Home Capital Group has recently dominated the conversation in capital markets. Although the Minister of Finance has proclaimed that HCG’s difficulties will not be the catalyst of a housing correction, no one can really predict what will be the actual fall out. Everyone remotely involved are telling us that they are being extra vigilant, whatever that means. In reality, I wonder if many are more sanguine in private about contagion, possessing a false confidence premised on the regulatory changes that have been made following the 2008 crisis in the US. You know, the same crisis that showed us that financial instability could spread from one of the most regulated industries in the economy, the large banks. This same crisis revealed that the competence of the regulator and implementation and enforcement of the existing regulations was more important than what was written. In this context, what we see in Canada so far should scare us.
The regulators would be the first to tell you that things are different this time. This is not 2008, the entities that are on their watch have more capital, they have more liquidity and are held to higher standards when it comes to compliance. They are right. Things are different but I am not sure that guarantees that things will be better. Actions taken by regulators globally have made each individual bank safer, but at the cost of making the system weaker. The new rules have created an environment where it will be extremely challenging for a distressed bank to find a private sector buyer for their liquid securities if they are in need of funding. The same new rules make it more costly to accept new deposits coming from a failing institution and the precedence set with the forced merger between Bear Sterns and J P Morgan will scare any sane financial institution away from voluntarily stepping forward to take over a failing firm regardless of where they are located geographically. If a housing correction causes a US- like crisis of liquidity, regulators have assured us that it will not look like it did in 2008, and who is going to argue. My fear is that it may actually be worse, with more non-bank victims caught by the banking system hoarding liquidity in response to the newly minted regulation.
Currently, despite all the changes to the rules, here we are again witnessing a bank about to become road kill, all the while meeting the stricter requirements set out by the new regime and while being scrutinized more intensely by the regulators. The regulators deserve kudos for sniffing out the fraudulent mortgage activity at the firm, but they also should collect an award for pulling defeat out of the jaws of victory. They somehow managed to fumble the ball and ended up as an accessory to seeing about $1.0 billion in deposits vanish. Did the crime deserve this punishment? They aided and abetted the demise of HCG and are now watching a solid, well capitalized bank dissolve in front of them.
How did they aid and abet this crime? Some analysts say that the regulators mishandled the public disclosure that the firm had mislead investors by not acknowledging the fraudulent mortgages. The regulators could have stressed that this action was done well in the past, it was dealt with and would not happen again under their watch. This message did not get across.
The regulators may have also underestimated the sensitivities of depositors and market participants to any suggestions of wrong doings in the Alt-A mortgage market given still fresh memories of 2008.
Additionally, if you assume that there had been ongoing dialogue between HCG and the regulators as to how their plight was unfolding, what did the regulators say or do as they watched HOOPP securely fasten the cement boots on HCG with the $2.0 billion line of credit at an effective rate of 22.5%? I understand that the regulators would prefer a private sector solution, but did our ace regulators give any thought that by having HCG sign on the dotted line of a deal that reeked of desperation that it might scare the pooh out of the remaining depositors?
The regulators tell us that HCG is not systemically important. I hope they are right. It is still very sad however if we see it upside down in the aquarium or even worse find out later that it played a part in ultimately starting a correction in the housing market. If and when that day ever comes, there will be plenty of finger pointing, but it might have been the ones who are suppose to keep the system safe that actually shoulder some of the blame.
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