They’re also keen to blame the people who took out mortgages that they couldn’t pay and would inevitably default on, since we know banks apparently lack the ability to say “no, sorry, I don’t think you’ll be able to keep up with the repayments”.

As I understand it, the whole scam was about feeding as many mortgages as possible to as many people as possible, however financially precarious they were, then bundling all those mortgages up and selling them to pension funds etc. as if they were rock-solid investments.

And I do mean “scam”, by the way.

This is all technical stuff – and rather reminiscent of the Latin American loan scandal of 1982/3. More important to us here – who will be to blame if the UK property market crashes, and how ill it happen? In the USA people just give back the keys because their loan is higher than the property price. I reckon here it might be more like Spain where you can surrender the property but still have to repay your loan.

I’m not sure who these right wingers are that you claim say no bank or banker did anything wrong. I can’t think of any well known right wing politicians, journalists, bloggers or commenters who would claim this.

Just on the examples of UK banking bad deeds there was plenty of right wing criticism of Sir Fred Goodwin’s acquisition of ABN-Amro, of Northern Rocks 130% mortgages and bankers paying themselves bonuses out of all comparison with genuine profits made or returns to shareholders.

Surely the way to deal with fraud is to prosecute, not to discuss regulation for the future. We need no regulations to deal with fraud. The law should clear, and if it is not clear, then it must be made clear.

The problem is that the fraud goes to the very top, and the chances of Inspector Fox bringing charges relating to the Poultry Massacre are slim.

Well, not quite exactly and totally, up to a point Lord Copper.

It was indeed a pretty scummy deal which is why they’re having to cough up that $285 million. Note that much of that is compensation to those who bought it, not just a fine.

However, what the NYT doesn’t point out is that no mortgages were harmed (or issued) in the creation of this deal. This was a CDO squared: that is, a CDO or bond offering made up of CDS (credit default swaps) on CDOs that already existed.

Because by this time Wall Street had already run out of mortgages to put into CDOs. Feb 2007 there just weren’t any new mortgages coming through as the housing market was already tanking.

“only government regulation was to blame for the crash. ”

Not the only cause of course but without the govt regulation stating that you had to hold little or no capital against securities rated AAA then this particular part of the mess wouldn’t have happened, no.

I don’t normally approve of the death penalty, but would be prepared to make an exception here.

I don’t think that they were being charged with breaking some moral code. The charges were that they violated Sections 17(a)(2) and (3) of the Securities Act of 1933, which is, umm, government regulation. Maybe something wrong with how the existing regulations were enforced?

The SEC complaint was not really about them selling the security and taking a short position against it. The complaint was that when they marketed the security to investors that they misled them by representing that the assets had been independently selected by a Credit Suisse Group AG collateral manager. When in fact, Citigroup Global Markets Inc had chosen half the assets. If they had disclosed that they had chosen half the assets they would have done nothing wrong. There is nearly always fine lines between legitimate hedging and outright short positions, which the media love to misrepresent.

Selling bad assets is about as immoral as football clubs selling their bad players. Would you like to buy our goalkeeper, he is a crap goalkeeper? Except football clubs do not market their duds like that because there is no asymmetrical information. Anyone buying should be able to ascertain for themselves that the goalkeeper is crap. Citigroup had an information advantage and profited from not disclosing their information advantage. Hence, they had to pay back the $160 million of improper fees and profits, plus $30 million of interest, and a $95 million fine. That is the system working as intended, yes?

@ Tim Worstall

“without the govt regulation stating that you had to hold little or no capital against securities rated AAA then this particular part of the mess wouldn’t have happened, no.”

Hang on a minute – are you saying this particular part of the mess would have been less likely to happen if the government had kept its nose out entirely (leaving it up to the banks how much capital they held against AAA securities), or if it had imposed stricter regulations about the level of capital they had to hold? If the former – how so? If the latter – surely that supports the case for more and tighter government regulation, not less?

“Hang on a minute – are you saying this particular part of the mess would have been less likely to happen if the government had kept its nose out entirely (leaving it up to the banks how much capital they held against AAA securities), or if it had imposed stricter regulations about the level of capital they had to hold? If the former – how so? If the latter – surely that supports the case for more and tighter government regulation, not less?”

You can run the argument any way your prejudices want to take you with it really.

But here, without prejudice, is an explanation of the problem.

Banks hold assets: that’s what they do. An asset is a loan they’ve made to someone else, a bond they’ve bought, that sort of thing (yes, a debt to the bank is an asset to the bank).

Banks also have liabilities: all the money they owe to other people. The deposits of savers for example.

Government say that, quite rightly, some assets are more risky than others. They’re more likely to go boom, taking the depositors (which is what the bank is using to buy the assets of course) money with them.

So, in order to reduce the risks of losing the depositors money government again insists that banks much have capital. That is, the bank’s (or the shareholders) own money which is the first to get lost if the assets go boom.

And, again, government insists that the risker the assets that the bank buys (lending to Nigernian about to inherit types is riskier than lending to IBM, lending a mortgage to a low income peep risker than to Bill Gates) then the more capital the bank must have to cushion any losses from boom going before the depositors start to lose their money.

Apologies for the simplicity of the above but I wanted to make it simple.

OK, now, government regulation actually said that if an asset is AAA (by two out of three ratings agencies) then the bank doesn’t have to hold any capital at all against it. Please note this wasn’t just about CDO is the US: this is the same problem that many EU banks now have with soveriegn debt. It’s (or was) AAA so they loaded up on it.

Because they didn’t have to put capital against such assets thus they could leverage up their capital many more times. Bank leverage did rise many times in recent years: because they could bascially, because holding AAA assets meant they could.

This is what actually called into being those AAA CDOs. A great hunger to have AAA assets which a bank didn’t need to hold capital against. There weren’t enough natural ones but perhaps they could be created?

Well, we know how that went. However, no, by no means the only problem, but one of them, was that AAA assets did not need capital held against them (or perhaps entirely minimal amounts).

This was a direct result of government regulation and this is where the prejudice starts. Now, as to the solution to this? There are several:

1) No regulation of capital requirements dependent upon AAA, AA, A etc.

2) Stricter regulation: stricter regulation of what? Leverage perhaps? Mebbe, although that is piling regulation on to solve something caused by hte last regulation and that way madness lies.

3) Different regulation? OK, as we’rte doing with Basel III, trying to rectify the mistakes of Basel II and I and …..well, yes, no one’s going to get regulation right first time around, are they? We all learn from our mistakes after all.

4) Letting a few banks go bust for being stupid boys? Mebbe: no one’s actually going to make that mistake again are they, if that happens.

Ultimately, if you want to argue that “better” or “different” or “stricter” regulation would have prevented disaster then you’ve got to identify exactly which and what regulation would have done so.

The usual “abolish bonuses” won’t do it. Given the regulatory capital allocations for AAA, what would have prevented it? Or, wqhat different regulatory captial allocations for AAA would have prevented it?

Not the only cause of course but without the govt regulation stating that you had to hold little or no capital against securities rated AAA then this particular part of the mess wouldn’t have happened, no.

How did that happen, Tim? Did the government wake up one day with a wild urge to slash the amount of capital banks had to hold or was there perhaps some reason why they allowed this? I don’t know, perhaps somebody else wanted it to happen, and might have pressed as hard as they could for it via donations and lobbying, maybe.

“Did the government wake up one day with a wild urge to slash the amount of capital banks had to hold or was there perhaps some reason why they allowed this?”

Well, actually, all the bank regulators got together and tried to work out a system by which they could regulate banks.

This lot:

http://en.wikipedia.org/wiki/Basel_Committee_on_Banking_Supervision

What we’ve had is the *result* of international bank regulation. May well have been bad regulation, we might well want to change it, but calling for “regulation of the banks” when it’s the intricacies of that very regulation that got us here makes just “regulation” a pretty weak call.

“I don’t know, perhaps somebody else wanted it to happen, and might have pressed as hard as they could for it via donations and lobbying, maybe.”

That’s also possible. And when you’ve got a solution for regulatory capture do be sure to let us all know. Various people have been trying to solve that one for some millennia, no sure fire answer as yet.

@ 11 FlyingRodent

The reason governments “allow” this is that they force banks to hold a certain amount of assets as tier 1 regulatory captial against their existing loans. What they want the banks to hold is their own government debt, supposedly the safest stuff out there and (until recently anyway) usually rated AAA.

Essentially the banks were forced to hold a lot of this paper or had to have massive cash reserves (which pays little interest). It also suited governments for banks to have to hold a lot of their debt.

Of course, if you then forced the banks to hold more capital against the AAA government debt it would then become uneconomical and they’d hold less, and more cash. You also get escalation issues as they have to hold more and more assets for regulatory reasons if made to hold a lot in reserve against AAA assets, which would kill lending….and again governments need banks to lend in a big way to keep debt financed consumer bubbles going.

The byproduct of all this though is that other AAA assets were catagorized and treated in exactly the same way as government debt. So the top AAA tranches of CDOs were cheap for banks to hold and typically gave better returns than government debt.

Even CDOs themselves aren’t that mysterious. All they do is bundle a huge number of mortgages together then sell them on in bite sized chunks easier to invest in. its really for pension funds etc to buy individual mortgages as they simply don’t have the expertise or time to look at each one, where banks do.

There is a failure rate, and the CDO gets split into tranches of increasing risk (and return). Basically, if you expect 10% of mortgages to go delinquent, the guy with the safest AAA part of the CDO isn’t going to get touched, as the holder of the BB part of the CDO is going to get hit first – but the investor knows roughly the risk, and gets a much higher interest on the BB part than the AAA part.

The problem came when all the mortgaegs fell over at basically the same time. CDOs were priced using historical models. Which of course had house prices going up year on year and very few mortgages failures. Perfectly sensible in its own way, with the large and fatal flaw of not really pricing in the chance of a black swan – the credit bubble bursting sending house prices down dramatically and recession causing many to lose their jobs.

A few people at a few banks did clearly put together CDOs full of absolute junk and sold investors pups. I think it really was a very few cases though where the intention was definately bad though – this case and the GS/Paulson case are the manin ones. The great majority of CDOs were put together honestly, normally at investors request rather than the banks origination (banks still have to sell them remember, so they don’t want too many on their books). Many of those still failed in the 08 crisis, for the reasons above, but the banks made an honest mistake in modelling and forecasting rather than any criminal act – remember they took huge losses on this stuff as well. Even now though, the great majority of CDOs created are still in existence and haven’t failed. You tend not to hear much about them though.

I think “government capture” might be the real issue here, Tim. The US financial industry and its government are composed of the same people, in large part, promiscuously flitting between Wall St. and Pennsylvania Avenue. You’re talking about government officials making policy for their once-and-future bosses – the robbers have effectively been policing themselves.

I mean, it wasn’t all plain sailing between 1930 and 1980 or so, but regulation worked for the most part during that era. What changed in the eighties that returned us to a situation that looks worryingly like 1929?

Folk who know me will know that I’m no genius, but I wouldn’t be surprised if the answer was “Governments started to give the finance industry most of the things the finance industry wanted”. Further, if we’re talking about how capital-to-asset ratios were set so low, I wouldn’t be surprised if several now-defunct banks had campaigned hard for it.

Whether all this is a problem of government or the finance industry, well, take your pick. All I’m saying is, you didn’t get quite so many planet-crushing financial disasters back in the days before the economics whizz-kids opened Pandora’s Box.

“What changed in the eighties that returned us to a situation that looks worryingly like 1929? ”

An honest answer?

Computers. I interned in a bank just as the IBM XT arrived in the UK. People were amazed, what, I can do that? Lotus 123 n’ stuff? Analyse the portfolio? Seriously?

Later in the 80s I was computer marketing and the prime market for the number crunching computers (about as powerful as your graphics card now but hey ho, they were £300,000 a pop at the time) were the arbitrage desks of banks. This was before the word “quant” had even been invented.

A huge, huge, amount of what is done in the financial markets today wasn’t done 30, 40 years ago, not because no one wanted to or because regulations said you couldn’t but because the technology to allow them to be done simply didn’t exist. You *couldn’t* physically do many things. But they were all things that people could see were simply developments of earlier techniques and if only we had the technology to enable us to do them.

Yes, this is a serious answer: if you want to return the financial markets to what they were 1945 to 1975 (say) then you’re going to have to uninvent the computer.

@10 – We could make it so that bailouts involve jail time and disqualification from holding positions in finance companies for the executives of the company who needed it.

And no, you simply need to dampen high volume computer-mediated trading. There was this proposal for a thing called a Tobin Tax, see…

Err, no Leon.

“And no, you simply need to dampen high volume computer-mediated trading”

Neither CDOs, one of the last problems, CDS, one of the last problems, or sovereign debt, the current problem, are traded very much at all, let along using any high volume trading.

Bond markets are illiquid outside a few very special markets.

It really would help if those proposing solutions had a clue as to how what they want to solve actually operates.

A transactions tax on something that doesn’t have many transactions doesn’t solve very much at all, does it?

Oh, right, so not some of the main problem areas. Well, explain the magical things you can do on computers which make the difference then!

“you can do on computers which make the difference then!”

Construct and price a CDO?

1. Cylux

They’re also keen to blame the people who took out mortgages that they couldn’t pay and would inevitably default on, since we know banks apparently lack the ability to say “no, sorry, I don’t think you’ll be able to keep up with the repayments”.

I don’t know anyone who does. I know a lot of people who blame Fannie Mae and Freddy Mac for backing those loans. Thus making them rock solid in effect. I know other people who blame the Feds for prohibiting the practice of Red Lining and bullying the Banks into lending to people they would not otherwise have lent to. With good reason as it happens.

Sunny,I can’t believe you are just writing about banks in this way.US investgn was publsed JAN THIS YR. This yr I set up my website to show the truth of what happened, I was so astonishd to find Democy had become so filled with greed that Philanthropy had been excluded. However,it was the rating agencys that were the real culprits. They gave out AAA security instead of FFF.The banks could not have sold the CDO investments without a 3A rating. Later the rating agencys gave 3As without establishing security, they just took banks word for it that they were highly secure. Their integraty is now below zero, discredited does not describe them. this is now old- hat. What we can do to restore the city is now the question, and this coalition is only going part way there.I have a plan and if you would like to be part of the solution pls join in.Richard Murphy is my tax expert (unofficial) he has an excellnt grip of the situation. Best regards Robin

@21 Robin

“richard murphy is my tax expert”

Oh dear.

Please read what i said ealier about CDOs. As I also said, the great majority of the AAA tranches were and still are. There were a few cases of what amounts to fraud, and should be punished accordingly, but most CDO failures were failures of modelling future risk, and whilst unfortunate and costly, were indeed honest – not least because the banks themselves were the ones who suffered most.

Calvin and Hobbes predicted something like this: http://andreasmoser.wordpress.com/2011/10/24/calvin-and-hobbes-explain-the-economy/