DISSENTING OPINION OF
THE NEW DEMOCRATIC PARTY

The Future Starts Now

"I've seen the future, and brother, it is murder"

Leonard Cohen

"When the capital development of a country becomes a by product of
the activities of a casino, the job is likely to be ill done"

J.M. Keynes

Preamble: Statement of concern over the process followed within the Standing Committee on Finance

The New Democrat members of the Standing Committee on Finance feel it is necessary to go on record and state that the process followed by this Committee must be changed in the future, and that never again a 250 page majority report be imposed to the members of the Committee without adequate time for review, debate and input from its members. In this instance the Opposition members of this Committee had effectively less than 24 hours to react to the report of the majority, on which they had no direct input. If we are to ensure that committees remain at the core of parliamentary democracy, and the public interest is upheld, then these concerns must be heeded and acted upon.

The majority report of the Standing Committee on Finance generally endorses the vision and the recommendations of the MacKay task force. One of the major exceptions is the report's opposition in allowing banks to retail insurance and automobile leasing products. New Democrats strongly support the position of the Standing Committee on Finance, regarding the restrictions on banks and life insurance companies selling insurance and automobile leasing.

The New Democrat members of the Standing Committee on Finance are pleased that the MacKay task force adopted some of the recommendations that we have been advocating for years such as: appointing an independent financial ombudsman (albeit with limited powers), enhancing the credit union system, ensuring a broader access to the Canadian Payment system and better access to basic banking services. For the Finance Committee, we are pleased to see that the majority report is urging the government to put in place a consumer protection bureau and supports the establishment of a Financial Consumers' Organisation as advocated by the Canadian Community Reinvestment Coalition. However, we believe (as was the original position in MacKay) that it may not be in the public interest for government to deny public funding to such an advocacy group.

For a decade, New Democrats have been advocating policies to protect otherwise viable small businesses against credit crunches and consumers against unjustified interest rate spreads and service charge abuse. There is no reason for businesses to fail for artificial financial reasons.

We are pleased to see the National Liberal Task Force on the Future of The Financial Services Sector recommended policies long promoted by the NDP, such as a) upholding the "big shall not buy big" policy (and rejecting the proposed mega-bank mergers between the Royal Bank of Canada and The Bank of Montreal as well as the Toronto Dominion and The Canadian Imperial Bank of Commerce); b) introducing a Canadian Community Reinvestment Act; c) creating an Independent financial ombudsman with binding powers; d) compelling credit card issuers to calculate interest charges in a manner which fully credits any partial payment by the credit card holder and e) capping credit card interest rates. In a telling contrast, the Majority Report of the Standing Committee excluded these recommendations.

The MacKay report fails in its fundamental objective to chart a policy for the financial sector that would achieve an acceptable balance between the private interest of financial institutions and the public interest of Canadians. The following explains why the failure of both the MacKay report and the majority report is not acceptable by the NDP, and why this NDP minority report must become a document for the public record:

1) The MacKay report and the majority report are based on a narrow and short-term definition of the public good that amounts to nothing more than the sum of private interest which would prevail at the expense of the public interest. It is dangerously simplistic to assume that a deregulated open financial system will somehow magically support the public interest. The global financial crisis and the inability of financial authorities to contain it demonstrate that there is simply no evidence that a deregulated financial system is efficient, especially in the long run, or that globalised finance will be stable. A number of international banks have either collapsed or are being rescued at great cost by taxpayers. Aggressive speculators extort exorbitant profits at the expense of the poor by pitting country against country, company against company and community against community in a merciless race to the bottom.

Close regulation of financial institutions and the dismantling of the global casino are required as well as the need to redefine how we measure and create wealth. Our ability for unprecedented wealth creation stands in sharp contrast with the reality of fewer people benefiting from this capacity, as well as the collapse of global demand because of shrinking purchasing power. In Canada, the effects are already felt through the collapse of commodity prices and the worst farm crisis since the Great Depression. The current chaos is largely created by the deregulation of global finance, the quest for fiscal surpluses and speculative greed. We need a new economic vision for the 21st Century, one based on increasing real wealth and reducing inequality.

A New Democrat vision for Canada's financial system emphasizes a much broader definition of the public good, one that includes, as core elements, full employment and cooperation between: trade unions, small and large businesses, community organisations, government, the financial sector, and, most importantly, a proactive role for the Bank of Canada. A social democratic perspective must go beyond the traditional image of the financial corporation and requires financial institutions have broader responsibilities than just to their shareholders. These responsibilities are commensurate with the vast powers and privileges granted to financial institutions by the public through Parliament. Financial regulation must therefore foster a commitment by chartered financial institutions to the public good, to the communities they serve and the country which supports them.

2) Regrettably, the MacKay report and the majority report recommend more deregulation; this will only amplify the strategy of financial institutions which have sought to take advantage of deregulation to maximize their earnings by financing massive speculative investments.

As financial institutions continue to fail, to cite the American experience, more and more U.S. politicians and bankers recognize existing mechanisms of control cannot cope. Meanwhile, it is disturbing to see that the total exposure of the big five Canadian chartered banks to risk in the ailing Asian markets exceeds $40 billion - or more than 100% of their combined capital. The Canadian government must recognize the pressing need for re-regulation. Regulators must deal with recent destabilizing financial innovations (see parts 4&12). The task force has not researched this crucial issue.

3) Neither MacKay nor the majority report deal properly with the crucial role of banks. The NDP rejects the notion that banks are just a special class of financial intermediaries. Banks are at the core of our economic system. If we cannot regulate banks properly, we lose financial and ultimately our political sovereignty. Banks decide which firms survive and which ones fail; which jobs are created and which jobs are destroyed; who gets a home and who does not. Simply put, banks are not ordinary corporations. The banking sector does much more than just lend deposits. Banking institutions create money by granting loans to firms, consumers or governments. Banks also create money through indirect means such as securitization and off-balance sheet activities. Banks are therefore not merely intermediaries. In the US, for instance, this reality is reflected by the Community Reinvestment Act (CRA), which creates a framework of accountability between banks and their communities. The Majority report is opposed to the principle of a CRA. In fact, the majority report moves further away from the notion of accountability by recommending that Community Accountability Statements, as proposed by MacKay, not be required from financial institutions. New Democrats believe it is essential that Parliament should empower an all party committee to conduct a full inquiry into the US community reinvestment system, and into its impact on job creation, affordable housing, and community development.

4) Both reports also ignore the central role of the Bank of Canada and its relation to the chartered banks. In Canada, the creation of money has been mostly privatized since the end of WWII. An effective monetary policy must not only address central banking policy, it must also regulate the role of private banks in the creation of money. By requiring banks to hold up to 100 % of the value of a category of loans in reserve, the Bank of Canada could influence lending selectively. Selective requirements on loans must be part of the monetary policy tool box in the 1990s, such as imposing 100% reserve requirement on loans which are not targeting the direct creation of wealth, productive investments and payment of salaries and wages (for instance, a 0% reserve could be required for lending that supports job creation, community reinvestment, or the redevelopment of polluted lands). As former Prime Minister Mackenzie King warned "Once a nation parts with the control of its currency and credit it matters not who makes the nation's laws... Until the control of the issue of currency and credit is restored to government and recognized as its most conspicuous and sacred responsibility, all talk of the sovereignty of parliament and of democracy is idle and futile."

5) Both reports embrace a purely micro-economic vision of the financial sector, which is the perspective of the CEO/manager. The reports substitute this narrow vision for a public interest perspective. This is particularly dangerous in a world where bankers who once prided themselves for prudence and due diligence now talk about their desire to "kick global ass."

6) In correlating the increase in earnings by Canadian chartered banks to the globalization of their services, MacKay ignores the fact that the bulk of the growth in bank profits originates from their domestic market power. This power allows banks to slap service charges across a vast and complex continuum of financial services, while engaging in highly profitable speculative activities through their securities affiliates. Because Canadian banks will strive to reach the same rates of return that large foreign banks achieve in speculative markets, Canadian bankers will in the end expect much higher rates of return on productive domestic operations. The globalization of banking leads to Canadian banks substituting speculative loans for productive lending to the domestic economy.

7) Both reports recommend relaxing the 10% ownership rule, which has worked successfully to uphold the public interest by preventing Canadian chartered banks from being controlled by foreign interests or dominated by owners who would use the bank to further their own interests (the 10% rule was put into place in the 1960s when the Chase Manhattan of New-York wanted to buy the Toronto Dominion Bank). This recommendation means the abandonment of the provision of domestic credit to financial institutions which will no longer have a preferred relationship with the Canadian domestic economy. Foreign financial institutions such as Wells Fargo and ING are only interested in skimming off the best customers and make it more difficult for Canadian financial institutions to serve all Canadians. In the long run, foreign financial multinationals operating in Canada will impose their profit margins on the Canadian consumer, and banks operating in Canada will lend to the Canadian public only if they can attain the same earnings that they achieve in their highly profitable and mainly international operations. And worse, they will impose compensation on the Canadian public for their losses as they have in the past.

8) Both reports abandon the "big shall not buy big policy" and therefore implicitly encourage mega-bank mergers. The reports state that mergers should be accepted as long as the Minister of Finance believes them to be in the public interest. Making this distinction is quite impossible because according to these reports, one of the main factors defining the public interest is the future enhancement of competitiveness in the global economy. And what exactly does that mean? Banks can always demonstrate merging will reinforce their competitiveness relative to their global competitors. By concentrating more powers in the hands of the Minister of Finance, MacKay further limits opportunities for parliamentary and democratic input on these issues which strongly affects the public interest.

9) The reports implicitly advocates a complete integration of the Canadian financial system to the global U.S. financial system. Again, this recommendation ignores the evidence of the distinctiveness of the financial industry. A complete integration would lead to the loss of control over our monetary policy and to the loss of Canada's sovereignty.

10) The reports do not address the consequences of systemic failures which may be triggered by the collapse of merged banks. In an unstable financial economy large banks can be much more exposed to risk than smaller ones and the larger they are, the higher the fall and the lower the capacity of government to let banks fail. For instance, clause 39 of the recommendations authorizes the Minister of Finance to sell off a Canadian chartered bank to foreign interests in "exceptional cases", and as long the sale conforms to the public interest. Mr. MacKay himself stated before the Finance Committee that the purpose of recommendation 39 was to give the Minister of finance a lower-cost solution for dealing with a mega-bank failure. Assuming the failure of a mega-bank in Canada because of losses in speculative markets (as happened in Japan recently), means there will be no domestic financial institutions large enough left to buy out the mega-bank. To have the costs underwritten by the Canadian taxpayer will be far too much of a burden. According to MacKay, then, the solution would be to sell the mega-bank to foreign buyers. In the long run, these mega-mergers could quite possibly accelerate the sell-out of our banking system to foreign interests.

11) The MacKay report only briefly talks about regulations and corporate governance. Canadians should be particularly concerned by the explosive growth in derivative products and off-balance sheet liabilities. Derivative products are very risky and the leading cause of the current banking failures. Like all pyramid-like schemes, these financial products are not supported by real economic activity and have resulted in the failure of trillions and trillions of dollars of highly leveraged contracts. Derivative products, which can bring down a large bank (i.e.Barings), are used primarily for speculative purposes instead of for hedging risk, which is their theoretical rationale. These huge losses then bounce back to all parties involved and ultimately impact on the real economy. Economic theory and regulations have not caught up with this huge and fast growing market and no one, not even the U.S. Federal Reserve, truly understands the potential of the disaster. It is interesting to note that Robert Merton and Myron Scholes who both won the Nobel Prize for their theoretical work on derivatives had to take responsibility for the collapse of the Long Term Capital Management, a hedge fund that lost its equity and had to be bailed out. It is frightening that the majority report has not taken into account the new dangers involved in derivatives and the inadequacy of self regulation in preventing huge losses which would have to be directly or indirectly underwritten by the public.

12) To control derivatives or to mitigate the effects of a spillover, the powers of the Office of the Superintendent for Financial Institutions (OSFI) should be extended. The reports should have recommended the creation of financial structures and rules that would make the work of the Superintendent effective in an age of ever-increasing complexity. The Auditor-General has written about "the capacity of the Office of the Superintendent of Financial Institutions to evaluate credit risks facing the banks from derivatives and securities activities." (Globe and Mail May 12, 1995, p. B1). These financial liabilities and the risk they carry must be brought back to formal accounting rules with adequate regulation and supervision. Today's accounting rules for derivatives and other similar financial operations leave regulators and investors largely in the dark. We should look into new ways of accounting which would integrate off balance sheet risk into the balance sheet. This is an issue which the two reports do not explore. The preferred option for the NDP would be to directly or indirectly prohibit the financing of derivative operations through bank credits.

Instead, the reports recommend that financial institutions be given maximum organizational flexibility, including the ability to set up sophisticated Financial Holding Companies (FHCs) with relaxed ownership rules, and "as non-intrusive as possible" regulatory requirements.

In a de-regulated global environment, these financial groups would make the job of the regulator impossible. Global FHCs will be extremely difficult to supervise and will be prone to tax avoidance. However, with adequate regulation, and provisions guaranteeing that the headquarters of both parents and subsidiaries remain in Canada, the FHC may open an avenue to segregate and contain higher risk activities such as derivatives from normal risk core banking activities. At a national level, the FHC structure could be used to combine innovative regulations which target speculation (such as selective reserve requirements), with functional regulation. Functional regulation would isolate speculative activities from core banking activities. This may help prevent speculative firestorms and somehow contain contagion while protecting depositors (and taxpayers). For instance, should a chartered bank be involved in a massive derivative meltdown, the damage would be confined to its securities affiliate. At best, the FHC system should be considered as a vehicle for more transparency and re-regulation and not for de-regulation as the report advocates.

In sum, the MacKay report favours the integration of the Canadian financial system to a costly and chaotic model of financial globalisation at a time where many are searching for a more equitable alternative model. Regrettably, the MacKay report and the $3.5 million spent on it provide little guidance for a banking system that must promote stability and serve all Canadians fairly in the new millennium.