At the Financial Program in Toronto, panelists agreed that continuing growth will be the biggest challenge in the wake of the U.S. financial crisis. This event, sponsored by the Canada Institute of the Woodrow Wilson International Center for Scholars, drew more than 100 business leaders to the head office boardroom of the Canadian Imperial Bank of Commerce. Rick Waugh, president and CEO of the Bank of Nova Scotia, and Bob Kelly, chairman and CEO of the Bank of New York Mellon, spoke about the present U.S. credit crisis, the future of its financial markets, and the way Canada can be both a leading example and a larger player in the global economy.

New Expectations

Though the U.S economy is improving, the country's recession is far from over. Enduring effects must be expected, given that the world came close to a global depression in the fall of 2008. Kelly predicted that the U.S. housing market will not bottom out for another four to five months, and that unemployment will not peak for another six to 12 months. Unemployment is directly connected to the decreased spending of American consumers; for every one percent increase in savings, 700,000 jobs are lost.

Economic improvements and growth will come slowly, said Kelly, and they will take time. Expectations therefore need to be adjusted in accordance with lower levels of absolute profitability and overall wealth. If banks take fewer risks, Waugh observed, there will be lower profits, and the growth rates over the next five years will decline compared with those in previous years. It is imperative that the U.S. banking industry be given adequate time to readjust and recover. If the bar is set too high, there is greater potential for another collapse.

The first crucial step in reviving the U.S. economy is to restart the securities market, which Kelly referred to as "dead." While securities were one of the major culprits in the U.S. market collapse, they are also essential to the nation's recovery. According to Kelly, the banks cannot revive the economy by themselves.

Reform measures must be put in place to ensure that the securities market does not spiral out of control again, Kelly insisted. These reforms include simplifying products and creating more price transparency. In the past, the market traded almost exclusively on rates, Waugh said. Issuers had the advantage because they paid fees to the rating agencies, which returned good ratings, and no one watched out for the interests of investors. Kelly admitted that buying instruments based solely on ratings was one of his company's "biggest mistakes." In the future, investors will have to do more homework and use ratings only as supplemental information to their own analysis of investments.

Canadian Complacency

Securities and mortgages, which triggered the U.S. collapse, are much smaller markets in Canada. This fact partially explains why Canada was affected to a lesser degree by the recession. The traditionally conservative Canadian banking system also fared better, Waugh said, because it has strong risk management and superior governance in the public and private sectors than does the banking system in the United States. While often criticized for being small, the Canadian banking system, made up of just five major banks, allows for great transparency and a genuine structure of checks and balances.

Canadian economic stability during the recession was especially impressive because of the unique political situation of the Canadian government. Given that Ottawa politics do not follow a linear path, John Manley said, policy is often more fluid, leading to complex results. Moreover, the government operates under the constant threat of an election, a highly disruptive event that has occurred four times in the past five years. The success of Canada's banking sector under these conditions can be attributed to good management.

At the same time, Manley admitted, Canada's success in the face of these challenges has created a certain smugness around the financial sector in Ottawa. Although the economic crisis has created wide-open opportunities for Canada, financial leaders and regulators must act if they want to capitalize on them. Otherwise, continued success is neither guaranteed nor likely over the long term.

The panelists agreed that it is imperative for Canadian banks to seize their current advantage and make their globally respected "Canadian brand" work to their advantage. They can do so by targeting niche markets and welcoming competition, rather than shying away from the risk, as they did in the past. This innate conservatism is one of the reasons why the U.S. capitalist economy has traditionally grown faster than its Canadian counterpart.

As for the future of the U.S. economy, the panelists agreed that, although large losses should be expected in the banking sector in 2009, the system has already proved that it will survive the crisis. As Kelly reminded the audience, "Over time, don't bet against the United States."

By Laura Pedro
David Biette, Director, Canada Institute