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  • How we Got into a Financial Meltdown


    by El Cid
    1st October, 2008 at 5:30 pm    

    The funny thing about this mess — the mother of all credit busts — is that it can be legitimately attacked from both left and right.

    Those on the left can point to the old Marxian critique about how profits are privatised in a capitalist system while losses are socialised. The man and woman on the street and the middle class professional bamboozled by a subject out of his or her comfort zone can rail against fat cat bankers bloated on ill-gotten gains and protected from their own incompetence.

    Those on the right meanwhile can rail against government interference in the market and argue in favour of letting it all go to pot, which would allow the free flow (eventually!) of capital to sort things out, no matter the damage caused in the interim. In the log run we would be better off and stronger. They can also point to the fact that credit extended by a quasi-state institutions to poor people so that they could live the American dream and buy their own homes lies at the heart of this crisis. After all, the Federal National Mortgage Association (or Fannie Mae) was created in 1938, a key pillar of Roosevelt’s New Deal policies.

    So if we can steer clear of the ill-informed knee-jerk partisanship for a moment, I would make the following observations.

    (Bullet points after the fold)

    1) The US (and to a lesser extent the UK) have long been living beyond their means on a cocktail of easy credit and unrealistic expectations. An adjustment that would mean people saved more, spent less, and were less dependent on Asian credit was inevitable. The longer it took, the bigger that adjustment.

    2) This crisis was a failure of regulation. Why were banks allowed to borrow massively from other banks beyond their means (i.e. beyond what they already had on their balance sheets through cutsomer deposits).

    3) Why were banks allowed to originate debt just to sell on to other investors rather to take on to their own balance sheets, seemingly without limitation?

    4) Why were rating agencies given an effective monopoly over credit quality checks affecting trillions, disincentivising investors from doing their own due dilligence.

    5) Why is a study of the history of bubbles not compulsory for an industry which tends to be relatively youngish?

    6) Why are financial bonuses not tied to long-term performance?

    7) All these and several more questions will — hopefully — be addressed in time by the regulators and by the market itself (the stand-alone Wall Street investment bank model, after all, seems already to have been wiped out).

    At the same time, though, it is important to understand what is going on here. This is the banking system, the oil that feeds the engine.

    If we don’t fix it, it’s going to get a lot worse. This is no time for novices.


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    Filed in: Current affairs,Economics






    45 Comments below   |  

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    1. douglas clark — on 1st October, 2008 at 6:56 pm  

      As a complete novice in financial matters, I’d suggest that a huge growth in Credit Unions would be a good thing. A replacement for our, sadly lost, Building Societies. With rules in place that they can’t demutualise. Ever.

    2. Gatwick — on 1st October, 2008 at 8:24 pm  

      “No time for novices”

      Er… and who was it who landed us in this mess?

    3. douglas clark — on 1st October, 2008 at 9:07 pm  

      Er… and who was it who landed us in this mess?

      Voracious bastards, as far as I can tell.

    4. Shamit — on 1st October, 2008 at 11:50 pm  

      Financial crises, since the late 1980′s, to the present day have one interesting thing in common. The trigger is usually the sudden collapse in real estate prices.

      The prices are taken to such stratospheric levels that one Bank suddenly say “sorry” we do not rate the asset value of that real estate to be an equitable collateral for the price being asked or for a loan. As soon as that happens, the domino effect comes into play and suddenly Banks find themselves carrying a lot of bad debt.

      This has been true of New York in the 1980′s - again the same in the case of Japan — followed by the entire South East Asian region in the 1990′s.

      Since 2001, in the Western Developed Economies especially in the UK and the US, we found the difference between the median wage and the median real estate value growing too fast and without much economic sensibilities. Then suddenly, someone somewhere said sorry this house or this plot of land is simply not equal to the value that it has been assigned.

      And, when due to rising bad debts more and more banks and therefore consumers, say no — the situation erupts because the confidence of the average joe just disappears. And,then the downward spiral begins.

      People have rightly argued that it is a fault of regulators. But, if they did regulate, when the going was good - most politicians and bankers on the right would say what the hell are the regulators doing when the market should decide what the price is. And, some in the left would say — see the rich don’t want the poor to have homes.

      The politician’s ambition is to create more home ownership and help people moving up the ladder irrespective of their own political ideology. This becomes more evident in our politicians in the left — look at the Clinton and the Blair administrations respectively — and you would see more people who could not have afforded a home earlier suddenly had the opportunity to be homeowners. And many of them became paper millionaires due to their homes on which they started borrowing heavily as the boom is there for ever.

      But the politicians could not use public coffers to make this happen and rightly bloody so. They had to depend on the market and our financial institutions to develop these debt instruments to support politicians and more importantly people’s aspirations.

      I don’t think we can create a governance or regulatory model that would effectively be able to anticipate a crisis in 20 years time and stop it before it begins. Unless, we tell people don’t take risks or don’t have aspirations. So we need to change our behaviour ie people. And we all know how difficult that is.

      One group of individuals have clearly failed their duty — the SEC for not monitoring what they are supposed to do and more importantly the Board of Directors of each one of this failed institutions who had a moral and legal responsibility to ensure the best interest of the shareholders. And they did fail.

      These people should face criminal prosecutions and the SEC Chairman should have been sacked. In my company, if a VAT payment goes wrong, the Government comes after me not the accounts payable person — and here the SEC as an organization failed miserably.

      But most importantly, its people’s aspiration for a better life is the key reason we are in this crisis. And this is a temporary and shrewd investors have already started investing heavily. Investment Banks are not a thing of the past — they might have gone but don’t forget Nomura and DKB still exist and some others will crop up. And, the Governments everywhere are doing the right thing by ensuring they enable the economic system to function.

      And again people’s interest and aspiration to have a better life will slowly but surely breathe life back to the economic system.

    5. Refresh — on 2nd October, 2008 at 12:22 am  

      Sorry Shamit your argument is built on a shaky plot.

      The left should be looking to make homes not just mortgages affordable. And in this case the government should have been looking to build homes to meet demand. And that included building council houses. It should have made it clear that the policy of selling off council homes at hugely discounted prices was ripping off the tax-payer. It was a ruse for the Tories to buy long term voters, not too far off the Shirley Porter model.

      Access to mortgages isn’t the issue, first time buyers chasing houses went a while back. What did happen was the buy-to-let crowd bought all the homes which they would then rent to what would have otherwise been bought by the first timers.

    6. Kismet Hardy — on 2nd October, 2008 at 12:53 am  

      Call me a clueless cock, but with everyone blaming greedy bankers and estate agents and such, can someone explain to me why no one seems to think the billions squandered on bombing the fuck out of countries on the other side of the planet didn’t contribute to this?

      And for all the ‘bomb his ass, get the gas’ bumper stickers on texan gas guzzlers, and western companies getting all the control of Iraqi oil, can someone please tell me why petrol is so expensive?

    7. Shamit — on 2nd October, 2008 at 12:56 am  

      I agree with you Refresh.

      But how can you stop buy to let people from buying? Even in shared equity homes, many first time buyers are the front for their dads or someone else and that I see a lot in South london.

      And guess what after three months or 6 months, when all the basic checks are done they leave citing jobs and they rent out the place. The specific places I am talking about are near the river in Wandsworth, Fulham and Putney.

      And people complained to the council, but no one really cares as long as the money is paid.

      Effective regulation would be difficult. And that was my point. And the Government’s heart was in the right place but they failed to anticipate the impact.

    8. Shamit — on 2nd October, 2008 at 1:09 am  

      petrol prices are so high because taxes on petrol are one of the biggest earners for the Government — and no Government of any party would want to give that up.

      Its indirect taxation at its best — which by the way hurts the poor more. Just like VAT.

    9. sonia — on 2nd October, 2008 at 1:39 am  

      refresh has a point. why is everyone in this nation thinks its even acceptable that people should have to get mortgages (in the same way people think health insurance in the states, not public healthcare). look at the germans for example - not this obsession with owning property and ‘valuing’ it at ridiculous non-real levels. and this idea that ‘social housing’ is only for the poor. Rubbish.

      anyway, the right has no ‘critique’ really because there is no such thing as the ‘free’ market - sorry. and its time to join the euro zone folks, if they’ll still have us. (so tories have absolutely nothing to offer anyone)

      and never mind mortgages though they worry us all so because we know we are in so much debt, we should be worried about what happens when the americans run out of easy credit (i.e. the chinese get fed up of funding their excessive consumption and endless greed for more credit) and decide to use their one remaining asset: nuclear capability and threaten the world with nuclear war.

    10. sonia — on 2nd October, 2008 at 1:42 am  

      and kismet makes a damn good point, no one seems to be connecting up the flexing of military muscle as being connected to all this. personally i think its obvious the americans know their empire is crumbling, classic tactic of failing empires is to shore up their strength militarily and show ppl: well we aint got money but we got a gun against your head. but that only works for so long when they become over-extended militarily.

      sound familiar anyone?

      and instead of thinking collaboratively, no, little Britain decides to side with the big bully with the big gun

    11. Refresh — on 2nd October, 2008 at 1:44 am  

      My point is that house pricing is determined by demand exceeding supply - something the government should have tackled a long time ago. But the govt. did not want to upset houseowners who were by then addicted to their ever-increasing equity, which in turn fed the bankers willingness to lend. The economy was being driven by debt underwritten by equity.

      This is what kept Thatcher in power, and it is what Blair harnessed.

    12. Refresh — on 2nd October, 2008 at 2:12 am  

      Kismet, Sonia makes the point well.

      For at least a couple of days I have avoided invoking the military option.

      If credit is the oil for the Anglo-American economic engine, then China is the oil well. And we know US and Oil doesn’t mix.

    13. Bert Rustle — on 2nd October, 2008 at 9:38 am  

      Not the usual talking head mediocrity, rather an illuminating BBC Hardtalk program with economist Nouriel Roubini … Roubini predicted the current crisis back in 2006. He thinks US Treasury Secretary Henry Paulson’s rescue package is too late — and furthermore, it’s “totally flawed”. …

      http://www.bbc.co.uk/newsa/n5ctrl/progs/08/hardtalk/roubini01oct.ram

    14. Shamit Ghosh — on 2nd October, 2008 at 10:29 am  

      How does us joining Euro help? They are in a far worse situation than us in pretty much all sorts of economic indicators.

    15. Jai — on 2nd October, 2008 at 10:57 am  

      The following is a good article from yesterday’s FT website, describing the predicted decline of the influence and size of the investment banking industry as a result of recent events.

      I’m not sure if it’s entirely accurate — bankers are frequently very cunning people, so I wouldn’t be surprised if they eventually get back on their feet and find new ways of making large amounts of money regardless of present seismic changes, depending on whatever the next “bubble” may be — but it’s interesting reading nevertheless:

      http://www.ft.com/cms/s/0/ccc6d456-8fd7-11dd-9890-0000779fd18c.html?nclick_check=1

    16. Riz — on 2nd October, 2008 at 11:41 am  

      A long time back, I jotted down this relevant quote from Galbraith’s ‘A Short History of Financial Euphoria’: ‘All crisis have involved debt that, in one fashion or another, has become dangerously out of scale in relation to the underlying means of payment.’

      Just to play devils advocate here:

      ) ‘An adjustment…was inevitable.’ - I generally agree but we have to be self-critical and ask ‘is there some confirmation bias in this statement?’ We are making it with the benefit of hindsight. Short sellers and sellers in general would have driven the market down a long time ago if it was so obvious. The fact that the dice landed on snake eyes makes it appear a higher probability event than may be the case.

      2) This crisis was a failure of regulation. Why were banks allowed to borrow massively from other banks beyond their means - it’s simple. They found a nifty way of packaging up the debt and selling it on. This is a great idea as it shift risk to those ready to bear it at the market price and enables the banks to lend more to needy public. Perhaps the problem was one of transparency. The fact that the banks simply did a jig where they swapped bad debt securities with each other suggests they did not try to pull a quick one on the public. In that sense, securitisation didn’t go far enough! Regulation plays a role here, but maybe it should have been to promote an even freer market, that is, much deeper transaparency which would have led to more efficient pricing.

      3) Why were banks allowed to originate debt just to sell on to other investors rather to take on to their own balance sheets, seemingly without limitation? - As above.

      4) Why were rating agencies given an effective monopoly over credit quality checks affecting trillions, disincentivising investors from doing their own due dilligence. - If you look at how slow the credit agencies are to adjust their views in previous crises, it becomes obvious their ratings should be taken with a pinch of salt. Debt prices (spreads), equity prices and other real time information often reveals more information, with the agencies lagging behind. We knew the approach was flawed and should have (and may have) incorporated this into the price.

      5) Why is a study of the history of bubbles not compulsory for an industry which tends to be relatively youngish? - It’s a free market. Nothing along these lines should be compulsory. If it’s good knowledge, it gets integrated into the price. Although banning short selling skews the balance in the wrong direction.

      6) Why are financial bonuses not tied to long-term performance? - Because the shareholders don’t deem it in their interest. One can argue that the separation of management from ownership creates a fundamental management incentive problem that leads to short-termism and excessive risk taking, and perhaps this will improve over time, but the market is dynamic, not static, and it may evolve to this point. What may be more important is full transparency so owners (shareholders) can see exactly what is happening inside these black box operations.

      7) All these and several more questions will — hopefully — be addressed in time by the regulators and by the market itself (the stand-alone Wall Street investment bank model, after all, seems already to have been wiped out). - The merging of banks creates spaces to be filled by new, nimble operators. Hedge funds and boutique banks may emerge to fill some of this space. And so the cycle continues. If the regulators take the ‘too much free market’ view versus the ‘not enough free market (ie more information is needed)’ this could eventually lead to a slowing of progress on all fronts.

    17. persephone — on 2nd October, 2008 at 12:08 pm  

      Some of the earlier responses have mentioned that its not only the financial institutions that have to be more responsible but also the individual.

      Consumerism & wannabeism has got to such a point that the masses want the latest gadgets, high status brands (inc. those who are unemployed..), a certain lifestyle etc. And yes, Banks & other lenders feed off this. But unfortunately alot of people lack budgeting skills.

      An example, I know a 35 year old woman who earns
      a salary in the mid £40′s. She is a first time buyer, no kids, no savings since she started working 15 years ago & wants to retain her lifestyle & spending habits. Yet she complains about banks and how difficult it is for her to get a 100% mortgage. I come across alot of people on good salaries, who never have a savings/ budget plan but ALWAYS have a spending plan.

      Perhaps a simplistic solution… but I do think budgeting should be a skill that needs to be taught and also reinforced by banks as part of their responsibility to their customers.

    18. MaidMarian — on 2nd October, 2008 at 12:40 pm  

      Refresh (5) and sonia (9) - ‘Access to mortgages isn’t the issue, first time buyers chasing houses went a while back. What did happen was the buy-to-let crowd bought all the homes which they would then rent to what would have otherwise been bought by the first timers.’

      Why stop there? I really like the ‘generational robbery’ argument. http://www.newstatesman.com/life-and-society/2007/03/generation-pensions-housing.

      To be clear, I do not agree with every word of that, but the overall thrust is worth dwelling on.

      I mentioned in a reply to you on another thread that to my mind one solution is to have a currency that appreciates rather than a housing market that appreciates. We have not had sound money for the best part of 50 years - I think that would be a good place to start.

      There are some slightly wider issues in pin-pointing the housing market however. It may be well and good with hindsight to dwell on lessons learnt, but what realistically could government have done? It would ahve taken a govrnment brave to the point of suicidal to have told individuals what the most they could sell their homes for was, place restrictions on home ownership, second-guess the risk appetite of individuals and so on. Can you imagine the headlines and talkboards if that had happened?

      This remains my problem with el cid’s article. It is all very true to attribute blame to bankers, regulators and so on. It is however striking that El Cid seems very reluctant to place any sort of responsibility on the shoulders of those actually taking out endless loans. Maybe government should have done more, but it is not their place to legislate for stupidity.

      Refresh is right that access to mortgages is not per se the problem, though I would suggest that climbing up the housing ladder as my parents did is rather more of an issue. Letting buy-to-letters go to the wall, tempting as it is, is not the answer. All that will do is free up houses for those who have already made their money from BTL.

      A currency that appreciates is the way forward. The euro is an interesting option.

    19. douglas clark — on 2nd October, 2008 at 1:30 pm  

      Maid Marian,

      Good points. I’d just like to say though that when I die, my kids will inherit what little I have left. Is it not pretty typical for your last will and testament to pass on whatever you’ve got to the next generation? So, I’m not sure it constitutes greed exactly… It might be enough to get each of them a deposit on a house, if that’s what they want.

    20. Refresh — on 2nd October, 2008 at 2:23 pm  

      Lets be optimistic;

      http://www.independent.co.uk/opinion/commentators/johann-hari/johann-hari-this-crisis-is-also-a-big-opportunity-948519.html

      Note the clampdown on the super-rich and the tax havens. Extradite the stateless billionaires. Lets have an Executive version of Guantanamo. Waterboard them until they tell us where they have stashed their (our) stash.

    21. Refresh — on 2nd October, 2008 at 2:24 pm  

      Tough enough, Douglas?

    22. Refresh — on 2nd October, 2008 at 2:30 pm  

      http://www.guardian.co.uk/commentisfree/2008/oct/02/usa.creditcrunch

      ‘From empire to democracyLet’s not waste $700bn on a bail-out, but use ‘big government’ for what it’s best at – shaping a society that is fair and peaceable’

      An extract that really needs highlighting:

      ‘The rationale for taking $700bn from the taxpayers to subsidise huge financial institutions is that somehow that wealth will trickle down to the people who need it. This has never worked.

      The alternative is simple and powerful. Take that huge sum of money and give it directly to the people who need it. Let the government declare a moratorium on foreclosures and give aid to homeowners to help them pay off their mortgages. Create a federal jobs programme to guarantee work to people who want and need jobs and for whom “the free market” has not come through.

      We have a historic and successful precedent. Roosevelt’s New Deal put millions of people to work, rebuilding the nation’s infrastructure, and, defying the cries of “socialism”, established social security. That can be carried further, with “health security” – free health care – for all.

      All that will take more than $700bn. But the money is there. In the $600bn for the military budget, once we decide we will no longer be a war-making nation. And in the swollen bank accounts of the super-rich, by taxing vigorously both their income and their wealth.’

      Glad to see our debate here is being closely monitored.

    23. dave bones — on 2nd October, 2008 at 3:06 pm  

      I’m not a big fan of Michael Moore though I like his films. He has collected some good ideas here

    24. douglas clark — on 2nd October, 2008 at 3:14 pm  

      Refresh @ 21,

      Heh. Excellent suggestions at 20 and 22.

      Yup, we’ve got to give these folk some tough love…

    25. Refresh — on 2nd October, 2008 at 3:18 pm  

      Good piece Bones.

      I draw attention to this specific point:

      ‘And when they’re done with that, they can restore the regulations for the airlines, the inspection of our food, the oil industry, OSHA, and every other entity that affects our daily lives. All oversight provisions for any “bailout” must have enforcement monies attached to them and criminal penalties for all offenders.’

      There is a lot to be said on these other sectors, and for the UK, I would aslo home in on the advertising, energy, drink and gambling industries. Oh and weapons.

    26. El Cid — on 2nd October, 2008 at 4:35 pm  

      Riz,

      Thanks for your comments. I don’t have much of a problem with most of what you said. I’m sure you appreciate that my questions were largely rhetorical in nature. I read Galbraith at Christmas. funny enough.

      However, what’s with point 5? Of course it can be made compulsory. It can at least be incorporated into the exams financial professionals have to take just to trade. The problem with booms is that people who haven’t experienced busts get suckered into thinking they can last forever.

      I’m not saying that we can completely get away from the perennial investment cycle of greed and fear, but let’s not kid ourselves that the market is self-healing. Maybe it is in the long-run, but in the long-run we are all dead (to quote another famous economist).

      I don’t doubt the capacity of financial whizz kids to circumvent regulations, but at the end of the day the only reason Banco Santander is snapping up UK banking business is because its capital base is relatively stronger and a lot of that has got to do with the Bank of Spain’s insistence a few years back that Spanish banks park more capital with the central bank. The right kind of regulation can sometimes go a long way to ensure capital flows freely but not recklessly.

      I’m not a financial nationalist by any means, but it is ironic that Spain, which has a well known housing crash of its own, has been spared the worst excesses of the U.S. subprime moretgage crisis. Sure, some smaller Spanish banks are in trouble — but that’s a problem of their own making and in their own backyard.

    27. El Cid — on 2nd October, 2008 at 4:39 pm  

      Separately, I have been trying at work to come up with a boilerplate summary of the current crisis. I think we still have a bit of work to do, but this is our best effort to date:

      “A credit crunch involves a significant shrinking in the general availability of debt. It is a cyclical phenomenon that typically follows a period of expansion as monetary policy is tightened, economic conditions deteriorate, real estate prices peak and deflate, and more borrowers default, causing banks to rein-in lending.

      However, financial turmoil has preceded an economic slowdown this time around and the scale of the problem is much larger after an unprecedented credit boom fuelled by financial innovation and looser lending standards turned sour as the U.S. housing bubble burst. This has led to banks writing off billions or even disappearing and stopped banks trusting each other’s capacity to repay, undermining confidence in the entire system.”

    28. Rumbold — on 2nd October, 2008 at 4:44 pm  

      Why would we join the Euro when it appears to be coming apart at the seams?

      http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3118994/Financial-Crisis-So-much-for-tirades-against-American-greed.html

    29. justforfun — on 2nd October, 2008 at 4:50 pm  

      Latest news - everything is all OK !

      I must say I was worried for a moment - my life plan had been to resist taking out credit cards until I was in sight of the finish line so to speak , and then take out 10 and rack up a huge debt before going awol in India for a bit of final meditation. This credit crunch had me worried my plan might not work as I have not received ANY offers in the post for the last few months.

      However the postman brought me GOOD NEWS this morning.
      I’ve just received a credit card application in the post this morning offering a limit of £20k. So did my wife!!

      All must be well with the world and its business as usual. Yipeee

      justforfun

    30. Riz — on 2nd October, 2008 at 6:09 pm  

      Hey El Cid, I sometimes forget to add the caveat that I don’t know what I’m talking about. Re point 5 I think the only people that need to know about bubbles in any depth is investment professionals. I don’t know about the syllabus in most professional financial courses, but I guess there should be some aspect of financial history in there, at the very least telling people that bubbles exist everywhere. Afterall, it’s in their self-interest. One problem is that bubbles only seem to be identified after they pop, but this is still sufficient for a basic history lesson. As for whether this would influence the formation of bubbles, I doubt it. I see them as a self-reinforcing process that is inherent in markets (ie almost unavoidable).

      What many people aren’t talking about is whether gvt action is making things worse not better. Of the top of my head I have:
      - If central banks flood the overnight money market with funds, it is no shock that commerical banks are not lending to each other on longer durations. Is the central banks distorting the market and prolonging the crisis?
      - Ireland backs all deposits - theoretically, this could lead to a flood of deposits to Ireland and a deposit drain elsewhere. Governments around the world would have to ramp up their protections to matching levels. Hello taxpayer risk. Umm, wasn’t the Great Depression partly a result of a tarriff/subsidy arms race?
      - Gvt banks continue to operate such as Northern Rock. They have effective gvt gurantees, so why bank anywhere else?
      - Fed bailout plan - set it up quickly! Otherwise the banks stay in a holding position until they know what they can offload at decent prices to the government. Why trade with each other when you have a monster buyer coming through soon?

      Just random thoughts from the flip-side.

    31. MaidMarian — on 2nd October, 2008 at 6:32 pm  

      Douglas Clark (19) – Thank you for taking the time to reply. That point about wills is indeed one of the issues I have with the article I linked to.

      I firmly believe that there is an inter-generational issue, though the negative side is effectively randomly spread. Some young people have their parents or whoever die leaving substantial assets (which may or may not be housing), others get help.

      I believe that upto the 1980s mortgages were tax deductible and there was no stamp duty (happy to be corrected). There is I suppose a legitimate point that ‘unearned income’ on investments like houses should be taxed, but I wonder whether some sort of targeted tax deductibility may help the economy, possibly a staged set-up like tax bands?

      At the end of the day we all have to live somewhere whether there is a credit crunch or not, but that one truth rather escapes the reckless BTL crowd.

    32. El Cid — on 2nd October, 2008 at 7:46 pm  

      Riz,
      You seem very finance-savvy to me. Who knows whether any of us really know what we’re talking about. The huge amounts of intellectual capital being spent trying to get us out of this hole didn’t stop us getting into it in the first place.
      All I know is that right now the onus is on shoring up confidence and making sure the house doesn’t fall down. We can talk about renovation separately. These are emergency rather than long-term measures.

      There could be an unhelpful parallel here: people biggin’ up the terrorist threat in order to clamp down on our rights. However, in the very short term, we really are in big economic trouble. As a former colleague put it: this is the bear that ate the world. The spillover into the real economy — even the public sector — is a done deal. The only pending question is how much spillover.

      Luckily for me, I’m an optimist. Remember Y2K?

    33. Goldenbrown — on 2nd October, 2008 at 9:33 pm  

      I’m a pretty confused layman with a limited economics education. I found your ideas very informative. Mine are vaguer: Money is an arbitary mechanism. But it seems to me that somewhere a unit of money needs to be fixed clearly rated in value - not to GOLD - but to some sort of advanced formula or ratio that takes into account world population, food, energy and land supplies. And I think that population pressures - often caused by aggressive colonial religions are somewhere at the back of the need to own homes and land rather than just live well in any home as the Germans seem to have learned to do.

    34. El Cid — on 3rd October, 2008 at 9:19 am  

      http://tinyurl.com/3fpk37

      Check the date out. As I said, it is a dilemma

    35. Jai — on 3rd October, 2008 at 6:55 pm  

      Very slightly off-topic but still directly related to the investment banking sector and the credit crunch — this is from FT’s online problem page. It’s generated a huge number of replies but it’s worth ploughing through when you have a spare 30 mins or so; a lot of the comments are really funny in a snarky way, and the overall discussion may also be interesting in the sense of possibly confirming some of the worst stereotypes about people (and their spouses) in this industry.

      http://blogs.ft.com/dearlucy/2008/09/my-husband-has-just-lost-his-job-on-wall-street/#comments

      “My husband has just lost his job on Wall Street. When he was in work he was impossible, living on the adrenaline of deal making. Now he loafs around the house, sullen, full of self-pity and criticising everything the children or I do. I have spent years living with his oversized ego, but now his ego has collapsed it is even worse. Is there anything I can do? Should I pretend to be sympathetic? Or shall I tell him to suck it up and be grateful that we are not under any financial pressure? I’m not going to divorce him, because of the children, but I would like to know: do damaged Masters of the Universe ever recover?
      Wife, 42″

    36. Refresh — on 3rd October, 2008 at 7:19 pm  

      She should worry when the Special Prosecutor discovers he loafed at work too.

    37. El Cid — on 3rd October, 2008 at 8:43 pm  

      Who’d'a thought so many comments!
      Deep down FT readers want to read the Mail.

    38. El Cid — on 4th October, 2008 at 11:30 am  

      Purely fyi, just so you know, this is the current state of the global real economy according to the latest projections by economists at JP Morgan:

      “Having made sweeping downward revisions to our forecasts over the past two weeks it is appropriate to now characterize the global economy as having slipped
      into recession last quarter. Global GDP growth is expected to hover around zero
      over the three quarters from 3Q08 to 1Q09, similar to the performance recorded in 2001. With the economies of the United States, Western Europe, and Japan
      all contracting, the developed world is likely to experience a weaker outcome than it did at that time. EM economies are not expected to be sheltered from the
      storm, and are sharply slowing. For now, however, our forecasts incorporate modest collateral damage in EM and project growth to bottom at 4%—a significantly
      stronger performance than was recorded earlier this decade.”

    39. El Cid — on 4th October, 2008 at 11:58 am  

      Separately, this is what the bank’s strategists are saying. I think it is a good summary:

      “Markets are facing a battle of giants. On the offence are the forces of darkness –– panic, deleveraging, flight-to-quality, bank runs, spending cuts, fire sales and firing lines. On the defence are governments, legislators, central banks, regulators and leaders of industry who are doing all in their power, plus more, to prevent a collapse of markets and economies. So far, the recessionary forces are winning. Every new defensive measure that the forces of good have put up –– each at greater costs and impact –– has been met and matched by even stronger moves by the forces of fear.

      Fear is not limited to the financial sector. Corporates are also afraid of the future and have become more cautious, cutting spending and turn driving the world economy into recession. The issue is now how long and how deep. The last 3 world recessions were rather shallow and long, lasting 3 years. This was because countries did not contract at the same time. The current global recession is synchronised, as the US, UK, EU and Japan entered at virtually the same time. The risk is thus towards a shorter but deeper recession. “

    40. El Cid — on 6th October, 2008 at 12:56 pm  

      Uno mas (I’m not a Spectator reader. Honest. Someone sent this to me):

      http://www.spectator.co.uk/the-magazine/features/2189196/part_2/clinton-democrats-are-to-blame-for-the-credit-crunch.thtml

    41. El Cid — on 6th October, 2008 at 1:04 pm  

      He’s got a point when he concludes:

      “..but I believe the most important lesson of all is an ethical one: it’s about not behaving ruthlessly when trying to change the world for the better.

      Bill Clinton’s team, like so many progressives here in Britain, were not content to wait and see what fruits equal opportunities might bring. They felt compelled to secure their equal outcomes by any means necessary, even if that meant debauching institutions, corrupting professions and trying to skew the operation of markets. That only ever leads to chaos.”

      It’s not so much the objective that is in question. But the method.

    42. Bert Rustle — on 9th October, 2008 at 10:59 am  

      The following article by Porter Stansberry “How AIG’s Collapse Began a Global Run on the Banks” seems plausible.

      http://www.kitco.com/ind/stansberry/oct072008.html

      … banks must comply with … Basel II regulations. … The rules are based on the quality of the bank’s loan book. The riskier the loans a bank owns, the more capital it must keep in reserve. … AIG appeared to offer banks a way to get around the Basel rules, via unregulated insurance contracts, known as credit default swaps.

      … Say you’re a major European bank… You have a surplus of deposits …You know you could buy a portfolio of high-yielding subprime mortgages. But doing so will limit the amount of leverage you can employ, which will limit returns. … AIG is selling a five-year policy … to guarantee the subprime security you’re buying against default for five years for say, 2% of face value.

      Although AIG’s credit default swaps were really insurance contracts, they weren’t regulated. That meant AIG didn’t have to put up any capital as collateral on its swaps, as long as it maintained a triple-A credit rating. There was no real capital cost to selling these swaps; there was no limit. And thanks to what’s called “mark-to-market” accounting, AIG could book the profit from a five-year credit default swap as soon as the contract was sold, based on the expected default rate.

      … With this structure in place, the European bank was able to assure its regulators it was holding only triple-A credits, instead of a bunch of subprime “toxic waste.” The bank could leverage itself to the full extent allowable under Basel II. AIG could book hundreds of millions in “profit” each year, without having to pony up billions in collateral.

      It was a fraud. AIG never any capital to back up the insurance it sold. And the profits it booked never materialized. The default rate on mortgage securities underwritten in 2005, 2006, and 2007 turned out to be multiples higher than expected. And they continue to increase. In some cases, the securities the banks claimed were triple A have ended up being worth less than $0.15 on the dollar.

      … On September 15, all of the major credit-rating agencies downgraded AIG … The world’s largest insurance company was bankrupt. … The Fed stepped in and agreed to lend AIG $85 billion to facilitate an orderly sell off of its assets in exchange for essentially all the company’s equity.

      … AIG’s largest trading partner … was Goldman Sachs.

      … Goldman hedged its exposure via credit default swaps with AIG. Sources inside Goldman say the company’s exposure to AIG exceeded $20 billion, meaning the moment AIG was downgraded, Goldman had to begin marking down the value of its assets. And the moment AIG went bankrupt, Goldman lost $20 billion. Goldman immediately sought out Warren Buffett to raise $5 billion of additional capital, which also helped it raise another $5 billion via a public offering.

      The collapse of the credit default swap market also meant the investment banks – all of them – had no way to borrow money, because no one would insure their obligations.

      … The mainstream press hasn’t reported this either: A provision in the $700 billion bailout bill permits the Fed to pay interest on the collateral it’s holding, which is simply a way to funnel taxpayer dollars directly into the investment banks. …

    43. Katy Newton — on 9th October, 2008 at 1:44 pm  

      Bill Clinton’s team, like so many progressives here in Britain, were not content to wait and see what fruits equal opportunities might bring.

      It’s true that banks were expected to show that they had invested in poorer communities, but it wasn’t loans to those communities that were responsible for the “toxic debt” problem. I will find a link to the study that I am thinking of, which indicates that the problem is more middle class borrowers on reasonable income overreaching themselves + banks either not realising or not caring that they were doing so.

    44. Bert Rustle — on 10th October, 2008 at 7:07 am  

      Kulvinder 14 wrote … Basel 3 … Yet more regulations designed to avoid the results of market participants shenanigans to circumvent restrictions of Basel 2 which in turn were partially motivated by regulations designed to circumvent the results of previous regulatory restrictions.

      Kulvinder 15 wrote … I’m more than willing to accept the US government as a whole is to blame but singling out one party makes no sense. The Republicans used those two organisations for their own goals just like the Democrats did …

      In my opinion, those who took loans, the mandated availability of which was motivated by the egalitarian ideology of the Ruling Class, are an order of magnitude less culpable than the legislators, regulators and providers of such loans.

      For example, these http://www.youtube.com/watch?v=vLUbb2DUYGk aggregated clips of George W Bush on the promotion of minority home ownership in the USA. Ignoring the intermittent partisan titles in this link, it clearly demonstrates that George W Bush was as much on-board as the Democrats. I would hazard a guess that similar videos of Clinon(s), McCain and O’Bama exist.

      It appears to me that the three most obvious legs to this stool are Kulvinder’s original post above, the article http://www.pickledpolitics.com/archives/2373#comment-131344

      “How AIG’s Collapse Began a Global Run on the Banks” by Porter Stansberry and the articles below by Stan J Liebowitz http://www.utdallas.edu/~liebowit/ professor of Economics in the Business School at the University of Texas at Dallas has addressed this topic.
      http://www.nypost.com/seven/02052008/postopinion/opedcolumnists/the_real_scandal_243911.htm?page=0 “The Real Scandal”

      “…the mortgage crisis is that it is a direct result of an intentional loosening of underwriting standards - done in the name of ending discrimination, despite warnings that it could lead to wide-scale defaults. … In the 1980s … activists [claimed] … that banks discriminated against minorities in mortgage lending. In 1989, sympathetic members of Congress got the Home Mortgage Disclosure Act amended to force banks to collect racial data on mortgage applicants; this allowed various studies to be ginned up that seemed to validate the original accusation. … the Boston Fed [stated] “discrimination may be observed when a lender’s underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants.” … Some of these “outdated” criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification. Instead, the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant’s ability to manage debt. …”

      An early paper of his on this topic is http://www.utdallas.edu/~liebowit/mortgage/mortgages.pdf “Mortgage Discrimination in Boston: Where’s the Bias?”

      His latest paper is downloadable at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1211822 “Anatomy of a Train Wreck: Causes of the Mortgage Meltdown” “… Why did the mortgage market melt-down so badly? Why were there so many defaults when the economy was not particularly weak? Why were the securities based upon these mortgages not considered anywhere as risky as they actually turned out to be? It is the thesis of this paper that, in an attempt to increase homeownership, particularly by minorities and the less affluent, an attack on underwriting standards was undertaken by virtually every branch of the government since the early 1990s. The decline in mortgage underwriting standards was universally praised as an ‘innovation’ in mortgage lending by regulators, academic specialists, GSEs, and housing activists. This weakening of underwriting standards succeeded in increasing home ownership and also the price of housing, helping to lead to a housing price bubble. The bubble increased the number of housing speculators with estimates indicating that one quarter of all home sales were speculative sales prior to the bubble bursting. The recent rise in foreclosures is not related to the subprime/prime distinction since both markets had similar size increases in foreclosures that occurred at exactly the same time. Instead, the adjustable-rate/fixed-rate distinction is the key to understanding the rise in foreclosures. This is consistent with speculators turning and running when housing prices stopped rising. It is not consistent with the nasty-subprime-lender hypothesis currently considered to be the cause of the mortgage meltdown. …”

      The Boston Fed. Boston Fed - Equal Opportunity Lending manual can be found at http://www.bos.frb.org/commdev/commaff/closingt.pdf

    45. Bert Rustle — on 10th October, 2008 at 7:16 am  

      Please delete post 44, it was intended for Kulvinder’s Pete Tong thread.

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