Intelligent and informed, but anybody who still "believes in markets" should be in a padded cell. If you are genuinely interested in understanding the causes of the financial crisis, the problems of the euro zone, where we are now and what might happen next, this blog won't help you very much.
Intelligent and informed, but anybody who still "believes in markets" should be in a padded cell. If you are genuinely interested in understanding the causes of the financial crisis, the problems of the euro zone, where we are now and what might happen next, this blog won't help you very much.
The problem is that for ignoramuses such as myself, the people who were supposed to know what they were doing turned out to be people who didn't know what they were doing. There were opposing blocs of people who warned us that people didn't know what they were doing, but it was only after it all happened that it became apparent which group was correct. I just felt that the amount of credit slushing about was totally ludicrous and I never did understand how it was possible that bad debt could be disguised, repackaged and relabelled and then sold on again and again. I never understood how it was expected that a one size currency would fit all. I'm not an economist, I don't understand financial markets so I ask very sincerely, how do I know who to believe now?
Utter tosh, the pursuit of libertarian/monetarist economics was the a main policy of center right/left goverments from Carter onwards: Britain included. Carter reduced regualtion, which was furthered more agressively by Reagan. Bush snr made the first big concerted push for affordable housing, making targets and forcing government sponsorhip that way. Clinton re-emphasised it towards the late 90's. Bush jnr constantly waffled on about Thatchernomics in 2002, mainly home ownership.
Of course there's truth in the article. Europe will radically alter, if the North and South of Europe don't split monetarily - which is too late now - some global economic shock will pull it apart. But frankly the guy is talking so much bullshit something will happen, though his mad statements like 'always with the risk of having the wheelbarrow stolen' means he has to take his hyperbole pill every hour.
Read Gillian Tett's book Fool's Gold and it'll have a little more insight as to the causes and problems.
Intelligent and informed, but anybody who still "believes in markets" should be in a padded cell. If you are genuinely interested in understanding the causes of the financial crisis, the problems of the euro zone, where we are now and what might happen next, this blog won't help you very much.
The problem is that for ignoramuses such as myself, the people who were supposed to know what they were doing turned out to be people who didn't know what they were doing. There were opposing blocs of people who warned us that people didn't know what they were doing, but it was only after it all happened that it became apparent which group was correct. I just felt that the amount of credit slushing about was totally ludicrous and I never did understand how it was possible that bad debt could be disguised, repackaged and relabelled and then sold on again and again. I never understood how it was expected that a one size currency would fit all. I'm not an economist, I don't understand financial markets so I ask very sincerely, how do I know who to believe now?
You seem very well informed to me and your question is a very good one to which I have no answer I'm afraid. I'd make the following observations, but these are simply my views, for what they are worth;
In essence, the credit crisis was/is simply the result of banks lending more money than was prudent to people who borrowed more than they were ever going to be able to afford to pay back. How did that happen? There is no doubt that greed, dishonesty and incompetence all played their part, but in my view the real underlying cause was the widespread belief that "markets are efficient, that they deliver good outcomes (for society), that banks are better placed than regulators to judge and manage risks and incentivised to do so etc." Hence, even though many people felt that there was excessive leverage in the system, such concerns were dismissed by the argument that "markets work and risks are very well managed and distributed throughout the system". That position was supported, of course, by the fact that the western democracies were enjoying a credit fuelled boom. Nobody wanted the party to end.
Of course, this view was very badly wrong. Banks made serious mistakes, including making assumptions about liquidity which proved to be absurd. Moreover, the system had become so complex that "nobody really knew what was going on". Arguably though, the real problem was the endemic short-termism that pervaded the financial system; people weren't stupid, but they felt obliged to "keep dancing until the music stopped"; rational at the individual level, nonsensical at the financial system wide level.
If markets don't work or, more gently, can't be reiled upon whilst banks can't be trusted, then the obvious and inevitable reaction is more regulation. The real debate is about what form this regulation should take. Banks are already and will continue to be subject to much more stringent rules on capital and liquidity and this will, unambiguously, make the financial system safer and less likely to blow up. Ironically though this may not be good for society if if reduces the quantum and increases the price of available credit. Moreover, more generally, banks are being subjected to increasingly onerous and intrusive regulation. This is placing an increasing burden upon them and again this might not lead to better outcomes. There is a difficult trade-off here.
My own reaction to all of this that the banks "deserve it". They've failed society and been paid excessively for the privilege. It follows that "something needs to be done". I'd like to see them broken up - a much more draconian version of the so-called Vickers recommendation. I guess that's a minority view, but I'd argue, of course, that the reasoning is logical and objective though I won't bore you with that analysis. Of course, this view is, as you rightly point out, just one of many, but back to your question "who to believe", I would be very sceptical of anyone with an "interest". I wouldn't believe what the banks have to say about reform, for example. Turkeys don't vote for Christmas.
For what it's worth, I agree entirely with your view on the euro zone; it never made sense. Whilst Germany, France and the Benelux might, just have formed what economists would call an "optimal currency area" that was never going to be the case with the periphery included. Of course, Mitterand and Kohl had a political agenda and had no knowledge of, interest in, or respect for economics so that there was never a serious debate in Europe. Many years ago I described the euro project as an irreversible leap into the dark. It remains irreversible in my view. There is no way out. Ultimately, the big countries, Germany, France, Italy and Spain, will need to do "whatever it takes" to hold the system together. That won't be easy given the different starting positions and difficult political dynamics so the process will be tortuous and fractious with an inevitable deflationary bias. We are well out of it, but gloating serves no purpose and remaining part of Europe remains an important objective in my view.
The guy in the blog is jumping all over the place and looks to be harking back to some long ago place that never actually existed...I'm not sure he takes the time to prove / justify a single assertion! It's really up to every individuals and society overall to gain some understanding so that we make the right decisions - politically and with our life choices... The Big Short is where I started but there is a lot more to it than just sub-prime and related derivatives...I find it a convincing argument that it was the lack of regulation combined with the banks failing to model(understand) the risks they took that led to 2007-9 crash. Basically with less and less regulation they went for more and more quantity, paying themselves more along the way so the whole thing threatened global catastrophe. I think Spain didn't suffer from sub prime toxic shite because their government simply refused to allow banks to play around with foreign derivatives - perhaps their is a role after all for pan European regulation?!
And we must all be aware that government intervention saved us from something much worse. Once Lehman was allowed to fall over everything might have gone! With the €uro most acknowledge that, as per the Irish giving directions, "well I wouldn't start from here!" But it will keep going and, according to INET and others, the big players need to deal with a "trilemma" ... the €uro, national sovereignty and a lack of pan european fiscal (political ) union cannot co-exist... Something has to give and it ain't the €uro! Italy & Spain are starting to pull through which will pave the way for Banking regs and all sorts... As a guy from Munich Re told an audience recently, "Europe buy BMWs and other goods - which German chancellor is going to go down in history as the one who collapsed the €uro?!"
Yeah I know the markets think they sniff weakness but hang on a minute, add up the 17 €uro nation economies and you have something around 2/3 the size of the US. Regions in one nation are not in sync let alone all 17 but, like the US there will have to emerge fiscal transfers - a lot larger than the current regional development fund
Question is whether we in London want to be part of the team putting it together ? Yeah we can go it alone but, as the blog does point out sooner or later the Eurozone will want to agree financial regulations with/without London as well as tackling tax avoidance we have heard about recently by corporates and rich individuals... Again the only effective way is going to be through pan European regulation and compliance...
Is it all going to happen overnight? Not a chance! no-one knows the end state and no single country would vote for what is needed right now but over the years to come we will have an ever changing Europe and set of financial regs, hopefully someone will realise that jobs are fairly important for people and maybe safe standing and beers while watching the game will happen in my lifetime!!!
There are so many myths around financial crisis and anyone can tend to jump on board with their pet theory. For example, the idea that retail banks have given lots of personal and business loans that they should not have is a myth - they actually did a very good job on this.
Likewise the idea that the euro caused it is a myth - there is very little that EU countries could do even if they were not in the euro (devaluation in a fragile economy like Greece would mean people carrying their wages home in a wheelbarrow for the foreseeable future),
I am a journalist to the retail credit industry, so I don't know much myself, but those who do point to several factors:
1, Government spending - we have simply been spending more than we have got for decades.
2, Relative strength of Western economies - we just aren't as profitable compared to everywhere else as we used to be.
3, Volatility of the financial markets - Ideas like securitisation were (and are) very good and pretty easy to understand. Plus the retail banks were very good at assessing the risks involved, but once they were traded on the markets, that went out of the window. The market was not efficient and they lost any concept of their real value.
4, This is simply a cyclical thing - Recessions happen on regular basis and every time they do, people wonder what they can do to stop them happening again; sadly the answer is 'not much'.
5, The vetoing of the 'European Constitution' - The greatest problem the EU has is that it does not have a central figure perceived to have 'a plan'. Unfortunately, the UK was integral in vetoing this.
So lots of causes, but like it always has, things will get better in time - except if the markets get their teeth into the American balance of payments crisis, in which case it is probably time to man the lifeboats!
The original culprits: Bill Clinton (insisting that the US banks make housing finance available to hopeless credits) and Alan Greenspan (prolonged easy money).
Very succinct but way too simple! And, come to think of it wrong...Bush had 8 years to rectify this but didn't. on his watch volume increased and quality decreased. The situation caused a worry as early as 2005 but nothing was done.
Sub prime tipping over was the trigger not the underlying cause. unless you are talking about winding the clock back then complete. finance instruments are the way forwards...just that you shouldn't let idiots play with them...with other peoples money.
I like StevieK's basic summary. However surely what's really the issue are the failed/failing attempts by the UK Govt. to get us out of this hole. In my opinion, the decision to give monetary control to the Bank of England (which, oddly seems to avoid much blame) is a major factor. The BoE's forecasts have been so well off that they must have been playing the statisical equivilent of "pin the tail on the donkey". The actions of Mervyn King and his sycophants at the BoE's Monetary Policy Committee have really made for some terrible, unaccountable choices. First the decision to give up the fight against inflation. This has led to an artifically low interest rate. Now, while that has been of benefit to a number of borrowers short-term, it has created undue hardship for the much larger number of savers, who have consequently been unable to assist the country in spending its way out of recession. If interest rates had been kept high, savers would have had an income, inflation would be much lower, the pound would have been higher against other currencies, helping to keep a lid on energy prices and by now we'd all be much better off. QE has only compounded the problem. On a light-hearted note, I also think statistics themselves must take a lot of the blame. If none of us knew what the data were saying, we'd all be blissfully happy and unaware that we were in recession. At the moment we seem to be fixated on economic growth, double-dip recessions and the like. But does it actually matter what the latest growth figures are? I remember growing up as a kid and seeing the monthly balance of payments figures being given prominence on the news and how the country was in a dire state because we were not exporting enough. Now, well no one gives a damn about that anymore. I suspect the growth targets will go the same way - it is of course impossible to have never ending growth and the sooner we and our politicians realise that and take a more pragmatic approach the better.
Soooo, lending money for whatever reason to those (countries, businesses and individuals) who could not afford to pay back was a stupid idea
And inflating the public sector to the size it was/is also was a bad idea
The house price thing always used to make me chuckle, you'd hear someone gloating about how their house was worth xxx amount. So you would ask if they were selling it, 'no' they would say. Added to this if you did sell the place at an inflated price surely you would only be paying an equally inflated price for your next property?
Really interesting comments from people who obviously have a detailed understanding of the issues.
StevieK : I recognise that you are citing other people's opinions, but this one "Ideas like securitisation were (and are) very good and pretty easy to understand. Plus the retail banks were very good at assessing the risks involved, but once they were traded on the markets, that went out of the window. "
bothered me. Are we talking here about the bundling up of good and toxic loans in the States in a way that the buyer could have no idea what all the loans consisted of, and therefore how solid they were? Doesn't securitisation automatically involve trading of these instruments on the market? I think the trading of those packages amounts to a criminal act and the people responsible ought to be in jail. But maybe I misunderstand "securitisation" and would be pleased if you or somebody else could sort me out on that.
Securitisation is as you understand it. It's actually a very powerful idea. In a simple world where all mortgage lending is via building societies, for example, the volume of housing finance available is limited to the deposits those building societies are able to take from people like you and I.
Now, suppose that the building society is able to package up their mortgage portfolio into a "security" which can then be sold to and traded by insurance companies and pension funds, for example. The building society can now lend our deposits again or, alternatively, we might say that their funding possibilities have increased significantly.
Either way, the effect is to open up a much larger pool of savings as a further source of mortgage finance. That's the power of securitisation. Many further innovations then built on this basic idea. In essence, the mortgage backed securities created via securitisations were then tranched so that different investors could "invest" in same underlying pool of mortgages and yet have different combinations of maturity and risk. Indeed, huge sums of money were invested by money market funds, for example, in the senior tranches of Securitised Investment Vehicles (SIVS) which had very short maturities and which were rated as having very low risk (viewed at the time as no risk). In turn, corporate treasurers invested their cash in these funds believing that their money was completely safe and available overnight. These vehicles opened up further huge sums of savings for mortgage lending, including into the so-called sub prime market.
Intellectually, there was nothing wrong with any of this. Indeed, if you believed in market efficiency, the power of market discipline and in the professionalism of all participants in the financial markets, you would, in turn, have viewed these developments as being extraordinarily beneficial to society; providing cheap credit enabling us all to buy homes.
As I noted above, however, markets failed to function effectively. In a technical sense the reasons for this are complex -and will be debated by academics for years - but in essence bank balance sheets became excessively leveraged whilst the quality of their assets turned toxic. A functioning financial system is, in practice, a bit of a confidence trick and once the crisis began in July/August 2007 (when the SIVS began to unravel) that confidence began to erode. A process driven by a lack of transparency. By mid 2008 banks no longer trusted each other and liquidity problems were becoming extreme. The Lehman event in September of that year finally brought the financial system to its knees. Had Governments not intervened on an extraordinary scale we'd all be living in caves. This crisis was not just about the risk that some banks might fail. Without the extraordinary policy action we eventually got, ALL banks would have gone under, JP Morgan and HSBC included.
These vehicles opened up further huge sums of savings for mortgage lending, including into the so-called sub prime market.
Intellectually, there was nothing wrong with any of this.Indeed, if you believed in market efficiency, the power of market discipline and in the professionalism of all participants in the financial markets, you would, in turn, have viewed these developments as being extraordinarily beneficial to society; providing cheap credit enabling us all to buy homes.
markets failed to function effectively. In a technical sense the reasons for this are complex -and will be debated by academics for years - but in essence bank balance sheets became excessively leveraged whilst the quality of their assets turned toxic. A functioning financial system is, in practice, a bit of a confidence trick and once the crisis began in July/August 2007 (when the SIVS began to unravel) that confidence began to erode. A process driven by a lack of transparency. By mid 2008 banks no longer trusted each other and liquidity problems were becoming extreme. The Lehman event in September of that year finally brought the financial system to its knees. Had Governments not intervened on an extraordinary scale we'd all be living in caves. This crisis was not just about the risk that some banks might fail. Without the extraordinary policy action we eventually got, ALL banks would have gone under, JP Morgan and HSBC included.
So 1) The Fed should have intervened in Lehman to stop a drama becoming a crisis 2) Nothing wrong with leverage as long as you understand risks and lay off particular risks in the event of certain scenarios like house prices dropping by 20% occuring 3) The technical reason for failure is laid out in "the big short" these complex financial instruments were not being priced correctly - if at all - as they were not tracking the quality of the underlying loans... as the cashflows (mortgage payments) go up and down and the asset prices also fluctuate (house prices) then the risk associated with the vehicle changes
So Banks and whoever should trade and invest with whatever as long as they understand the risks and that there is a quality standard attached to the underlying data & associated pricing... which takes us back to Prague's point - was there criminal deception or incompetence involved???
Again I thank you guys for a bit of education here, and I am in danger of sounding simplistic when I talk of criminal deception. But I recall my best man ( now a stand-up comedian but whose Dad was former chairman of A&L) putting it very succinctly: "the American banks started giving mortgages to tramps and then pretended to be surprised when they couldn't pay them back? Hello!" Now as I understood it the likes of Goldman Sachs said "doesn't matter if they can't pay back, we will bundle them up with some good mortgages and flog the bundle to some mugs, and you'll be covered. By the way we think the German banks are amongst the biggest mugs so we'll target them in our sales pitch". I reckon that's criminal because it implies deliberate deception and the consequences for the whole world were unthinkable, as Mr Fleming chillingly points out.
1) The decision not to intervene in Lehman had very serious consequences and might be seen as a major error. That was certainly my view at the time. However, it might be argued that near catastrophe has done us a big favour in making it very clear that the financial system is broken and in need of radical reform. Again, just a personal view..
2) There is nothing wrong with leverage per se provided the risks are understood. However, it is possible for individuals/firms to make rational decisions which in aggregate don't make sense for society at large. Somebody needs to understand the system wide implications of individually rational decisions, the more so the more interconnected that system is. That didn't happen and/or if it did, central banks didn't feel able to intervene. The system needs to be more transparent to accommodate this even if some argue that's sub optimal.
3) Michael Lewis provides an excellent insight into the toxic, greed fuelled world of structured credit in the period leading to the crisis, but his book does not explain the crisis. He does not explain how those products pervaded the financial system, for example, or why firms that weren't directly involved came close to failure. I really enjoyed the book by the way and would recommend "The New New Thing", his book on the Tech bubble which is even better.
Anyway, back to Prague's point - and again just a personal view only. Was there incompetence? Almost certainly. There always is. We're only human. But that didn't cause the crisis. Or to be more precise, we won't make the financial system better serve society simply by seeking to make its employees more competent.
Was criminal deception involved? Perhaps, but at the very margin only I'd suggest and even if this is true it didn't cause the crisis.
Was there a lack of integrity? A lack of concern for customers and counterparties? Absolutely yes and this is much closer to being the underlying, structural weakness of today's financial system.
I'm probably was too "romantic", but I strongly believe that policy makers need to aim to shift dramatically the culture and values of our financial institutions. They won't do it themselves - despite the mission statements some might be adopting.
Regulators need to tame the endemic short-termism which has led to a myopic, rules-based focus on short-term gain. This needs structural reform, not excessive micro regulation. A Glass Steagall on steroids along with other measures to curb short-term trading activity is the place to start in my view. It's a complete mess, but it's not really about bad guys and morons (though the Big Short makes that sound very funny I accept!!). It's about structure and incentives and will need vision and courage to sort out.
About a year before the Northern Rock crisis, I was sitting round in a pub with mates - all of them congratulating themselves on the massive houses they were living in, after having spent the best part of three, four, and in some cases, six years in a permanent state of flux from buying a house, doing it up, then moving to a bigger one (more on them later). I'd stayed exactly where I was, having not moved once since I bought my place for a paltry 70k. They were all on 25/30 year mortgages, paying out an obscene amount of money each month - I had seven years left on mine, and the repayments were so small I could cover them if I went and worked down Deptford market.
We had a discussion about how naive I was being - that I should be riding the wave along with them, and that there was no real risk involved because there was no way the economy could go tits-up - the banks wouldn't let it happen. After a history lesson involving the South Sea bubble and (more recently) the dotcom boom, a lot of political discussion about responsible capitalism and a lot more beer, one of my mates foolishly made the point that, because the economy needed to keep turning, credit would just keep on getting extended to people, including those who couldn't hope to pay it back. Similar to Prague's mate's one-liner above, my line back was "you can't just give a 300k loan on a house worth 150k to a couple who work in Tesco's". Unfortunately, you COULD just do that, and that, in a nutshell is what has caused the current, immediate crisis of the past five years.
However, this doesn't begin to scratch the surface of what the real problem is - namely, that we haven't figured out a way to have 'responsible capitalism' yet. There aren't any other acceptable ideologies out there that 'work' as well as capitalism - they've all been tried with varying degrees of failure. There are some unacceptable ones that seem to work well on the surface, but are fraught with problems underneath - take current communism in China as an example. A tiger economy that is held up as an example of success, but only does so because of the exploitation of hundreds of millions of it's own people.
So capitalism, in one for or another, is probably the way to go - but, human nature being what it is, it will always be undepinned by greed. It was nice and simple when we (Western Europe and the US) were trampling roughshod over foreign economies, in cahoots with despots, dictators and lunatics to keep their local populations down whilst pilfering their resources for a pittance of what they were really worth. The world has changed and (ironically) it's globalisation that has been the cause of it. Dismantling barriers to trade has encouraged ludicrous situations like massive corporations doing business in countries like the UK and making billions in profits, but paying pretty much fuck-all in the way of tax. Even more laughably, there's no really way out of this now, because if corporate tax avoidance was stopped tomorrow, overnight the stock market would have about 80% of it's value wiped out and we'd be in a recession that made the great depression look like a kid losing his piggybank for ten minutes.
The only thing that can be done is to keep loading the debt burden on future generations, whist diminishing the state to almost nothing. Politicians have become almost an irrelevance anyway in the past fifteen years thanks to Blair and his cronies - all parties dance to the tune of their paymasters in business, so doing away with the state is pretty much a given. The NHS will disappear in the next ten years, to be replaced by PFI (or whatever they call it when they re-jig it to pull the wool over peoples' eyes after the inevitable outcry). We'll continue to fund the huge - and growing - underclass that's been created by dependence on the welfare state, but proportionately more and more money from the lower-middle class will go towards this, whilst salaries at the top continue to rise inexorably. The spectre of thirty/forty year olds still living at home with mum and dad will become the exception rather than the norm, as whatever jobs they manage to get will go towards paying off the mortgages that their parents over-extended themselves on, rather than getting a deposit of their own together for an absolute hovel somewhere.
In short - there is nothing - NOTHING - that can be done. The only way out of this is a global conflict of some sort, which will serve as some kind of economic 'reboot'. Think it can't happen? Think again.
And the denouement of the start of this rambling post? Of the blokes I was sitting with, one got bailed out by his mum and dad and now lives with them, one moved to Australia and is doing OK, two of them got repossessed and now pay obscene rent and have no hope of being able to start again despite having decent jobs, one of them was a sparks and has been fucked for years due to the economy (an unfortunate choice of trade) and the other one is me. Mortgage free, split up with the wife, large lump sum in the bank ready to do whatever it is I want for the rest of my life. Sometimes following the crowd isn't the best choice of action.
the big short - michael lewis, pretty much covers it in a way that thickos like me can understand.
Finished this a few weeks ago. Stupidity on a stunning level by by some of the biggest banks out there. Banks coming up with these complex products for lending to people who had no chance of paying back such vasts sums of money was one of the catalysts and those Banks not fully understanding how the products worked.
Leroy - Responsible capitalism is the answer and the academics/politicians on left and right had better come up with something to feed into the next set of elections across Europe - including our own in two/three years time... the tabloid approach to hacking phones (NOTW) and libelling people (twitter action) is coming to an end so how about the mass media take up the challenge of real discussions on all the points mentioned in this thread...
As Mundell states... Lehman collapsing has made this discussion urgent and important ... "we can do nothing"? I disagree as we can educate ourselves, discuss and feed into something ???? ...blogs, internet forums or, just as the Valley Party did, you find your own space in the political spectrum
I only have half answers to many of the points raised as I've only just started reading around but maybe, just maybe people in the London suburbs can link economic theory to local people and modern day challenges... to start building a voice to sound out solutions to Europe, jobs and the financial services industry (and the regulatory framework)
Then again, maybe I'll just stick to supporting the CAS Trust and getting a voice for Charlton Fans - much simpler!
I'm pretty ignorant compared to a lot of you guys, but I think one of the big issues here is that the politicians seem to be trying to solve the problem with more of the same. We need some new thinking and radical new ideas.
As a "guardianista leftie" I am always concerned about working men and women who want to earn a decent wage and have some stability in their lives - this has been taken away from them in recent years. We need a system that will look after the vast majority of our population.
As a former US President once said: "The nine most terrifying words in the English language are: 'I'm from the government and I'm here to help.'"..............even if strictly speaking it's 11 words.
It was an asset bubble in the US which was led by lending to people that shouldn't have been lent to. These people defaulted and because all of the mortgages had been sold on in collateralised debt obligations, all people knew was that someone had lost money, but they didn't know who. Because of this none of the banks would lend to each other which meant that banks that had gap issues with assets and liabilities mismatching (such as Northern rock) were in trouble. Northern rock effectively lent people mortgages using short term credit. They couldn't borrow money from banks anymore, so they had to go to the Bank of England. This combined with the fact that some banks were lending people up to (130%) of the value of the property... People would be in a state of negative equity the second they moved in, which wasn't an issue when property prices were rising, but the second they fall you have a big problem. And they fell.
You then have a lot of money which has been lent to people which is backed by very small amounts of assets. It got to the point where $1 of asset value was supporting $40 of debt in some areas of financing.
It isn't actually that complicated when you realise the incentives that were there for everyone along the way to do what they did.
About a year before the Northern Rock crisis, I was sitting round in a pub with mates - all of them congratulating themselves on the massive houses they were living in, after having spent the best part of three, four, and in some cases, six years in a permanent state of flux from buying a house, doing it up, then moving to a bigger one (more on them later). I'd stayed exactly where I was, having not moved once since I bought my place for a paltry 70k. They were all on 25/30 year mortgages, paying out an obscene amount of money each month - I had seven years left on mine, and the repayments were so small I could cover them if I went and worked down Deptford market.
We had a discussion about how naive I was being - that I should be riding the wave along with them, and that there was no real risk involved because there was no way the economy could go tits-up - the banks wouldn't let it happen. After a history lesson involving the South Sea bubble and (more recently) the dotcom boom, a lot of political discussion about responsible capitalism and a lot more beer, one of my mates foolishly made the point that, because the economy needed to keep turning, credit would just keep on getting extended to people, including those who couldn't hope to pay it back. Similar to Prague's mate's one-liner above, my line back was "you can't just give a 300k loan on a house worth 150k to a couple who work in Tesco's". Unfortunately, you COULD just do that, and that, in a nutshell is what has caused the current, immediate crisis of the past five years.
However, this doesn't begin to scratch the surface of what the real problem is - namely, that we haven't figured out a way to have 'responsible capitalism' yet. There aren't any other acceptable ideologies out there that 'work' as well as capitalism - they've all been tried with varying degrees of failure. There are some unacceptable ones that seem to work well on the surface, but are fraught with problems underneath - take current communism in China as an example. A tiger economy that is held up as an example of success, but only does so because of the exploitation of hundreds of millions of it's own people.
So capitalism, in one for or another, is probably the way to go - but, human nature being what it is, it will always be undepinned by greed. It was nice and simple when we (Western Europe and the US) were trampling roughshod over foreign economies, in cahoots with despots, dictators and lunatics to keep their local populations down whilst pilfering their resources for a pittance of what they were really worth. The world has changed and (ironically) it's globalisation that has been the cause of it. Dismantling barriers to trade has encouraged ludicrous situations like massive corporations doing business in countries like the UK and making billions in profits, but paying pretty much fuck-all in the way of tax. Even more laughably, there's no really way out of this now, because if corporate tax avoidance was stopped tomorrow, overnight the stock market would have about 80% of it's value wiped out and we'd be in a recession that made the great depression look like a kid losing his piggybank for ten minutes.
The only thing that can be done is to keep loading the debt burden on future generations, whist diminishing the state to almost nothing. Politicians have become almost an irrelevance anyway in the past fifteen years thanks to Blair and his cronies - all parties dance to the tune of their paymasters in business, so doing away with the state is pretty much a given. The NHS will disappear in the next ten years, to be replaced by PFI (or whatever they call it when they re-jig it to pull the wool over peoples' eyes after the inevitable outcry). We'll continue to fund the huge - and growing - underclass that's been created by dependence on the welfare state, but proportionately more and more money from the lower-middle class will go towards this, whilst salaries at the top continue to rise inexorably. The spectre of thirty/forty year olds still living at home with mum and dad will become the exception rather than the norm, as whatever jobs they manage to get will go towards paying off the mortgages that their parents over-extended themselves on, rather than getting a deposit of their own together for an absolute hovel somewhere.
In short - there is nothing - NOTHING - that can be done. The only way out of this is a global conflict of some sort, which will serve as some kind of economic 'reboot'. Think it can't happen? Think again.
And the denouement of the start of this rambling post? Of the blokes I was sitting with, one got bailed out by his mum and dad and now lives with them, one moved to Australia and is doing OK, two of them got repossessed and now pay obscene rent and have no hope of being able to start again despite having decent jobs, one of them was a sparks and has been fucked for years due to the economy (an unfortunate choice of trade) and the other one is me. Mortgage free, split up with the wife, large lump sum in the bank ready to do whatever it is I want for the rest of my life. Sometimes following the crowd isn't the best choice of action.
Great post Leroy. A smart guy who is obviously clued up. You've earned your lump sum mate. Put your feet up and chill:)
Comments
I refuse to believe the mass-stupidity was not pre planned somehow
Of course there's truth in the article. Europe will radically alter, if the North and South of Europe don't split monetarily - which is too late now - some global economic shock will pull it apart. But frankly the guy is talking so much bullshit something will happen, though his mad statements like 'always with the risk of having the wheelbarrow stolen' means he has to take his hyperbole pill every hour.
Read Gillian Tett's book Fool's Gold and it'll have a little more insight as to the causes and problems.
In essence, the credit crisis was/is simply the result of banks lending more money than was prudent to people who borrowed more than they were ever going to be able to afford to pay back. How did that happen? There is no doubt that greed, dishonesty and incompetence all played their part, but in my view the real underlying cause was the widespread belief that "markets are efficient, that they deliver good outcomes (for society), that banks are better placed than regulators to judge and manage risks and incentivised to do so etc." Hence, even though many people felt that there was excessive leverage in the system, such concerns were dismissed by the argument that "markets work and risks are very well managed and distributed throughout the system". That position was supported, of course, by the fact that the western democracies were enjoying a credit fuelled boom. Nobody wanted the party to end.
Of course, this view was very badly wrong. Banks made serious mistakes, including making assumptions about liquidity which proved to be absurd. Moreover, the system had become so complex that "nobody really knew what was going on". Arguably though, the real problem was the endemic short-termism that pervaded the financial system; people weren't stupid, but they felt obliged to "keep dancing until the music stopped"; rational at the individual level, nonsensical at the financial system wide level.
If markets don't work or, more gently, can't be reiled upon whilst banks can't be trusted, then the obvious and inevitable reaction is more regulation. The real debate is about what form this regulation should take. Banks are already and will continue to be subject to much more stringent rules on capital and liquidity and this will, unambiguously, make the financial system safer and less likely to blow up. Ironically though this may not be good for society if if reduces the quantum and increases the price of available credit. Moreover, more generally, banks are being subjected to increasingly onerous and intrusive regulation. This is placing an increasing burden upon them and again this might not lead to better outcomes. There is a difficult trade-off here.
My own reaction to all of this that the banks "deserve it". They've failed society and been paid excessively for the privilege. It follows that "something needs to be done". I'd like to see them broken up - a much more draconian version of the so-called Vickers recommendation. I guess that's a minority view, but I'd argue, of course, that the reasoning is logical and objective though I won't bore you with that analysis. Of course, this view is, as you rightly point out, just one of many, but back to your question "who to believe", I would be very sceptical of anyone with an "interest". I wouldn't believe what the banks have to say about reform, for example. Turkeys don't vote for Christmas.
For what it's worth, I agree entirely with your view on the euro zone; it never made sense. Whilst Germany, France and the Benelux might, just have formed what economists would call an "optimal currency area" that was never going to be the case with the periphery included. Of course, Mitterand and Kohl had a political agenda and had no knowledge of, interest in, or respect for economics so that there was never a serious debate in Europe. Many years ago I described the euro project as an irreversible leap into the dark. It remains irreversible in my view. There is no way out. Ultimately, the big countries, Germany, France, Italy and Spain, will need to do "whatever it takes" to hold the system together. That won't be easy given the different starting positions and difficult political dynamics so the process will be tortuous and fractious with an inevitable deflationary bias. We are well out of it, but gloating serves no purpose and remaining part of Europe remains an important objective in my view.
It's really up to every individuals and society overall to gain some understanding so that we make the right decisions - politically and with our life choices...
The Big Short is where I started but there is a lot more to it than just sub-prime and related derivatives...I find it a convincing argument that it was the lack of regulation combined with the banks failing to model(understand) the risks they took that led to 2007-9 crash. Basically with less and less regulation they went for more and more quantity, paying themselves more along the way so the whole thing threatened global catastrophe. I think Spain didn't suffer from sub prime toxic shite because their government simply refused to allow banks to play around with foreign derivatives - perhaps their is a role after all for pan European regulation?!
And we must all be aware that government intervention saved us from something much worse. Once Lehman was allowed to fall over everything might have gone!
With the €uro most acknowledge that, as per the Irish giving directions, "well I wouldn't start from here!" But it will keep going and, according to INET and others, the big players need to deal with a "trilemma" ... the €uro, national sovereignty and a lack of pan european fiscal (political ) union cannot co-exist... Something has to give and it ain't the €uro! Italy & Spain are starting to pull through which will pave the way for Banking regs and all sorts... As a guy from Munich Re told an audience recently, "Europe buy BMWs and other goods - which German chancellor is going to go down in history as the one who collapsed the €uro?!"
Yeah I know the markets think they sniff weakness but hang on a minute, add up the 17 €uro nation economies and you have something around 2/3 the size of the US. Regions in one nation are not in sync let alone all 17 but, like the US there will have to emerge fiscal transfers - a lot larger than the current regional development fund
Question is whether we in London want to be part of the team putting it together ? Yeah we can go it alone but, as the blog does point out sooner or later the Eurozone will want to agree financial regulations with/without London as well as tackling tax avoidance we have heard about recently by corporates and rich individuals... Again the only effective way is going to be through pan European regulation and compliance...
Is it all going to happen overnight? Not a chance! no-one knows the end state and no single country would vote for what is needed right now but over the years to come we will have an ever changing Europe and set of financial regs, hopefully someone will realise that jobs are fairly important for people and maybe safe standing and beers while watching the game will happen in my lifetime!!!
Likewise the idea that the euro caused it is a myth - there is very little that EU countries could do even if they were not in the euro (devaluation in a fragile economy like Greece would mean people carrying their wages home in a wheelbarrow for the foreseeable future),
I am a journalist to the retail credit industry, so I don't know much myself, but those who do point to several factors:
1, Government spending - we have simply been spending more than we have got for decades.
2, Relative strength of Western economies - we just aren't as profitable compared to everywhere else as we used to be.
3, Volatility of the financial markets - Ideas like securitisation were (and are) very good and pretty easy to understand. Plus the retail banks were very good at assessing the risks involved, but once they were traded on the markets, that went out of the window. The market was not efficient and they lost any concept of their real value.
4, This is simply a cyclical thing - Recessions happen on regular basis and every time they do, people wonder what they can do to stop them happening again; sadly the answer is 'not much'.
5, The vetoing of the 'European Constitution' - The greatest problem the EU has is that it does not have a central figure perceived to have 'a plan'. Unfortunately, the UK was integral in vetoing this.
So lots of causes, but like it always has, things will get better in time - except if the markets get their teeth into the American balance of payments crisis, in which case it is probably time to man the lifeboats!
Sub prime tipping over was the trigger not the underlying cause. unless you are talking about winding the clock back then complete. finance instruments are the way forwards...just that you shouldn't let idiots play with them...with other peoples money.
In my opinion, the decision to give monetary control to the Bank of England (which, oddly seems to avoid much blame) is a major factor. The BoE's forecasts have been so well off that they must have been playing the statisical equivilent of "pin the tail on the donkey".
The actions of Mervyn King and his sycophants at the BoE's Monetary Policy Committee have really made for some terrible, unaccountable choices. First the decision to give up the fight against inflation. This has led to an artifically low interest rate. Now, while that has been of benefit to a number of borrowers short-term, it has created undue hardship for the much larger number of savers, who have consequently been unable to assist the country in spending its way out of recession. If interest rates had been kept high, savers would have had an income, inflation would be much lower, the pound would have been higher against other currencies, helping to keep a lid on energy prices and by now we'd all be much better off.
QE has only compounded the problem.
On a light-hearted note, I also think statistics themselves must take a lot of the blame. If none of us knew what the data were saying, we'd all be blissfully happy and unaware that we were in recession. At the moment we seem to be fixated on economic growth, double-dip recessions and the like. But does it actually matter what the latest growth figures are? I remember growing up as a kid and seeing the monthly balance of payments figures being given prominence on the news and how the country was in a dire state because we were not exporting enough. Now, well no one gives a damn about that anymore. I suspect the growth targets will go the same way - it is of course impossible to have never ending growth and the sooner we and our politicians realise that and take a more pragmatic approach the better.
And inflating the public sector to the size it was/is also was a bad idea
The house price thing always used to make me chuckle, you'd hear someone gloating about how their house was worth xxx amount. So you would ask if they were selling it, 'no' they would say. Added to this if you did sell the place at an inflated price surely you would only be paying an equally inflated price for your next property?
StevieK : I recognise that you are citing other people's opinions, but this one
"Ideas like securitisation were (and are) very good and pretty easy to understand. Plus the retail banks were very good at assessing the risks involved, but once they were traded on the markets, that went out of the window. "
bothered me. Are we talking here about the bundling up of good and toxic loans in the States in a way that the buyer could have no idea what all the loans consisted of, and therefore how solid they were? Doesn't securitisation automatically involve trading of these instruments on the market? I think the trading of those packages amounts to a criminal act and the people responsible ought to be in jail. But maybe I misunderstand "securitisation" and would be pleased if you or somebody else could sort me out on that.
Securitisation is as you understand it. It's actually a very powerful idea. In a simple world where all mortgage lending is via building societies, for example, the volume of housing finance available is limited to the deposits those building societies are able to take from people like you and I.
Now, suppose that the building society is able to package up their mortgage portfolio into a "security" which can then be sold to and traded by insurance companies and pension funds, for example. The building society can now lend our deposits again or, alternatively, we might say that their funding possibilities have increased significantly.
Either way, the effect is to open up a much larger pool of savings as a further source of mortgage finance. That's the power of securitisation. Many further innovations then built on this basic idea. In essence, the mortgage backed securities created via securitisations were then tranched so that different investors could "invest" in same underlying pool of mortgages and yet have different combinations of maturity and risk. Indeed, huge sums of money were invested by money market funds, for example, in the senior tranches of Securitised Investment Vehicles (SIVS) which had very short maturities and which were rated as having very low risk (viewed at the time as no risk). In turn, corporate treasurers invested their cash in these funds believing that their money was completely safe and available overnight. These vehicles opened up further huge sums of savings for mortgage lending, including into the so-called sub prime market.
Intellectually, there was nothing wrong with any of this. Indeed, if you believed in market efficiency, the power of market discipline and in the professionalism of all participants in the financial markets, you would, in turn, have viewed these developments as being extraordinarily beneficial to society; providing cheap credit enabling us all to buy homes.
As I noted above, however, markets failed to function effectively. In a technical sense the reasons for this are complex -and will be debated by academics for years - but in essence bank balance sheets became excessively leveraged whilst the quality of their assets turned toxic. A functioning financial system is, in practice, a bit of a confidence trick and once the crisis began in July/August 2007 (when the SIVS began to unravel) that confidence began to erode. A process driven by a lack of transparency. By mid 2008 banks no longer trusted each other and liquidity problems were becoming extreme. The Lehman event in September of that year finally brought the financial system to its knees. Had Governments not intervened on an extraordinary scale we'd all be living in caves. This crisis was not just about the risk that some banks might fail. Without the extraordinary policy action we eventually got, ALL banks would have gone under, JP Morgan and HSBC included.
1) The Fed should have intervened in Lehman to stop a drama becoming a crisis
2) Nothing wrong with leverage as long as you understand risks and lay off particular risks in the event of certain scenarios like house prices dropping by 20% occuring
3) The technical reason for failure is laid out in "the big short" these complex financial instruments were not being priced correctly - if at all - as they were not tracking the quality of the underlying loans... as the cashflows (mortgage payments) go up and down and the asset prices also fluctuate (house prices) then the risk associated with the vehicle changes
So Banks and whoever should trade and invest with whatever as long as they understand the risks and that there is a quality standard attached to the underlying data & associated pricing... which takes us back to Prague's point - was there criminal deception or incompetence involved???
Personal views only - for what they are worth.
1) The decision not to intervene in Lehman had very serious consequences and might be seen as a major error. That was certainly my view at the time. However, it might be argued that near catastrophe has done us a big favour in making it very clear that the financial system is broken and in need of radical reform. Again, just a personal view..
2) There is nothing wrong with leverage per se provided the risks are understood. However, it is possible for individuals/firms to make rational decisions which in aggregate don't make sense for society at large. Somebody needs to understand the system wide implications of individually rational decisions, the more so the more interconnected that system is. That didn't happen and/or if it did, central banks didn't feel able to intervene. The system needs to be more transparent to accommodate this even if some argue that's sub optimal.
3) Michael Lewis provides an excellent insight into the toxic, greed fuelled world of structured credit in the period leading to the crisis, but his book does not explain the crisis. He does not explain how those products pervaded the financial system, for example, or why firms that weren't directly involved came close to failure. I really enjoyed the book by the way and would recommend "The New New Thing", his book on the Tech bubble which is even better.
Anyway, back to Prague's point - and again just a personal view only. Was there incompetence? Almost certainly. There always is. We're only human. But that didn't cause the crisis. Or to be more precise, we won't make the financial system better serve society simply by seeking to make its employees more competent.
Was criminal deception involved? Perhaps, but at the very margin only I'd suggest and even if this is true it didn't cause the crisis.
Was there a lack of integrity? A lack of concern for customers and counterparties? Absolutely yes and this is much closer to being the underlying, structural weakness of today's financial system.
I'm probably was too "romantic", but I strongly believe that policy makers need to aim to shift dramatically the culture and values of our financial institutions. They won't do it themselves - despite the mission statements some might be adopting.
Regulators need to tame the endemic short-termism which has led to a myopic, rules-based focus on short-term gain. This needs structural reform, not excessive micro regulation. A Glass Steagall on steroids along with other measures to curb short-term trading activity is the place to start in my view. It's a complete mess, but it's not really about bad guys and morons (though the Big Short makes that sound very funny I accept!!). It's about structure and incentives and will need vision and courage to sort out.
I fully respect your view if it's different.
We had a discussion about how naive I was being - that I should be riding the wave along with them, and that there was no real risk involved because there was no way the economy could go tits-up - the banks wouldn't let it happen. After a history lesson involving the South Sea bubble and (more recently) the dotcom boom, a lot of political discussion about responsible capitalism and a lot more beer, one of my mates foolishly made the point that, because the economy needed to keep turning, credit would just keep on getting extended to people, including those who couldn't hope to pay it back. Similar to Prague's mate's one-liner above, my line back was "you can't just give a 300k loan on a house worth 150k to a couple who work in Tesco's". Unfortunately, you COULD just do that, and that, in a nutshell is what has caused the current, immediate crisis of the past five years.
However, this doesn't begin to scratch the surface of what the real problem is - namely, that we haven't figured out a way to have 'responsible capitalism' yet. There aren't any other acceptable ideologies out there that 'work' as well as capitalism - they've all been tried with varying degrees of failure. There are some unacceptable ones that seem to work well on the surface, but are fraught with problems underneath - take current communism in China as an example. A tiger economy that is held up as an example of success, but only does so because of the exploitation of hundreds of millions of it's own people.
So capitalism, in one for or another, is probably the way to go - but, human nature being what it is, it will always be undepinned by greed. It was nice and simple when we (Western Europe and the US) were trampling roughshod over foreign economies, in cahoots with despots, dictators and lunatics to keep their local populations down whilst pilfering their resources for a pittance of what they were really worth. The world has changed and (ironically) it's globalisation that has been the cause of it. Dismantling barriers to trade has encouraged ludicrous situations like massive corporations doing business in countries like the UK and making billions in profits, but paying pretty much fuck-all in the way of tax. Even more laughably, there's no really way out of this now, because if corporate tax avoidance was stopped tomorrow, overnight the stock market would have about 80% of it's value wiped out and we'd be in a recession that made the great depression look like a kid losing his piggybank for ten minutes.
The only thing that can be done is to keep loading the debt burden on future generations, whist diminishing the state to almost nothing. Politicians have become almost an irrelevance anyway in the past fifteen years thanks to Blair and his cronies - all parties dance to the tune of their paymasters in business, so doing away with the state is pretty much a given. The NHS will disappear in the next ten years, to be replaced by PFI (or whatever they call it when they re-jig it to pull the wool over peoples' eyes after the inevitable outcry). We'll continue to fund the huge - and growing - underclass that's been created by dependence on the welfare state, but proportionately more and more money from the lower-middle class will go towards this, whilst salaries at the top continue to rise inexorably. The spectre of thirty/forty year olds still living at home with mum and dad will become the exception rather than the norm, as whatever jobs they manage to get will go towards paying off the mortgages that their parents over-extended themselves on, rather than getting a deposit of their own together for an absolute hovel somewhere.
In short - there is nothing - NOTHING - that can be done. The only way out of this is a global conflict of some sort, which will serve as some kind of economic 'reboot'. Think it can't happen? Think again.
And the denouement of the start of this rambling post? Of the blokes I was sitting with, one got bailed out by his mum and dad and now lives with them, one moved to Australia and is doing OK, two of them got repossessed and now pay obscene rent and have no hope of being able to start again despite having decent jobs, one of them was a sparks and has been fucked for years due to the economy (an unfortunate choice of trade) and the other one is me. Mortgage free, split up with the wife, large lump sum in the bank ready to do whatever it is I want for the rest of my life. Sometimes following the crowd isn't the best choice of action.
As Mundell states... Lehman collapsing has made this discussion urgent and important ... "we can do nothing"? I disagree as we can educate ourselves, discuss and feed into something ????
...blogs, internet forums or, just as the Valley Party did, you find your own space in the political spectrum
I only have half answers to many of the points raised as I've only just started reading around but maybe, just maybe people in the London suburbs can link economic theory to local people and modern day challenges... to start building a voice to sound out solutions to Europe, jobs and the financial services industry (and the regulatory framework)
Then again, maybe I'll just stick to supporting the CAS Trust and getting a voice for Charlton Fans - much simpler!
I'm pretty ignorant compared to a lot of you guys, but I think one of the big issues here is that the politicians seem to be trying to solve the problem with more of the same. We need some new thinking and radical new ideas.
As a "guardianista leftie" I am always concerned about working men and women who want to earn a decent wage and have some stability in their lives - this has been taken away from them in recent years. We need a system that will look after the vast majority of our population.
Because of this none of the banks would lend to each other which meant that banks that had gap issues with assets and liabilities mismatching (such as Northern rock) were in trouble. Northern rock effectively lent people mortgages using short term credit. They couldn't borrow money from banks anymore, so they had to go to the Bank of England. This combined with the fact that some banks were lending people up to (130%) of the value of the property... People would be in a state of negative equity the second they moved in, which wasn't an issue when property prices were rising, but the second they fall you have a big problem. And they fell.
You then have a lot of money which has been lent to people which is backed by very small amounts of assets. It got to the point where $1 of asset value was supporting $40 of debt in some areas of financing.
It isn't actually that complicated when you realise the incentives that were there for everyone along the way to do what they did.
That asset is surely still worth something?