THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 242

210 PA R T I I I Financial Institutions Bailout Package Debated The financial crisis then took an even more virulent turn after the U.S House of Representatives, fearing the wrath of constituents who were angry about bailing out Wall Street, voted down a US$700 billion bailout package proposed by the Bush administration on Monday, September 29, 2008 The Emergency Economic Stabilization Act was finally passed on Friday, October The stock market crash accelerated, with the week beginning on October showing the worst weekly decline in U.S history Credit spreads went through the roof over the next three weeks, with the U.S Treasury bill-to-Eurodollar rate spread going to over 450 basis points (4.50 percentage points), the highest value in its history (see Figure 9-2) The crisis then spread to Europe with a string of failures of financial institutions Recovery in Sight? The increased uncertainty from the failures of so many financial institutions, the deterioration in financial institutions balance sheets, and the decline in the stock market of over 40% from its peak all increased the severity of adverse selection and moral hazard problems in the credit markets The resulting decline in lending led to the U.S unemployment rate rising to 7% by the end of 2008, with worse likely to come The financial crisis led to a slowing of economic growth worldwide and massive government bailouts of financial institutions (see the Global box, The U.S Treasury Asset Relief Plan and Government Bailouts Throughout the World) Subprime Mortgages in Canada The subprime mortgage crisis in the United States dominated news headlines, but there is also the Canadian version of subprime mortgages High-risk, long-term (40-year), zero-down mortgages proliferated in Canada in 2007 and 2008 after the Conservative government opened up the Canadian mortgage market to big U.S players in its first budget in May of 2006 This created the Canadian version of subprime mortgages How did Canadian regulators allow the entry into Canada of U.S.-style subprime mortgages? The Canadian mortgage insurance market is the second largest and one of the most lucrative mortgage insurance markets in the world For over 50 years, since revisions in the National Housing Act and the Bank Act in 1954 allowed chartered banks to make insured mortgage loans, the business of mortgage insurance was mainly the domain of the Canada Mortgage and Housing Corporation (CMHC) CMHC insured the mortgages of those home buyers that could not make a 25% down payment, charging them an insurance premium, with the federal government backing the CMHC s insurance policies with a 100% federal guarantee In May of 2006, however, after years of orchestrated lobbying the Department of Finance and Office of the Superintendent of Financial Institutions by U.S insurance companies, the government allowed big U.S players such as AIG to enter the Canadian mortgage insurance market and also committed to guarantee their business up to $200 billion In February of 2006, in an attempt to protect its business in anticipation of the entry of the big U.S insurers, CMHC announced that it would insure 30-year mortgages Two weeks later, Genworth Mortgage Insurance Co., the Canadian mortgage subsidiary of the U.S conglomerate General Electric and the only other (private) mortgage insurer in Canada at that time (with an estimated market share of about 30%), announced that it would insure 35-year mortgages By October of 2006, AIG, CMHC, and Genworth were competing in the Canadian mortgage insurance market by insuring 40-year mortgages