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Blame-storming begins on banking crisis - David Guyatt - 09-10-2008
http://money.sky.com/money/recession/credit_crisis_whos_to_blame.html
The Credit Crisis: Who’s to Blame?
Nic Cicutti, Thursday October 09, 2008
Now that the £50bn banks’ rescue package - plus another £450bn in loans and guarantees - has been unveiled and its potential effects in the weeks and months are being digested by analysts and markets, our Special Correspondent Nic Cicutti takes a look at how the crisis started - and why
The credit crunch exploded into our consciousness in August last year, when it became increasingly obvious that banks in the US were sitting on piles of “toxic” mortgage debts that would probably never be repaid. Here in the UK, Northern Rock was the first bank to face a run of savers looking to withdraw their funds as consumers became concerned about its solvency. The bank had been lending mortgages for up to 125% of a home’s value - not a clever move when house prices start to fall, as they did late last year. Since then, the effects of the credit crunch have infiltrated almost every part of the UK’s economy. We have seen loans dry up and become more expensive, especially for first-rime buyers, massive falls in property prices, share prices have collapsed and unemployment is starting to rise. But who’s to blame for all of this? We name the guilty parties. 1: Mortgage lenders As property prices rocketed from the mid-1990s onwards, it became increasingly difficult for many borrowers in the UK to buy homes on “traditional” earnings multiples of three or four times their salary. Lenders became more and more willing to stretch definitions of “affordability” so that in some case they were lending up to six and even seven times earnings - without requiring any deposits at all. In the US, borrowers with no credit histories or proof of earnings were being lent so-called “ balloon” mortgages, in which no payments were made in the first year or two and any interest was added to the capital owed. A recipe for disaster – and the bubble duly burst when house prices crashed.
2: US politicians What many people have not faced up to is that much of the lending spree seen over the past years was politically motivated. Quite apart from the presumed profits to be made by lenders, there was pressure on them from the mid-1990s onwards by politicians who wanted to ensure that “socially disadvantaged” borrowers could achieve their property-owning dream. Lenders caved in to that pressure - leaving US Treasury Secretary Henry Paulson (pictured) with a major headache. 3: Investment banks As lenders lent more and more, they needed increase sources of funding. They weren’t getting them from savers’ deposits. So they “securitised” their mortgage books, selling them on to investment banks for money which they then lent out again. The investment banks then packaged up these loan books, slicing and dicing them up into packages that were supposedly “risk rated”, before they were sold on again to other banks around the world. In effect, the entire financial system became infected by these toxic loans. But for the investment banks themselves, the rewards were massive. Dick Fuld, the chief executive of Lehman Brothers, whose collapse last month was the most recent twist in the crisis, earned an estimated $500m in salary, bonuses and share options over the past eight years. Joe Cassano was head of giant US insurer AIG’s financial products division, which reinsured these toxic loans, theoretically making them safer. He earned $280m in 2007. After his unit lost $11bn last year, Cassano was finally fired in February - but still got to keep $34m in bonuses and was retained as an AIG consultant at a salary of $1m a month. AIG needed to be bailed out by the US government to the tune of $85bn.
4: Financial watchdogs While all of this was going on, financial watchdogs were largely asleep at the wheel. There is some evidence of growing concern on their part at the increasingly risky lending strategy and incomprehensible financial dealings they were seeing on the part of financial institutions they regulated. From 2006 onwards, the Financial Services Authority here in the UK was warning borrowers that they should not be extending the credit they were taking out to such dangerous limits. Their warnings were largely disregarded. At the same time, regulators failed to “catch” what was happening at Northern Rock and intervene to stop its increasingly barmy business strategy until it was too late. They basically felt that as the bank was sound, they had no right to intervene. As it turned out the Rock was not sound after all. Meanwhile, the Bank of England has been accused of taking too long to recognise the seriousness of the financial crisis. Its governor, Mervyn King, has repeatedly delayed major interventions in the markets partly because he was opposed to the “moral hazard” of baling out banks that were authors of their own misfortunes.
5: UK Politicians Alistair Darling, the Chancellor, was responsible for not acting quickly enough when the run on Northern Rock started by savers in the autumn of last year. It took 48 hours before he declared their savings were 100% safe. This week, he has again been accused of dithering as he took agonisingly long to cobble together the banks’ rescue package unveiled on Wednesday – even as share prices collapsed and banks themselves came under unprecedented assaults. Other politicians are also to blame: in the US, mainly Republican Congress members delayed the passage of the $700bn rescue scheme for a fund to buy toxic products off the banks. Part of that blame also attaches to Hank Paulson, the US Treasury Secretary, whose rescue package was set out on three sheets of A4 paper. How did he ever imagine that would be approved by politicians? Here in Europe, there has been a near-total lack of co-ordination between various leaders, allowing the crisis to get worse.
7: Ourselves We’re not blameless either. For more than a decade we have borrowed more and more from banks and other lenders, building up more and more debt and owing more and more to our creditors. It was less a case of greed than one of repeatedly failing to understand that if you want something you should save for it and not put it ion the never-never.* The result is that the verage household debt in the UK is £9,500, excluding mortgages. This figure increases to £21,650 if the average is based on the number of households who actually have some form of unsecured loan. Including mortgages, the average household debt in the UK is £59,350. The average owed by every UK adult is £30,255, including mortgages. It was some party, but it’s over now. It will take us years to recover from the hangover.
Blame-storming begins on banking crisis - David Malone - 09-10-2008
Jan,
Very interesting post. Seems like classic Prisoner's Dilemma to me.
All the banks would benefit if they collectively started to lend to each other. But they don't because each thinks it can do best if others participate but they don't. So no one does and they all suffer.
They would all do best if they participated in the bail out plan as it will help them all in the long run. (whether or not it helps us, I doubt - but that's another matter) But they don't because each reasons if the others participate the system but we 'cheat' ( say we'll participate but then don't ) we can get the benefits of the system being rescued without taking the costs of participating.
Interesting to remember that PD doesn't really reflect accurately how real people act - except for a single group of human beings ( I use the term loosely) Economics students.
PD will kill them in the end.