I have a confession to make. During the financial crisis I secretly bailed out the Bank of Montreal. I was part of a vast conspiracy of millions of other Canadians doing the same thing. It's worse. My personal bailout program for the Bank of Montreal started long before the financial crisis. It started when I first arrived in Canada. It's even worser. The Bank of Montreal still has not repaid me what it owes, and my bailout continues to this day. Without this bailout program, the Bank of Montreal could never have continued in business; it would have gone bust centuries ago. This secret bailout program is far bigger than the total market value of Bank of Montreal shares, so the Bank of Montreal is deeply underwater! It would have been much cheaper for me and my fellow conspirators to have bought the Bank of Montreal outright. And we could have earned a far higher return on our investment if we had done that. The Bank of Montreal eagerly borrowed every single dollar we were prepared to lend it in our bailout program, and made a profit by lending those dollars to other borrowers. We should have just lent our dollars directly to those ultimate borrowers, and cut out the middleman.
Or, to say the same thing more simply: I have a chequing account at the Bank of Montreal, and the Bank of Montreal is a bank.
I do not know the answers to those questions, but I think they are important. For what it's worth, my hunch is that the channel between central banks and commercial banks currently plays a far larger role in the monetary policy transmission mechanism than it should. And I am very uneasy about the lack of transparency that seems almost inherent in the role of lender of last resort; it's in stark contrast to the transparency of inflation targeting.
David Macdonald has collected the facts of Bank of Canada lending to the commercial banks during the financial crisis. No worries. But his interpretation of those facts is simply to restate those facts in the same way that I restate my facts in my opening paragraph above.
For example, David says (pages 8 and 9):
"In fact, several banks drew government support whose value exceeded the bank’s actual value. Canadian banks were in hot water during the crisis and the Canadian government has remained resolutely secretive about the details."
And on page 28:
"Total support for CIBC was worth almost one and a half times the value of all the company’s shares in March 2009. In fact, almost every day from mid-January 2009 and the end of April, CIBC was completely “underwater,” receiving support worth more than the value of the company."
All banks always borrow more than the value of the bank. (OK, I expect that's not strictly true, and if I searched I could find a counterexample, where a newly-formed bank had raised capital but hadn't yet got its act together to attract some deposits and make some loans.) That doesn't mean the bank is in "hot water", or "underwater". It means it's a bank. Hell, most homeowners with a mortgage worth more than 50% of the value of the property are "underwater" or in "hot water" and being "bailed out" by the mortgage under that definition. Banks typically borrow more than 90% of what they lend. They always live "underwater" and in very "hot water" indeed. That's where banks live.
Banks borrow and lend. Banks' balance sheets are much bigger than the market value of their shares. That's what banks do. Banks are banks.
(Oh, and the one really interesting and important thing about banks, which is what sets them apart from you and me and other financial intermediaries, is that some of banks' liabilities are used as media of exchange. That is the really important fact about banks.)
What we really need is a counterfactual conditional. What would banks have done instead if the Bank of Canada had not provided those loans? Would they have gone bust? Or would they have just had smaller balance sheets? And that analysis is exactly what I didn't find in reading David's Report.
If I hadn't got the mortgage, what would I have done? Maybe I would have gone bust, or maybe I just wouldn't have bought the house? You can't answer that question just by noting that the mortgage was more than my equity in the house.
[Update: let me make the central point even more strongly. When a recession appears more likely, the central bank may offer loans on easier terms. That's what central banks are supposed to do. And commercial banks may accept those loans. That's what banks are supposed to do. We wanted the banks to accept that "bailout" money, whether they needed it or not. The time to get worried is not when banks act like banks and accept that "bailout". The time to get worried is when banks stop acting like banks and don't accept that "bailout". (Or, like many US banks, they just park the "bailout" money back at the same Fed which lent it out in the first place). It's when banks stop acting like banks that we should start to wonder what use they are in the big scheme of things. We wanted the Canadian banks to borrow the "bailout" money. We wanted them to act like banks. The very last thing we should be doing is criticising them for doing this. The very worst result of this Report would be if it made banks more reluctant to borrow and lend in any future recession. That's the last thing we need.)
I own some BNS shares. The Carleton University pension plan almost certainly holds Canadian banks' shares. I have a chequing account at BMO, as mentioned above. I'm probably biased.