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It is all about debt

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July 05, 2009 – Comments (4)

There are two blogs that got my attention since my last post.

The first is about Canadian banks.  Canadian banks did not go crazy with leverage like American banks.

The World Economic Forum in October ranked the country’s financial institutions No. 1 in the world for solvency. 

There are some enormously important difference in the Canadian banking system compared to the US banking system that I have outlined previously.

In Canada there is no "safely" of a fixed mortgage rate until your home is paid for.  Mortgages renew at the current rates when mortgage terms are up.  Generally the longer the term, from 6 months to 5 years, the higher the rate.  Additionally, our banks match deposits with loans.  I have done a blog post in the past which expresses my utter horror that US banks have all of this mortgage debt commitments over 30 years and they have done so by using short term money to finance long term obligations.  The banking system doesn't get strong again until the price of risk is built back into rates and that any mortgages were issued for 30 years at the current low rates will prove to be a long term problem.   Of course issuing bonds on the mortgages means that the investors who bought those bonds have also taken on risk of bond values declining not only from the foreclosures, but also from bond prices going down when interest rates correct.  Interest rates are artifically low and must correct.  It is a huge long term problem for US banks.

Having said that, Canada really weakened its lending practices in the past couple years, but because of the structural differences in the banking system the problem will never be as bad as the US, but I do expect to see problems.

The other post that got my attention is Market Ticker's half year report on his predictions. I can't agree more that this whole mess is about excessive leverage and debt.

I am reminded of great debates I had with others about the most responsible financial plans, which generally includes home ownership.

On a macro perspective the belief that we can take debt and invest it and come out ahead is insane.  There is a spread in the rates and someone has to pay for that spread and ultimately the average will be that you will be behind by that spread.  You can make all of the arguments against that in the world that you want, but ultimately where you figure you are saving or getting ahead in one place results in more cost elsewhere.  I don't believe in immaculate conception and structurally the beliefs seem about the same to me.

There is no question there has been the appearance of money made and getting ahead, but everything about what was made has been about increased leverage and that is simply short term illusionary and paying for that illusion will be hard, very hard.

Market ticker's post is long, but I think it is a good.

4 Comments – Post Your Own

#1) On July 05, 2009 at 2:23 PM, ikkyu2 (99.38) wrote:

"Risk" and "U.S. banking" are just not a particularly meaningful combination, nowadays.  Banking is not, apparently, a business model that has to bear the consequences of the risks it incurs during operations.  Those, instead, are for the U.S. taxpayer to bear.

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#2) On July 05, 2009 at 10:26 PM, russiangambit (29.49) wrote:

People poined out that not only Canadian banks behaved more prudently, but also US investment fims which are still partnerships, like Jeffries. It is only publicly traded companies that went crazy because they weren't playing with their own money. And they were getting their bonuses, so everything was good. The link between the crime and panishment is broken in the modern day corporations.

Corporations by their nature limit risk of the owners, therefore they should be limited in the amount of risk they are able to take and it should never exceed the assets of the corporation.

I am not sure how much of depostis banks actually keep in reserves. But assuming that it is 5%, and everything else is lent out. It banks suffers as little as 5% loss on its lent out assets, that is it, it could be wiped out if not for FDIC guarantee.

Now, take Citi or BAC or WFC, even today they are probably leveraged 1 to 20-30 still, what % of loss can they get without being wiped out? If you think that the bank crisis is over, you are kidding yourself. It is like hiding under the blanket so you don't see the monster.

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#3) On July 06, 2009 at 4:01 AM, portefeuille (99.56) wrote:

Now, take Citi or BAC or WFC, even today they are probably leveraged 1 to 20-30 still, what % of loss can they get without being wiped out? If you think that the bank crisis is over, you are kidding yourself. It is like hiding under the blanket so you don't see the monster.

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#4) On July 06, 2009 at 9:56 AM, outoffocus (23.59) wrote:

On a macro perspective the belief that we can take debt and invest it and come out ahead is insane.

I'm glad somebody said it.  The whole notion of "good debt" vs. "bad debt" is also insane.  Debt is like fire. If controlled and well contained it can be a useful tool, but if played with and used recklessly, it can cost you everything.

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