The financial crisis, how did it happen?

The financial crisis – how did it happen?

I get irritated when I can’t understand what’s going on! So I read and listened and watched, even talked to a friend who is a banker. This is what happened – I think.

It began with the ‘Big Bang’ in 1986 when the Thatcher government deregulated the stock market. Fixed commission rates were abolished and the era of big bonuses arrived. Trading was no longer on the trading floor with loud young men waving their hands in the air, selling or buying stocks. The system was now Electronic, screen-based trading. It used the newly available powerful computers. This speeded up and expanded the whole system and made possible the disasters that were to follow.

This led to increased wealth and a ‘Boom’ that Gordon Brown proudly boasted would not again go ‘Bust’ – how wrong he was! This led to a steep and prolonged rise in the price of houses, both here and in America. There is an old financial adage that says ‘As safe as houses.’ Simply because, in living memory, the cost of houses have relentlessly risen.

Consequently, the holy grail of the banking world was a loan secured against a house – because houses always went up in value and you only loaned a percentage of the house’s value anyway. It was a safe loan – the bank or finance company couldn’t lose. If you hadn’t a house with equity in it, you couldn’t have a loan thank you very much!

The crisis began in America with as little as two thousand greedy managers and their subordinates, who approved mortgage loans. The normal system of carefully assessing if a person could pay the monthly mortgage payment and was the house worth the asking price, disappeared. Anyone, even if they had no hope of ever finding a job, could have a loan. It didn’t matter if they couldn’t pay because banks or financial institutions will bear the risk. The mortgage seller got a big fat bonus ( typical estate agent’s fee in America is an astonishing 6% of the value!) and there was no comeback if it all went south – as the Americans say.

Why? The guys at the banks were smart. They could sell the mortgage risk on to another bank. They in turn might sell it – or usually – a fraction of it on to another bank. These fractions of mortgages were sold in ‘bundles’. Sometimes hundreds or thousand of fractions of dodgy mortgages were flying round the world, carried on super-computers and hardly anyone understood it all. To make matters worse, the further away from the original lender the money travelled, the lower the priority it had on any repayment or foreclosure sale. The first lender had ‘First call’ on say the first ten percent. Someone else had ‘Second call’ on the next, say twenty percent and so on until the banks that had bits of the last fifty percent had no chance of getting anything back. But no one knew because the computers were too complicated, or those that did, didn’t care because they had just had a Christmas bonus of one million pounds.

The most important facts were:
• The seller and the buyer of a bundle received a fat bonus every time the bundle was moved.
• There was no risk because it could be sold on.
• It would all be fine eventually because everyone knew they were secured against houses – that always went up in value – didn’t they?

The value of houses everywhere had become over-inflated. A readjustment had to occur. The values went down. Banks here had been making loans up to six times a persons income – all to get the big bonuses. After all, there was no risk – they thought house prices would always go up.

Except they didn’t! There was no incentive or check on the reckless sellers of mortgages in America. All they cared about was their big bonuses. Eventually, there were trillions of dollars in ‘TOXIC LOANS’ swishing around the banking world in thousands of bundles. The inbuilt warning mechanisms in the super-computers’ programmes began to flash red as the situation neared meltdown levels. The worst culprit in the UK was Northern Rock. It was borrowing billions on very short-term contracts of typically three months, to finance long-term loans many times greater than its assets. Then someone noticed! Other banks refused to lend them any more money because they were insolvent. In steps the government bails out this small Mickey Mouse bank with tens of billions of taxpayers money, to save a nationwide run on the banks.

The worst in America was Lehman Brothers who amazingly had loaned out eighty dollars for every dollar it owned! The American government had more sense than ours and let it go bust. Now all the banks in the world turned the computers to looking at how much their competitors were in trouble and the news was bad, very bad. As a result they stopped the short-term loans to each other that the whole ‘house of cards’ depended on and the toxic bundles carousel came to a grinding halt.

Trillions of dollars of taxpayers money around the world were poured in to stop a worldwide collapse of the banking system and our grandchildren will still be paying it off when we are gone. The chief accountant to the British government was asked in a TV interview, ‘If I gave you a copy of the annual audited accounts of Lloyds TSB Bank, would you be able to understand them?’ The answer was a firm ‘No’, and this from the country’s most senior accountant!

The human cost has been appalling. Repossessed houses and millions more jobless. Our children will be less prosperous as a result. The lesson is that unfettered greed and powerful computers together are a TOXIC mix.