Money Matters

Having been born into a family with a near-century’s worth of expertise in real estate, mortgages, and investments, my interest in high finance is only natural. But even for the layperson, the history of money, banks, and financial institutions is multi-layered and intrinsically fascinating. It stands out because of its cast of actors—economic wizards, free marketers, and others—as well as its unique melding of mercantilism, capitalism, and, alas, occasional bouts of cronyism.

There’s no shortage of material on the subject. There are scholarly accounts on early banking methods employed in ancient cultures such as Assyria, Greece, and Italy. The Bank of England and money markets were brilliantly examined in Walter Bagehot’s Lombard Street (1873). Alexander Hamilton’s championing of the First Bank of the United States in 1791 has been widely discussed in business, historical, and biographical accounts. And the illuminating tales of successful financial families such as the Rothschilds and Medicis have been tackled by historians such as Niall Ferguson and Christopher Hibbert.

Which brings us to two intriguing, well-written books that examine aspects of the past, present, and future of American and Canadian financial institutions.

The most familiar terms denoting American and Canadian high finance are Wall Street and Bay Street. They are often employed to describe the entire financial systems in each nation. Surprisingly, these two systems have rarely been compared in any systematic way. This is the task that Christopher Kobrak and Joe Martin set out to achieve in From Wall Street to Bay Street: The Origins and Evolution of American and Canadian Finance. The book was written, and was about to be revised, before Kobrak’s untimely death in January 2017. Fortunately, Martin, his writing partner in crime, completed their shared journey, and the final result is an impressive one.

The task of juxtaposing two separate financial regimes in a historical context can be daunting. Kobrak and Martin recognize that while “Americans and Canadians share many experiences, they see the world very differently.” Indeed, each country looks at the size of government, state intervention, and private enterprise through a unique lens. Though the literature on American finance and financial players is immense, the same cannot be said of Canada. The authors acknowledge this difference, and note that it forced them to consult numerous Canadian primary documents so that they could undertake a detailed comparison of the two systems.

Of course, there are deep similarities, with banks playing a major role in money creation and capital formation in both countries. In the case of the U.S., these issues have been front and centre ever since the political debates that accompanied the American Revolution. The founding fathers discussed the role of banks with considerable passion. There were serious divisions between the followers of Hamilton’s vision of a consolidated system based on a central bank, which ultimately won out, and Thomas Jefferson’s derision of “all banks and all paper money.” In Canada, the evolution of banking was less contentious. The first permanent commercial bank was the Bank of Montreal in 1817, its design owing much to Hamiltonian principles.

As they range back and forth across the border, Kobrak and Martin adeptly explore how banks in the two countries dealt with the free market economy, periods of war and financial instability, and the introduction of railroads, computers, and other technological marvels. The U.S. Civil War, for instance, exposed serious financial divisions between North and South. British neglect of its economic interests in the North caused it to unwisely hedge its bets by lending to the South using future cotton deliveries as collateral. Meanwhile, the tragedy of this bloody battle between families and communities led to considerable turmoil for banks on both sides of the conflict. During this difficult period, the Canadian banking system, unlike its American counterpart, experienced no failures. The Fathers of Confederation even passed an act explicitly aimed at ensuring that the new country managed to sidestep the mistakes being made south of the border and to establish a set of basic financial tenets that have endured in Canada ever since.

During the twentieth century, Canada led the world in branch banking. Consolidations and mergers were another defining feature, especially from the 1920s onward. For example, after the Royal Bank and Winnipeg-based Union Bank merged in 1925, the Bank of Montreal slipped into second place in terms of size and influence. At the same time, while the U.S. was becoming the world’s major economic powerhouse, its financial system remained extremely fragmented. Even the establishment of the Federal Reserve in 1913, and a major overhaul in its banking system, failed to end this fragmentation.

The book’s latter chapters, which examine the last four years of the Second World War and then the postwar era up to 2008, illuminate the fundamental changes in North American finance over this period. In particular, the U.S. was regarded as a safe haven even during occasional economic slowdowns, while many foreign investors viewed the nation’s growth potential in more favourable terms than they did the growth prospects in their home countries. All of this was compounded by American pre-eminence in world financial markets, especially between 1945 and 2000, in spite of the collapse of the original international monetary system known as Bretton Woods.

Kobrak and Martin point out that the Canada-U.S. relationship was transformed in the postwar period. “Many business leaders in both countries,” they write, “began to think of the pair as nearly one country for business purposes, despite growing fervour in each nation for a more nationalistic economic policy.” Yet the authors believe “Canada has met more success by far than America in realizing the intentions of the creators of the country’s financial system.” This is because our country has been able to circumvent many of the worst financial convulsions that the U.S. has confronted, while our concentrated banking system has given us a system that has a surprising degree of independence given its relatively small size in global terms.

Is this contention true? Many commentators criticize Canada’s overarching degree of state intrusion within our financial system, and would prefer to see greater degrees of economic freedom, deregulation, and internationalization. But our historically cautious nature with respect to financial institutions did enable us to bypass some of the worst components of the 2008 global economic crisis.

Patricia Meredith and James L. Darroch’s Stumbling Giants: Transforming Canada’s Banks for the Information Age offers a nuanced look at the post-financial meltdown period, providing a unique and original perspective in the process. While regulation enabled Canada to escape the worst effects of the crisis, they recognize that these priorities, which “served Canada well in the past…now cast a shadow over the future.” Hence, they examine some innovative ways to end the archaic nature of Canadian banking and help move it completely into the twenty-first century.

The authors believe Canadian banks have fallen well behind in the modern age of technology. In their view, the institutions “either appeared to be too slow in recognizing the changing temperature or wilfully chose to ignore a mortal threat.” As an example, our banks are losing at least $8 billion in potential annual savings by refusing to eliminate something as basic as paper cheques and invoices. Delaying the move toward more digitized banking processes also means Canadian companies and financial institutions are not reaping the cost efficiencies, which Meredith and Darroch estimate to be between one and two percent of GDP. That’s not something Canadians should take any pride in.

Another interesting piece of this puzzle is the mortgage market. Meredith and Darroch correctly point out that while Canada “avoided the extreme excesses of the U.S. sub-prime mortgage market, it was nonetheless moving in a similar direction in the run-up to the 2008 crisis.” How so? The Canada Mortgage and Housing Corporation was in the process of reducing mortgage insurance terms to allow for a near-zero down-payment capacity, which obviously tempted more home buyers and led them down the worrisome path of massive borrowing and significant debt.

Other trends were visible before the crisis, say Meredith and Darroch, and these have continued since. Canadian banks have been gaining ever greater relative weight in the market for mortgages and financial services. In contrast, private mortgage lenders are finding it increasingly difficult to properly compete. This reduces consumer choice and unnecessarily increases the banks’ influential hand. Meanwhile, small and mid-sized businesses are suffering due to the lack of innovation. The preponderance of cautious-minded lenders and investors in Canada, along with fragmented capital markets and a minuscule role for venture capital, means domestic start-ups lack sufficient funding. Indeed, this reduces opportunity, eliminates potential job opportunities in the private sector, and restricts the growth potential of new businesses to enhance the Canadian economy.

It’s also worth mentioning Canada’s historical over-reliance on branch banking. Although our country traditionally benefited from its flourishing branch system, the digital age is causing the sun to set on brick and mortar. One important indicator is that our banks are making international investments, but shareholders haven’t reaped a substantial financial windfall. Meredith and Darroch point out this “might be considered a sound strategy if the banks were building sustainable customer-focused franchises using the latest technology, but they are not. Instead, they are doubling down on the traditional branch-banking business model at home and in costly foreign acquisitions, an approach that is increasingly open to question.”

What can be done to correct this downward trend? In the book’s weakest section, the authors inexplicably suggest the federal government should intervene—since the banks seem -unwilling—to do what is necessary to ensure a financially secure future themselves. They propose several solutions, including new sources of funding that draw directly on financial markets and are focused on small and mid-sized businesses, modernizing the payments system to encourage new forms of innovation and competition, and setting up a governance model “that is inclusive, collaborative, flexible, and adaptable while protecting the public interest.”

Supporters of free markets would obviously prefer to see the private sector lead the charge toward innovation. But Meredith and Darroch, much like Kobrak and Martin, have provided a wealth of information about the North American banking system. Their readers will come away with a greater understanding of American and Canadian high finance, too.