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Should we pay for bankers' folly?


March 13, 2008 at 1:22 PM EDT

OTTAWA As the credit squeeze continues to worsen in the U.S., the talk has turned to using public funds taxpayers' money to bail out the banks.

We are nowhere near that state of alarm in Canada. Our banks are less exposed to the risky products that are shaking the financial foundations of Wall Street. But let's suppose for a moment that the ripple effect Canada is already feeling turns into a financial tsunami. Were that to happen, we need to ask ourselves: Should Canadian taxpayers pay for the fecklessness of bankers?

Of course, some Canadians are already paying. Interest rates on loans and mortgages are higher than they would be otherwise because the banks are having a tougher time raising the funds they need to make loans. And bank shareholders, which broadly speaking includes most of us because pension plans invest in bank shares, have paid through reduced profits as the banks write off hundreds of millions of dollars worth of holdings in these products.

If the credit squeeze becomes a full-blown crisis in Canada, these less visible costs of bankers' folly could be followed by an overt request for government support. Should we pay?

There are at least three good arguments against a taxpayer-funded bailout.

The first is that banks created this mess, so they should cover the clean-up. This was the initial thinking behind the Montreal agreement between financial institutions meant to unfreeze about $33-billion worth of one of these risky products, asset-backed commercial paper. The market disappeared when questions were raised about the quality of assets behind these products.

Whether the details of the Montreal agreement, expected to be released later Friday, will honour that spirit remains to be seen. What can be said is that if the government bails out financial institutions every time they run into trouble because of products they created and happily bought and sold, there will be no end of bailouts. The ingenuity of Bay Street and Wall Street in thinking up new, complicated ways to make money knows no bounds.

Canadian institutions could argue that the problems were not of their making and that the problematic asset-backed commercial paper in question came from the U.S. However, there's no getting around the fact that they willingly bought the stuff and are responsible for ensuring that it was a solid investment. That it turns out to be rotten to the core would not have come as a surprise if they had taken a closer look.

The second argument is that the financial sector is forever calling on government to let the free market work, unimpeded by government interference. If this is true for the good times, shouldn't it be equally true for the bad? What is a bailout if not blatant government interference in the market?

The lack of such interference may well result in certain institutions going bust. But that's what the free market is all about: survival of the fittest. The financial sector always seems to be a fan of unfettered free markets, and so should live by its own beliefs.

The third argument is related to the second. Financial institutions and the broader corporate community constantly demand lower corporate taxes. To lower taxes, however, means a commensurate reduction in government spending. Yet you rarely see corporate leaders saying they would be willing to give up specific government subsidies or other forms of support in exchange for a lower tax rate.

A bailout means more government spending, not less, and hardly fits with the demand for lower taxes. A plan to use government money to prop up shaky financial institutions and its worth repeating here that so far this is not the case in Canada would be more palatable to taxpayers if it also included the stipulation that the institutions repay the money out of future profits. That's unlikely, to say the least.

Sadly, the counter-argument makes all of these points null and void. It is this: The financial sector is so tightly woven into the fabric of our economy that allowing feckless institutions to founder is a bit like cutting off our nose to spite our face. They would not fall alone, but would take countless individuals, companies and other institutions with them. The institution that invested unwisely in the latest get-rich-quick product from Wall Street is the same one making loans to small businesses, providing mortgages to homeowners, and whose shares are in your pension fund.

If the current credit problems turned into a crisis in Canada, taxpayers would have to hold their noses and help out.

However, we should not do so without imposing conditions. The first is that the roots of the crisis be thoroughly investigated and changes made both to internal procedures at the financial institutions and to regulations to ensure there is no repeat. That is a bit like closing the barn door after the horse has bolted, but it still must be done.

The second is that an effort should be made to identify and address potential sources of future crises. While it may seem that these problems burst forth unannounced, there are almost always warning signs. Industry insiders are usually aware of suspect practices and products and, if prompted, could advise on how they should be addressed.

And the bill for all this research and action? It should be sent to the institutions benefiting from the bailout.

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