Canadian banks, bailed out by the Fed.

Documents released by the Federal Reserve show that Canadian banks used the Fed’s special loan programs to strengthen themselves when the economy started to go sour.

I find this very enlightening. First of all, there is stubborn myth that circulates our country, averring that Canadian institutions did not need a bailout. This is simply untrue. Canada’s bank bailout was a little more sophisticated, a little less blatant, than, say, the US bank bailouts, but it amounted to a bailout nonetheless. The Canadian government buffered its big financial institutions with a whopping $75 billion dollars used to buy bad assets.

Second, the Fed’s loan programs are bailouts too.

Canadian banks said the moves to seek loans from the Fed were dictated by strategy and not by necessity.

RBC accessed funding from the Fed “purely for business reasons – better pricing and collateral rules – and because they were the best deal for our shareholders at the time,” said Gillian McArdle, a bank spokesperson. “Our access to funding remained very strong through the entire crisis.”

This is an interesting thing to say. Let us think about this a bit.

Remember that the Federal Reserve has a monopoly on the creation of US dollars. It can buy any asset it wants with digital dollars created out of nothing. Other institutions cannot do anything like this.

If an institution like Royal Bank cannot raise capital on the market and turns to a central bank for help, this is a bailout. This allows it to strengthen its balance sheet in a way that would not be possible without the central bank’s intervention. Saying this does not amount to a bailout is incoherent.

Central banks exist to bail out big financial institutions and governments when markets go bad. In 2008, the Fed bought a trillion dollars or so in garbage assets that the market would not touch at face value. The Bank of Canada helped bailout banks too.

So in addition to getting bailed out by the the BoC and the Canadian government, Canadian banks were bailed out by the Federal Reserve as well!

Why is this important? In the business cycle, when the boom period reaches its apex and market forces begin initiating vengeful corrections, bad debts must be liquidated for the economy to become rebalanced. This is value of the recession — it restores soundness to the economic system by clearing out the malinvestments perpetuated by expansionary monetary policies that create the bubble. Of course, in 2008 governments and central bankers around the world stepped in to ensure that would not happen.

The fact that Canadian institutions availed themselves of the Fed’s interventionary loan programs (to say nothing of the $75 billion bailout from Canada) reveals that Canadian banks are not as strong as people claim. Like all commercial banks operating on fractional reserve banking systems, Canadian banks are inherently on the verge of bankruptcy at all times. Our system ought not be the envy of the world — instead, it is just another facet of the nightmarish system that Bank of England Governor Mervyn King candidly called “the worst banking system conceivable.”