Aaron Ford

I find it amazing how very little if no coverage has been given to the bailout of the Canadian banks in a very similar fashion to what has happened in the USA. It just shows the level of apathy and blindness here in Canada. Embarrassing to say the least.

The twenty dollar bill you just pulled out of your pocket has had the assets behind that $20 switched from “high-grade” government debt, to “other” or “troubled” otherwise known as “junk” assets to get those assets off of the books of the private banks.

Oh well at least I’m doing well in my hockey pool(not in one), time to put the blinders back on and get back to being a slave.

Courageous job by John Paul Koning from Pollitt & Co., I commend you sir for writing this article. You are a true Canadian.

BoC’s mystery assets

The Bank of Canada’s balance sheet now lists 42% of its assets as ‘other.’ Canadians should be worried

John Paul Koning, Financial Post Published: Thursday, December 04, 2008

For most Canadians, bringing up the goings-on at the Bank of Canada is enough to inspire yawns or changes in conversation. And with a slew of vague acronyms like SPRA, TLF and SLF dominating the bank’s public documents, who can blame them?

Ignore it at your peril though, because our central bank is embarking on one of the largest and fastest revisions of its asset structure in history. Like a company, the bank has a balance sheet; assets on the one side and liabilities on the other. The majority of the bank’s liabilities are circulating notes held by the Canadian public. Pull $20 out of your wallet and you are holding not just a pretty piece of paper that buys stuff but a liability of our central bank. Collectively, there’s about $51-billion worth of cash circulating in the economy, all of which the bank is liable for.

A liability is only as good as the asset that backs it up. The $20 you’re holding is backed by various assets held in the vaults of the Bank of Canada in Ottawa. In times past the asset side of the bank’s balance sheet had a large gold component. Over the years gold lost its popularity with central banks and was replaced by government bills and bonds. As late as August of this year, the bank held assets of $22-billion in government T-bills and $31-billion in long-term bonds to back the cash in Canadians’ wallets, under their beds and in their deposit boxes.

This has all changed. Over the last three months, the bank has sold off a large part of its government T-bill portfolio and replaced it with assets classified as “other.” In August this “other” category comprised a miniscule 0.4% of the bank’s total assets, or about $200-million. It has since ballooned in size to an impressive $32.4-billion. Last week “other” surpassed government bonds to become the largest component of the bank’s assets, about 42% of the total. At the same time the bank has sold off $11-billion worth of government T-bills, which now make up just 15% of the bank’s assets, down from a hefty 41%.

The assets in the fast growing “other” category have been acquired through term purchase and resale agreements from the Big Six banks and other participants in Canada’s financial system. What is the category comprised of? No one really knows, but given the Bank of Canada’s disclaimer on such transactions, they could include any combination of government-guaranteed mortgages, asset-backed commercial paper, corporate bonds and anything classified as a non-mortgage loan, which could presumably include items like working capital loans and credit card debt.

The bank’s move mirrors some of the actions taken by the U. S. Federal Reserve since 2007. U. S. T-bills and bonds comprised 88% of the Fed’s assets last December. Since then they have been sold off and replaced by a range of unnamed assets, as well as questionable items like the remainder of Bear Stearns. Bills and bonds now make up only 21% of the Fed’s total assets.

From the perspective of Canada’s financial firms, the bank’s move brings cheers since it allows bankers to swap all sorts of financial assets off their balance sheet for cash, rather than having to offload them in often-illiquid markets. For the average Canadian who holds the Bank of Canada’s cash, the move may not be in their best interests. Our central bank has swapped a sure thing; a large chunk of liquid and non-volatile AAA-rated government debt, for a slew of “other” assets whose nature remains uncertain to everyone but bank insiders, assets which are inherently more volatile and less liquid than government debt. When the nature of any institution’s assets becomes “murkier” and more volatile, the nature of its corresponding liabilities is compromised. In sum, while the big banks may be happier, those dollar liabilities we all hold in our wallets don’t look so good anymore, thanks to the Bank of Canada’s massive balance sheet alteration.

The best way to understand what the Bank of Canada has done to its balance sheet is to imagine a private institution doing the same in a free market. If a manufacturing firm sold off 42% of its assets, say some factories, and replaced them with assets classified as “other,” you can be sure the holders of that firm’s liabilities — bankers, bondholders and the like — would raise the alarm bells, maybe even selling off their holdings. If the Royal Bank sold 42% of its performing loans and replaced them with mystery assets, it’s probable that a portion of depositors would get nervous, close their accounts, and go to the Bank of Montreal to do business.

Likewise, the Bank of Canada’s decision to lower the stability and transparency of its balance sheet may incite people to sell Bank of Canada liabilities. The result would be a drop in these liabilities’ value, which is just a different way of saying inflation, or a decline in the purchasing power of money.

Of course the bank doesn’t operate in a free market. As a monopoly provider of currency, Canadians are forced to hold some of its liabilities as a means of paying for the things they need. When the quality of the assets behind these liabilities is being degraded they can only bite their tongue rather than turn to another provider. This is unfortunate. Increased transparency and reassurances from the central bank that it is not sacrificing the integrity of our dollar with mystery assets just to help the big banks would help restore some trust. If not, its time to remind the bank that monopolies that don’t help Canadians deserve to be broken up.

-John Paul Koning is a stock market researcher at Pollitt & Co, a brokerage based in Toronto.