Small-Town Computers and Big-Time Bond Defaults: Two Challenging Exam Questions

On final exams I always try to challenge students by including one or two questions that require them to apply what they have learned in new and different contexts. I had two such questions in this year’s public management class. The first began with Industry Canada’s recent termination of the Community Access Program that provided funding for rural Internet access. A small town that had benefited from the program must decide if it should attempt to keep the public use computer room at the local library open using its own resources. The second imagined that one of Canada’s chartered banks had “bet the bank” on Spanish Euro-denominated bonds and, as a result of a fictitious Spanish decision to leave the Euro zone and resume using the peseta, the bank would have to write down more than half of its capital base, and could no longer meet its reserve requirements.

The first question dealt specifically with a township in Ontario cottage country. The township was funding a public access computer room in the local library with a $60,000 grant from CAP and $20,000 in user fees, assessed at $ 1 per hour. The township’s year-round residents have income and education levels below the Ontario average, while its cottagers are much wealthier and more highly educated. The $60,000 grant represented less than 1 percent of the township’s budget. The alternative to library-based Internet is relatively expense satellite-based service, provided by either Rogers or Bell. The student is to imagine him/herself as a recent MPA graduate who works as township manager, and is asked to do a policy analysis for township council as well as design a public consultation process.

My first question of the students was what the objective of the program should be. A limited objective – essentially that of the CAP program – would be to provide Internet service for rural residents who have no other broadband access. The existence of satellite service would justify the township confirming Industry Canada’s decision by not replacing CAP with its own resources. A more ambitious objective would be to contribute to the quality of life in the township by ensuring that it maintained broadband Internet access. The latter objective is comparable to the justification some larger cities have given for putting in place infrastructure making the entire city a wi-fi zone. The essential point is that how you envisage the goals of public policy will influence your solution.

While some students were explicit in setting out the more ambitious objective, almost all the students chose to try to keep the computer room open with municipal resources. The facts of the case made that relatively easy. One alternative would be to pay for it with a small increase in property taxes. Because cottage properties are major contributors to the tax base, cottagers as well as locals would be paying for the computer room. A second alternative would be by increasing user fees. That could be done through a form of price discrimination, for instance selling low-price annual or seasonal passes (say $ 50 for the year) and increasing the single visit fee from $1 per hour. A third approach would be to look for a private sector partner who might be willing to pay some of the cost in return for the marketing opportunity.

The consultation question mentioned that the township manager’s report would be discussed and recommendation voted on at the township council meeting, but left open other forms of consultation, making clear that cottagers, as property owners, had the right to vote in municipal elections. I was disappointed that most of my social media-savvy students didn’t suggest posting the report on the township website well in advance of the meeting, encouraging online discussion, or facilitating an online town hall meeting.

The financial crisis question assumed that the Spanish government made a dramatic announcement of the currency conversion on New Year’s Eve, which happened to fall on a Friday. It froze all Euro deposits in Spanish banks and would convert them to pesetas when business reopened the following Tuesday. It also suspended payment of interest on Euro-denominated Spanish bonds and intended that, when the bonds were converted to pesetas and payment resumed, bondholders would take a 75 per cent haircut. The one Canadian chartered bank that had invested so heavily in Spanish bonds was National Bank, which has traditionally had a stronger regional Quebec focus than the others. The facts of the case were presented in a New Year’s Eve phone call from Bank of Canada Governor Mark Carney to Prime Minister Harper. The student, cast as an adviser to the Prime Minister, was asked whom the Prime Minister should consult in formulating a response and posed three options: extending massive loans to keep National Bank afloat, temporarily nationalizing it, or trying to find another chartered bank to take it over. Finally, the student adviser was asked to outline how a decision would be announced and write the first paragraph of the speech or media release.

I expected that the Prime Minister would initiate secret but widespread consultation with the Government’s economic advisers (Bank of Canada, Department of Finance, Superintendant of Financial Institutions); with the banking industry and with National Bank itself; with knowledgeable sources on the ground in Spain, say the Canadian ambassador; and, given National Bank’s profile in Quebec, with the premier or Finance Minister of Quebec.

All the options are unpleasant. Bailing out the bank will be very expensive, even if the Bank of Canada monetizes the debt. Clearly, the management of this bank has made some major mistakes and deserves to be replaced or closely watched. Micro-management of business is not something that would appeal to the Harper Government, whether exercised as part of a temporary nationalization effected through purchase of equity or as conditions for a loan. A merger raises the question of which other bank would want to merge with the now-crippled National Bank. It might well be that the only way a merger could be achieved is if the federal government assumed the toxic assets. A merger also poses the problem of reducing competition as well as eliminating a Quebec-based financial institution, which the Government of Quebec would oppose. In effect, National Bank’s bet on Spanish bonds has given the Canadian financial system a gift of a huge lump of burning coal that, one way or another, will come to rest in the federal government’s lap. From the Harper Government’s viewpoint, a loan with numerous conditions attached is probably the least bad alternative.

Given the consequences major investments by Canadian banks in toxic overseas assets would have for the Canadian financial system and indeed Canadian society, one wonders about the Bank of Canada’s ongoing closed-door consultations with, and moral suasion upon, the banking system.

Because the matter is not yet a national crisis, an announcement would best come from the Government’s high profile financial spokesmen, Finance Minister Flaherty and Bank of Canada Governor Mark Carney. It would have to be made on Monday, before markets open on Tuesday. The media would undoubtedly have questions, so a press conference would be preferable to a press release. Finally, the statement should begin with the context and then move to the course of action the Government has decided upon.

To some extent, the question is posed in what economists would call partial equilibrium rather than general equilibrium. Spain’ sudden exit from the Euro zone would have consequences for the viability of the Euro itself and for the European economies as well. Better to reserve the Prime Minister for a response to the next phase of the financial crisis.

As the Chinese say, we live in “interesting times.” Surely, public management exams should be no less interesting.

 

1 comment

  1. Now that I am out of the exam stress, I agree that the case based questions were interesting and thought provoking. Thank you for a very knowledgeable and engaging course!

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