Contrary to what one hears in popular media outlets, the global financial crisis that reached its apex in the fall of 2008 was not the singular result of “greedy” investment banks, but the severe fracturing of a system that so over-extended along the entire food chain that we are all to blame.
This crisis was a long time in the making. One of the hallmarks of the U.S. marketplace–as we know–is competition. This naturally extended to home finance. Lending margins for banks on traditional mortgage products had become so thin that is was a superior return on capital to facilitate mortgages, collect fees, and sell off their mortgage portfolios to securitization operations run by Wall Street investment banks. Having less “skin-in-the-game” led to lax lending standards, which ended in tears. Investment Banks in the U.S. did not execute the mortgage pool purchases in a vacuum. They were fulfilling a need at the other end of the food chain, the institutional bond portfolios that needed yield.
Misjudging risk
Just as the post dot-com low rate rubric fueled the housing boom with cheap money, this same situation created challenges for institutional funds to meet yield targets. With the enablement and blessing of solid investment grade ratings, fund managers were able to buy all assortments of structured yield and credit investments in order to achieve better results. The ratings enablement as we now know was a severe misjudgment of the risk profile of many of these mortgage related securities. So, when sub-prime defaults began to uptick the cascade of carnage was unavoidable.So what happens now? At this juncture, the U.S. regulatory response seems light relative to the precipice that their banks took them too in 2008. It is clear, however, that at some point. regulation will likely look, act and feel a lot like Glas-Steagal. “Utility” Banks where individuals and companies do their banking will face renewed regulation that will limit their areas of business operations. The fear of systemic failure is the overriding risk that must be dealt with. On the other side of the equation, Investment Banks will be allowed to take risks and will be allowed to fail. This in itself, the moral hazard/too big to fail issue must be dealt with. Knowing that an investment bank can in fact fail will in itself limit the degree and/or scope of business it can put on its balance sheet.
The Canadian advantage
This brings us to the opportunities available to Canadian banks. Largely avoiding the many of the issues identified above, Canadian banks have an unprecedented opportunity to grow. Coupled with their relatively healthy positions, they are well placed to enable a prolonged period of healthy commodity related business growth.
Canada has what the world needs most right now: namely key energy, agricultural, precious and base metal resources. The challenge is one of scale, especially internationally. The ultimate dealer position for the Canadian banks is their matching off with their main corporate client segment, commodity producers, with consumers of said commodities many of whom are in emerging nations. This is the principal challenge and opportunity set before us.
Bill Bamber is Global Head of Structuring with CIBC Capital Markets