Fabrice Taylor is a chartered financial analyst.
Wall Street's fat cats get picked up by the scruff and thrashed, but their Bay Street cousins lick their paws by the bonus pool. How do our well-fed felines get away with it?
If you listen to U.S. President Barack Obama and others with a distant view of things, Canada's bankers are role models for the world, paragons of restraint and sound business practice. That might be relatively true but no one ever talks about the generous subsidies our banks enjoy.
Canadian bankers will earn record bonuses for 2009, during which they enjoyed a timely multibillion-dollar lifeline from the Canadian taxpayer. What's more, our banks are increasingly subsidized by the federal government, using our money. Yet no one says hell-no to the Big Six banks' collective $8.3-billion in bonuses.
The foundations of our big banks are their retail businesses - lending money to you and me. This is the prodigious cash cow, not the wholesale side (investment banking and so on, which is where the really big bonuses are paid).
As Toronto-Dominion CEO Ed Clark once put it, "Just stop doing the stupid things and these are money machines like God has never created before." By "these" he means banks, but you knew that. As for stupid things, they tend to come from the wholesale side. In other words, retail supports wholesale. That's an important point.
So what makes a retail bank a cash cow? Ultimately, it's mortgages.
Banks use mortgages to tie up customers. Once they have your house loan, they likely have your credit card, line of credit, car loan, deposit, RESP, RRSP and other business, too. The mortgage is crucial and they fight hard to win you over. But it's no loss leader. One bank I looked at, chosen randomly, earned net interest margins (a crude measure of profitability) of $2.3-billion from domestic residential mortgage lending last year. Mortgages are profitable and make possible other highly profitable things.
But here's the nub: Our banks give lots of mortgages that are guaranteed by the government of Canada. Home-buyers who can't put down at least 20 per cent must buy mortgage insurance, the vast majority of which comes from Canada Mortgage and Housing Corp. The banks, in other words, make these loans without taking any risk. And while borrowers pay for the insurance, the program is guaranteed by taxpayers.
Giving mortgages in Canada is a lucrative and ultimately subsidized, business. CMHC makes money on paper, but it's pretty hard to see if it does in reality over time. And even if so, the guarantee is a subsidy.
Mortgages are the cornerstone of retail, and profits from retail "insure" banks against wholesale stupidity. This allows them to take risks that, if they work out, lead to big bonuses for bankers, who bear none of the agony if the risks don't pay off. In short, even wholesale bankers benefit from the subsidy.
But the plot thickens. Guess who, on paper, is the biggest mortgage lender in Canada? Royal Bank? Wrong. Toronto-Dominion? Not even close. Who is this great benefactor? The Canadian government.
At the end of 2008, the latest figures we have, CMHC had $149-billion of investments in mortgage-backed securities on its balance sheet, up from $96-billion the previous year.
At the height of the financial crisis, the government of Canada announced a plan to buy mortgages from banks to provide them with cash. The money comes from the sale of government bonds and CMHC uses it to buy loans. So far that program has bought $66-billion of mortgages.
The other mortgages on the CMHC balance sheet are technically owned by the little-known but huge and growing Canada Housing Trust, but they are consolidated because CMHC bears all the risk of default.
Canada Housing Trust is financed by the issuance of bonds (which are sold by, among others, Canadian banks in return for a nice fee). And it is an insatiable beast. It has no trouble raising money because the government guarantees the return and that return is higher than comparable Canadian bonds.
It's a no-brainer for banks that want to originate (i.e. sell) mortgages but not keep them on the balance sheet. To return to our example bank above, over the past three years it has done a brisk business in real-estate lending: Its "managed" mortgage portfolio has grown 15 per cent. But on an increasing number of these loans, the bank is merely the collection agent, having unloaded many of those mortgages to another party and the risk to the government. The amount of mortgages the bank has kept has dropped by 6 per cent.
Of course, banks earn fees for servicing the mortgages they sell, collecting the money and remitting it to the ultimate owners. At the current pace, CMHC's in-force guarantees and insurance will get to a trillion in fairly short order.
This is a boon for banks and their shareholders, and I'm one, so I kind of like it even if I don't think bankers entirely deserve their bonuses. Where's my bonus for taking all this real-estate risk as a taxpayer? CMHC obviously helps Canadians get into the housing market even as it benefits bond investors and banks. But are the benefits equitable?
And as the government becomes more and more active in the mortgage market, you have to wonder whether it's contributing to a housing bubble. Even some bank economists warn of over-inflated prices. That's what easy money does. Real-estate prices have held up well thanks to government intervention, which I guarantee was in part prompted by the advice of banks.
I also guarantee that if housing prices tumble and defaults rise, taxpayers will suffer, but those bonuses won't be paid back.