Monday, August 27, 2007


Criminal Irresponsibility of Banks Should be Made Accountable

Some topics seem so confusing that it's easy to avoid trying to understand them; this frequently applies to me in relation to economic items. The recent plunge in the stock markets did not affect me as I do not own a single share directly but I was vaguely aware that it was a lot to do with 'sub prime' mortgages(ie loaned to the poor) in the USA. It's a measure of our globalised world that the problems of poor Americans have in repaying debts on their homes can end up wiping hundreds of billions off share values, but this indeed seems to be the case.

The above graph indicates how large the share in mortgages the sub prime sector has become. It seems the British fetish for home ownership has spread to the US big-time, with the major loan company Countrywide,and others, lending to virtually anyone with a vague yearning for bricks and mortar, irrespective of their ability to pay. Should this have sparked any fall in shares worldwide? Yesterday Will Hutton explained and complained in a fashion I (at least thought) could understand:

The nonsense at the heart of the crisis - lending 100 per cent mortgages to borrowers with no income, employment or assets, packaging up the resulting debt and selling it to banks around the globe while taking a handsome fee on every transaction - can be launched with impunity. Financial regulation, we are told, hinders the efficiency of financial markets.

Hutton blasts the companies that lent so recklessly, insisting they should have gone bust, as they deserved, together with the hedge funds which bought the debt and traded it on the global market. He suggests governments:

'should bring suits against the executives involved, the repositories of vast personal wealth, to help repair the hole in private and public balance sheets.'

Instead though, governments throughout the west have pledged huge sums of public money to staunch the outflow of confidence in the system. Hutton concedes that mending a system built on credit might be the first priority but, once done, the need for care regarding future terms of borrowing should be addressed. But this has not happened; rather, the European Central Bank has made hundreds of billions of euros available with no penalty while the US 'Fed' has actually lowered the interest rates allowed for banks in difficulties.

It is as though Europe and America had announced an amnesty to the world's criminal gangs after they had gone on a killing spree because they feared the killing would get worse.

The Bank of England, at least, has not made borrowing any easier but, while France and Germany have called for transparency and maybe regulation to prevent repetition of such irresponsibility, Gordon Brown's Labour government, founded in a movement dedicated to hounding international financiers, has uttered 'not one peep'. Labour, it seems, is terrified of appearing 'anti-business'; the Conservatives are sure they are not; and the Lib Dems scared to do anything lest they provoke a fatal hostility to their fledgling chances of power. Hutton gloomily concludes:

The Americans at least take capitalism so seriously they challenge, monitor and regulate it. No such culture exists in degenerate Britain.

From another perspective loose lending is an economically efficient way of redistributing cash liquidity (and, ultimately, wealth) away from unproductive retired folks and towards the entrepreneurial poor.

But of course there's a problem when companies exploit the pull of instant gratification by persuading the unsavvy to borrow on credit cards.
Two points - Britain did very well from the American regulatory crack-down that followed Enron.

Secondly, the following saying is relevant when considering who should pay for the spread of subprime risk into the wider financial markets through repackaging of debt:
'If you owe the bank £100, it's your problem. If you owe the bank £1 million, it's the bank's problem.'
Sure, but if the bank is owed £100 from 10000 people, doesn't it amount to the same thing (assuming all 10000 have an equally high level of risk)?
In financial terms, yes. In terms of who's hurt if someone defaults, no.

If the £1 million borrower defaults, it's the bank that gets hurt. That's not the case if a £100 borrower defaults.

My point was that in the current situation, seeking to punish the organisations that packaged up and sold on this debt would be rather like a bank letting the £1 million borrower default. Think about where the subprime reparcelled debt has gone; pension funds and other institutional investors hold it. The problem is that nobody knows who's been hit (yet).
Letting the hedge funds and other reckless financial institutions go bust would only worsen the hit on individuals' finances, when it comes. (Which it will, once the banks and institutional investors manage to work out what subprime debt they're holding - cf. today's story on Barclays in the FT for an example).
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