Friday, February 13, 2009

Cash for Trash?

I can't decide where I stand on this debate.

At the Progressive Economics Forum, Duncan Cameron is saying that the Canadian government is bailing out Bay Street's bad loans just the same way that bush II and Obama are using taxpayers' dollars to help Wall Street.

Though you may not have read about it, the federal government is borrowing up to $200 billion to provide cash to mortgage lenders, cash to crown corporations that lend to business, cash to life insurers, and cash to shore up the reserves of our chartered banks.
Called the Extraordinary Financing Framework, or EFF, you have to go back to the Canadian postwar loan to Britain to find a financial operation anything like (though a lot bigger than) the 2009 Bay St. bailout. In 1945-6 we were lending to an overseas customer, so that it could buy our products. This time the government is providing cash to the financial sector, so its shareholders can stay afloat.
Instead of bailing out Bay St. the government could take over ownership of the banks at less cost, and use the sizable amount left of the $200 billion to stimulate the economy, so that people could make a living, and businesses not go belly up in the first place.

In the comments section, Stephen Gordon disagrees:

Um, no. Duncan doesn’t understand what is going on. These are exchanges of assets that leave the banks’ balance sheets unchanged. The point of these transactions is to increase the liquidity of the banks’ capital (CMHC paper is more liquid than mortgages), not to improve their capital ratios. Neither the federal government’s not the banks’ balance sheets are affected by these activities. No-one has suggested that the mortgages purchased by the CHMC are toxic waste.
This story being told in that column is about what is going on in another country, one that happens to be a neighbour of ours. But it’s not a story of what is going on in Canada.

I'd read about that somewhere before, long ago, at a website now lost to the mists of time. Or something. But I can't seem to figure out how an "exchange of assets" isn't "cash for trash." If the banks' mortgage assets aren't in any trouble then why are they having difficulty with them? If they're causing problems, why are we taking them over at the valuation levels that the banks are saying they're worth?

Cameron responded:
Stephen please explain why the government is borrowing up to $200 billion to help out the banks? Please explain why Carney is in Davos calling on the banks to lend? Please tell us how the banks are planning to deal with the loans out to the Detroit three equal to 50 per cent of their capital? And review for us what it takes for a balance sheet to undergo de-levering successfully.

And there things stand.

A couple of links for the Extraordinary Financing Framework.


Stephen Gordon said...

Easy enough to resolve: The government is not borrowing $200b to help out the banks. At least, the Canadian government isn't.

The reason that the govt bought mortgages was to provide liquidity. Banks were holding mortgages that were performing, but since everyone was panicking about any and all mortgages, the backs couldn't use them as collateral to borrow and carry on their usual business.

What the government did was to trade those mortgages for CMHC bonds. CHMC bonds are more liquid, because it is almost-certainly backed by the federal government.

So CHMC got a bunch of performing mortgages (I repeat: this is not the 'toxic waste' that TARP is expected to eat), and in return, banks got assets that they could use as collateral to carry on their business.

You're welcome.

thwap said...

Yeah, that's how I understood it awhile ago.

But then I heard something about mortgage companies wanting CMHC to insure 100% of their mortgages instead of 90% as it is now, and I wondered what the deal with that was.

Maybe I'm just paranoid that Canadians are complacent only because our business reporting is so scanty. Didn't we start with those 40-year mortgages and interest-only things a few years ago?

Maybe there's some skeletons in the closet after all. I just don't know.

P.S. - I wondered if you stopped by. I was going to link your name to your blog but I got lazy. Didn't know you'd be able to hear your name being called.

Stephen Gordon said...

I will generally make the effort to respond to questions and comments from interlocutors from the old days. Happily (unhappily?), you fall into this category.