Are Canadian Banks the Answer?

David Leonhardt’s interview with President Obama includes a fair amount of conversation about the economy, including a question about whether big banks need to be split up:

THE PRESIDENT: You know, I’ve looked at the evidence so far that indicates that other countries that have not seen some of the problems in their financial markets that we have nevertheless don’t separate between investment banks and commercial banks, for example. They have a “supermarket” model that they’ve got strong regulation of.

Like Canada?

THE PRESIDENT: Canada being a good example….So — that doesn’t mean that, for example, an insurance company like A.I.G. grafting a hedge fund on top of it is something that is optimal….And in that sense I think you can make an argument that there may be a breaking point in which functions are so different that you don’t want a single company doing everything.

But when it comes to something like investment banking versus commercial banking, the experience in a country like Canada would indicate that good, strong regulation that focuses less on the legal form of the institution and more on the functions that they’re carrying out is probably the right approach to take.

I’m sort of waffly on the whole question of limiting bank size, but this isn’t an especially persuasive answer.  The experience of Canada is, I suppose, an existence proof that big banks can be regulated effectively, but when Obama says “other countries” he sure seems to be suggesting more than just Canada.  And frankly, I think he’d run out of examples pretty quickly.  After all, big banks Europe are in pretty bad shape.  Ditto for big banks in Japan following their property crash.  And big banks in Russia.  And big banks in Asia following their 1997 meltdown.

In some sense, I guess this comes down to a belt and suspenders issue.  I suspect Obama is basically right: regulating leverage is more crucial than regulating bank size.  A big bank with reasonable gearing is pretty safe.  But if you really want to be safe, you’ll have a fallback: not only will you regulate leverage, but you’ll limit bank size and complexity as well, so that even if a bank manages to evade the leverage rules it still can’t do too much damage.  It can only do that if it manages to evade two separate sets of rules.

More to the point, though, I wish Leonhardt hadn’t let Obama off the hook by feeding him the Canada example.  I would have have been curious to hear what Obama had to say without prompting.  Does he really think the banking system in the rest of the world is doing well because it’s better regulated than ours?  I’m not sure the evidence supports that.

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