Chrystia Freeland and Bernard Simon Published on Monday, Jan. 25, 2010 9:19AM EST Last updated on Monday, Jan. 25, 2010 5:47PM EST

As governor of the Bank of Canada, Mark Carney has had a ringside seat on the global credit crisis. But he is in the fortunate position that his own country’s financial system remains relatively healthy. Mr Carney also has the advantage of having seen regulation from both sides of the table. He worked at Goldman Sachs for more than a decade before moving into government. In a video interview with, Mr Carney, 44, discussed President Barack Obama’s proposals to limit the size and scope of the biggest US banks as well as the outlook for the global economy and Canada’s financial system. Edited highlights appear below.

President Obama seems to be embracing the notion that too big to fail is a real concern, and that they need to be able to break banks up. Is that the right approach?

Certainly we need to build a system that’s robust to failure and it’s important to have the ultimate sanction of the market for financial institutions. All of us found ourselves in a position over the past couple of years where firms had to be saved in order to ensure some measure of function in the system. That has to be rectified.

How worried are you about the US deficit and debt right now?

The fiscal response of G20 nations as a whole has been extraordinary, and it is entirely reasonable that debt-to-GDP in the G20 will go from about 70 per cent, as it is right now, to about 120 per cent or more over the course of the next four or five years. That is a major move, and it will require consolidation of fiscal positions in the US and other major economies. Those decisions need to start to be taken in the near future.

Paul Volcker, who seems to be having a lot of influence on the White House’s financial reform at the moment, has been very outspoken in his view that banks should not be engaged in proprietary trading. Is he right?

Mr Volcker has an important point, but where do you draw the line between proprietary businesses and market-making businesses?

How much of a restriction would you put on proprietary trading in banks that we know pose a real systemic risk if they fail?

The devil is in the detail. I’ve had discussions with Mr Volcker on this issue. But it’s got to be an engaged debate, so I’m not going to give you a blanket answer.

Which side are you on?

Well, we start from two principles. One is you have to have a system that’s robust to failure, so we have to move to a system where institutions can fail in an orderly fashion. Secondly, as a central bank, what we care deeply about is that markets function and that we can enlarge the number of markets that are continuously open. We might not have liked what equity prices were during 2008-09, but at least we always knew what they were and you always could transact. You couldn’t transact in a host of derivative markets and you had challenges in repo markets for anything other than the most liquid government securities. That’s totally unacceptable. So we have to work to make these markets open. That means we’re going to need firms that are market-makers.

Is double-dip recession a fear?

It’s certainly not our base case expectation. It always sounds odd, but central bankers talk in terms of positive risk. There is a possibility of more momentum in emerging markets for longer, and a faster return to growth in major economies. That’s not our base case, but things could go more right than expected.

Chrystia Freeland and Bernard Simon