Lessons in mortgage lending, Canadian-style: with the credit crisis easing and capital returning to U.S. financial institutions, a Canadian banking attorney offers some advice for American lenders and borrowers: learn to be boring.

• Author: Elliott, Robert
• Position: VIEWPOINT

The battered United States banking system is showing signs of a turnaround--welcome news around the globe, and certainly here in Canada, which relies heavily on our southern neighbor, our largest trading partner.

A number of institutions--including JPMorgan Chase & Co., Goldman Sachs Group Inc. and others--have opted to return their Troubled Assets Relief Program funds to the U.S. Treasury, while banks have raised tens of billions of dollars in fresh equity to shore up capital levels in the wake of the government's stress tests.

Private equity firms are starting to take over distressed thrifts and regional banks, a sign that the smart money is betting on a return to profitability. And loans are flowing to small businesses and homeowners as well as large corporations.

While we hate to rain on a recovery, our northern perspective makes us see things a bit differently. That's because in Canada, strong capital levels and increased loan activity offer only a partial picture of a bank's health. Equally important are lending standards and risk management, the key drivers for how a lending institution succeeds in managing its business. By those metrics, we still view the U.S. banking sector with some concern, especially in residential lending that was at the center of the financial crisis.

As U.S. lenders stabilize and reopen their credit pipelines, this might be a good moment to reflect on the Canadian experience, where more prudent lending and borrowing played a big part in preventing the housing bubble that proved the near-undoing of the American banking sector. Our view is that without improving the management of credit risk, all the fresh capital in the world may not prevent another cycle of misery down the road.

Views on Home Ownership Differ

To understand how our two systems diverged when the storm hit, start with the concept of home ownership. For many Americans, owning one's home--a long-held symbol of financial independence and personal success--has been transformed into a constitutional right. That entitlement was aggressively encouraged by mortgage lenders offering "innovations" such as no-documentation loans with flexible payment options, often requiring minimal down-payments and other dubious terms.

U.S. public policy furthered the goal of single-family home ownership, with government-sponsored entities Fannie Mae and Freddie Mac buying up vast pools of mortgages that could be sliced and sold to investors. The subprime boom, in some...