As a specialist in the history of Canadian business, Professor Martin has interesting perspectives and insights into last year’s financial crisis. In an interview, he placed recent events and conditions into a historical context, explaining some of the reasons Canadian financial institutions have shown much more resilience through the financial crisis than their U.S. counterparts.

Many would say that Canadian financial institutions weathered the recent financial crisis better than their U.S. counterparts because of their more prudent lending practices, much fewer sub-prime mortgage loans and lower levels of securitization and use of derivatives (such as credit default swaps and collateralized debt obligations). However, you are suggesting that beneath these differences lie some more fundamental historic reasons?

JM: Yes-the reasons go back to the time of Alexander Hamilton, the secretary of the U.S. Treasury during the first Congress in Philadelphia, and to that of President Andrew Jackson. Alexander Hamilton was a true genius among the advisors who surrounded George Washington. He introduced the charter of the First Bank of the United States in 1791. However, the U.S. didn’t continue for very long on the path of a nationally regulated banking industry. The First Bank’s charter expired in 1811 and in 1816 following the war of 1812-1814 against the British Empire, the Second Bank of the United States was created. But Andrew Jackson vetoed the proposed continuation of the second Bank Act in 1836 and ensured state-chartered or ‘free banking’ would prevail thereafter. In Canada, the Bank of Montreal was created in 1817 and its charter was based on that of the First Bank of the United States with relatively minor changes. In the 1860s, the Fathers of Confederation who met in Quebec City to create what became The Dominion of Canada were mindful of the U.S. civil war taking place to the South. (In 1864 a U.S. $1 was briefly worth only 40 Canadian cents). Not much has been written about this era in Canada. Author and columnist Richard Gwyn recently wrote John A, The Man Who Made Us, a biography of Sir John Alexander Macdonald, which makes it clear that the men involved with Canadian banking legislation during this era deliberately chose to ensure that banking, currency and insurance were federal responsibilities unlike in the U.S. The originally proposed Canadian Bank Act of 1869, which would have made our system more like that of the U.S., was defeated. Sir Francis Hincks, the new Minister of Finance, ensured the improved Bank Act of 1871 passed instead. This legislation required institutions to maintain a high level of paid up capital (a ratio of 3:1 of liabilities to paid up capital) and that the Bank Act be reviewed every 10 years to ensure that it was adjusting to changing circumstances. The Constitutional provisions of the British North American Act and the Bank Act of 1871 formed the cornerstone of the Canadian financial system that we enjoy today.

The differences between the financial regulatory systems in the U.S. and Canada have been major factors in helping Canada avoid the bank and other financial institution failures experienced in the U.S. For example, AIG is not federally regulated but was recently saved by receiving a massive quantity of U.S. federal government funds. Canadians often overlook the significance of these differences. In the U.S. over the years there have been numerous very large federal government sponsored bailouts of institutions that were not federally regulated—notably regional banks and virtually the entire savings and loan industry in the 1980s.

Canada’s Bank Act and Constitution have been admired just as much in the past as they are today. In the 1907 crisis in the U.S., JP Morgan saved Wall Street and the U.S. government appointed a monetary commission which undertook a study on the Canadian financial system. This study praised the Canadian model as it existed then.

So it seems that a good part of the success and strength of the Canadian financial sector is due to historical legislation and the structure of the Bank Act?

JM: Yes that’s correct, I think that around the corner of King and Bay two statues should be raised; one of Sir Francis Hincks (the third minister of finance in Canada during the late 19th century) who pushed the Canadian Bank Act through, and one of Alexander Hamilton, the first secretary of the U.S. Treasury. These two men were the ones who laid the foundation for our system which is widely praised today. The IMF and many Americans, including the famous former Federal Reserve chairman Paul Volcker, admire the Canadian system because it is stable. A banking system needs stability if the rest of the economy is to flourish. It is noteworthy that the OECD has just released a report projecting that growth in the Canadian economy will far outpace the other G7 nations in 2010.

Why is understanding business history fundamental for business success?

JM: The Spanish-American philosopher and poet George Santayana said, “Those who cannot remember the past are condemned to repeat it.” We all learn from our mistakes and learn about success from successful people. A fundamental requirement of long-term success, however is to realize the need to learn through analyzing the failures of others even during times of success.

We must learn from failures to draw insight to avoid mistakes. Studying history enables businesses as well as people to learn from the past and to establish processes to improve their performance in the future. This applies to any industry and has been the key to human evolution. All too often executives have what I call ‘white painter syndrome’, in other words they believe that history starts with them.

Do you see opportunities in the current legislative environment to improve?

JM: I think in banking and insurance Canada has done a great job. It’s unfortunate that there is no national securities regulator, but I can appreciate the country’s concern with the prospect of being dominated by Toronto. However, I do believe that we need a national securities regulator and I’m pleased there’s a push towards forming one. With 13 security regulators, corporations have extra costs for filing and, as a result, more Canadian corporations are opting to file with the U.S. SEC to avoid the hassle of having to file with multiple jurisdictions in Canada. The securities regulatory system would be much more competitive under a federal body.

The financial failures and liquidity crisis in the U.S. in recent years provide a great many insights into what can go wrong in a financial system and we can all benefit from studying these mistakes.

How do you see the initiatives to draw up new financial industry regulation evolving?

JM: Through good luck or good management Canada has been successful with its original legislation of the 19th century. Even in the late 1980s when Canada had its financial industry de-regulation in the form of the “Little Bang”, it turned out to be a good initiative. Since then OSFI has emerged as a successful federal regulator for major Canadian financial institutions and has contributed to the strong system we have, which is well positioned to achieve success in the future. In the U.S., in spite of the repeal of the Glass Steagall Act of 1932, each financial pillar has had a separate regulator rather than a single one looking at the whole financial system picture.

I see the U.S., the U.K. and other nations as having major issues that need to be addressed. The U.S. and U.K. are facing government ownership of large banks as part of the process of avoiding a collapse of the financial system.

In conclusion, overall Canada has come through the recent crisis remarkably well and we must not forget to thank our past legislatures for building the solid framework that we enjoy today.

Professor Martin is director of Canadian business history, adjunct professor of business strategy and executive in residence at the University of Toronto Rotman School of Management. He is also chair of the Governors of the National Business Archives of Canada, and most recently, the author of Relentless Change: A Casebook for the Study of Canadian Business History.