Banks: The Credit Crunch Was Their Fault
The thing that angered me about the Credit Crunch was that the banks were bailed out by governments around the world when it was entirely and utterly their fault.
At the heart of banking is the concept of “No Risk”. There is a saying that a bank is like a person who will lend you an umbrella when the sun is shining and take it away if it looks like it is going to rain – and it is correct. When you go to a bank to lend money to (say) start a business, you have to provide a guarantee that you can pay it back whether the business is a success or not – like offering up your home for sale should the business fail. So they make money regardless of whether you do and without any risk.
The problem with this concept is that reward is only possible because there is risk; and the greater the reward, the greater the risk. So banks ran out of conventional loans and would have to stop declaring massive profits year after year. Well no one wanted that because it would have meant less bonuses for everyone. Then someone came up with a brilliant but vicious idea: toxic debt. Lend money to people who will not be able to pay it back (known as the Sub-Prime Market) and then offload the debt onto another bank before it explodes in your face. You have succeeded in making the profit from an area previously closed to you and someone else is taking all of the risk. So you make your money by putting your competitors into a position where they lose money. Now that would have worked if the bank that invented the idea only ever sold toxic debt. But the idiot then went and bought toxic debt from other banks until everyone held toxic debt. It was like a crazed game of Pass the Parcel where everyone has a ticking time bomb in the parcel that they must hand away and the winner is one NOT holding a time bomb when they go off – unfortunately there were the same number of time bombs as participants! And the irony was that as soon as one of the bombs exploded, it would cause a chain reaction and cause all the rest to explode. This is known as the Credit Crunch where the greed and stupidity of bankers helped them to bankrupt each other so the whole industry teetered on the brink of collapse before governments intervened.
But that is not why I am angered about the banks being bailed out. The reason for my annoyance is that the banks invented toxic debt: it is a fiction, a make-believe, a lie. To demonstrate that toxic debt does not exist, I am going to use three typical examples of toxic debt to show that toxic debt does not exist - the first one is specific and the the next two are general:
- There was a programme on Current TV demonstrating the human side of toxic debt. It showed one couple who had just a single year left on their mortgage when the husband had been made redundant. They went to their bank to discuss re-scheduling the remainder. The bank responded by re-possessing their home and making them bankrupt. Now on a typical mortgage you will pay back between 2.5 to 3.5 times the amount of the loan depending on the interest rate used. So for every £100,000 you borrow, you will repay between £250,000 to £350,000. By the end of the last year, the bank has made most of that money and could afford to just write off the remainder. However, a more profit-minded bank would see this as a great opportunity to make even more money: by re-scheduling the remainder of the loan over a longer period, they could have charged a higher interest rate and made a bigger profit. As it was, they lost the remainder of the loan because no one has bought the property and they have destroyed the creditworthiness of this couple so that they cannot make further profits by lending to them in the future. Is that not incredibly stupid and unprofitable or am I wrong?
- As far as mortgage lenders are concerned, an acceptable debt loading is 3.5 times your salary. Therefore if you earn £50,000, you would be eligible for a mortgage of £150,000. If you only earned £10,000, the top mortgage would be £30,000. So when people can afford to buy a property, they belong to the Prime Market Sector and if they do not earn enough money to buy a house, then they are defined as part of the Sub-Prime Market Sector. As an aside, if house prices increase faster than wages (which they did during the latter part of the 20th Century), it raises the bar and more people find themselves in the Sub-Prime Market. Take Jersey as an example. The average wage is £30,000. So, presuming both partners work, then the household income is £60,000 and they should be able to afford a mortgage of £180,000. The problem is that an entry level house is £450,000 meaning that only people who earn £150,000 (or 5 times the average) and above are in the Prime Market and the rest of us are Sub-Prime. But this shows the complete lie that the Sub-Prime Market cannot afford to pay a mortgage because large numbers of the Jersey population have mortgages which they are paying. There are two reasons that this idea is a lie. The first is that it is true that the Sub-Prime Market would not be able to re-pay a loan in the standard 25 years but they would if it were 35 years or 45 years. In either case, the loan would generate more interest and more profit. In actual fact, this is just a variation of the first example. The second reason is because it ignores a fundamental part of our lives: inflation. A mortgage is a set number of fixed payments. So, every year, the actual cost of repayment reduces by the rate of inflation. For example, if we take the alleged official rate of 3% inflation, that means that at the end of the year, the pound in your pocket is only worth 97p when compared to its value at the beginning of the year. Even a small rate like 3% will soon whittle a mortgage down to a more reasonable size. So if the bank provided the Sub-Prime Market with index-linked re-payments, they would also get their money back
- You have to live somewhere, even if it is on the street. The other alternatives are renting or buying. One of the reasons to buy your own property is because rents increase year on year while the mortgage payment remains the same. As we have already seen in the previous example, this means that the mortgage becomes a smaller part of your income. In addition, property investors claim that property doubles in value every 8 years. That means that the house value will have doubled three times over a 25 year mortgage so that a house originally costing £100,000 would be worth £800,000 25 years later. So take a person or couple who cannot afford a normal mortgage and give them an interest only mortgage whereby, he just pays back money to cover interest and at the end of the 25 years has to re-pay the amount of the mortgage, in this case £100,000. So what happens at the end of the period? Well, the bank has 1.5 to 2.5 times its money back as in a normal mortgage and, in the worst case scenario, a house worth £800,000 that they only paid £100,000 so that they can make even more profit selling it. Or the owner could sell it and have £700,000 towards a new house. Or if the owner was sensible, they would set up a savings account and put the rate of inflation into it so that at the end of the 25 years, you have most if not all of the money you needed to pay back the bank and keep the property. The bank could even engineer such a system because it is not a million miles away from the previous example
In each of these cases, there is a tiny, microscopic risk of non-payment. However, a businessman will tell you that that risk is dwarfed by the giant risk of losing all of your money by re-possessing the property. But bankers do not understand risks because they do not take risks. Talking to a banker about risk is about as much use as trying to teach goldfish to juggle harpsichords. Any amount of risk, no matter how small causes bankers to panic and run away and, in so doing, creating toxic debt that did not exist until their gutless, spineless response.
And that is what makes me angry: that they hurt millions of ordinary people by taking away the fruits of decades of work and saving and then got bailed out of this mess by our governments out of the pockets of those who had managed to escape their ravages.
What the governments should have done is to purchase the toxic debts from the bank at a nominal rate and informed the people who are the victims of this debt that it is business as usual and that they will not lose their homes. They should have then passed laws to prevent banks from creating more toxic debt as they have in Spain. This would have left the banks in the same condition as Santander so they could get on and do what banks do. There would have been no outcry over bonuses and if the bank then went under then it went under.
Instead, we have rewarded the banks for their short-sightedness and incompetency and allowed them to go ahead and do it all over again. They have given banks a new saying. People used to say “If you owe £10,000, you have a problem. If you owe £10 million, the bank has a problem.” Now the saying is “If you owe £10,000 or if you owe £10 million, its the government that has the problem.”