Saturday, March 28, 2009

Toxic Plan




Last week, Tim Geithner unveiled his Public-Private Partnership Investment Program to remove toxic assets from the American banking system. The markets reacted like kids in a candy shop – so it’s best to ignore them right now. The New York Times has dedicated this blog page for the greatest economists in the America to explain to us how this plan won’t work.

Personally, I feel bad for Geithner. Wall Street is never going to be his friend because he was never one of them. Meanwhile, economists acting as watchdogs of his every move are extremely critical, rarely offering alternative solutions. What is particularly annoying is that it’s a well known fact that Geithner has absolutely no help as the Treasury Secretary right now. If I were a renowned economist in tune with the complexities of today’s market, had a blog on the NY Times, or was a professor at Princeton – I might give Tim a call and see if he needs help.

My father and I watched both Tim Geithner, and Paul Krugman (the self-declared nemesis of Tim Geithner) on This Week with George Stephanopolous. Geithner made it clear that this was a small part of a bigger plan. The other thing that stuck with me was that despite the state of emergency, this administration has very little power to takeover these banks and deal directly with its problems, and Geithner is actively working on getting those powers.

The example that was given to the media to describe the mechanics of how this re-purchase plan will work is as follows:

  • The US government will partner up with private investors to purchase these “toxic” assets;
  • To purchase $100 of “toxic” assets, the government will pitch in $7 and the private investor will pitch in $7 (50/50 equity ownership of the asset);
  • The remaining $86 will be funded by a loan issued by the Federal reserve

To a private investor, like a hedge fund, the government is funding 93% of the venture, so the incentive to get involved in the purchase of these assets has been well-established. Following our example above, if a hedge fund and the government purchased $100 of mortgaged backed securities from an American bank in need of liquidity, and 5 years from now it turns out that the asset they bought could be sold for $200 - the proceeds would be divided as follows:

  • $200 cash received on the sale
  • Subtract from that the loan that we owe the feds $86 + interest on that loan we've been paying the Feds all along, which would be something like $4, so a total of $90 goes to the Feds
  • The remaining $110 is split, 50/50 between the government and the hedge fund
  • The hedge fund could boast a return of 785% on the initial investment

And now, I'll present an excerpt from a conversation I had with Tim Geithner in my head:

--------------------------------------------------

Umar: Hi Tim. I'm a big fan of America in general. I'm wondering, by introducing this plan, you're allowing investors like hedge funds to profit while the American people bear most of the risk - aren't you worried about a public backlash? Hedge funds aren't exactly popular among the public to begin with.

Secretary Geithner: I'm a big fan of yours too, Umar. Like, I follow you on twitter and everything. The problem is I don't have a choice. The market for these mortgage backed securities (MBS) is currently non-existent. These banks are heavily invested in MBS, and because there is no market for them, their money is essentially stuck. When our banks have this much money locked up in illiquid securities, they lack the ability to lend, which is the most fundamental economic action a bank can do in order to help stimulate the economy.

Also, we actually want private investors involved. As you already know, if the government was to offer to buy these assets from the bank, we would end up overpaying.

Umar: Yeah, that's true. I remember when Paulson first suggested that the government would have to purchase these assets from the banks to create liquidity, we were laughing at my office. It was clearly a bad idea. There was no doubt in my mind that if the government offered to pay for these toxic assets, you guys were going to overpay. That's simply how private banks deal with the government.

Secretary Geithner: That's right. I think your very first blog post was very appropriate given what you are writing about - people seem to think that corporations will do the right things simply because it's an emergency, but that's not the case. You can't trust them in the negotiation process. By partnering up with private investors, which can be anyone from the investment community, not just hedge funds, we're creating a market for these investments. Because the private investor is financially vested in the transaction, the government is far less likely to overpay. It also protects the government from participating in completely worthless assets. Sure, the hedge funds might be leveraging Fed loans to enter the transaction, but the government is leveraging hedge fund expertise and resources to ensure that the transaction is profitable.

Umar: But Tim, based on what I know about the Mortgaged Back Securities market, the spreads are huge. How do you respond to all the experts out there saying that this scheme won't work? If the private partnership wants to purchase something for $0.20 on the dollar, but sellers are adamant that $0.80 is a good price - your plan doesn't actually resolve that basic discrepancy.

Secretary Geithner: No - the plan simply lays the infrastructure for market forces to resolve this issue, it doesn't directly force transactions. The reality is that because there currently is no market for these securities, accounting guidelines require you to write them off (remove them from your balance sheets). When the banks go to borrow money, other banks look at the value of their assets in order to assess how much credit will be extended. When you have hundreds of billions of dollars invested in MBS that you are forced to write down to zero - your balance sheets do not look good, and other banks can't lend you money. The first step is to create a market for these securities, so that we have some basis to value these assets. It's not necessary to sell all of these assets - that's only part of the objective. Those banks that desperately need cash will accept lower offers. However, by accepting offers the market will slowly grow, and entice more buyers. The more private investors get involved, the better we can reflect the true value of these MBS using real market transactions. This means banks that don't end up selling these MBS assets to anyone still benefit from revaluing them on their balance sheets at a value other than zero.

Just to put things into perspective, these assets having a market value of zero is like saying every single American just defaulted on their loan. That's simply not the case. The market is currently being choked by fear and overexposure, and I'm just trying to loosen the grip.

Umar: Okay, let's assume that in a month or two, investors start bidding for these assets. Explain to me how this will create liquidity? How does it loosen the grip?

Secretary Geithner: Sometimes I wish you were American, you know that? You have to understand, the problem with these banks very closely resembles the problem that everyday Americans are having - they've maxed out their credit. Just like ordinary people, banks are extended credit based on the assets they own, and their liquidity ratios which tell us how easily they will be able to pay their interest payments.

Despite all the money we seem to be spending and lending, the fact that the banks are not lending to each other is single-handedly stopping any progress. Once a market is created, the banks will now have the option to increase their liquidity and reserve ratios by selling these MBS assets in exchange for cash. In addition to this, there will be a benchmark to value these assets, which will help some banks because they will be able to write up those assets that are currently valued at zero. For these banks, they can now borrow against the value of these assets.

Once the financial health of the banks improves, banks will not be hesitant to lend to one another, because there will be enough cash on hand to pay interest and the loan back. Once the troubled banks are able to borrow from the healthier banks, then they can lend to the American people, which ultimately stimulates the economy. But make no mistake about it - we can not grow unless the banks lend. It's as simple as that. It's how our system works.

Umar: Look. I just have to ask you this because I might not have the chance again. Don't you find it the least bit disturbing that in order to get American people and corporations out of their debt problems, you're offering a solution that gets investors into more debt

Secretary Geithner: Yeah, I know. It's weird, eh?

--------------------------------------------------

If we view the plan for the specific objectives Geithner is trying to fulfill, it’s not as disastrous as the economists are speculating. It obviously isn’t enough to resolve this crisis, but it’s a necessary step to spread the MBS risk which is currently concentrated with the banks in order to unclog the financial system. The government is taking virtually all of the risk on the proposed transactions, but I urge economists to describe an alternative where the government doesn’t take on risk? Finding a flaw in any proposed plan during a time of turmoil and crisis is not exactly rocket science. There is never going to be a single all-encompassing perfect plan to solve the crisis. Also, don’t overestimate how much the government can actually do besides throwing money at people or corporations. This is America – they are a nation staunchly against any form of government control over corporations.

Geithner has to get America walking before She can run again. All he can do is clear the path and hope She follows.



Wednesday, March 25, 2009

World's Apart

This is a great article from the New Yorker. It serves as a reminder that what seems obvious to us on the road to recovery has actually been paved profoundly by our past.




Sunday, March 22, 2009

Understanding AIG


American International Group has been dominating the news for a good week, and I really didn't want to write about it because it's more politics than economics, but reporters have truly lost perspective over these bonuses. Well, everyone except for Rex Murphy of the CBC. It's impossible not to get outraged about those bonuses, but as Rex points out, this is only one of several politically related distractions with the AIG bailout.

I didn't have time to watch the hearings myself, but my friend Paul did - and he gave me his account of what unfolded. Most of the hearings consisted of congressmen grandstanding, which is to be expected. Paul did mention one particular congressman who brought up the issue of credit default swaps. Just one.

Why are credit default swaps important?

Fact: the total notional amount of credit default swaps that exist in the world is larger than the world’s economy.

Credit Default Swap: It's like buying insurance on your neighbour's house and then setting it on fire.

The sole reason AIG needs billions upon billions of financial relief is because of credit default swaps. If they didn't have these swap obligations to pay, there would be no problem. If Congressmen want to hold AIG accountable for anything, it should be how they are using federal funds to pay these liabilities down. I'm not oversimplifying this - the magnitude of these swap obligations is so large that nothing else should matter.

I've always found it ironic that an insurance company got themselves into so much trouble with these swaps, simply because the swap itself is a surrogate for insurance. It's not actual insurance. Real insurance involves the burden of abiding by regulations, keeping a reserve for potential payouts, and someone involved actually needs ownership of the very thing being insured. The way these swaps have been structured, they are more like bets than insurance. When you hear about how Wall Street lost "bets," they literally mean bets.

How could AIG’s exposure to swaps grow so ridiculously large? Obviously, none of the executives had sufficient oversight of the process. It's an understatement to say they took an optimistic view of the American credit market.

But for an insurance company, managing its exposure to the risk generated by swaps should have been intuitive. This is what AIG does for its core business, except it uses real insurance products and not swaps. Not bothering to assess the true risk these swaps brought the company is like loading up the shopping cart even after you realize you’ve forgotten your wallet at home.

But how did credit default swaps get so out of control?

Recall:

  1. Financially, a CDS works like insurance: AIG was providing “protection” on a wide variety of credit products. So in return for monthly “premiums”, AIG made a promise to guarantee the principal if the underlying creditor(s) went into default;
  2. Structurally, this was like betting: There were no regulations surrounding these swaps, no limit to how many bets you can make, and no requirement for you to set aside some just-in-case reserve money should you need to pay a large number of obligations at once.

Here’s an important footnote – in order to participate in the swap arrangement, neither party involved needs to own the credit product being insured. It's like buying insurance on your neighbour's house and then setting it on fire (I know I already said that one, but I've heard it floating around and I'm falling in love with it). With normal insurance, the insurance company will verify the existence and value of the asset being insured. But with credit default swaps, AIG got involved without performing such due diligence. Even if the analysis was performed, they ignored it. Overall, they thought, bad credit will not be an issue.

I happen to have an intimate relationship with the credit default swap. Since 2003 I’ve watched the CDS transform from a clever way to hedge credit-heavy investment strategies into a misunderstood “hot” commodity that led to quick cash for those who were willing to provide "protection" or guarantees (like AIG).

It’s clear now AIG was willing to multiply these swap arrangements without actually asking themselves why others were so eager to get into business with them. When two people shake hands on a credit default swap – one of them has to lose. AIG repeatedly took the wrong side of the bet. It’s fair to conclude that they are a bunch of losers.

Saturday, March 21, 2009

Newspaper Turmoil



Growing up, I thoroughly enjoyed the newspaper experience. I remember reading hockey and baseball box scores so carefully that I could recite the previous day’s stats to my friends at school. Reading the funnies on the weekend was a ritual; It started with Beetle Bailey, and it always ended with Family Circus. I surrounded myself with newspapers, especially when I didn't know what to believe. When kids were getting tear-gassed at the Quebec City Summit, or when the Twin Towers collapsed in New York, I carefully read every single account of what happened from every newspaper I could find. Newspapers take the time to struggle with tough questions like: why is this happening? TV often jumps to the conclusion.

But newspapers are dying. I'm not exaggerating; they're disappearing at an alarming rate. There's a website tracking the death count.

The problem is the business model. Traditionally, newspapers made the bulk of their money through selling ad space. The big papers were widely distributed, which meant they could command a good price for ad space. The $0.50 on the face of the paper covered the delivery cost. Remember, before TV there was no other place where a single ad would reach the entire nation. Another thing that the large newspapers did to make money was they maximized the use of their printing press. They provided printing services to other newspapers, magazines and book publishers.

The local papers had a modest version of the same business model. With a local circulation, people in that community kept the local paper thriving by listing their companies or personal belongings in the classified ads.

But by posting the exact same content online for free, the National papers lost a big chunk of their circulation. And with the emergence of Craigslist and Ebay, the local papers are failing to collect the classified ad revenue that used to hold them up.

There’s not really much to add from a business standpoint. Local papers are going to disappear without local people wanting to advertise. Municipalities can make a conscious decision to fund some regular local medium, for the sake of keeping a sense of togetherness in the community.

As for the larger news organizations, it's unclear whether they have a vision of how to reinvent themselves for the new media world. Perhaps they’ve got the right ideas, but they're not close solving their financial issues. Here’s the financial situation of one of my favourite newspapers, the New York Times. To quote the conclusion of this analysis:

The bottom line is that the New York Times will find it very difficult and/or expensive to borrow more money to meet its upcoming liabilities, even over the short term. Now that the stock has collapsed, moreover, it is not in a strong position to issue equity.

That means they need money fast and they don’t have very many options available to them. Not good. David Carr of the NY Times proposes some excellent solutions, while going over some of the mistakes the industry made along the way. In the future, we can expect quality news publications to ask you for money if you want to continue reading them online.

I want to leave you with this article. It's a reminder that although reading a newspaper is a very private experience, reading the same news article as everyone else brings clarity and community together. Gary Kamiya is quite pessimistic about a future without newspapers, but it's important that someone highlight all the potential problems with the new online media regime. A lot of things “die,” during a recession, but the death of newspapers is a rare event that will leave a gaping void in our experiences with each other.


Sunday, March 15, 2009

Canada's Subprime Problem

The Globe and Mail broke this story. Canada's subprime problem appears to be a West coast thing, B.C. and Alberta in particular. But when I first saw the headline on the front page of Saturday's Globe and Mail, I panicked. I'll tell you why.

The term "Subprime" is being thrown around a lot, so I want to take some time and elaborate on this topic. Subprime refers to loans made to people who have bad credit. The term comes from the lender’s perspective. A “prime” borrower is a person you give your most competitive interest rate to. Everyone else is sub-prime, so they receive a relatively unfavourable rate. As a result of profiling as higher risk clients (bad credit history, or unemployed, etc), these borrowers must go to subprime lenders in order to finance their houses or cars. In exchange for receiving these loans, the lender needs to be compensated for higher risk, which results in sometimes outrageous interest charges.


One of the additional quirks to subprime lending is that they don’t verify income or assets as strictly as normal banks do. A normal bank in Canada has to verify and record how much money you make, and what assets you own, in addition to checking your credit rating. Subprime lenders got themselves, and everyone else, in trouble by ignoring the standard procedures.


On a loan-by-loan basis, the subprime lending business comes with it's fair share of foreclosures and defaults. But believe it or not, the business model is sound. If they set their interest rates correctly, they stand to make money on the loans overall. The basic idea is that the extremely high interest paid by 90% of their clients will offset the 10% that default.


In the Globe article, they briefly discuss the business model. They discuss how if the price of a house keeps going up, even when people default, the banks can flip the house for a profit. Subprime lenders were leaning heavily on this. Having a profitable backup plan meant they could be more aggressive in issuing loans. They did this by easing up on the standard procedures even more. In turn, the rate of default was increasing. But there was little consequence, since the housing market was so hot. This aggressive style of lending was employed in booming cities. Places where real estate agents would preach, "Housing prices haven't gone down in 40 years!"


Around the same time, Wall Street was devouring mortgages from all sorts of lenders in the US. They were purchasing mortgage loans, aggregating them, packing them up and selling them as Mortgage-backed securities. At first, Wall Street purchased the safer ones, but by the end of it, they realized nobody was really looking at the quality of the loans, so they started to sprinkle in some of the subprime stuff on top of the good ones. At the root of it all, no matter how complicated the transaction became, there was an underlying assumption that housing prices would continue to rise.

The entire investment community was acting on it as if it were a fact. With access to Wall Street, subprime lenders no longer carried the traditional risk of lending. In fact, with Wall Street taking the mortgages off their hands, they really didn’t have to do any sort of analysis anymore. It allowed them to indiscriminately issue mortgages - no background checks necessary.

Subprime lenders, who were inherently in a risky business, woke up one morning to find the risk was all gone. It was no longer their problem if people went into default. No more math exercises for the accountants of trying to balance interest rates with foreclosure rates. They went from banks to salesmen overnight.

Which brings us back to the article. The Globe gets on Harper for failing to acknowledge the subprime problem we have. But honestly, Canada got off easy. The subprime problem is so far spread in the US that they’ve literally killed their banks. You might come across the term "Zombie Banks," which are banks that are financially dead, but being kept alive by government bailout injections.

We can rest assured that our financial institutions won't come crumbling down because of these loans. You'll notice it was American subprime lenders coming into Canada. That means one half of the problem is theirs. As the article notes, we've got a lot of regulations in Canada that don't let you transfer the risk that way. Actually, we have housing insurance, which means an independent third party is now financially vested in home owners paying their loans back.

Yes, we must fix Canada's half of the problem – we must find solutions so people can keep their homes in B.C. and Alberta. And yes, we shouldn't be ignoring this, we should investigate immediately the extent of troubled home owners because of American subprime lending. But given what’s just happened to our neighbours to the south, and the fact that we didn’t actually have any true protection from American subprime lenders infiltrating our mortgage markets, I was actually relieved when I finished reading the piece. This is a nice problem to have.

Saturday, March 14, 2009

How to Quiet Cramer



This weekend, I decided to pay my folks a visit, and my father was completely giddy in the car ride home from the train station. He asked me if I had seen the Jon Stewart show Thursday, trying to contain himself. I hadn't. He started to tell me about it, but stopped, not wanting to spoil it for me. We could watch the re-run on Saturday.

In case you didn't get a chance to see the show, you can watch Jon Stewart interview Jim Cramer in three parts, courtesy of the comedy network.

If you don't know Jim Cramer or his show, Mad Money, know this: he hosts a surreal investment advice show where he reveals trade secrets to investment aficionados. He fields phone calls, has more sound effects than morning radio, says "boo-yah" way too often, and is constantly yelling although he's the only one in the studio.

I could not believe how small and ashamed he looked on the Daily show. With the truth shoved in his face, one of the loudest TV personalities withered away before our eyes. It was a horrible public relations move for Cramer (and CNBC) to make this appearance. We'll always remember the way Jon Stewart carved Cramer up, reducing his trademarked nonsensical yelling to a guilt-ridden whimper. You can't help but feel you're witnessing justice.

I happen to follow American stations much more than the average Canadian, and perhaps even more than the average American. This is partly because of a personal fascination with the US, but also because the quality of their field reporting is exceptional. I find CNN as annoying as the next person, but they're often the first to break a big story. The quality of PBS Frontline makes it quite simply one of the best in-depth news programs I've seen (check out their free podcast and you'll be hooked).

But you get both ends of the spectrum. The garbage that some American networks produce is unprecedented as well. Fox and CNBC compete with each other, showcasing an amazing commitment to TV personalities that are loud and unaccountable.

But don't you wonder - who watches this crap? In this piece, Time magazine pinpoints the Jim Cramer audience: Day Traders

"When ordinary people think about the economy, they think about jobs, college, retirement. Sure, the stock market affects them in the long run — but so do job security and the threat of getting wiped out by health-care bills. When CNBC considers the economy, it means Wall Street's numbers that day, that hour, that minute. CNBC may pay lip service to the long term, but it has the time horizon of a fruit fly."

Cramer's Day Traders might benefit from a little perspective. There's something to be said for how much the investment industry just shrank. It's very tough to make money in equity trading right now. Professional equity traders that still have jobs are struggling to justify their existence.

I've personally seen several hedge funds slash their equity research and trading departments. These were talented equity veterans (day traders that worked for companies). Unfortunately for them, things just got a whole lot simpler. People are only going to invest in companies that are not in distress. And when they find one, they'll leave the money there. The Corporate Cowboys, as well as their stay-at-home counterparts, are no longer in the plan.

Tuesday, March 10, 2009

Harper's package


My gut feel says they undershot it. This stimulus package has "wait and see," written all over it. I started to look at historical data, but quickly realized there's no point - that's exactly what they used to build this plan. History says, Canada will be fine.

The package is 2% of Canada's GDP per year. That tells me they don't expect more than a 2% drop in our GDP this year or next. I'm sure the math is fine. I just don't think they're accounting for the dramatic shift in resource allocation that we're headed for. They definitely don't feel a sense of urgency.

I'll try to do something meaningful with the numbers on the weekend. But believe me, it's not easy. They make these documents for accountants that hate numbers.

Now, some fun points!
  1. I absolutely love what they've done on page 13 of the stimulus document. They've included raves from three different associations on how amazing this stimulus package is. The Canadian Chamber of Commerce believes it's an important step forward!
  2. If you're wondering about how Harper's speech went, Adam Radwanski does a nice job recapping that Stephen Harper is still a prick.
  3. I spoke with my Dad about the package, and he said he felt like Harper was just doing a stimulus package for the sake of doing it. It confirms my initial feeling that the government doesn't believe Canada's in trouble. I hope they are right.

Monday, March 9, 2009

Warren's Edge





Warren Buffett said the American Economy has just fallen off a cliff. Most of you know him as a business mogul, or a billionaire celebrity, or maybe as a philanthropist, but the world of finance knows him in quite a unique way. I’ve laced this piece with some of his silky fine thoughts, to remind us how wisdom doesn’t expire.

In the financial world, Warren Buffett is like our dad. No matter how much truth and wisdom he tries to pass on to us, we all end up ignoring him in the end. There’s a general impression that he is too old school to really know what’s going on in today’s business world. His investment principles are largely ignored by investment banks, hedge funds, and other money managers.

Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years.

But that’s so boring, Dad! It’s not that we think he’s wrong; it’s just that we want to do things our way. Wall Street is under the impression that he simply does not understand some of the more sophisticated ways of investing, or he’s too risk averse to get into the new way of investing.

Derivatives are financial weapons of mass destruction.

But the truth is he understands almost everything about investing. What he doesn’t care for is speculation. Buffett has a publicly listed stock on the New York Stock Exchange (BRK.A). But you can’t speculate on it the way you can with other stocks. Berkshire Hathaway, which is a holding company for several other private and public Buffett-approved business ventures, trades for over $70,000 per share. He’s fully aware of how to make that stock more affordable, but he has no interest in doing that. He wants you to think long and hard before purchasing it. He doesn’t want impulsive or whimsical speculators. He wants long term investors.

Risk comes from not knowing what you're doing.

Buffett is like the Jenny Holzer of finance. You can read what he writes, and just brush it off as something so obvious that it’s not insightful. But when the unexpected happens, you’ll realize that these are the only truths we can know. I suspect the whole world is listening to him right now.

Only when the tide goes out do you discover who's been swimming naked.


This is a piece he wrote for Fortune magazine back in 2003. It is somewhat lengthy, but I urge you to read at least the first part where he describes a story of two simple island economies. He uses this to illustrate what is a very real possibility: a dramatic shift of economic power from the US to other nations. He even admits to putting his "money where his mouth" is by purchasing the currencies of other nations. That isn't just speculation, it’s an investment.

Sunday, March 8, 2009

A State of Urgency


I feel a nagging sense of urgency. Our government and other powerful figures are making hasty decisions amid this global financial crisis. They're being forced to respond quickly, without taking the time to gather information, ask experts, or perform proper analysis. Mistakes are being made, but the rug of confusion looms so large that the mess can be swept under it.

In the elevator at work, the news monitor caught my eye with one particular headline:

BOC says Canada needs stimulus NOW!!!

Okay, maybe it wasn't written exactly like that, but that’s how I read it. Here's what Pierre Duguay, Deputy governer at the Bank of Canada, had to say:

“I agree there is a sense of urgency. Very clearly we will be hit by a string of bad news in the coming months,” Mr. Duguay said.

“When consumers are nervous about employment prospects they stop spending and at that point it doesn't matter much whether credit is available or not, they prefer not to go into debt.”

You can read more about it here. Apparently those power hungry Liberals are holding up the parliamentary passing of this package. The nerve. And do you know what they're holding out for? Transparency. This is urgent! The government doesn’t have time to go into detail about who’s supposed to get this money! All details can be found under the rug.

I’m not politically affiliated in any way. I’m a fan of politicians who admit that this global financial crisis is too large and complicated to understand. This is reality. Our economy is largely dependent on the US, and all we know is that things in the US are really bad. We won’t be able to quantify the impact of US decline until it happens; there’s a lag.

But does our Prime Minister really have to parade around Wolf Blitzer’s situation room talking about how awesome Canada is? Near the end of this clip, he appears to take credit for well-established Canadian banking regulations. He mentions in passing some "small market transactions" that the Canadian government executed in order to create liquidity in the banks, and how it “wasn’t a bailout.” Those small market transactions totaled $25 billion worth of money that the government gave to Canadian banks in exchange for mortgages. That’s approximately 2% of Canada’s GDP. To put this in perspective, the US financial bailout was initially said to be $800 billion, which is about 6% of the US GDP.

But relax: it wasn’t a bailout. A bailout is trying to save financial institutions in need. This was more like purchasing a single gigantic mortgaged back security from our banks. In other words, the Canadian government (on our behalf) locked up $25 billion into the mortgage business. Flaherty said that the government might even make money on this deal. But who cares? We have $25 billion less available to us for our spending package. We will need to borrow that money, making the cost of the package higher for all of us. Not surprisingly, the move didn’t create any liquidity or loosen up lending in Canada.

It’s been well documented how our banks are being tight with money, which is speeding up our slide into this recession. But just as the US is learning, when you hand money over to banks without legislating its specific use, the banks will just do whatever they want.

Milton Friedman wrote his paper on the corporation's social responsibility almost 50 years ago. To paraphrase, he said the corporation has no obligation or duty to anyone in society except to its shareholders. From this, it follows that the corporation's sole responsibility is to increase share value. But he wasn't saying this is how our world should be, he was telling us that this is how things will be. He pointed to the lawmakers as the only ones who can take care of society's needs. If society feels corporations are not acting appropriately, it's up to the lawmakers to change the laws and regulations, forcing corporations to do the right thing. Don't just sit back and expect them to do the right thing, because that's not how they're designed.

I know if Milton was still with us, and if I had a chance to speak with him about the $25 billion not-a-bailout in Canada, or even the $800+ billion bailout in the US, he would respond quite simply:


What did you expect them to do with the money? Did you expect them to save jobs or homes? Did you expect them to stimulate the economy? You should expect corporations to do whatever actions yield the highest profit. Oh - and by the way, Umar, that paper you wrote in third year defending my ideas was money!