I draw your attention to the right-hand graph, which shows the securitization. The yellow is for subprime and the green is for non-conforming mortgages, which is another polite word for bad mortgages. You can see they were about one half of the approximately $2 trillion in mortgages written.
What did this do? Well, as anybody who understands economics and banking would know, it drove up the home ownership rate from about 62% to 69%. In other words, millions of new buyers entered the market.
If millions of new buyers enter the market, what is that going to do? It's going to drive up house prices. During this period throughout the nineties, real incomes were flat; they were not going up. Take a look at that red line; that's average house prices. Even though incomes were not going up at all in aggregate, the house prices went almost vertical, because of these policy mistakes. As a consequence, it drove up debt service from the long-term average over a period of some 25 to 30 years of 12% up to almost 14% of income being allocated to service debt, which is unsustainable.
So this was the outcome of the bad laws and bad regulations. It was perfectly predictable. It drove up inflation. The Fed put up interest rates—which were probably too low in the first place. Secondly, it drove up mortgage delinquencies; that's the graph on the bottom right. And thirdly, home prices started to come down.
So what does this mean for Canada? The very good news is that Canada did not melt down. The argument I'm providing in the paper is, number one, that this was due to the very high quality of the human capital in the Canadian chartered banks, the strongest banking system in the world, in my judgment and according to international evaluators. Second, it should be said that Canada has been very fortunate to have had very strong Canadian regulators. I'm referring specifically to Parliament: you did not go over the cliff, as the U.S. Congress did. Also, the Department of Finance has outstanding people, as does the Bank of Canada and OSFI, the Office of the Superintendent of Financial Institutions. Finally, there is a pragmatic, small-c conservative culture amongst Canadians.
I've read the transcripts of the committee hearings and know that the committee is very concerned about bank credit and its availability and the perception that bank credit granting has declined. In fact, empirically, factually or statistically, it has not. Bank credit has gone up in the last year.
However, before I go to the next slide dealing with the pricing of credit, what has happened is that the so-called shadow banking sector has collapsed and is not lending. So there's less credit being granted, although the banks are doing more heavy lifting.
In terms of the pricing—because some of you are very concerned about the widening spread, and David Dodge has spoken about this in his interviews and his two excellent presentations in late November—banks are recapitalizing in anticipation of loan losses, because in every recession loan losses go up, and that's going to drive up the pricing.
So what is not working today in Canada? The shadow or parallel banking system, which are the money funds, the asset-backed securities, the investment banks, the hedge funds, derivatives, exchange-traded or OTCs, which is over the counter, derive from something else. These are not regulated. I don't have a number for Canada, but Secretary of the Treasury Geithner estimates the shadow banking sector in the United States—this is end of 2007 data—is $10 trillion.
The regulated banking sector is $10 trillion. In other words, the shadow banking in the States was about 50% of the total. That figure corresponds to that of Canada. The Bank of Canada estimates that banks make up 55%, so shadow banking is somewhere around 45%. Almost one-half of the financial system in Canada is not regulated. In other words, there is no recourse for assets, there is no transparency, and there are spurious credit ratings.
MPs are worried about the decline in credit. Yet the shadow banking provided about half of all the loans. But the shadow bankers withdrew because of the financial crisis. I argue they withdrew because they were overleveraged. They were overleveraged because they were not regulated. Now is the time to solve the problem by supporting a national securities regulator. How do you deal with the question of solving the declining availability of credit? For 25 to 30 years banks have wanted to lease cars, and this was opposed by the dealers' association. I was in a bank when they were opposing it. Now the chickens are coming home to roost for them because the acceptance companies, such as GMAC and Chrysler Credit, have pulled out. There's insufficient credit.
Parliament has an opportunity to resolve this by authorizing direct bank leasing in the branches.
These are my last two slides. My recommended policies are: one, approve and establish a national securities regulator to include the regulation of the shadow banking system; two, authorize banks to lease through branches; three, modify mark-to-market accounting rules to eliminate pro-cyclicality, which David Dodge has spoken about as well; four, maintain the OSFI raw leverage ratio at 20:1; five--I argue, with all due respect to the people from CMHC, that we have a problem in Canada--CMHC should be more regulated because they have two businesses in one and they're not regulated by OSFI or some similar agency, and David Dodge has also spoken about this; six, you have to create a clearing house for credit swaps; and finally, I support the lending program, the extraordinary financing program announced in the budget, as there are very imaginative, innovative, and prudent ways to partially address this problem.
Thank you.