Buy American

Canadian banks have money, and our Prime Minister wants everyone to know it. Apparently he believes this is a good time to buy foreign banks. In this piece from the Globe and Mail, Harper outlines how this is a great time for Canadian banks to expand their modest empire. The logic is that there are several financial institutions in the US with stock values so low that our banks can theoretically swoop in and acquire them - an action that was previously impossible before the financial crisis.

So how did our banks become so "relatively" wealthy? As Harper suggests in the article, tight regulations in the Canadian banking sector is a major reason why our banks are not as stressed as the American ones. The reserve ratios are much higher for Canadian banks. This restricts how leveraged our banks can be, relative to the American banks. Stricter regulations also means that when times are good, our banks can't grow as fast as the US ones. Don Drummond of TD Bank covers all the angles of why our banks are awesome in this piece he wrote for the Star.

Without doing anything, the big five Canadian banks have all found themselves among the top 13 banking companies in North America. To put this into perspective, our largest bank (Royal) used to be only a third of the size of a large American bank (like Citigroup). Now, Royal Bank is more than twice as large as Citigroup. The relative values of Canadian banks versus American banks has changed drastically. But just because something’s ridiculously cheap – should you buy it?

Experience tells us that the recessions bring about tremendous opportunities, simply because asset prices are depressed. When everyone is scared to buy – that is exactly the right time to buy.

[An aside: I personally believe in Dollar Cost Averaging, which refers to purchasing an investment in little pieces over time, rather than purchase it all in one lot. For example, if I had $5,000 that I wanted to invest in a Canadian Equity mutual fund, rather than trying to figure out when Canadian stocks will bottom-out, I would blindly purchase $200 of the mutual fund each month. This is what they refer to in the investment industry as being a "scaredey-cat." The reality is by the time our phsyches are ready to invest, it's already too late - economic recovery is well on its way. That's why the best way to remove the psychological element from investing is dollar-cost averaging. Let the experts pick the market-bottoms (and then change their mind, and then pick them again, and so on). By averaging your purchases, you'll have participated in the market bottoming out process, which ensures that you're buying low.]

But I'm not concerned about timing. I'm concerned about the quality of the assets they could potentially buy. Let's not forget last fall when Lehman collapsed, the entire American banking system was lined up to follow, like dominos. If it wasn’t for that blank-cheque financial bailout package that everyone is now criticizing, Lehman would have been the first of several casualties. They were all guilty of borrowing to the max in order to invest in mortgage backed securities althewhile failing to have enough reserves for any potential losses or impairment to their assets.

[Another aside: It’s easy to criticize how poorly that bailout package was written, but the fact of the matter is Congressmen were holding the government hostage because its passing was essential to prevent imminent bank failures.]

As it stands, it’s very difficult to value of one of these banks while they are getting so much assistance from the US government. The reason the value of these stocks is so low is due to the uncertainty surrounding their financial assets. There is so much uncertainty that the stock prices are not likely a good indicator of the true value of these American banks.

Although AIG is not a bank, it would be naive to think what killed AIG doesn't also ail other financial institutions. Even though it is obviously not a target for a merger, right now it serves as a powerpoint presentation to the world as to how deranged the American corporate system can be, and how easy it is for these banks to deceive the public about their financial situation.

Naturally, before a takeover, there has to be some thorough due diligence performed on these American bank assets. If one of the big Canadian banks is interested in taking over Citigroup, for example, they would need to determine exactly how many of these "toxic" assets Citibank actually owns, and how much they're really worth. They will also need to determine the degree to which Citi is affected by credit default swaps. Once they do that, they would be prepared to make an appropriate bid on the true value of the company. Basically, they just need to do what US government has been trying to do for about half a year now.