Why The Canadian Financial System Did Well During The 2008 Credit Crisis

Written by guest blogger, Joe Martin.

A decade ago much of the world suffered through a financial credit crisis. In North America, the United States and Canada –two countries with many similarities, not the least of which are physical location and similar legal roots based in the United Kingdom –had very different experiences. The US experienced a full-blown financial crisis, beginning in the subprime mortgage market and culminating in the failure of Lehman Bank. Many other financial institutions were bailed out or failed. North of the border, Canadian financial affairs were much calmer. Although there was an Asset Backed Commercial Paper (ABCP) problem, no financial institutions failed and the economic decline was not as severe as in the US.

Why did the Canadian financial system perform so much better than that of the US financial system? Before answering the question it must be understood that a financial system begins with public policy. Governments set the rules in both countries. On the other side of the system are the private sector players who are governed by the rules set in the public sector.

In order to answer the question of why Canada performed better it is necessary to go back to the late eighteenth century – NOT the late twentieth century. While the Government of Canada’s decision to block the big bank mergers in the late twentieth century was a useful decision, it was not a transformative one. Four of the five key reasons the Canadian system did better than the American system in 2008 reach back to the late eighteenth and nineteenth centuries. They are:

  1. Canada has a Hamiltonian financial system. Yes, the same Hamilton, Alexander from the Tony award-winning musical Hamilton, with limited joint stock liability and branch banking. The US has a Jacksonian system, or at least did have, which limited US banks within states – indeed in some states no bank could have a branch other than the main office.
  2. The Fathers of Confederation ensured that both banking and currency were federal responsibilities when they defined Canada’s form of federalism at the 1860s Conferences. This was in marked contrast to the US where “banking” is not mentioned in their Constitution.
  3. Canada had the good fortune of having John A. Macdonald as our first Prime Minister with his capability in “cabinet making.” While his first two Ministers of Finance did not pass the test, the third one did.
  4. Sir Francis Hincks was John A’s third and best choice for Finance Minister. Hincks not only knew finances, he knew politics and how to work with the media, and he was not from Montreal. Hincks brought in compromise on the issue of currency and had the wisdom to ensure all banks were equal. In addition, he introduced the far-sighted policy of providing for decennial Legislative reviews, which resulted in more continuity in Canada than almost all other countries, especially the United States.
  5. Our financial system more or less behaved itself from the 1870s to the 1980s, but in the 1980s misbehaved. The consequence was failure – both bank and trust company, and the appointment of the Estey Enquiry. The report of the Estey Enquiry, plus Minister Hockin’s Blue Paper, resulted in the creation of the Office of the Superintendent of Financial Institutions (OSFI).

 

The OSFI – plus nearly two centuries of a Hamiltonian financial system in which banking was a federal responsibility from day one, the right choice for Minister of Finance in 1869, and in 1871 the foresight to provide for regular reviews of the Bank Act – led to Canada to doing much better than the United States in the 2008 financial crisis. In addition, there have been basic and fundamental differences between the way the two countries finance the housing market which were also a big factor. But those are the subject of a future blog post…

 

 

Joe Martin is the Director of the Canadian Business and Financial History Initiative at the Rotman School of Management as well as President Emeritus of Canada’s History Society. He is the co-author of From Wall Street to Bay Street. Want to learn more? Check out the trailer for Stability and Crisis: The History of the Canadian Financial System, a new documentary from Kevin Feraday based on the book.