limits on paper, Canadian banks were actually significantly more leveraged – and therefore more risky – than well-run American commercial banks.  For example JP Morgan was 13 times leveraged at the end of 2008, and Wells Fargo was 11 times leveraged.  Canada’s five largest banks averaged 19 times leveraged, with the largest bank, Royal Bank of Canada, 23 times leveraged.   It is a similar story for tier one capital (with a higher number being safer):  JP Morgan had 10.9% percent at end 2008 while Royal Bank of Canada had just 9% percent.  JP Morgan and other US banks also typically had more tangible common equity – another measure of the buffer against losses – than did Canadian Banks. If Canadian banks were more leveraged and less capitalized, did something else make their assets safer?  The answer is yes – guarantees provided by the government of Canada.  Today over half of Canadian mortgages are effectively guaranteed by the government, with banks paying a low price to insure the mortgages.  Virtually all mortgages where the loan to value ratio is greater than 80% are guaranteed indirectly or directly by the Canadian Mortgage and Housing Corporation (i.e., the government takes the risk of the riskiest assets – nice deal if you can get it).  The system works well for banks; they originate mortgages, then pass on the risk to government agencies.  The US, of course, had Fannie Mae and Freddie Mac, but lending standards slipped and those agencies could not resist a plunge into assets more risky than prime mortgages.  The systemic strength of the Canadian system is camaraderie between the regulators, the Bank of Canada, and the individual banks.  This oligopoly means banks can make profits in rough times – they can charge higher prices to customers and can raise funds more cheaply, in part due to the knowledge that no politician would dare bankrupt them.  During the height of the crisis in February 2009, the CEO of Toronto Dominion Bank brazenly pitched investors: 'Maybe not explicitly, but what are the chances that TD Bank is not going to be bailed out if it did something stupid?'  In other words:  don’t bother looking at how dumb or smart we are, the Canadian government is there to make sure creditors never lose a cent. With such ready access to taxpayer bailouts, Canadian banks need little capital, they naturally make large profit margins, and they can raise money even if they act badly”.   

“The Conservative government claims that Canadian banks had more sensible investment policies. It is true that the banks did not indulge in as much wild speculation as US and European banks, but only because the Canadian government had not gotten around to de-regulating the banks.  However, contrary to government claims, Canada’s five largest banks (RBC, TD Bank, Scotiabank, BMO and CIBC) were bailed out. The banks’ borrowing from the US Federal Reserve peaked at $33 billion, while loans from the Bank of Canada peaked at $41 billion in December 2008. In addition to this, in an unusual move, the Canada Housing and Mortgage Corporation (CHMC) bought $69 billion of bank held mortgages from the banks – in other words a $69 billion injection of cash. To put this bail-out into perspective, the money would have “made up 7% of the Canadian economy in 2009 and was worth $3,400 for every man, woman and child in Canada.” (CCPA, 6, 2012). In early 2009 CIBC, BMO and Scotiabank were bankrupt, only staying afloat with government support which was equal to or greater than the value of the companies. Nevertheless, while being bailed out the five biggest Canadian banks reported $27 billion in profits. In addition, their CEOs remained among the highest paid 100 CEOs of Canada’s public companies and received substantial raises. This raises the question – are Canadian banks too big to fail? The amplitude of the financial support given to Canadian banks in 2008-2010 suggests that the Government of Canada, the Bank of Canada and the big banks themselves believe that the major banks are ‘too big to fail’ and will be bailed out irrespective of the cost.  Meanwhile, the 2013 Canadian federal budget, released on March 21st, makes provisions for possible bank defaults that raise some serious questions. Chapter 3 “Supporting Jobs and Growth” in the budget lays out the framework for bankrupt Canadian banks to recapitalize themselves using ‘bank liabilities’ (Economic Action Plan, 2013, pp. 144-145). The budget states that:  “The Government proposes to implement a “bail-in” regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers. The Government will consult stakeholders on how best to implement a bail-in regime in Canada. Implementation timelines will allow for a smooth transition for affected institutions, investors and other market participants.” (Establishing a Risk Management Framework for Domestic Systemically Important Banks”, pages 144 and 145).  The proposal disingenuously does not define “bank liabilities.” Bank liabilities are the debts incurred by a bank, what a bank owes. While a bank has traditional business liabilities and debts (for electricity, office supplies, employee wages), the bulk of a bank’s liabilities are financial, of which the most important liability category is clients’ deposits. In its present wording, the proposal seems to allow insolvent banks to use clients’ bank accounts to recapitalize themselves.  During March mainstream media reported that Cypriot depositors were going to get a ‘haircut’ to pay for Cyprus’ economic crisis. The Cypriot government, agreed to a Troika (IMF, ECB and EU) imposed plan to seize up to 40% of the money in people’s accounts with more than 100,000€.  This strategy became known as a ‘bail-in.’ As a result of these levies, many small, family businesses will face ruin, and many middle class savings will be severely hit. The news that everyday Cypriots will be losing parts of their savings was alarming, but seemed far removed from the reality of most Canadians’ lives until the release of the 2013 budget.  The Finance Department issued a statement emphasizing that depositors’ money would not be used to help stabilize an insolvent bank and that instead, Canadian banks would have to rely on their own capital. Under the proposed Canadian plan, banks would set aside contingent capital, such as shares, which could be quickly converted to cash to provide liquidity and stabilize their operations should a crisis hit. It also stated that depositors’ accounts will continue to remain insured through the Canada Deposit Insurance Corporation (CDIC), preventing tax-payers from taking a hit like they did in Cyprus in case of a bank default.  Ministry of Finance’s statement, that banks will have to rely on themselves, seems to support the budget’s conclusion that “this risk management framework will limit the unfair advantage that could be gained by Canada’s systemically important banks through the mistaken belief by investors and other market participants that these institutions are ―too big to fail”.  The Tories are claiming that the Canadian state will not back failing banks. However, they also claim that the banks did not receive a bail-out in the last financial crash. It is clear that if, or when, the next financial crisis hits, Canadian banks will be vulnerable. Canadians have one of the highest rates of household debt in the world, standing at 165% of disposable income. Household debt was 128% of disposable household income in the USA in 2007, the year before the economic crisis hit. Much of Canadians’ debt is tied up in housing mortgages and there is still a housing bubble in many parts of Canada. Without state intervention the next financial crisis will be devastating. If banks are expected to convert their liabilities (especially if these remain loosely defined) into regulatory capital, there would just be all the more reason for depositors to make a run on their banks in case of an economic crisis.  In the case of a Canadian ‘bail-in,’ depositors holding under $100,000 would probably be safe, as accounts up to $100,000 are insured by the Canada Deposit Insurance Corporation (CDIC), a Federal Crown Corporation. However, anything above $100,000 could hypothetically be seized. In such a scenario small businesses and the middle class could be severely hit.  If deposits under $100,000 were included, either the CDIC insurance would have to be voided, causing a huge political row, or the CIDC would be bankrupt and so the government would have to bail it out. The CDIC does not have nearly enough money to cover all the deposits it insures. The 2012 CDIC report shows that the Crown Corporation is increasingly pessimistic about its own ability to intervene successfully (guarantee deposits) in the case of bank insolvency. According to its annual report, the CDIC insures $622 billion and but only has $2.4 billion in funding and a $18 billion borrowing limit. The 2013 budget proposal indicates that in private the government is less confident about Canadian banks than it states in public. The proposal also shows that if there would be a problem with Canadian banks, the government would mainly go after the middle layers of society, those with accounts exceeding $100,000, while ‘respecting’ the CDIC. The poor, those with under $100,000 in savings would probably be spared, as would the very wealthy, assuming that they have their assets in complex financial portfolios, stock options, and off shore accounts.  What does all this mean in the end? The 2008-2010 bail-out and the proposal in the 2013 Federal Budget mean that Canadian banks are not as safe as the Canadian government and the big banks claim. Moreover, the ongoing secrecy about the 2008-2010 bail-outs also casts serious doubt over the sincerity of Flaherty’s statement and his assurances that taxpayers and depositors will remain untouched in the event of a bank becoming insolvent.  Nowhere does Flaherty propose to make the rich pay for a future crisis anymore than they did for the last one. He has made sure that the big banks and the inflated salaries of the top management are protected".

“Since the financial crisis of 2008, Canada’s banks have become the darlings of the financial world, lauded by experts and observers for weathering the global storm arguably better than banks anywhere else in the world.  But according to an influential U.S. finance blog, that status is an illusion, and Canada's banks face potential catastrophe if their assets drop in value
 According to 'Tyler Durden', the pseudonymous blogger behind Zero Hedge, 'there is one place that has been very much insulated from the whipping of the market, and one place where banks are potentially in just as bad a shape as anywhere else in Europe.  That place is...CANADA'.  Durden's argument centers around the Canadian banks' tangible common equity ratio - a measure of banks' ability to absorb losses. Durden reports that all of Canada's major banks have a TCE ratio below 4 per cent, meaning the banks could be insolvent if their assets lose more than 4 per cent of their value -- a narrow margin indeed.  According to Boyd Erman at the Globe and Mail, such a scenario could happen if Canada's housing market weakens considerably.  'In Canada, the concern would have to be the housing portfolios, the biggest chunks of Canadian banks' assets," Boyd writes. "If you believe that housing is in for a severe correction in Canada, and that Canadians won't repay their mortgages when the value of their homes falls, and that the banks will have to take significant write downs on the portions of their mortgage portfolios that are not insured by the federal government, then maybe you will come to the conclusion that Mr. Durden is onto something."  A chart comparing world banks' TCE ratios shows that all of Canada's six largest banks are among the 21 banks with the lowest TCE ratios, or the highest risk of becoming insolvent if the economy goes south.  CIBC's TCE ratio places it fourth in the world, with only Societe Generale, Deutsche Bank and Credit Suisse showing lower ratios. The National Bank, Scotiabank, RBC, TD and BMO all make the list as well, with five of the banks showing TCE ratios below 4 per cent, meaning a 4 per cent decrease in the value of their assets could sink the banks.  Canada's banks commonly report TCE ratios of 6.5% or better, but as the Globe's Boyd explains, those ratios are based on risk-weighted assets rather than total asset values.  'Risk weighted assets adjust for the chance that the assets will go bad, and that's hardly a science. Total assets doesn't allow for such judgment calls', Boyd writes"

"Not only does the BoC not have any gold holdings in foreign countries to ask for, it lacks any substantial gold holdings at all.  The Bank of Canada today holds less gold than at any other point in its 79 year history. The total reserve of just over 3 tons pales in comparison to the highest level recorded in its history at 1,023 tons in 1965. This means that there are about 0.003 ounces of gold sitting in reserve at the BoC for every Canadian, or just a little under $5.80 at today´s market prices
.  Of course, one can easily ask what difference it makes. Like all fiat currencies, the Canadian dollar is nonredeemable. If you go to your bank and ask for something in exchange for a beautiful new twenty dollar bill the best you can hope for are two tens.  Even though it is nonredeemable, the gold in a central bank´s vaults serves two purposes.  It is an asset that is steady in value and aids central banks in maintaining their operations. Central banks are not so different than private banks. Both hold assets and liabilities and in the BoC´s case, its assets include government of Canada bonds and its liabilities are comprised mostly of the currency outstanding. Central banks, much like private banks, don´t wish to go bankrupt. Partly this is to protect their independence. Central banks covet their independence from the governments that grant them their monopoly right to control the money supply. If the Bank of Canada entered insolvency tomorrow, there would be a bailout coming from Ottawa. And you better bet there will be increased political attention on the BoC´s operations as a result. I´m sure that central bankers at the BoC are not gluttons for the paperwork, overtime and other forms of pain this could entail.  Of course, the BoC could only enter insolvency if its assets lost value below its liabilities. (It's liabilities, being compromised mostly of currency, are fixed at par value, and as such cannot change in value.) A potential source of a loss of value on its assets could come from default and whether partial or full amount the assets it holds. The government of Canada is not the least fiscally responsible one in the world. Yet as I have outlined here, Canada ranks among the illustrious peer group of the United Kingdom and Portugal as the only other developed country to have debt-GDP levels above 90% for the government, household and corporate sectors. (Maybe this extreme indebtedness will help Mark Carney feel at home as he returns to the UK to take over the Bank of England´s helm).  Holding gold erases the possibility that a central bank will have to turn to its government for help, along with the increased oversight that will come with it.  The second reason why gold in a central bank´s vault makes sense is that, well, something has to be there, and it might as well be gold. In order for a central bank to alter the money supply without causing undue disruptions to the economy, it must undertake a process called sterilization. This relatively simple procedure involves buying or selling an asset whenever the money supply is increased or decreased. If the central bank did not do this important step, it would be forced to give newly issued money directly to some parties, resulting in large wealth re-distributions.  It is commonly argued that instead of holding gold in its vault and not earning interest on it, the central bank should just hold another risk-free asset in the form of government bonds. It will earn a little interest on these bond holdings, and thus be able to pay off some of its operating costs.  This strategy is indeed cost reducing for the Bank of Canada, with an important caveat. The government of Canada must make good on the bonds that the BoC holds. Increasingly it is becoming clear that the government is jeopardizing its financial stability by spending beyond its means and running deficits.  And this brings us to the core part of the argument. Her Majesty´s Government of Canada runs a deficit in part because it is cheap to do so. Interest rates on federal bonds are quite low. One reason why these interest rates are low is because the Bank of Canada stands ready to continue buying these debt issuances in a bid to hold on its own balance sheet as it increases the money supply. By pledging to purchase and hold on its balance sheet federal bonds, the BoC allows the government to take on a more precarious financial position than would otherwise be the case. The culmination of this process could be a loss on the BoC´s assets, if the government gets to the point of default.  Gold is not a barbarous relic for a central bank. The Bank of Canada, by shedding its gold reserves to the point where it holds less than Bolivia, Bangladesh, Cambodia, or Macedonia, has placed itself in a difficult position. Refraining from buying federal debt now would cause interest rates to rise, and potentially endanger the government´s solvency. While this outlook is none too pleasing, the threat of insolvency would send a strong signal to Ottawa to get the government´s finances back on track. Threatening to recommence gold purchases to hold in its reserves at the expense of government bonds is an easy option available to the BoC. The federal government doesn´t have to listen to too many people, but in this case, the Bank of Canada has the ability to make the government an offer it can´t refuse".

1.) When the Global Economy Crashes, "Canada's real estate is estimated to collapse by 90% (highest), 25% (lowest)".  It will probably be somewhere in the middle of both of those numbers but
regardless, it's still something to think about.  We know the crash is coming, it is a matter of time, and it is unavoidable.  The economy itself presently is shrinking.  The effect of the crash on National Economies and the Date it occurs is what's left to speculate about.  Historically, Crashes have occurred during the end of the Summer season and during the Fall season.  It is a possibility it could occur around that time again in 2013 or 2014 because the Economy globally has continued to contract since 2008 with minimal gains or recovery The way it is working now, it works perfectly for the Elite, and the Wealthy, and Big Business. They are getting what they want bit-by-bit, day-by-day. They really do not need to completely tank the Canadian economy. Full time jobs are turning into part time jobs, Major companies from the US are coming into Canada (ex: Target, Nordstrom, etc.), Mergers and Monopolies are occurring everywhere, people have accepted the new norm of working 2-3 jobs, the infrastructure is eroding everywhere and needs heavy investment which the government(s) on all levels do not have the luxury to afford, and Inflation is rising (among other things occurring presently). This formula works for the Elite and Big Business presently. The only thing they are unable to do presently is get the Free Trade Agreements signed and to find a way to introduce Privatization into the Transportation and Medical Industry which I believe they will need the economy to tank for that to happen and have Canadians accept it. If they want to speed it up and bring it all down, they have the power to do it overnight and all they have to do is pop one if not two bubbles and the trickledown effect is imminent . Either way, the Elite and Big Business are slowly moving forward and creating a Third World economy in Canada. There is no going back to before 2008 and the reality we lived then.

2.) "Our economy is based on being a 'Fire Economy' –finance, insurance, and real estate- which puts us in major trouble for job losses when the Economy crashes and people start defaulting. A 'Fire Economy': is New York City's largest industry, a prominent part of the service industry in the U.S. overall economy, as well as being a prominent part of other Western developed countries. Criticism exists on the internet and in the blogosphere for the shifting of North American economies to a FIRE economy at the expense of a manufacturing and export-based economy. As the consumer of last resort, many believe that North America has eschewed productive elements of its economy in favor of consumption to its long term detriment".

3.)  How large is the Derivatives Market? $1.2 QUADRILLION IN NOTIONAL VALUE; AT LEAST $12 TRILLION IN CASH AT RISK.
You read that headline right. By at least one estimate, in 2010 there was a total of $12 trillion in cash tied up (at risk) in derivatives as defined above, all of which controlled contracts connected to assets valued at $1.2 quadrillion.  Here’s how we got those numbers — be sure to differentiate the two values, cash value vs. notional value, as explained below.  Big Risk: $1.2 Quadrillion Derivatives Market Dwarfs World GDP.  One of the biggest risks to the world’s financial health is the $1.2 quadrillion derivatives market. It’s complex, it’s unregulated, and it ought to be of concern to world leaders that its notional value is 20 times the size of the world economy. But traders rule the roost — and as much as risk managers and regulators might want to limit that risk, they lack the power or knowledge to do so. A quadrillion is a big number: 1,000 times a trillion. Yet according to one of the world’s leading derivatives experts, Paul Wilmott, who holds a doctorate in applied mathematics from Oxford University, $1.2 quadrillion is the so-called notional value of the worldwide derivatives market. To put that in perspective, the world’s annual gross domestic product is between $50 trillion and $60 trillion. To understand the concept of “notional value,” it’s useful to have an example. Let’s say you borrow $1 million to buy an apartment and the interest rate on that loan gets reset every six months. Meanwhile, you turn around and rent that apartment out at a monthly fixed rate. If all your expenses including interest are less than the rent, you make money.  But if the interest and expenses get bigger than the rent, you lose"

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