Financial Markets

The Canadian Minister of Finance, Jim Flaherty, made comments last week about stronger regulations regarding the bonuses that financial industry employees receive. With the world looking to Canada for leadership on the finance plateau, Flaherty needs to proactively avoid the scandals seen in American Banks who were paying huge bonuses to employees while simultaneously begging for a bailout.

Granted, there hasn't been a public outcry of disgrace at the bonuses received by Canadian financial employees, but that doesn't change the fact that much of the financial services industry is about achieving sales, using bonuses as incentives to meet specific targets.

Some would heartily argue a bonus skews the employees' sense of integrity, and might tempt them to make riskier decisions. How many people are out there right now, with no idea what type of RRSP investments they are in, having relied only on the advice of their banker? Did said person invest according to the client needs, or invest according to the pressure to achieve sales numbers for their company? The higher up the ladder you go, the bigger the bonus structure.

The suggestions made by Flaherty are mostly to make the bonuses long term; paid out over several years rather than each year. This should reduce the potential risk from "get paid now" decisions, and keep Canada from entering the same bonus fiasco as seen south of the border.

Today is federal Election Day in Canada. Surprisingly, mortgage investors at the Toronto Stock Exchange did not wait to find out the results before celebrating financial plans made by G7 representatives over our Thanksgiving weekend. The TSX is already up 12% this morning (1096.34 points). The S&P 500 and the Dow have also made gains.

Canadian federal Finance Minister Jim Flaherty was one of the planners seeking to lessen the effects of the U.S. mortgage market meltdown uncovered in August and September. However, his approach was much more restrained than that of other finance ministers. Flaherty assisted Canadian banks with $25 billion. Yesterday, the U.S., U.K. , Australia, New Zealand, and 15 European governments made substantial investments in their countries' banking sectors, including guaranteeing deposits and mortgage debts - the equivalent of hundreds of billions of Canadian dollars. Investors feel more secure knowing a government guarantees their investments, and will flock to a country offering this security.

Hence, foreign banks may find it less expensive and easier than Canadian banks to raise money to lend to consumers seeking mortgages and credit. The strong government guarantees offered by foreign governments are called regulatory arbitrage, and they are likely to make investors invest outside of Canada. Our federal Finance Minister Flaherty may have to bow to market forces and extend more help to the banks than the $25 billion he announced last week, which the banks claim is too little.

Otherwise, Canada may find itself like Australia, where Prime Minister Kevin Rudd resisted calls to invest in its banks, and Australia subsequently lost investments. Mr. Flaherty had a problem explaining to Canadian voters why he should prop up Canadian banks with tax money, when the banks already had good financial performance and high profits. Perhaps he would have been quicker to follow suit with other world governments if this mortgage crisis had occurred earlier in his term of office.

A Dalhousie University economics professor told CTV's Kate Wheeler on Thanksgiving Day that it will probably take a year for Canadian markets to recover from the American mortgage crisis, providing there are no further repercussions forthcoming. Looks like we may be in for a recession, but it won't be as deep as originally feared. No matter which leader inherits Stephen Harper's chair, he or she will have an easier economic time than expected because the Canadian mortgage system has good underpinnings

Unlike Americans, Canadians have always been required to qualify with the bank or other lender before obtaining a mortgage. The TD Bank's chief economist Don Drummond reports 4% of Canadian mortgages are subprime, whereas 40% of U.S. mortgages are subprime. Hence, most Canadians are capable of repaying their mortgage debt, and are ten times less likely to default on their mortgages than Americans. Large Canadian banks are very unlikely to close or require bail-outs as a result of the U.S. banking crisis.

Deposits and GICs in Canadian banks up to $100,000 are covered by the federal Canada Deposit Insurance Corp. The Canadian Investor Protection Fund and the Mutual Fund Dealers Association Investor Protection Corp. protect up to $1 million of mutual fund investments. The Toronto Stock Exchange rebounded today in recognition of these reassuring facts. Canadian investors with government bonds, utility stocks, and cash in their portfolios are largely unaffected by the U.S. mortgage crisis.

Canada Savings Bonds will probably increase in popularity, even though their return on investment is only 2.75% for Year 1. The U.S. mortgage crisis will affect Canadians not by the loss of their homes, but by tightening their credit. It will no longer be possible to just increase the size of your mortgage at will, as a cheaper alternative to credit cards.

Boomers who counted on selling the family home and moving to a mortgage-free, smaller dwelling with a comfortable nest egg from the profits need to rethink their plans. Younger people with steady income who were unable to find an affordable home may finally gain access to the coveted Toronto housing market if prices drop.

Yesterday, the U.S. Congress found the $700 billion bank bail-out authored by Paulson and Bernanke too left wing. Although Americans now mistrust bankers and investment brokers, they are even more reluctant to have George Bush as their landlord, even if their monthly mortgage payments are smaller. Paulson and Bernanke are expected to revise their next proposal to include private mortgage insurance, which should make it more palatable to the American right and advocates of a free market economy.

During an appearance on CTV's Question Period on Sunday, Flaherty noted the differences in the financial systems in the two countries: "We have a solid banking system in Canada. Our banks are well capitalized. Our households are well capitalized... and our fiscal fundamentals are solid."

Flaherty's comments echo those made by the Prime Minister on Friday. Both reassured Canadians that the banking, insurance and mortgage lending sectors in this country are just fine. They also addressed concerns that Canadian taxpayers would be on the hook for any financial institutions that suffered losses because of the US crisis. Flaherty and Harper stated clearly that there would be no government bailout of financial institutions, period.

Last week's turmoil in the US banking and mortgage sector has had some people dredging up the spectre of the Great Depression. At least one expert on this side of the border disagrees profoundly with that comparison.

Speaking to the Montreal Gazette, Thomas Velk of McGill University noted that the fundamentals of the US economy are, in fact, sound. A similar statement by US presidential contender John McCain landed him in hot water last week, but the numbers presented by Velk give evidence to the argument. Unlike the situation in the 1930s, growth in the US economy in the last quarter was strong, unemployment is low, and productivity is high.

Velk also addresses concerns about the writedowns Canadian insurance companies are being forced to accept. He thinks the impact will be minimal, unless our government decides to bail out the companies. Speaking to reporters last Friday, Prime Minister Harper put any fears of a government-led rescue to rest: "...the Canadian financial system is very strong and the balance sheets of the banks and insurance companies are solid enough that they don't need any financial aid."

All of this news is sure to put the minds of many Canadians at ease.

The big news of the day is the US government' "rescue" of giant mortgage firms Fannie Mae and Freddie Mac. It is hoped the move will calm fears about the US economy and restore some stability to the US housing market. The two firms own or guarantee close to half of the $12 trillion in outstanding mortgage debt in the US, but have close to $1.6 trillion in debt outstanding.

Mounting losses were the driving force behind the bailout decision.The two firms have been placed into a government-controlled conservatorship, which allows their stock to continue being traded while putting common shareholders last in line for any claims. As reported on globeandmail.com, stocks in both companies plunged on the news, as investors reasoned that the move would "wipe out shareholders but fully guarantee their bonds." The news was welcomed by many Asian central banks who are some of the biggest holders of the companies" bonds.

Equity markets around the world surged when the bailout was announced, in hopes that the long-awaited government action would restore faith in shaky world financial markets.