http://www.guardian.co.uk/money/blog/2011/feb/28/northern-rock-first-time-buyer-mortgage
First-time buyers who have struggled to get a mortgage have been given a glimmer of hope following the announcement that Northern Rock – the bank owned by UK taxpayers – is at long last offering a reasonably priced mortgage for those with a small deposit.
...
The real elephant in the room is house prices. Although they have fallen 0.9% over the past year, according to Land Registry figures, it is not nearly enough to make property affordable for most first-time buyers. While the average salary in the UK is just £26,510, the average price of property is still more than six times that at £163,177.
Monday 28 February 2011
Are the press finally getting it?
http://www.guardian.co.uk/business/2011/feb/28/baby-boomers-secret-millionaires
Baby boomers are up in arms: they are being criticised for stealing from the younger generation when so many of them are doing all they can to promote a sustainable and fair society.
They want to save the planet and protect welfare spending as much as other age groups. And anyway, they argue, there are plenty of older workers and pensioners who are poor and should not be blamed for bequeathing young people a life of low incomes, sky-high bills, a reduced welfare state and costly debts.
Tomorrow the National Pensioners Convention will head a lobby of parliament. Angry at the government's decision to downgrade the inflation link for annual pension increases, its message is that many over-65s are struggling to keep warm and will be made poorer, and colder, by the change. Their plea shows up the problem when debating the effect of the boomer generation on the rest of society, which is that this group is far from homogeneous. Rich and poor are both found in the boomer cohort just as much as they are in any other.
Yet the accusation that boomers are protecting themselves at the expense of everyone else still stands, because relatively ordinary boomers will retire as millionaires, paid for by younger workers. Even the poorer over-50s need to recognise they are going to take out of society more than they put in.
Baby boomers are up in arms: they are being criticised for stealing from the younger generation when so many of them are doing all they can to promote a sustainable and fair society.
They want to save the planet and protect welfare spending as much as other age groups. And anyway, they argue, there are plenty of older workers and pensioners who are poor and should not be blamed for bequeathing young people a life of low incomes, sky-high bills, a reduced welfare state and costly debts.
Tomorrow the National Pensioners Convention will head a lobby of parliament. Angry at the government's decision to downgrade the inflation link for annual pension increases, its message is that many over-65s are struggling to keep warm and will be made poorer, and colder, by the change. Their plea shows up the problem when debating the effect of the boomer generation on the rest of society, which is that this group is far from homogeneous. Rich and poor are both found in the boomer cohort just as much as they are in any other.
Yet the accusation that boomers are protecting themselves at the expense of everyone else still stands, because relatively ordinary boomers will retire as millionaires, paid for by younger workers. Even the poorer over-50s need to recognise they are going to take out of society more than they put in.
Wednesday 11 November 2009
Monday 9 November 2009
We are lucky just now in having a Chief Rabbi who is always worth listening to, whether in philosophical and social analysis or jokes. But in his Theos lecture last week, the thing that stuck with me came up casually in the question session at the end. It was about Islam in modern society. Rabbi Jonathan Sacks observed that the advantage of being Jewish is that for 2,600 years you have learnt to “sing in a minor key”, in societies you did not dominate. Christianity, he said, is learning this as its numbers decline, but Islam is new to the experience.
The musical metaphor works. Jews maintained their identity in diaspora, a perennial minority. Yet they have added their voice to many a social choir, enriching and counterpointing without expecting to play the lead. The prophet Jeremiah did not urge his co-religionists in Babylonian exile to become terrorists: he told them to wish no ill to their new neighbours but “Seek the welfare of the city where I have sent you into exile, and pray to the Lord on its behalf, for in its welfare you will find your welfare.”
For Christians, too, there was a time of minority. Jesus ordered followers to render their dues to Caesar, and the early Church enjoined “Honour the Emperor”. Contemplating the later corruptions of Christian authority in crusades, persecutions and forcible conversions, words such as “Christendom” ring bitterly: the “dom” of domination jars with the gentleness of the founder.
There were benign social and aesthetic effects of homogeneous European Christianity, but against those must be set its abuses: hypocrisies, cruelties, petty rules. Authoritarianism and self-righteousness are the chronic diseases of religiosity, and no corruption of power is worse than the perversion of religion, because religion claims to speak to the deepest private part of us. For an illustration of that, ask yourself whether it is worse to stop a child’s pocket money for being obstreperous, or to inform him that he is sinful and likely to burn in hell forever.
So faith and power are not good bedfellows, and I for one am always glad to see religion kicked out of bed by a secular state. Not least because religion can then stand upright, and in the words of George Fox, founder of that perennial minority the Quakers, “. . . walk cheerfully over the world, answering that of God in everyone”.
Curiously, however, because of the prevailing mildness of established Anglicanism in Britain we have a unique situation: real power has left the Church but it remains a useful ritual figurehead. Yesterday we stood in a vast crowd by the war memorial in Oxford while the Salvation Army band played and the City Rector prayed alongside Muslim, Hindu, Jewish and Sikh representatives. Harmoniously.
But that was about shared sorrow and respect: not power or evangelism. Christianity now, said Rabbi Sacks, is having to learn the Jewish lesson about being a minority that enriches and harmonises, modestly. Some Christians are learning it better than others: the rise of a spiteful “moral majority” in parts of the US is dismaying, with the pious terrorism that bombs abortion clinics and torments homosexuals. Equally deplorable is the stranglehold of the Catholic Church in countries where it impedes humane campaigns against Aids because it cannot tolerate condoms, even for married couples where one partner is infected.
The minor key need not involve diluting faith. Hindus, Buddhists, Sikhs and others seem to know instinctively that you can treasure your beliefs and customs, cautiously welcome serious converts, yet not throw your weight around or go out of your way to give (or take) offence. Surrounded by infidels, you treat them politely and think your own thoughts. And while you may be stern on morals within your own community, if you live under a civilised democratic law you abide by it, and refrain from harming your apostates or murdering your daughters for loving the wrong man.
But some Muslims, said the Chief Rabbi without disrespect, have yet to learn the knack of the minor key. Which is understandable: it is a younger faith, and ruled great empires in the age before globalisation. Like Catholicism, it thrived on authority: a statist faith that can burn, behead, flog and imprison is always attractive to some. Islamist extremists now — impotent and prickly, beached in secular Luton or Bradford or Boston — may feel it shameful to be a “tolerated” minority. Hence the murderous vainglory of suicide videos, and before that the crazy rantings we ignored for far too long from Abu Hamza al-Masri on his Al-Jihaad site (“[Unbelievers] are filthy scum of the earth . . . beneath the level of the cattle. We must crush them without mercy . . . So now it is time to make your decision . . .” ).
Decent Muslims, undoubtedly a majority, opt like Jews and sane Christians for the minor key and the modesty of a settled faith which resolves neither to despise nor proselytise. But it takes discipline and rationality to hold a strong private faith and moral culture while living in a society that does not share it. If society must tolerate diverse faiths, so must faiths return the compliment and pragmatically avoid clashes. It seems ever more obvious that Major Nidal Malik Hasan of Fort Hood, dismayed when his country went to war in Iraq and Afghanistan, should have left the US armed service promptly, and been allowed to do so. Instead he blogged, ranted and seethed until he cracked and murdered 13 people who trusted him.
Equally, on a lesser matter, it seems obvious that when her country’s law brought in civil partnerships, the Islington registrar who huffily refused to perform them on Christian grounds should just have sighed, muttered a prayer and found another job. One makes sacrifices for one’s beliefs, surely? The tribunal should never have rolled over as it did, agreeing to exempt a public servant from civic duty. Religion is religion, law is law. Render unto Caesar.
It’s a hard lesson to learn. But once it has been learnt, as Judaism has found, it brings great rewards. You can be a citizen, valued and accepted and eminent, yet preserve your faith, rituals, roots and community values. Your voice can harmonise with the diverse choir around you without being drowned or cracked. It can be done. There are many roads up the holy mountain, and no need to chuck rocks down on people you consider to be on the wrong one.
The musical metaphor works. Jews maintained their identity in diaspora, a perennial minority. Yet they have added their voice to many a social choir, enriching and counterpointing without expecting to play the lead. The prophet Jeremiah did not urge his co-religionists in Babylonian exile to become terrorists: he told them to wish no ill to their new neighbours but “Seek the welfare of the city where I have sent you into exile, and pray to the Lord on its behalf, for in its welfare you will find your welfare.”
For Christians, too, there was a time of minority. Jesus ordered followers to render their dues to Caesar, and the early Church enjoined “Honour the Emperor”. Contemplating the later corruptions of Christian authority in crusades, persecutions and forcible conversions, words such as “Christendom” ring bitterly: the “dom” of domination jars with the gentleness of the founder.
There were benign social and aesthetic effects of homogeneous European Christianity, but against those must be set its abuses: hypocrisies, cruelties, petty rules. Authoritarianism and self-righteousness are the chronic diseases of religiosity, and no corruption of power is worse than the perversion of religion, because religion claims to speak to the deepest private part of us. For an illustration of that, ask yourself whether it is worse to stop a child’s pocket money for being obstreperous, or to inform him that he is sinful and likely to burn in hell forever.
So faith and power are not good bedfellows, and I for one am always glad to see religion kicked out of bed by a secular state. Not least because religion can then stand upright, and in the words of George Fox, founder of that perennial minority the Quakers, “. . . walk cheerfully over the world, answering that of God in everyone”.
Curiously, however, because of the prevailing mildness of established Anglicanism in Britain we have a unique situation: real power has left the Church but it remains a useful ritual figurehead. Yesterday we stood in a vast crowd by the war memorial in Oxford while the Salvation Army band played and the City Rector prayed alongside Muslim, Hindu, Jewish and Sikh representatives. Harmoniously.
But that was about shared sorrow and respect: not power or evangelism. Christianity now, said Rabbi Sacks, is having to learn the Jewish lesson about being a minority that enriches and harmonises, modestly. Some Christians are learning it better than others: the rise of a spiteful “moral majority” in parts of the US is dismaying, with the pious terrorism that bombs abortion clinics and torments homosexuals. Equally deplorable is the stranglehold of the Catholic Church in countries where it impedes humane campaigns against Aids because it cannot tolerate condoms, even for married couples where one partner is infected.
The minor key need not involve diluting faith. Hindus, Buddhists, Sikhs and others seem to know instinctively that you can treasure your beliefs and customs, cautiously welcome serious converts, yet not throw your weight around or go out of your way to give (or take) offence. Surrounded by infidels, you treat them politely and think your own thoughts. And while you may be stern on morals within your own community, if you live under a civilised democratic law you abide by it, and refrain from harming your apostates or murdering your daughters for loving the wrong man.
But some Muslims, said the Chief Rabbi without disrespect, have yet to learn the knack of the minor key. Which is understandable: it is a younger faith, and ruled great empires in the age before globalisation. Like Catholicism, it thrived on authority: a statist faith that can burn, behead, flog and imprison is always attractive to some. Islamist extremists now — impotent and prickly, beached in secular Luton or Bradford or Boston — may feel it shameful to be a “tolerated” minority. Hence the murderous vainglory of suicide videos, and before that the crazy rantings we ignored for far too long from Abu Hamza al-Masri on his Al-Jihaad site (“[Unbelievers] are filthy scum of the earth . . . beneath the level of the cattle. We must crush them without mercy . . . So now it is time to make your decision . . .” ).
Decent Muslims, undoubtedly a majority, opt like Jews and sane Christians for the minor key and the modesty of a settled faith which resolves neither to despise nor proselytise. But it takes discipline and rationality to hold a strong private faith and moral culture while living in a society that does not share it. If society must tolerate diverse faiths, so must faiths return the compliment and pragmatically avoid clashes. It seems ever more obvious that Major Nidal Malik Hasan of Fort Hood, dismayed when his country went to war in Iraq and Afghanistan, should have left the US armed service promptly, and been allowed to do so. Instead he blogged, ranted and seethed until he cracked and murdered 13 people who trusted him.
Equally, on a lesser matter, it seems obvious that when her country’s law brought in civil partnerships, the Islington registrar who huffily refused to perform them on Christian grounds should just have sighed, muttered a prayer and found another job. One makes sacrifices for one’s beliefs, surely? The tribunal should never have rolled over as it did, agreeing to exempt a public servant from civic duty. Religion is religion, law is law. Render unto Caesar.
It’s a hard lesson to learn. But once it has been learnt, as Judaism has found, it brings great rewards. You can be a citizen, valued and accepted and eminent, yet preserve your faith, rituals, roots and community values. Your voice can harmonise with the diverse choir around you without being drowned or cracked. It can be done. There are many roads up the holy mountain, and no need to chuck rocks down on people you consider to be on the wrong one.
Good article:
Lending must support the real economy
By Dirk Bezemer
Published: November 4 2009 22:21 Last updated: November 4 2009 22:21
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Economists have been mulling over the shape financial reforms should take. Robert Shiller wrote on these pages in defence of “financial democracy”, arguing that a wide range of financial products allows everyone to access liquidity and insure against risk. A week earlier in The New York Times, Paul Krugman pinpointed the way bankers are paid as the focal point of reforms. The problem with these discussions is that they introduce red herrings. Dear top economists, the problem is debt. Any solution that sidesteps this is a non-starter.
As I wrote in the FT last month, the crisis and recession were not all that difficult to predict once you started to look at the flow of funds – at credit and debt – and at the financial sector as separate from the real economy. Following the same logic, it should now be fairly uncontroversial what our long-term aim in financial reform is. It is to redirect lending away from bloating the financial sector and towards supporting the real economy, rather than loading it down with debt.
In the 1980-2007 era of cheap credit and deregulation, banks had every incentive to move from real-economy projects, yielding a profit, towards lending against rising asset prices, yielding a capital gain. In the 1990s and 2000s, loan volumes rose to unprecedented levels, supporting global assets booms in property, derivatives and the carry trade. The share of lending by US banks to the US financial sector – instead of to the real economy – went from 60 per cent of the outstanding loan stock in 1980 (up from 50 per cent in the 1950s) to more than 80 per cent in 2007.
But the price was growing indebtedness. Profit and capital gains may look much the same to the individual bank – a stream of revenues – but they have different macroeconomic consequences. Lending to the real sector is self-amortising: it creates a debt, but also the value-added to repay principal and interest. Such loans enlarge the economy in proportion to the debts created and are financially sustainable. By contrast, loans to create or buy financial assets and instruments are not, by themselves, self-amortizing. In a credit boom, successive owners may sell the asset at a profit, but their buyers will have to shoulder proportionally more debt in order to acquire the asset, balanced (for the time being) by the asset’s value. Asset trading may be individually profitable; but it is a zero sum game, sustainable only if the real economy furnishes enough money to support the rising debt burden. Beyond a point, the lure of capital gains diverts funds from real-sector investment, and households’ rising debt-service cuts demand for real-sector output. In both ways, excessive growth of financial asset markets is self-defeating.
This logic may be traced in the statistics (all figures from the Bureau of Economic Analysis). The US stock of loans to the real sector (as a proportion of gross domestic product) has remained roughly constant since the 1980s. In contrast, loans by US banks to other US banks have grown from 2.5 times GDP in 1980 to a factor of 5.8 in 2007 – all attributable to growth in loans to the financial sector. The US financial sector was over three times larger in 2007 compared with 1980.
Credit flowing into asset markets created a debt overhead while the real economy’s capacity to pay the debt declined. Demand for the real sector’s output also suffered as US households by 2007 were paying over a fifth of their after-tax, disposable income to the financial sector in debt servicing and financial fees. The US had become an economy trying to drive with the brakes on. The real-sector recession, after the 2007 financial crisis, occurred because the real economy had become overly dependent on continued lending against rising asset values. Those are the trends that financial reforms must curb.
A promising policy avenue is tax reform. During the asset boom of the last decades, taxes on capital gains in the US, UK and most other OECD economies have fallen sharply relative to value added tax and labour taxes. When the banks have recovered, they need a regulatory and policy climate that discourages the pursuit of capital gains for their own sake, and which favours growth of the real economy. Finance should be the economy’s handmaiden, not the other way round.
In this perspective, it is beside the point to focus on exorbitant bonuses or financial democracy. In fact, Mr Shiller’s proposal risks boosting yet again the volume of financial instruments and the debts they generate. Didn’t we once welcome credit derivatives for extending mortgage finance to the financially unreached? We forgot that such instruments need to have a basis in the real economy. Likewise, enthusiasm about the rally in asset markets (even as the real economy continued to contract) shows how widespread the confusion between the financial sector and the real economy is. The priority now is not to revitalise asset markets, but to transform a bloated and dysfunctional financial sector towards one that supports the real economy in a sustainable and cost-efficient way.
The writer is a fellow at the Research School of the Economics and Business Department, University of Groningen
Copyright The Financial Times Limited 2009. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.
Lending must support the real economy
By Dirk Bezemer
Published: November 4 2009 22:21 Last updated: November 4 2009 22:21
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Economists have been mulling over the shape financial reforms should take. Robert Shiller wrote on these pages in defence of “financial democracy”, arguing that a wide range of financial products allows everyone to access liquidity and insure against risk. A week earlier in The New York Times, Paul Krugman pinpointed the way bankers are paid as the focal point of reforms. The problem with these discussions is that they introduce red herrings. Dear top economists, the problem is debt. Any solution that sidesteps this is a non-starter.
As I wrote in the FT last month, the crisis and recession were not all that difficult to predict once you started to look at the flow of funds – at credit and debt – and at the financial sector as separate from the real economy. Following the same logic, it should now be fairly uncontroversial what our long-term aim in financial reform is. It is to redirect lending away from bloating the financial sector and towards supporting the real economy, rather than loading it down with debt.
In the 1980-2007 era of cheap credit and deregulation, banks had every incentive to move from real-economy projects, yielding a profit, towards lending against rising asset prices, yielding a capital gain. In the 1990s and 2000s, loan volumes rose to unprecedented levels, supporting global assets booms in property, derivatives and the carry trade. The share of lending by US banks to the US financial sector – instead of to the real economy – went from 60 per cent of the outstanding loan stock in 1980 (up from 50 per cent in the 1950s) to more than 80 per cent in 2007.
But the price was growing indebtedness. Profit and capital gains may look much the same to the individual bank – a stream of revenues – but they have different macroeconomic consequences. Lending to the real sector is self-amortising: it creates a debt, but also the value-added to repay principal and interest. Such loans enlarge the economy in proportion to the debts created and are financially sustainable. By contrast, loans to create or buy financial assets and instruments are not, by themselves, self-amortizing. In a credit boom, successive owners may sell the asset at a profit, but their buyers will have to shoulder proportionally more debt in order to acquire the asset, balanced (for the time being) by the asset’s value. Asset trading may be individually profitable; but it is a zero sum game, sustainable only if the real economy furnishes enough money to support the rising debt burden. Beyond a point, the lure of capital gains diverts funds from real-sector investment, and households’ rising debt-service cuts demand for real-sector output. In both ways, excessive growth of financial asset markets is self-defeating.
This logic may be traced in the statistics (all figures from the Bureau of Economic Analysis). The US stock of loans to the real sector (as a proportion of gross domestic product) has remained roughly constant since the 1980s. In contrast, loans by US banks to other US banks have grown from 2.5 times GDP in 1980 to a factor of 5.8 in 2007 – all attributable to growth in loans to the financial sector. The US financial sector was over three times larger in 2007 compared with 1980.
Credit flowing into asset markets created a debt overhead while the real economy’s capacity to pay the debt declined. Demand for the real sector’s output also suffered as US households by 2007 were paying over a fifth of their after-tax, disposable income to the financial sector in debt servicing and financial fees. The US had become an economy trying to drive with the brakes on. The real-sector recession, after the 2007 financial crisis, occurred because the real economy had become overly dependent on continued lending against rising asset values. Those are the trends that financial reforms must curb.
A promising policy avenue is tax reform. During the asset boom of the last decades, taxes on capital gains in the US, UK and most other OECD economies have fallen sharply relative to value added tax and labour taxes. When the banks have recovered, they need a regulatory and policy climate that discourages the pursuit of capital gains for their own sake, and which favours growth of the real economy. Finance should be the economy’s handmaiden, not the other way round.
In this perspective, it is beside the point to focus on exorbitant bonuses or financial democracy. In fact, Mr Shiller’s proposal risks boosting yet again the volume of financial instruments and the debts they generate. Didn’t we once welcome credit derivatives for extending mortgage finance to the financially unreached? We forgot that such instruments need to have a basis in the real economy. Likewise, enthusiasm about the rally in asset markets (even as the real economy continued to contract) shows how widespread the confusion between the financial sector and the real economy is. The priority now is not to revitalise asset markets, but to transform a bloated and dysfunctional financial sector towards one that supports the real economy in a sustainable and cost-efficient way.
The writer is a fellow at the Research School of the Economics and Business Department, University of Groningen
Copyright The Financial Times Limited 2009. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.
Tuesday 28 October 2008
From Bloomberg:
http://www.bloomberg.com/apps/news?pid=20601109&sid=a0jln3.CSS6c&refer=exclusive
Oct. 27 (Bloomberg) -- Tom Bosh lowered the telephone receiver into its cradle, making a decision on the way down. ``We're not buying any more,'' he told his traders at Bank of New York Co. ``Nothing.''
It was May 2007, and Bosh, who managed $25 billion from the bank's 13th-floor trading room above Times Square, had just hung up on Ralph Cioffi at Bear Stearns Cos. a dozen blocks away. Bosh had invested $50 million in notes from an issuer Cioffi controlled, and he was ready to pull the plug.
``I had a bad feeling,'' Bosh, 45, recalled. ``Cioffi was just bulldogging everyone. He was saying, `These assets are good, the collateral is paying down, and I know more than you.' That type of attitude.''
Bosh's premonition, a month before two of Cioffi's funds blew up, struck a death knell for structured finance, the system Wall Street banks devised to fuel more than two decades of unprecedented borrowing. The system allowed financial companies to lend beyond their capacity and outside the reach of regulators -- until it crashed this year.
While the collapse was most visible in the stock markets, the cause was the loss of confidence in the world's biggest bond market, structured finance. So far, it has led to the worst financial crisis since the Great Depression, the disappearance or takeover of more than a dozen banks, including three storied Wall Street firms, and almost $3 trillion in government expenditures and guarantees to contain the contagion.
Biggest U.S. Export
The bundling of consumer loans and home mortgages into packages of securities -- a process known as securitization -- was the biggest U.S. export business of the 21st century. More than $27 trillion of these securities have been sold since 2001, according to the Securities Industry Financial Markets Association, an industry trade group. That's almost twice last year's U.S. gross domestic product of $13.8 trillion.
The growth over the past decade was made possible by overseas banks, which saw the profits U.S. financial institutions were making and coveted the made-in-America technology, much as consumers around the world craved other emblems of American ingenuity from Coca-Cola to Hollywood movies. Wall Street obliged, with disastrous results: two-thirds of a trillion dollars in bank losses, about 40 percent of them outside the U.S.
``Securitization was based on the premise that a fool was born every minute,'' Joseph Stiglitz, a professor of economics at Columbia University in New York, told a congressional committee on Oct. 21. ``Globalization meant that there was a global landscape on which they could search for those fools -- and they found them everywhere.''
Eager Adopters
European banks, in particular, were eager adopters. Securitizations in Europe increased almost sixfold between 2000 and 2007, from 78 billion euros ($98 billion) to 453 billion euros, according to the European Securitization Forum, a trade organization.
Three Icelandic banks borrowed enough to buy $228 billion of assets, most of them securitizations, turning the country's financial system into a hedge fund. All three banks have been nationalized by the government, leading Prime Minister Geir Haarde to advise citizens to switch from finance to fishing.
In Germany, one bank, Landesbank Sachsen Girozentrale, bought $26 billion worth of subprime-backed investments, putting the state of Saxony on the hook for $4.1 billion.
In Japan, Mizuho Financial Group Inc., the nation's third- largest bank, acquired an entire structured-finance team, which proceeded to lose $6 billion issuing mortgage-backed securities.
Shadow Banking
The damage reaches all the way to Australia, where the town council of Wingecarribee, a municipality outside Sydney with a population of 42,000, bought $20 million of securities from Lehman Brothers Holdings Inc. Now, Lehman is in bankruptcy, the town council is in court and the securities are worth about 15 cents on the dollar.
Securitization is a shadow banking system that funds most of the world's credit cards, car purchases, leveraged buyouts and, for a while, subprime mortgages. The system, which pools loans and slices up the risk of default, made borrowing cheaper for everyone, creating a debt culture that put credit cards in wallets from Seoul to Sao Paolo and enabled people to buy luxury cars and homes. It also pumped out record profits for banks, accounting for as much as one-fifth of their revenue over the last decade.
Beginning about three years ago, investment banks revved the system's engine to boost earnings. They raised revenue by funding more subprime mortgages and cut costs by relying increasingly on the $4.2 trillion sitting in U.S. money-market funds. As it turned out, those decisions would prove fatal.
`Powerful Technology'
``It's a powerful technology that has been driven beyond the speed limit,'' said Juan Ocampo, a former consultant at New York-based advisory firm McKinsey & Co. who wrote a 1988 book popularizing structured finance. ``For the last five years, instead of going 65 mph, they've been gunning it to 140 mph, 150 mph.''
Before the invention of securitization, banks loaned money, received payments and profited from the difference between what the borrower paid and the bank's funding cost.
During the mid-1980s, mortgage-bond traders at Salomon Brothers devised a method of lending without using capital, a technique at the heart of securitization. It works by taking anything that has regular payments -- mortgages, car loans, aircraft leases, music royalties -- and channeling the money to a trust that pays bondholders principal and interest.
Off-Balance-Sheet
The word ``securitization'' implies safety. Investors with less appetite for risk buy higher-rated securities and get paid first at lower interest rates. Those with a bigger appetite get paid later and receive more interest.
Securitization's biggest innovation was the use of off-balance-sheet accounting. If a bank couldn't sell a bond or didn't want to, the asset could be sold to a trust within a so-called special-purpose entity, incorporated in a place such as the Cayman Islands or Dublin, and shifted off the books. Lending expanded, and banks still booked profits.
With this new technology, a bank could originate $100 million in loans, sell off some to investors, transfer the rest to a special-purpose entity and not have to hold any capital. The profit could be as much as 1.25 percentage points of the amount loaned, or $1.25 million for every $100 million issued.
``The banks could turn a low return-on-equity business into one that doesn't use any equity, which was the motivation for this,'' said Brad Hintz, a Sanford C. Bernstein & Co. analyst and former chief financial officer at Lehman. ``It becomes almost like a fee business because it requires no capital.''
`Capture the Prize'
Like most new products, securitization found a market at home before going abroad. Bankers at Salomon and First Boston Inc. raced from bank to bank to convince issuers it was the wave of the future.
William Haley remembers a 10 a.m. meeting in 1987 at Imperial Thrift & Loan Association in Glendale, California. As Haley, at the time a 33-year-old Salomon banker, and his team walked into the conference room to make a pitch, the First Boston team was walking out.
``We exchanged some knowing looks and then tried to beat the pants off them,'' said Haley, who now works at RBS Greenwich Capital Markets Inc., a firm specializing in mortgage-backed securities that is owned by Royal Bank of Scotland Group Plc. ``There was a fierce desire to capture the prize.''
First Boston
First Boston, housed in the same New York office tower as McKinsey, was first out of the gate in March 1985 with a $192 million computer-lease securitization for Sperry Corp., a predecessor of Unisys Corp. The bank then oversaw a series of auto-loan securitizations, including a $4 billion issue by General Motors Acceptance Corp. in October 1986, the biggest corporate debt issue at the time.
Haley's project was a $50 million deal for Banc One Corp. called Certificates for Amortizing Revolving Debts, or CARDs. It was the first credit-card securitization and a blueprint for the $358 billion of such securities now outstanding. The transaction also gave the banks a way to securitize their own assets and get them off their balance sheets, which allowed the money to be lent all over again.
The strategy was detailed in Ocampo's 282-page book ``Securitization of Credit: Inside the New Technology of Finance,'' which he co-wrote with McKinsey consultant James Rosenthal. Ocampo, who received an MBA from Harvard after graduating from the Massachusetts Institute of Technology, and Rosenthal, a Harvard Law School graduate, argued that banks could be more profitable if they used securitization.
McKinsey Book
The authors examined six of the first asset-backed transactions and gave readers a step-by-step guide for how to repeat them. They said that banks that didn't embrace the new technology would be at a disadvantage, and they predicted it would become the dominant form of financing.
``The McKinsey book helped with credibility with issuers,'' said Haley. ``It wasn't that easy in the beginning. Conferences now have thousands of people, but I remember once in Beverly Hills, I gave a speech and there were maybe 25 people in the audience. They were furiously taking notes, however.''
The new technology was spread around the world by the people who worked on the First Boston and Salomon teams. Salomon's group was led by Patricia Jehle, who later founded Bear Stearns's asset-backed unit. Another member, Michael Hutchins, started the first team at a European bank when he went to Zurich-based UBS AG in 1996. A third, Michael Normile, moved to Merrill Lynch & Co., where he ran its securities business, then switched to London-based HSBC Holdings Plc in 2004. Haley built similar teams at Lehman, Chase Manhattan Bank and Amsterdam-based ABN Amro Bank NV.
Hard Sell
First Boston's team included Walid Chammah, 54, who went on to head debt and equity capital markets at Morgan Stanley and is now co-president of that firm. Joseph Donovan, the banker responsible for the GMAC relationship, went to Smith Barney in 1995, to Prudential Securities in 1998 and two years later took over the asset-backed group at Credit Suisse First Boston after Zurich-based Credit Suisse bought First Boston.
Donovan remembers traveling to Europe for First Boston in the early 1990s, trying to convince Volkswagen AG in Wolfsburg, Germany, and Renault SA outside Paris of the benefits of securitization. It was a hard sell. Europeans, he said, didn't take out auto loans.
``We tried over and over,'' Donovan recalled. ``We were trying to get more issuers, and there weren't any.''
`50-Year Pedigree'
By the time Donovan went to work for Credit Suisse in 2000, European attitudes had changed. Home-mortgage securitizations were especially appealing, he said, because European banks didn't need a ``50-year pedigree to compete.''
``You don't need a whole equity-research department and relationships with CEOs and CFOs,'' Donovan said. ``You basically needed good computers and distribution. You can always buy a Fannie, Freddie or Ginnie Mae pool. You just go online and buy it. You can't buy a Ford Motor Credit deal, because you have to know people.''
CSFB went from third in underwriting structured finance in 2000, behind Lehman and Salomon Smith Barney, to first in 2001, when it issued $96.3 billion in securities. Its market share increased 50 percent to 12.7 percent. The bank fell to fourth place in 2005, although its volume soared to $144.5 billion.
Exporting Debt
As securitization caught on, borrowing increased. U.S. consumer debt tripled in the two decades after 1988 to $2.6 trillion, according to the Federal Reserve. Foreign banks used the new technology to expand lending, seeking borrowers on their home turf.
``One of the things the United States exported overseas was a debt culture,'' Haley said.
While consumers were snapping up credit cards, Nicholas Sossidis and Stephen Partridge-Hicks at Citibank in London were figuring out a way to sell the new bonds. Their solution: Alpha Finance Corp., the first off-balance-sheet structured investment vehicle, or SIV.
Alpha was created in 1988 as a way for Citibank, and later Citigroup Inc., to vertically integrate its business like an oil company. The raw material was found in a loan, refined into a security, then sold to a SIV at a profit.
Citigroup, formed in a merger of Citicorp and Travelers Group Inc., which owned asset-backed pioneer Salomon, also got a new product to sell: capital notes that boast returns of more than 20 percent a year. Owners of these notes receive all the excess return when borrowers pay their bills on time, though they are the last to be paid when times get hard.
Citi SIVs
In the beginning, SIVs were small and cautious. Alpha was capitalized with $100 million of equity that supported $500 million of commercial paper and medium-term notes. The SIV could hold only debt rated A- or higher and didn't take any currency or interest-rate risk, according to a 1993 Fitch Ratings report.
Alpha was followed by a slew of SIVs with names such as Beta Corp. and Five Finance. By 2007, Citigroup's SIVs had $90 billion of assets, equal to the stock market value of PepsiCo Inc., making up about one-fourth of the entire SIV industry.
In 2003, the bank was sued by creditors of Enron Corp. for its role in setting up entities that enabled the Houston-based company to move assets off the balance sheet for Chief Executive Officer Jeffrey Skilling. Citigroup paid $1.66 billion in March to settle the lawsuit. Skilling, a former McKinsey consultant, was convicted of accounting fraud and is serving a 24-year prison sentence.
Mismatched Funding
Starting around 2005, securitization began to rely more on short-term money-market funds for financing. This was especially true for securities made by pooling other bonds, known as collateralized debt obligations, or CDOs. Investors were loath to buy long-term debt of issuers that didn't have a track record, so new issuers sold asset-backed commercial paper that matured in less than a year. While money markets are the cheapest way to finance, they can also be the most dangerous for borrowers because they can mature as soon as the next day.
``What happened in 2005 was that because of subprime and some other changes, commercial paper and asset-backed securities offered a bigger spread than anything that had ever been in the market before,'' said Deborah Cunningham, chief investment officer of Federated Investors in Pittsburgh, who oversees $235 billion in commercial paper. ``It was hundreds of basis points, as opposed to 10 or 20 basis points before.''
SIVs, banks and CDOs sold trillions of dollars of asset- backed commercial paper between 2005 and 2007 in maturities ranging from nine months to overnight. In the U.S., the amount outstanding marched higher almost every week beginning in April 2005, peaking at $1.2 trillion for the week ending Aug. 8, 2007.
`Huge Appetite'
Once money-market funds began to be tapped for financing, Ocampo said, ``it created a huge appetite for high-yield assets, far more than could be originated on a sound basis.''
To accommodate the demand, banks funded more subprime mortgages, with an average life of seven years, replacing car loans with an average life of three years and credit-card bonds paid off within 18 months.
Among conservative lenders, that rang an alarm: Bankers are taught to avoid such mismatched funding, in which a lender has to pay back money before the borrower has to pay the principal.
``Most of the terrible things happening now are because of the presence of money-market assets, taking what used to be long-term funding and making it short-term,'' Bruce Bent, 71, who started the first money-market fund in 1970, said in an interview in July.
Reserve Funds
Bent, chairman of New York-based Reserve Funds, said he didn't buy any asset-backed commercial paper until 2007, when the market froze in the wake of the collapse of the Bear Stearns hedge funds. That's when his Reserve Primary Fund began buying castoffs of asset-backed commercial paper at cut-rate prices from other funds.
Yet asset-backed securities weren't Bent's undoing. His fund also owned $785 million in Lehman debt, bought before the firm filed for bankruptcy Sept. 15. In the two days following the bankruptcy, Reserve clients asked to pull about $40 billion from the $62.5 billion fund, and its net asset value fell to 97 cents. It was the first time that a money fund ``broke the buck,'' or fell below $1, in 14 years. The fund is now being liquidated, and Bent hasn't given an interview since.
Reserve Primary Fund's implosion, and the subsequent seizing up of two Commonfund portfolios used by universities and endowments to hold cash, triggered a panic in U.S. money markets, cutting off this form of credit to industrial companies and banks. No one could be sure whether the banks held securitizations that had dropped in value, making them insolvent. That set off a series of bank takeovers and bailouts around the world, including a $64 billion capital injection by the U.K. government into that nation's financial institutions and 400 billion euros in loan guarantees pledged by Germany.
`Absolute Disaster'
``We've created an absolute disaster,'' said Nouriel Roubini, a New York University professor of economics, who predicted the failure of investment banks in a paper he wrote in February titled ``Twelve Steps to Financial Disaster.'' ``The reputation of the United States as a financial center and a leader has been tarnished significantly.''
Also tarnished, if not blackened, is the securitization business itself. Sales of European asset-backed securities, including bonds for car loans and credit cards, fell by 40 percent to 12.7 billion euros in the second quarter, and CDO sales fell by two-thirds to 10 billion euros. In the U.S., mortgage bonds issued by entities not affiliated with the government plummeted to $10.8 billion in the first half of the year, one-twentieth of the $241 billion sold in the same period in 2007.
Cioffi, Bosh
The authors of the 1988 McKinsey handbook on securitization have moved on. Rosenthal, who declined to be interviewed, became a managing director at Lehman and is now in charge of information technology at Morgan Stanley. Ocampo received a patent for risk-controlled investing and founded an institutional fund-management firm, Trajectory Asset Management. The firm doesn't have any structured-finance obligations.
Bear Stearns's Cioffi, 52, was indicted on charges of misleading investors by assuring them that his hedge funds were healthy when he knew they weren't. Cioffi, who now works out of his home in Tenafly, New Jersey, has pleaded not guilty. He declined to comment.
The Bank of New York's Bosh lost his job when his company was merged with Mellon Corp. in June 2007. He's still looking for work.
``You try to do the right thing,'' Bosh said in an interview this month. ``And this is what happens.''
http://www.bloomberg.com/apps/news?pid=20601109&sid=a0jln3.CSS6c&refer=exclusive
Oct. 27 (Bloomberg) -- Tom Bosh lowered the telephone receiver into its cradle, making a decision on the way down. ``We're not buying any more,'' he told his traders at Bank of New York Co. ``Nothing.''
It was May 2007, and Bosh, who managed $25 billion from the bank's 13th-floor trading room above Times Square, had just hung up on Ralph Cioffi at Bear Stearns Cos. a dozen blocks away. Bosh had invested $50 million in notes from an issuer Cioffi controlled, and he was ready to pull the plug.
``I had a bad feeling,'' Bosh, 45, recalled. ``Cioffi was just bulldogging everyone. He was saying, `These assets are good, the collateral is paying down, and I know more than you.' That type of attitude.''
Bosh's premonition, a month before two of Cioffi's funds blew up, struck a death knell for structured finance, the system Wall Street banks devised to fuel more than two decades of unprecedented borrowing. The system allowed financial companies to lend beyond their capacity and outside the reach of regulators -- until it crashed this year.
While the collapse was most visible in the stock markets, the cause was the loss of confidence in the world's biggest bond market, structured finance. So far, it has led to the worst financial crisis since the Great Depression, the disappearance or takeover of more than a dozen banks, including three storied Wall Street firms, and almost $3 trillion in government expenditures and guarantees to contain the contagion.
Biggest U.S. Export
The bundling of consumer loans and home mortgages into packages of securities -- a process known as securitization -- was the biggest U.S. export business of the 21st century. More than $27 trillion of these securities have been sold since 2001, according to the Securities Industry Financial Markets Association, an industry trade group. That's almost twice last year's U.S. gross domestic product of $13.8 trillion.
The growth over the past decade was made possible by overseas banks, which saw the profits U.S. financial institutions were making and coveted the made-in-America technology, much as consumers around the world craved other emblems of American ingenuity from Coca-Cola to Hollywood movies. Wall Street obliged, with disastrous results: two-thirds of a trillion dollars in bank losses, about 40 percent of them outside the U.S.
``Securitization was based on the premise that a fool was born every minute,'' Joseph Stiglitz, a professor of economics at Columbia University in New York, told a congressional committee on Oct. 21. ``Globalization meant that there was a global landscape on which they could search for those fools -- and they found them everywhere.''
Eager Adopters
European banks, in particular, were eager adopters. Securitizations in Europe increased almost sixfold between 2000 and 2007, from 78 billion euros ($98 billion) to 453 billion euros, according to the European Securitization Forum, a trade organization.
Three Icelandic banks borrowed enough to buy $228 billion of assets, most of them securitizations, turning the country's financial system into a hedge fund. All three banks have been nationalized by the government, leading Prime Minister Geir Haarde to advise citizens to switch from finance to fishing.
In Germany, one bank, Landesbank Sachsen Girozentrale, bought $26 billion worth of subprime-backed investments, putting the state of Saxony on the hook for $4.1 billion.
In Japan, Mizuho Financial Group Inc., the nation's third- largest bank, acquired an entire structured-finance team, which proceeded to lose $6 billion issuing mortgage-backed securities.
Shadow Banking
The damage reaches all the way to Australia, where the town council of Wingecarribee, a municipality outside Sydney with a population of 42,000, bought $20 million of securities from Lehman Brothers Holdings Inc. Now, Lehman is in bankruptcy, the town council is in court and the securities are worth about 15 cents on the dollar.
Securitization is a shadow banking system that funds most of the world's credit cards, car purchases, leveraged buyouts and, for a while, subprime mortgages. The system, which pools loans and slices up the risk of default, made borrowing cheaper for everyone, creating a debt culture that put credit cards in wallets from Seoul to Sao Paolo and enabled people to buy luxury cars and homes. It also pumped out record profits for banks, accounting for as much as one-fifth of their revenue over the last decade.
Beginning about three years ago, investment banks revved the system's engine to boost earnings. They raised revenue by funding more subprime mortgages and cut costs by relying increasingly on the $4.2 trillion sitting in U.S. money-market funds. As it turned out, those decisions would prove fatal.
`Powerful Technology'
``It's a powerful technology that has been driven beyond the speed limit,'' said Juan Ocampo, a former consultant at New York-based advisory firm McKinsey & Co. who wrote a 1988 book popularizing structured finance. ``For the last five years, instead of going 65 mph, they've been gunning it to 140 mph, 150 mph.''
Before the invention of securitization, banks loaned money, received payments and profited from the difference between what the borrower paid and the bank's funding cost.
During the mid-1980s, mortgage-bond traders at Salomon Brothers devised a method of lending without using capital, a technique at the heart of securitization. It works by taking anything that has regular payments -- mortgages, car loans, aircraft leases, music royalties -- and channeling the money to a trust that pays bondholders principal and interest.
Off-Balance-Sheet
The word ``securitization'' implies safety. Investors with less appetite for risk buy higher-rated securities and get paid first at lower interest rates. Those with a bigger appetite get paid later and receive more interest.
Securitization's biggest innovation was the use of off-balance-sheet accounting. If a bank couldn't sell a bond or didn't want to, the asset could be sold to a trust within a so-called special-purpose entity, incorporated in a place such as the Cayman Islands or Dublin, and shifted off the books. Lending expanded, and banks still booked profits.
With this new technology, a bank could originate $100 million in loans, sell off some to investors, transfer the rest to a special-purpose entity and not have to hold any capital. The profit could be as much as 1.25 percentage points of the amount loaned, or $1.25 million for every $100 million issued.
``The banks could turn a low return-on-equity business into one that doesn't use any equity, which was the motivation for this,'' said Brad Hintz, a Sanford C. Bernstein & Co. analyst and former chief financial officer at Lehman. ``It becomes almost like a fee business because it requires no capital.''
`Capture the Prize'
Like most new products, securitization found a market at home before going abroad. Bankers at Salomon and First Boston Inc. raced from bank to bank to convince issuers it was the wave of the future.
William Haley remembers a 10 a.m. meeting in 1987 at Imperial Thrift & Loan Association in Glendale, California. As Haley, at the time a 33-year-old Salomon banker, and his team walked into the conference room to make a pitch, the First Boston team was walking out.
``We exchanged some knowing looks and then tried to beat the pants off them,'' said Haley, who now works at RBS Greenwich Capital Markets Inc., a firm specializing in mortgage-backed securities that is owned by Royal Bank of Scotland Group Plc. ``There was a fierce desire to capture the prize.''
First Boston
First Boston, housed in the same New York office tower as McKinsey, was first out of the gate in March 1985 with a $192 million computer-lease securitization for Sperry Corp., a predecessor of Unisys Corp. The bank then oversaw a series of auto-loan securitizations, including a $4 billion issue by General Motors Acceptance Corp. in October 1986, the biggest corporate debt issue at the time.
Haley's project was a $50 million deal for Banc One Corp. called Certificates for Amortizing Revolving Debts, or CARDs. It was the first credit-card securitization and a blueprint for the $358 billion of such securities now outstanding. The transaction also gave the banks a way to securitize their own assets and get them off their balance sheets, which allowed the money to be lent all over again.
The strategy was detailed in Ocampo's 282-page book ``Securitization of Credit: Inside the New Technology of Finance,'' which he co-wrote with McKinsey consultant James Rosenthal. Ocampo, who received an MBA from Harvard after graduating from the Massachusetts Institute of Technology, and Rosenthal, a Harvard Law School graduate, argued that banks could be more profitable if they used securitization.
McKinsey Book
The authors examined six of the first asset-backed transactions and gave readers a step-by-step guide for how to repeat them. They said that banks that didn't embrace the new technology would be at a disadvantage, and they predicted it would become the dominant form of financing.
``The McKinsey book helped with credibility with issuers,'' said Haley. ``It wasn't that easy in the beginning. Conferences now have thousands of people, but I remember once in Beverly Hills, I gave a speech and there were maybe 25 people in the audience. They were furiously taking notes, however.''
The new technology was spread around the world by the people who worked on the First Boston and Salomon teams. Salomon's group was led by Patricia Jehle, who later founded Bear Stearns's asset-backed unit. Another member, Michael Hutchins, started the first team at a European bank when he went to Zurich-based UBS AG in 1996. A third, Michael Normile, moved to Merrill Lynch & Co., where he ran its securities business, then switched to London-based HSBC Holdings Plc in 2004. Haley built similar teams at Lehman, Chase Manhattan Bank and Amsterdam-based ABN Amro Bank NV.
Hard Sell
First Boston's team included Walid Chammah, 54, who went on to head debt and equity capital markets at Morgan Stanley and is now co-president of that firm. Joseph Donovan, the banker responsible for the GMAC relationship, went to Smith Barney in 1995, to Prudential Securities in 1998 and two years later took over the asset-backed group at Credit Suisse First Boston after Zurich-based Credit Suisse bought First Boston.
Donovan remembers traveling to Europe for First Boston in the early 1990s, trying to convince Volkswagen AG in Wolfsburg, Germany, and Renault SA outside Paris of the benefits of securitization. It was a hard sell. Europeans, he said, didn't take out auto loans.
``We tried over and over,'' Donovan recalled. ``We were trying to get more issuers, and there weren't any.''
`50-Year Pedigree'
By the time Donovan went to work for Credit Suisse in 2000, European attitudes had changed. Home-mortgage securitizations were especially appealing, he said, because European banks didn't need a ``50-year pedigree to compete.''
``You don't need a whole equity-research department and relationships with CEOs and CFOs,'' Donovan said. ``You basically needed good computers and distribution. You can always buy a Fannie, Freddie or Ginnie Mae pool. You just go online and buy it. You can't buy a Ford Motor Credit deal, because you have to know people.''
CSFB went from third in underwriting structured finance in 2000, behind Lehman and Salomon Smith Barney, to first in 2001, when it issued $96.3 billion in securities. Its market share increased 50 percent to 12.7 percent. The bank fell to fourth place in 2005, although its volume soared to $144.5 billion.
Exporting Debt
As securitization caught on, borrowing increased. U.S. consumer debt tripled in the two decades after 1988 to $2.6 trillion, according to the Federal Reserve. Foreign banks used the new technology to expand lending, seeking borrowers on their home turf.
``One of the things the United States exported overseas was a debt culture,'' Haley said.
While consumers were snapping up credit cards, Nicholas Sossidis and Stephen Partridge-Hicks at Citibank in London were figuring out a way to sell the new bonds. Their solution: Alpha Finance Corp., the first off-balance-sheet structured investment vehicle, or SIV.
Alpha was created in 1988 as a way for Citibank, and later Citigroup Inc., to vertically integrate its business like an oil company. The raw material was found in a loan, refined into a security, then sold to a SIV at a profit.
Citigroup, formed in a merger of Citicorp and Travelers Group Inc., which owned asset-backed pioneer Salomon, also got a new product to sell: capital notes that boast returns of more than 20 percent a year. Owners of these notes receive all the excess return when borrowers pay their bills on time, though they are the last to be paid when times get hard.
Citi SIVs
In the beginning, SIVs were small and cautious. Alpha was capitalized with $100 million of equity that supported $500 million of commercial paper and medium-term notes. The SIV could hold only debt rated A- or higher and didn't take any currency or interest-rate risk, according to a 1993 Fitch Ratings report.
Alpha was followed by a slew of SIVs with names such as Beta Corp. and Five Finance. By 2007, Citigroup's SIVs had $90 billion of assets, equal to the stock market value of PepsiCo Inc., making up about one-fourth of the entire SIV industry.
In 2003, the bank was sued by creditors of Enron Corp. for its role in setting up entities that enabled the Houston-based company to move assets off the balance sheet for Chief Executive Officer Jeffrey Skilling. Citigroup paid $1.66 billion in March to settle the lawsuit. Skilling, a former McKinsey consultant, was convicted of accounting fraud and is serving a 24-year prison sentence.
Mismatched Funding
Starting around 2005, securitization began to rely more on short-term money-market funds for financing. This was especially true for securities made by pooling other bonds, known as collateralized debt obligations, or CDOs. Investors were loath to buy long-term debt of issuers that didn't have a track record, so new issuers sold asset-backed commercial paper that matured in less than a year. While money markets are the cheapest way to finance, they can also be the most dangerous for borrowers because they can mature as soon as the next day.
``What happened in 2005 was that because of subprime and some other changes, commercial paper and asset-backed securities offered a bigger spread than anything that had ever been in the market before,'' said Deborah Cunningham, chief investment officer of Federated Investors in Pittsburgh, who oversees $235 billion in commercial paper. ``It was hundreds of basis points, as opposed to 10 or 20 basis points before.''
SIVs, banks and CDOs sold trillions of dollars of asset- backed commercial paper between 2005 and 2007 in maturities ranging from nine months to overnight. In the U.S., the amount outstanding marched higher almost every week beginning in April 2005, peaking at $1.2 trillion for the week ending Aug. 8, 2007.
`Huge Appetite'
Once money-market funds began to be tapped for financing, Ocampo said, ``it created a huge appetite for high-yield assets, far more than could be originated on a sound basis.''
To accommodate the demand, banks funded more subprime mortgages, with an average life of seven years, replacing car loans with an average life of three years and credit-card bonds paid off within 18 months.
Among conservative lenders, that rang an alarm: Bankers are taught to avoid such mismatched funding, in which a lender has to pay back money before the borrower has to pay the principal.
``Most of the terrible things happening now are because of the presence of money-market assets, taking what used to be long-term funding and making it short-term,'' Bruce Bent, 71, who started the first money-market fund in 1970, said in an interview in July.
Reserve Funds
Bent, chairman of New York-based Reserve Funds, said he didn't buy any asset-backed commercial paper until 2007, when the market froze in the wake of the collapse of the Bear Stearns hedge funds. That's when his Reserve Primary Fund began buying castoffs of asset-backed commercial paper at cut-rate prices from other funds.
Yet asset-backed securities weren't Bent's undoing. His fund also owned $785 million in Lehman debt, bought before the firm filed for bankruptcy Sept. 15. In the two days following the bankruptcy, Reserve clients asked to pull about $40 billion from the $62.5 billion fund, and its net asset value fell to 97 cents. It was the first time that a money fund ``broke the buck,'' or fell below $1, in 14 years. The fund is now being liquidated, and Bent hasn't given an interview since.
Reserve Primary Fund's implosion, and the subsequent seizing up of two Commonfund portfolios used by universities and endowments to hold cash, triggered a panic in U.S. money markets, cutting off this form of credit to industrial companies and banks. No one could be sure whether the banks held securitizations that had dropped in value, making them insolvent. That set off a series of bank takeovers and bailouts around the world, including a $64 billion capital injection by the U.K. government into that nation's financial institutions and 400 billion euros in loan guarantees pledged by Germany.
`Absolute Disaster'
``We've created an absolute disaster,'' said Nouriel Roubini, a New York University professor of economics, who predicted the failure of investment banks in a paper he wrote in February titled ``Twelve Steps to Financial Disaster.'' ``The reputation of the United States as a financial center and a leader has been tarnished significantly.''
Also tarnished, if not blackened, is the securitization business itself. Sales of European asset-backed securities, including bonds for car loans and credit cards, fell by 40 percent to 12.7 billion euros in the second quarter, and CDO sales fell by two-thirds to 10 billion euros. In the U.S., mortgage bonds issued by entities not affiliated with the government plummeted to $10.8 billion in the first half of the year, one-twentieth of the $241 billion sold in the same period in 2007.
Cioffi, Bosh
The authors of the 1988 McKinsey handbook on securitization have moved on. Rosenthal, who declined to be interviewed, became a managing director at Lehman and is now in charge of information technology at Morgan Stanley. Ocampo received a patent for risk-controlled investing and founded an institutional fund-management firm, Trajectory Asset Management. The firm doesn't have any structured-finance obligations.
Bear Stearns's Cioffi, 52, was indicted on charges of misleading investors by assuring them that his hedge funds were healthy when he knew they weren't. Cioffi, who now works out of his home in Tenafly, New Jersey, has pleaded not guilty. He declined to comment.
The Bank of New York's Bosh lost his job when his company was merged with Mellon Corp. in June 2007. He's still looking for work.
``You try to do the right thing,'' Bosh said in an interview this month. ``And this is what happens.''
Wednesday 8 October 2008
How did this happen?
An interesting take on what has been happening:
http://www.sundayherald.com/news/heraldnews/display.var.2457240.0.smoke_mirrors_and_how_a_handful_of_missed_mortgage_payments_started_the_global_financial_crisis.php
LAST WEEK, something happened which I never expected to see in my lifetime. There was a general run on the entire British banking system, something that hasn't happened before, even in wartime. Ordinary people started moving their money around from bank to bank in fear that they might lose their cash. Millions of pounds were flowing across the Irish sea for the safe haven of the Irish government's recently-announced 100% depositor guarantee. The UK's banks were on the verge of losing public trust, and public trust is the one thing that banks need to survive.
We are witnessing what the commentator Martin Wolf of the Financial Times calls "the disintegration of the financial system". But how did we get here? How did a few dodgy sub-prime mortgages in American inner cities lead to what is beginning to look like the collapse of capitalism?
This is the great unanswered question in the midst of this extraordinary crisis, as banks implode one after the other across the world. We hear endless talk these days about "de-leveraging", "derivatives", "collateralised debt obligation" and "credit default swaps" most of which is completely incomprehensible - and very often designed to be. A lot of what has been going on is essentially fraudulent. But underneath all the jargon is a fundamental truth about banking: that it is based on a kind of confidence trick.
It's called "fractional reserve banking". Alone among commercial institutions, banks are allowed to create value out of nothing - in other words, they are allowed to lend out money they don't have.
To explain more fully: at any one time a bank may have, say, £1 billion in assets, but it will have lent out at least £10bn. That £10bn will yield interest, earning money for the bank - but it's interest on money the bank doesn't actually own, that is not based on deposits in its accounts. Magic. Money for nothing.
But this magic only works if the debtors the bank has lent to don't default on their loans and that the savers who have placed deposits in a bank do not all try to take them out all at once. If they did, then the bank would rapidly become insolvent, because of the £9bn it has lent out that it never had in the first place. That's what started to happen last week: the confidence trick began to fail.
Banking practice dates from medieval times when kings and aristocrats deposited their gold with goldsmiths for safekeeping. The goldsmiths noted that the owners didn't all ask for all the precious metals back at the same time, so they started to lend it out. This is why, until very recently, bank notes "promised to pay the bearer on demand" a sum of sterling silver. It was all based on precious metals. But not any more.
Currency ceased to be linked to precious metals in 1971 when America abandoned the gold standard and ordained that, instead, the world should regard their dollar as being "as good as gold" and use it as the universal medium of exchange. This is called "fiat" money, and some economists believe that it is the root of all evil because, with no intrinsic value, governments cannot resist printing more and more of it, thus devaluing their currency.
The prevailing view nowadays among economists is that central banks can maintain the value of their currencies by manipulating interest rates up or down to control inflation. But this depends on the willingness of the banks to do so.
It also depends on the wisdom and prudence of the banks who manufacture this magic stuff called credit. For the past 20 years, central banks have seen economic growth as more important than combating inflation, and banks have thrown prudence to the winds.
After the 1987 crash, central banks cut interest rates and economic life resumed. Again in the late 1990s, after the Asian financial crisis and the near-collapse of the hedge fund Long Term Capital Management, banks cut interest rates again. After the dotcom crash in 2001, the US Federal Reserve, followed by the Bank of England, cut rates dramatically yet again, and kept them low for the next three years, stimulating house price bubbles in both countries.
At the same time, the bankers made saving money a loser's game - interest rates were held below the rate of inflation, so anyone who saved actually lost money.
The bankers knew perfectly what they were doing - the former Bank of England governor, Sir Eddie George, told a Commons Select Committee two years ago that the housing boom was "unsustainable" but that he and Gordon Brown deliberately inflated it to prevent a recession. Unfortunately, it got a bit out of hand.
The other problem with central banks always cutting interest rates was that this encourages the banks to stop behaving themselves. Huge institutions, including Lehman Brothers and HBOS, started to think they were invincible, masters of the universe, "too big to fail".
Banks like HBOS piled into property, believing that house prices would never fall, and if they did, the Bank of England would slash interest rates and house prices would rise again.
Banks like Northern Rock stopped bothering about the boring business of attracting deposits from savers and started borrowing money on the international money markets to fund ever more ludicrous mortgage lending - such as their 125% so-called "suicide" loans. Northern Rock was still selling these "together" loans six months after it was nationalised.
This confidence that central banks would ride to the rescue led banks to take bigger and bigger risks. Instead of lending 10 times the value of its underlying assets, investment banks including Lehman started lending out 30 times their asset value. This is called leveraging, and allowed the hedge funds and private equity groups financed by Lehman to go on buying sprees across corporate world. They were getting colossal quantities of almost free money.
"Leveraged buy-outs" (LBOs) became the name of the corporate game. Groups of investors would get together, target a company - for instance, the AA in the UK - borrow to buy it, load it up with more debt, sell it, and move on.
Hedge funds flipped multi-billion companies the way amateur property speculators in California flipped houses.
But it was all based on credit, and the dark side of credit is debt. All of this leveraging works only as long as the underlying assets retain their value. Using leverage seemed like free money. But when assets decline in value, the ugly side of debt appears in the form of "de-leveraging".
If a bank has loaned out 30 times its assets, it has loaned out £3 trillion on the basis of only £100bn in reserves. If those assets lose half their value, the bank finds itself in the hole to the tune of £1.5trn.
Greatly simplified, this is what has happened in the last year. A class of complex paper assets called "securities", which are based on the value of residential mortgages, started to lose their value as US house prices started to slide. The banks suddenly stopped trading these mortgage-backed securities because they were afraid of the potential losses that might show up if they did.
These assets included the now-infamous sub-prime loans - money lent to Americans who couldn't possibly pay, in what was essentially fraudulent behaviour - which were packaged up into "collateralised debt obligations" and sold on to other banks and governments who didn't really know what they were buying.
THAT'S about where we stood at the time of the collapse of Northern Rock in August 2007. A general panic among banks froze inter-bank lending. Governments then stepped in, first to nationalise Northern Rock, then to pump billions of so-called "liquidity" loans into the system. In essence, the Bank of England agreed to exchange valuable Treasury bonds for dodgy mortgage assets. The banks could then use these Treasury bonds as a kind of currency, because everyone accepted their value was underwritten by the government - ie, by you and me.
But then something else happened. Huge Wall Street investment banks such as Bear Stearns started to discover that their assets were declining even more rapidly than expected, and investors started withdrawing their funds from them, causing a kind of bank run. To prevent widespread defaults, the US government stepped in and forced another bank, JP Morgan, to buy Bear at a fraction of its value. But this didn't stop the contagion.
Within the space of six months all the big investment banks on Wall Street had collapsed or been merged with other institutions in one of the greatest banking crashes of all time.
Then the big mortgage banks on either side of the pond started to go under - including IndyMac, Washington Mutual, Wachovia, HBOS and Bradford & Bingley. The two huge state-supported US mortgage banks, Freddie Mac and Fannie Mae - responsible for $5trn in mortgages - had to be nationalised, along with the world's largest insurance company, AIG.
Banks which had previously handled hundreds of trillions of investments were finding that they were becoming insolvent almost overnight.
Because of the global reach of these companies, this became a crash even more severe than the series of banking failures that led to the Great Depression in the 1930s.
We are now reaching what might be called the terminal stage in this crisis. The contagion has spread through the entire banking structure of the West. It has moved from a crisis of liquidity to a crisis of insolvency and, finally, to a crisis of confidence in the banking system - everyone wants their money out because no-one trusts their banks. The essential trust that allowed the goldsmiths to lend on the basis of their borrowed gold has begun to evaporate.
To prevent Ireland's banks going bust, the Taoiseach last week decided to guarantee all of the deposits in Irish banks, even though it would be impossible for the Irish government to pay up if everyone withdrew. Money is now flooding out of British banks to this "safe haven", causing fury in the UK.
So, what made the collapse quite so catastrophic that even hundreds of billions of pounds in liquidity loans was not enough to staunch the flow? Well, the answer appears to lie in what is called the "shadow banking system". This refers to the unregulated dealing by banks in what are called "derivatives" - these are financial instruments which don't have a value in themselves, but relate to a future value.
Originally, derivatives were things like pork belly futures - essentially bets on the value of that year's cull of hogs. But a hugely complex market evolved in the trading of derivatives called credit default swaps, which are like insurance policies taken out on corporate debt. In the space of five years the value of credit default swap contracts rose to $62trn, larger than the combined value of all the world's stock markets. The Bank for International Settlement in Basel calculated that the total value of all derivatives in the world last year amounted to some $500trn.
The market in these "over-the-counter" derivatives is unregulated, and traders are allowed to make bets and enter into contracts without having assets to back them up. The derivatives banks thought they had removed the risk by using complex mathematical formulae which seemed to indicate that they could so finely calculate the likelihood of making a loss that they could insure against it.
These derivatives and the mathematics underlying them are immensely complicated and very few people understand them. Indeed, it has emerged that the people who devised them didn't seem to understand them either, because the whole derivatives pyramid is now collapsing.
But through all the confusion the simple essential fact is that banks have hugely over-lent, their assets are declining, debtors are defaulting and their losses, multiplied by complex derivatives and de-leveraging, have become almost incalculable. The banks have had to cut back their lending drastically to build up their capital reserves, and they are now appealing to governments for direct injections of capital.
This is what the $700bn Troubled Asset Relief Programme was all about - using taxpayers money to try to shore up banking capital by buying their worthless assets. But the trouble with this scheme, devised by the former Goldman Sachs boss Henry Paulson, who is now the US treasury secretary, is that no-one really knows how big the losses of the banks are because of this huge amorphous cloud of impenetrable derivatives contracts.
But the story isn't over there. Not only did the banks lend too much and binge on dodgy derivatives, they based most of their devilish formulae on a presumption that house prices always go up. Now, statistically speaking, this is arguably the case - over time, house prices have always risen in the long run.
However, in the short run, the graph can be a very lumpy one, with rises and big falls. For some reason, the banks forgot this, and thought that the bubble in house prices that was ignited by the 2001 interest rate cuts would continue forever.
This was utter madness. House prices are now falling to trend - which means to their historic values. This means a reduction of something like 30%-50%, because the graph of prices always overshoots on the upside and downside. Look at any historical table of house prices and this is blindingly obvious - but for some reason the banks believed that the laws of economics had been suspended by their brilliant mathematics.
So now what happens? Well, as house prices continue to fall - as fall they must - the value of the assets in companies like HBOS will continue to be marked down. This is why Lloyds TSB shareholders are very reluctant to take on HBOS at any price, because it is stuffed with dodgy mortgages which are falling in value. The banks all hoped that by now the central banks would have cut interest rates and people would all have started buying houses again. But house prices are simply too high and have to fall, even with cuts in interest rates. The banks know this, which is why they are refusing to lend unless people can put up large deposits.
This creates a vicious circle which can only be resolved by the assets being revalued. House prices must come down; the banks' assets must be repriced; insolvent banks must be closed; interest rates must encourage saving; consumers will have to stop borrowing to spend and everyone will have to start paying their debts.
It's a tall order, and governments across the world are in denial. But the only way out of this mess is some very hard medicine. The longer governments and banks put off swallowing it, the longer the slump will last.
http://www.sundayherald.com/news/heraldnews/display.var.2457240.0.smoke_mirrors_and_how_a_handful_of_missed_mortgage_payments_started_the_global_financial_crisis.php
LAST WEEK, something happened which I never expected to see in my lifetime. There was a general run on the entire British banking system, something that hasn't happened before, even in wartime. Ordinary people started moving their money around from bank to bank in fear that they might lose their cash. Millions of pounds were flowing across the Irish sea for the safe haven of the Irish government's recently-announced 100% depositor guarantee. The UK's banks were on the verge of losing public trust, and public trust is the one thing that banks need to survive.
We are witnessing what the commentator Martin Wolf of the Financial Times calls "the disintegration of the financial system". But how did we get here? How did a few dodgy sub-prime mortgages in American inner cities lead to what is beginning to look like the collapse of capitalism?
This is the great unanswered question in the midst of this extraordinary crisis, as banks implode one after the other across the world. We hear endless talk these days about "de-leveraging", "derivatives", "collateralised debt obligation" and "credit default swaps" most of which is completely incomprehensible - and very often designed to be. A lot of what has been going on is essentially fraudulent. But underneath all the jargon is a fundamental truth about banking: that it is based on a kind of confidence trick.
It's called "fractional reserve banking". Alone among commercial institutions, banks are allowed to create value out of nothing - in other words, they are allowed to lend out money they don't have.
To explain more fully: at any one time a bank may have, say, £1 billion in assets, but it will have lent out at least £10bn. That £10bn will yield interest, earning money for the bank - but it's interest on money the bank doesn't actually own, that is not based on deposits in its accounts. Magic. Money for nothing.
But this magic only works if the debtors the bank has lent to don't default on their loans and that the savers who have placed deposits in a bank do not all try to take them out all at once. If they did, then the bank would rapidly become insolvent, because of the £9bn it has lent out that it never had in the first place. That's what started to happen last week: the confidence trick began to fail.
Banking practice dates from medieval times when kings and aristocrats deposited their gold with goldsmiths for safekeeping. The goldsmiths noted that the owners didn't all ask for all the precious metals back at the same time, so they started to lend it out. This is why, until very recently, bank notes "promised to pay the bearer on demand" a sum of sterling silver. It was all based on precious metals. But not any more.
Currency ceased to be linked to precious metals in 1971 when America abandoned the gold standard and ordained that, instead, the world should regard their dollar as being "as good as gold" and use it as the universal medium of exchange. This is called "fiat" money, and some economists believe that it is the root of all evil because, with no intrinsic value, governments cannot resist printing more and more of it, thus devaluing their currency.
The prevailing view nowadays among economists is that central banks can maintain the value of their currencies by manipulating interest rates up or down to control inflation. But this depends on the willingness of the banks to do so.
It also depends on the wisdom and prudence of the banks who manufacture this magic stuff called credit. For the past 20 years, central banks have seen economic growth as more important than combating inflation, and banks have thrown prudence to the winds.
After the 1987 crash, central banks cut interest rates and economic life resumed. Again in the late 1990s, after the Asian financial crisis and the near-collapse of the hedge fund Long Term Capital Management, banks cut interest rates again. After the dotcom crash in 2001, the US Federal Reserve, followed by the Bank of England, cut rates dramatically yet again, and kept them low for the next three years, stimulating house price bubbles in both countries.
At the same time, the bankers made saving money a loser's game - interest rates were held below the rate of inflation, so anyone who saved actually lost money.
The bankers knew perfectly what they were doing - the former Bank of England governor, Sir Eddie George, told a Commons Select Committee two years ago that the housing boom was "unsustainable" but that he and Gordon Brown deliberately inflated it to prevent a recession. Unfortunately, it got a bit out of hand.
The other problem with central banks always cutting interest rates was that this encourages the banks to stop behaving themselves. Huge institutions, including Lehman Brothers and HBOS, started to think they were invincible, masters of the universe, "too big to fail".
Banks like HBOS piled into property, believing that house prices would never fall, and if they did, the Bank of England would slash interest rates and house prices would rise again.
Banks like Northern Rock stopped bothering about the boring business of attracting deposits from savers and started borrowing money on the international money markets to fund ever more ludicrous mortgage lending - such as their 125% so-called "suicide" loans. Northern Rock was still selling these "together" loans six months after it was nationalised.
This confidence that central banks would ride to the rescue led banks to take bigger and bigger risks. Instead of lending 10 times the value of its underlying assets, investment banks including Lehman started lending out 30 times their asset value. This is called leveraging, and allowed the hedge funds and private equity groups financed by Lehman to go on buying sprees across corporate world. They were getting colossal quantities of almost free money.
"Leveraged buy-outs" (LBOs) became the name of the corporate game. Groups of investors would get together, target a company - for instance, the AA in the UK - borrow to buy it, load it up with more debt, sell it, and move on.
Hedge funds flipped multi-billion companies the way amateur property speculators in California flipped houses.
But it was all based on credit, and the dark side of credit is debt. All of this leveraging works only as long as the underlying assets retain their value. Using leverage seemed like free money. But when assets decline in value, the ugly side of debt appears in the form of "de-leveraging".
If a bank has loaned out 30 times its assets, it has loaned out £3 trillion on the basis of only £100bn in reserves. If those assets lose half their value, the bank finds itself in the hole to the tune of £1.5trn.
Greatly simplified, this is what has happened in the last year. A class of complex paper assets called "securities", which are based on the value of residential mortgages, started to lose their value as US house prices started to slide. The banks suddenly stopped trading these mortgage-backed securities because they were afraid of the potential losses that might show up if they did.
These assets included the now-infamous sub-prime loans - money lent to Americans who couldn't possibly pay, in what was essentially fraudulent behaviour - which were packaged up into "collateralised debt obligations" and sold on to other banks and governments who didn't really know what they were buying.
THAT'S about where we stood at the time of the collapse of Northern Rock in August 2007. A general panic among banks froze inter-bank lending. Governments then stepped in, first to nationalise Northern Rock, then to pump billions of so-called "liquidity" loans into the system. In essence, the Bank of England agreed to exchange valuable Treasury bonds for dodgy mortgage assets. The banks could then use these Treasury bonds as a kind of currency, because everyone accepted their value was underwritten by the government - ie, by you and me.
But then something else happened. Huge Wall Street investment banks such as Bear Stearns started to discover that their assets were declining even more rapidly than expected, and investors started withdrawing their funds from them, causing a kind of bank run. To prevent widespread defaults, the US government stepped in and forced another bank, JP Morgan, to buy Bear at a fraction of its value. But this didn't stop the contagion.
Within the space of six months all the big investment banks on Wall Street had collapsed or been merged with other institutions in one of the greatest banking crashes of all time.
Then the big mortgage banks on either side of the pond started to go under - including IndyMac, Washington Mutual, Wachovia, HBOS and Bradford & Bingley. The two huge state-supported US mortgage banks, Freddie Mac and Fannie Mae - responsible for $5trn in mortgages - had to be nationalised, along with the world's largest insurance company, AIG.
Banks which had previously handled hundreds of trillions of investments were finding that they were becoming insolvent almost overnight.
Because of the global reach of these companies, this became a crash even more severe than the series of banking failures that led to the Great Depression in the 1930s.
We are now reaching what might be called the terminal stage in this crisis. The contagion has spread through the entire banking structure of the West. It has moved from a crisis of liquidity to a crisis of insolvency and, finally, to a crisis of confidence in the banking system - everyone wants their money out because no-one trusts their banks. The essential trust that allowed the goldsmiths to lend on the basis of their borrowed gold has begun to evaporate.
To prevent Ireland's banks going bust, the Taoiseach last week decided to guarantee all of the deposits in Irish banks, even though it would be impossible for the Irish government to pay up if everyone withdrew. Money is now flooding out of British banks to this "safe haven", causing fury in the UK.
So, what made the collapse quite so catastrophic that even hundreds of billions of pounds in liquidity loans was not enough to staunch the flow? Well, the answer appears to lie in what is called the "shadow banking system". This refers to the unregulated dealing by banks in what are called "derivatives" - these are financial instruments which don't have a value in themselves, but relate to a future value.
Originally, derivatives were things like pork belly futures - essentially bets on the value of that year's cull of hogs. But a hugely complex market evolved in the trading of derivatives called credit default swaps, which are like insurance policies taken out on corporate debt. In the space of five years the value of credit default swap contracts rose to $62trn, larger than the combined value of all the world's stock markets. The Bank for International Settlement in Basel calculated that the total value of all derivatives in the world last year amounted to some $500trn.
The market in these "over-the-counter" derivatives is unregulated, and traders are allowed to make bets and enter into contracts without having assets to back them up. The derivatives banks thought they had removed the risk by using complex mathematical formulae which seemed to indicate that they could so finely calculate the likelihood of making a loss that they could insure against it.
These derivatives and the mathematics underlying them are immensely complicated and very few people understand them. Indeed, it has emerged that the people who devised them didn't seem to understand them either, because the whole derivatives pyramid is now collapsing.
But through all the confusion the simple essential fact is that banks have hugely over-lent, their assets are declining, debtors are defaulting and their losses, multiplied by complex derivatives and de-leveraging, have become almost incalculable. The banks have had to cut back their lending drastically to build up their capital reserves, and they are now appealing to governments for direct injections of capital.
This is what the $700bn Troubled Asset Relief Programme was all about - using taxpayers money to try to shore up banking capital by buying their worthless assets. But the trouble with this scheme, devised by the former Goldman Sachs boss Henry Paulson, who is now the US treasury secretary, is that no-one really knows how big the losses of the banks are because of this huge amorphous cloud of impenetrable derivatives contracts.
But the story isn't over there. Not only did the banks lend too much and binge on dodgy derivatives, they based most of their devilish formulae on a presumption that house prices always go up. Now, statistically speaking, this is arguably the case - over time, house prices have always risen in the long run.
However, in the short run, the graph can be a very lumpy one, with rises and big falls. For some reason, the banks forgot this, and thought that the bubble in house prices that was ignited by the 2001 interest rate cuts would continue forever.
This was utter madness. House prices are now falling to trend - which means to their historic values. This means a reduction of something like 30%-50%, because the graph of prices always overshoots on the upside and downside. Look at any historical table of house prices and this is blindingly obvious - but for some reason the banks believed that the laws of economics had been suspended by their brilliant mathematics.
So now what happens? Well, as house prices continue to fall - as fall they must - the value of the assets in companies like HBOS will continue to be marked down. This is why Lloyds TSB shareholders are very reluctant to take on HBOS at any price, because it is stuffed with dodgy mortgages which are falling in value. The banks all hoped that by now the central banks would have cut interest rates and people would all have started buying houses again. But house prices are simply too high and have to fall, even with cuts in interest rates. The banks know this, which is why they are refusing to lend unless people can put up large deposits.
This creates a vicious circle which can only be resolved by the assets being revalued. House prices must come down; the banks' assets must be repriced; insolvent banks must be closed; interest rates must encourage saving; consumers will have to stop borrowing to spend and everyone will have to start paying their debts.
It's a tall order, and governments across the world are in denial. But the only way out of this mess is some very hard medicine. The longer governments and banks put off swallowing it, the longer the slump will last.
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