Was the Crash caused by people borrowing too much? No


11:01 am - November 28th 2011

by Sunny Hundal    


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There’s a simple lie about the financial crisis of 2008 that is still frequently wheeled out by the Westminster commentariat and advocates for the City.

The lie is that the crash happened because people borrowed too much when they couldn’t afford it.

Last week, after Grant Shapps MP wheeled out a doomed plan to kick-start growth by building a few houses, the editor of City AM Allister Heath thundered in his free-sheet:

Have we all forgotten the sub-prime crisis in the US? Over there, politicians concerned that many poor people couldn’t afford homes forced and bribed lenders to lower credit standards and extend mortgages to those who couldn’t afford them. In the short-term, this boosted home-ownership; but it all ended in tears.

But to put it bluntly, this is simplistic rubbish. But I’m not surprised the editor of a City-lobby-group-masquerading-as-a-freesheet would say that.

There are three main reasons why the massive crash happened and all are interrelated.

First: Let’s assume a bank ends up lending a ton of money to high-risk customers (sub-prime mortgages). It ends up with a tranche of high-risk debt, which should be labelled as such by its own risk management department. Furthermore, a prudent bank would insure against the risk of the investment failing, usually by buying a derivative. Such hedges are routine in the industry.

Except that isn’t what happened, and why this narrative is fallacious. What happened was that banks misled investors about the riskiness of those assets, and borrowed even more money by using them as collaterel. When the music stopped they all found out that there weren’t any chairs left.

The banks bundled high-risk sub-prime assets with low risks assets and sold them to each other as low-risk assets.

There are instances of US banks aggressively roping in customers into complex mortgages ‘more expensive than they appeared‘. Deutsche Bank is accused of failing to adequately check borrowers’ finances before issuing loans.

Goldman Sachs sold mortgaged-backed assets to big investors who didn’t know the riskiness of those assets. They also weren’t told it knew other Sachs customers were heavily betting those risky assets would fail. This why they were fined $550m.

Second, they borrowed massive amounts using those risky assets as collateral.

There’s little doubt that mortgage defaults by some bank customers started the ball rolling, though most were private lenders not govt backed banks.

The sums they needed to cover themselves after the crash were huge. Bloomberg reveals today that in one day they had to borrow $1.2 trillion just to survive. And that’s still not all their outstanding debt.

All that did not come from people borrowing too much from banks, but banks borrowing too much from each other.

Thirty years ago, financial markets fuelled by the junk-bonds boom followed a similar trajectory. But at least you knew they were ‘junk’.

Third part: banks had to be bailed because they were too inter-connected and would take everyone down with them. After Lehman Bros was allowed to collapse, the US Federal Reserve didn’t want to take any chances.

When AIG – the world’s biggest insurer – was about to go bust, Goldman Sachs pleaded with the Fed to bail them out because they were exposed to $20bn of losses.

If they weren’t ‘too big to fail’ and so interconnected to each other, the banks could have been allowed to fail. But taxpayers were forced to bail them out thanks to the way the banking industry has consolidated.

We rarely hear from politicians, City bankers or commentators about the need to stop financial institutions trading in such a way again or breaking them up so they don’t become ‘too big to fail’.

Instead, they take the easy route of blaming ordinary people for their expensive mistakes. Don’t fall for this lie.

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About the author
Sunny Hundal is editor of LC. Also: on Twitter, at Pickled Politics and Guardian CIF.
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Reader comments


“We rarely hear from politicians, City bankers or commentators about the need to stop financial institutions trading in such a way again or breaking them up so they don’t become ‘too big to fail’.”

Rubbish. If there is one area of consensus about the whole crisis it is that banks being too big to fail was at the heart of the problem.

You hear this all the time from commentators, such as Allister Heath in City AM (who you were so rude about).

The whole Vickers Commission was about dealing with the too big to fail problem.

Osborne has said it countless times.

Talk to most bankers and they say that the bail outs have given capitalism a bad name. Businesses that take on too big risks and fail need to go bust, not be bailed out by the tax payer.

Interesting but you systematically fail to address the govt. role in this. A great deal of the momentum for the crash came from US.

The US government created the Federal Home Loan Mortgage Corp (Freddie Mac) and Federal National Mortgage Association (Fannie Mae) in the 1970’s and 1930’s respectively. These corporation were set up as government sponsored companies for the provision of mortgages. They had easy access to vast quantities of money (being state backed) but more importantly they could borrow money at peanut rates. Why? Because they were backed by the US government. The FM’s quickly became the biggest mortgage lenders in America dishing out billions in loans for people all over country. For years this continued, business was good and America was a happy place.

All was not well though. In the early 90’s regulations began to change. The FM’s before this time had issued mortgages to those who could realistically afford them. They were operated as a business, and were run for profit. In the early 90’s however the FM’s took on a different role. A role that was to prove disastrous in the long run. During the period of double breasted suits and giant cell phones the Clinton administration started to put pressure on the FM’s to increase mortgage lending to lower income families. Democrat policy started to kick in and the policy that all American’s should own their own home was put into action. Over a number of years the government pressured the FM’s to start issuing mortgages to all who approached them.

A decisive move came in the form of the Federal Housing Administration cutting deposits. Easing the pressure on the lower class having to find ready cash. Another decisive decision came when Clinton through the actions of Andrew Cuomo introduced increased quotas on home lending drastically. By the year 2000 Mr. Cuomo had increased the affordable home lending quota to 50%. This meant that 50% of all of the FM’s lending had to be made to lower income families. Just a year previously, in 1999, lending by the FM’s under these quotas had hit $1 trillion. That was a trillion worth of mortgage debt sitting in what could only be described as the high risk category.

Another nail in the coffin came in 2003 when Bush signed into law the American Dream Downpayment Act. An act designed to pump $200m a year into the lower income mortgage class. A shot of adrenaline to help Bush’s rating with the lower income class. All of this meant that American’s no matter how much they earned, no matter how they lived could start buying houses.

Banks naturally followed. Banks followed because the FM’s were the largest mortgage lenders on the market. Big money and big products produced interest from parties all over the world. A government backed organisation was issuing massive debt packages enabled by the social policy of the US. Sure, banks the world over made mistakes. They played in these products without realising what they were, and why would they look? They were earning good money from a state backed organisation. High street banks followed, and the virus that was sub-prime quickly spread.

What is the result? the interaction between financial institutions and government needs to stop. Mortgage crisis, bailouts, massive debts caused by sub prime, in essence the major proponent of the crash would have been avoided had the govt. not been involved with banks. By all means provide a frame work in which financial institutions may operate thorugh law, but don’t believe that bailouts and the endemic connection between govts. and financial institutions is a good thing. It poisons the economy.

There is absolutely nothing in your account which is inconsistent with what Alistair Heath is quoted as saying. The core problem was moral hazard: privatised benefits, socialised losses. But while the system seemed to be working, Government’s were happy to exploit it and push debt ever higher in order to make it appear that everyone was prosperous. Osborne is doing the same now, by trying to re-inflate the housing market with Government-backed credit.

I don’t think that many (any?) people are claiming that high debt itself was the cause of the crash. Everyone understands that it was the lack of visibility as to assets/liabilities when the crash did occur that caused the debt markets to seize up.

Bad debt was the problem – but was also a manageable one.

A problem that is being resolved with the setting up of clearing houses for these forms of debt instruments so that when the next crash occurs it will not be exaggerated by this issue.

However, when the crash occurred, the impact on the economy was such that it caused the effect of high debt held by governments to become an issue.

If you had believed the unbelievable and that Gordon Brown had really abolished boom and bust — while at the same time building up one of the biggest housing booms this country has ever seen — then you can blame the banks for everything.

Most people are fortunately more sensible, and accept that you cannot abolish booms or busts — that is an impossibility.

So, when the economy is doing well, do you pay down the debt (in cash terms, not % signs), or do you borrow more?

Most sensible people would say pay down the debt when times are good, and if times carry on being good, you can divert the money saved in interest payments to your chosen political cause (more spending or lower taxes).

…but if a recession occurs, at least you have the flexibility to borrow without paying a high-debt premium at a time you can least afford it.

High debt didn’t cause the crisis, but it made the crisis far worse when it hit.

Banks certainly deserve their share of criticism for their role in the sub prime crisis.

However, they don’t deserve 100% of the blame for passing off risky mortgages as AAA products, for in many instances they were lied to by mortgage companies and ordinary people.

Everyone is aware of liar mortgages where people lied about their job status and income.

There are, however, issues about too much easy credit rather than proper wages that the left should be addressing.

This article is absollute rubbish. Sunny – I wish you had actually worked in finance or knew how such things actually worked in real life before spouting rubbish like the above.

This crisis started life in subprime borrowing. Subprime itself began in 94 with Clinton’s CRA act, forcing banks to lend more to the poor and minorites. It didn’t really take off though until after 2001 when interest rates came down after the dotcom bubble (Greenspan effectively did what Krugman was campainging for, to inflate a housing bubble).

With low teaser rates and house prices rising even subprime mortgages looked pretty good as investements, as the increased value of the house made remortgaging easy. Even a lot of the banks believed that these mortgages and the CDOs built on the back of them were good right until the end. Why else do you think so many were holding them.

Where Sunny goes completely wrong is what caused the crash. In short, it was too much unnaffordable subprime debt. When house prices stopped going up, and supply was starting to get to large, remortgaging became near impoosible and repayments went the same way. This was compounded in 2007 when the bulk of the higher rate resets started to hit.

Let me say that again just to be clear. People borrowed too much.

Yes, a lot of banks were lax, made mistakes and a couple acted in an improper if not illegal manner.

Sunny is wrong when he starts talking about CDOs though. They increased the speed and concentration of the problem but they really only refelct the value of the underlying mortgages. The real problem the CDO caused was that it enabled the packaging of mortgages. Where before mortgages were not easy to invest in, because of their individual nature, now you had handy bite sized chunks. What this did was allow even more lending to the mortgage market as it was easier to sell the existing mortages to other investors.

Again, the problem was increasing debt burdens.

Sunny is oonce again wrong when he talks about collateral and bailouts. CDO tranches were almost never used as collateral because they are not liquid. In practice only cash and some liquid government bonds are. The bailouts he talks about of 1.2 trillion, were when short term liquidity dried up in the money markets and governments had to lend short term cash to banks. This has almost totally been paid back.

The big bailouts were for Fannie and Freddie, the big US government backed mortgage lenders and AIG, the insurer. If that doesn’t give you a hint where the problem lay, nothing will.

I think Sunny willfully misrepresents what happened here for various reasons. Debt crisis don’t fit with his view that spending should always be going up and any kind of austerity is a bad thing. Only last week he was busy trying to tell us the Eurozone crisis wasn’t a soveriegn debt crisis at all. Nor does it fit with his narrative that it is all the evil capitalists bankerrs fault, and that the people who took thoser mortgages out should also shoulder their share of the b lame.

@shinei67
You say ‘Businesses that take on too big risks and fail need to go bust, not be bailed out by the tax payer.’
Surely you would include banks as businesses, the banks took on the risks when they made the shoddy loans, the banks deserve to go bust. You also talk of ‘liar mortgages where people lied about their job status and income.’ The charge here is that the lenders were wilfully myopic in doling out sub prime loans without checking facts.

Yea right, and we all know that business men do EVERYTHING they are told to by politicians. HO HO HO

These poor little bankers had no option but to lend to strawberry pickers in California, and hookers in Las Vegas. We are constantly told by the free market morons that people at the top must be paid squillions of $s because their expertise and genius status is so rare that they will walk away if you don’t indulge them.

This crises lays bare the bankruptcy of the right wing business model in all it’s glory. Overpaid, overated cretins who had not the intelligence, expertise or morality to stop it. It is no wonder they want to try to blame someone else for it.

The lie that silly little people was widespread within the city/rightwing circles, where extremists consider even a mortgage as debt (it is, but you know what I mean). Go to the Christian Left’s facebook page, and check out the cartoon, which I am unable to link to here (and no I am not a Christian left member/supporter, but it was shared by a friend before you comment). Poor people in the USA were led into mortgages they couldn’t afford, and they didn’t care.

@Hengist

1) Yes, of course banks should have gone bust too. I think the government needs to safeguard the bank depositors but the bank’s bond holders and and equity investors need to lose all their investment. Would make bank investors and bankers themselves more risk averse if they knew they weren’t going to get bailed out by the government.

2) Mortgage lenders, primarily in the USA but also the UK, allowed people to lie on their mortgage forms. No one checked their wage slips (or they printed off false pay slips from websites) or their employment history.

A photocopier salesman on commission could annualise his best month and claim that was his typical annual salary.

I don’t think this was myopic so much as criminal fraud. And I’m surprised more prosecutions haven’t taken place.

Because once the mortgage was made (Guy on £40k getting £150k mortgage) the ratings agencies than rated mortgages like that as pretty safe and investment bankers then traded mortgages like that assuming it was a pretty safe mortgage.

All very well saying the inv bankers should have checked, but when I buy a kettle I assume it has been tested correctly that it isn’t dangerous.

So far as I can see the US banks were not forced to lend recklessly. The CRA specifically provides against that. Banks were supposed to assess risk without discrimination: that is not the same thing as not assessing it at all. I find it quite amazing the lengths people will go to to blame government

13. Limiting Factor

“This article is absollute rubbish. Sunny – I wish you had actually worked in finance or knew how such things actually worked in real life before spouting rubbish like the above.”

Yes, yes, yes, everyone knows that its these disabled claimants and dole signers and public sector workers with their globe-trotting, celeb-shoulder-rubbing, luxurious lifestyles who are to blame. Taking all those stupid stupid loans to buy flat screens from Argos, or book holidays to Gstaad, or get in bags of actual food – talk about profligacy. The real victims here are those heroes of finance, those olympic exemplars of fiscal magnificence, the bankers and investors and commodity speculation techicians, all princes among men, each and every one, men that I am proud to call friend! (sob) – will no-one stand up for them??

(brought to you by Satirical Postings Unlimited. Yr welcome)

14. Luis Enrique

I don’t know why people apparently find it so difficult to accept that the crisis had multiple causes.

It is wrong to say that the crash happened because of “irresponsible borrowing”. It is also wrong to say that irresponsible borrowing (which is just another way of saying irresponsible lending) had nothing to do with it.

This is why the idea of trying to kickstart the housing market by handing out daft mortgages is foolish. See Tim Hartford Back to the Glory Days of Northern Rock

Lots of people like to cite Minksy’s idea of Ponzi finance – deals that will collapse unless asset prices keep rising. Most would say mortgage lending took on that characteristic at the height of bubble – lenders and borrowers can share the blame (up to you how you apportion it) .

In principle, there need be no problem with banks making risky loans, so long as they are recognized as such and the system is prepared and can withstand those loans not being repaid. So Sunny’s point about the mislabelling of risk is key.

Some small points – when you securitize loans into different tranches, that needn’t mean you are “bundling high risk and low risk loans”. You could take 100 loans of the same quality – all sub-prime – and split them into 10 tranches, so you say when up to 10 loans fail, the first tranche holder takes the hit, when up to 20 loans fail, the second does etc. and so the holder of the 10th tranche only loses if more than 90 of the loans fail. That tranche may justly be regarded as very safe, even if all the loans are low quality.

You run into problems when you underestimate the probabilities of a large number of loans defaulting at the same time and/or you have been misled about the quality of the underlying loans (those fraudulent mortgage applications you mention)

Furthermore, if the problem was that bankers lied about risks when they sold this stuff to investors, we wouldn’t have had the crisis as we did – investors would have lost money, but the banks would have been okay, because they’d have sold the rubbish. As it happens, the banks kept a bunch of this stuff themselves – they misled themselves. In many cases, I don’t think they understood what they were doing. See Causes of the Crisis available here – (all Acharya’s work is worth reading)

Lastly, “prudent banks” did insure themselves against all this mortgage backed stuff going pear shaped, but it took the form of end-of-the-world insurance – when it came to it, the insurers couldn’t afford to pay out, that’s why AIG went under. So banks that thought they were safe, were not.

@2 Steve

If the problem was borrowing pushed by Freddie Mac etc. why is that there was a bigger boom and bust in the commercial property sector compared to the residential property sector?

That doesn’t make sense based on your analysis since Freddie Mac etc. is specifically excluded from the commercial property sector.

@7 Sunny. The use of CDOs etc. was used to disguise the risk whilst keeping the financial products being offloaded given a AAA credit risk. If they couldn’t hide the risk from the investors the money wouldn’t have been available for lending.

There appears to be no other purpose for complex financial vehicles other than to make financial transactions opaque, providing opportunities for those on the inside and offloading risk onto those with less inside information.

Kevin

17. Luis Enrique

[sorry - sloppy phrasing - I should have written "if the problem was only that bankers lied about risk when selling ..." - obv. that did happen, I'm just saying that was the half of it]

18. Luis Enrique

for those who are interested, two good reads:

1. How to stop the bogus bonuses Tim Hartford (accessible)
2. Manufacturing Tail Risk Acharya (heavier going, but still free of maths)

For an alternative analysis of house-price bubbles, try this in The Economist of 26 November:
http://www.economist.com/node/21540231

@Oxford Kevin

Sorry but I think you misunderstand what Freddie Mac and Fannie Mae are. They are not Mortgage Providers in the sense that you can run along and get a Freddie Mac mortgage. They are whole salers of mortgage debt underwritten by the govt. This is then sold to institutions as “securitised debt”. The effect was that as soon as one domino fell it drove many other sectors down.

Try: “Goldman Sachs has moved to justify spending millions of dollars short-selling some of the financial products it made and sold to clients”
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/6907640/Goldman-Sachs-denies-betting-against-its-clients-on-CDOs.html

22. Charles Wheeler

The housing market was one giant Minsky-style asset bubble which morphed into a giant Ponzi scheme – as all asset bubbles must. The easing of credit regulations saw borrowing levels increase, feeding into asset prices which fuelled more borrowing, higher prices, and repeat until cooked. Sub-prime wasn’t the cause of the crisis, it was the inevitable consequence of a saturated market. When you need more borrowers to come into the market to keep the bubble inflated, and prime candidates all have loans, where do you go but NINJAs. In the US 80% of sub-prime went into remortgaging as existing borrowers tried to keep on the hamster-wheel – this was the end-game of a long-term process. The massaging of risk by the rating agencies, and through the fictional insurance of Credit Default Swaps which turn out not to have been worth the paper they were written on simply added fuel to the fire. As Steve Keen has demonstrated, the housing market has little connection to changes in population, planning laws, etc. but exhibits a strong correlation with the creation of debt.

In any case: let’s say you’re working in London; there’s little social housing, and you’re not likely to get on the list anyway; a one-bedroom ex-council flat in Wandsworth costs £1k per month to rent. The only other option is to take out a mortgage you pray you’ll be able to keep affording. That’s some ‘choice’.

23. Luis Enrique

That’s interesting Bob – the argument is that if they were shorting this mortgage backed stuff because they knew it was rubbish, why didn’t they have long positions too? In fact they were net long, which is why they made losses when it all went pear shaped, and the shorts were just hedges. Does that explanation add up? Perhaps there’s some slight of hand – they were net long on some assets, but net short on others (where they were screwing their clients).

@Tyler,

The problem is, as even Niall Fergusson points out, promoting home ownership amongst lower income households is an excellent policy. Not only is it politically popular accross the spectrum (except the far left) due to the fact it feeds into the aspirations of those people, but it has several postive social effects as well. It increases the sense of ownership within communities, increases pride in the appearance of areas and is associated with lower crime rates, increased school,attainment amongst the children of the new home owners and increased employment. In other words It has postive externalities, and it’s therefore perfectly fine to subsidise it.

The problem comes from the way it was financed in the US, with salesmen given serious financial incentives to lie, banks essentially misreprenting the risks of default due a combination of both miscalculation of the risks of collective default and outright fraud, and the constant slicing of products to create more super products in the industry based on this house of cards.

But the above certainly does not mean throwing the baby of home ownership out with the bathwater of rotten finance.

Also, if we want to talk about debt generally, Peston was reporting last week that a substantial number of private equity deals are due for re-financing in 2012. If that proves to be expensive, then leveraged buyouts are going to make buying plasma TVs on credit cards look like good investments.

Gosh, Sunny doing finance is like that Dr. Johnson thing about women preachers. Not surprise at how well it’s done but surprise at it being done at all.

“There are three main reasons why the massive crash happened and all are interrelated.”

You fail to note the ultimate cause. There was a housing bubble which then burst. $7 trillion of wealth that the US thought they had they found out they did not have. This will cause a recession whatever else happens afterwards. See Dean Baker on this.

Why there was a housing bubble is another matter. And no, it wasn’t banks which caused the bubble: they got caught up in it, pandered to it and ultimately suffered from it but they didn’t cause it.

“Let’s assume a bank ends up lending a ton of money to high-risk customers (sub-prime mortgages). It ends up with a tranche of high-risk debt, which should be labelled as such by its own risk management department. Furthermore, a prudent bank would insure against the risk of the investment failing, usually by buying a derivative. Such hedges are routine in the industry.”

No, such hedges are not routine in the mortgage industry. A hedge against a move in interest rates (most US mortgages are fixed rate) oh yes, that’s certainly true. But no, hedges against credit risk are not normal in the US moprtgage industry. In fact, that’s something that was very new: it’s exactly what AIG was providing with their CDS and precisely because it was all very new people screwed it up.

And there isn’t actually a hedge against delcining house prices: which is exactly whty Robert Shiller has pointed out that we ought to create a speculative, derivatives based market to enable such hedges.

Finally, a tranche is not a collection of debt (high risk or not). A tranche is, by definition, some slice of a pool of debt. If you add a group of mortgages together, then slivce them up into high risk (equity tranche) medium )A or AA tranche) and low risk (AAA tranche) then you can have tranches. But if you don’t have the pooling and the slicing you cannot have the tranche.

And do note: when creating a tranche you do not allocate high risk mortgages to the high risk tranche, low risk to the low risk. You allocate the high risks of all of the pool of mortgages to the high risk tranche. The medium risks of all of the mortgages to the medium risk tranche etc.

“What happened was that banks misled investors about the riskiness of those assets,”

No, the banks also got the riskiness wrong. There had never before been a general decline in house values across the USA. They thought there wouldn’t be. We can tell that ths is what they thought because the banks themselves happily held on to and even bought the AAA tranches themselves.

“The banks bundled high-risk sub-prime assets with low risks assets and sold them to each other as low-risk assets. ”

Sorta but no, not really. They were just using the law of large numbers. Imagine you’re issuing sub prime mortgages (for whatever reason, you’re a greedy bastard, the government tells you to, you think it might be a good idea that poor people can buy houses). You know that the default and foreclosure rate is 10% on these loans (no, just imagine). If you only issue one loan then you’ve a 90% chance of getting your money back and a 10% of losing it all (well, sorta, disregard recovery from the foreclosure). If you isse 100, then, well, you actually think that you might lose on 10% of those loans. But if you charge a slightly higher interest rate on all 100 then you’ll come out OK. But 100, hmm, maybe it will be a 20% or a 2% default rate….there is variance around your 10% rate after all. Well, if you issue 2,000 mortgages, then you should be able to rely upon your statistics.

Just like when you poll a population you only need to ask 2,000 people. You get plus or minus 3% accuracy, don’t you?

What you’re actually doing with these pools of motrgages is saying that we know each one is risky, risky in an unpredictable way. But have a big pile of them and they’re risky in a predictable way. And we can also slice that risk, so that Bob over there takes the first 20% of defaults, Jim takes the next 40% and I’ll keep the last 40%. Bob’s got the equity tranche, and gets the highest interest rate and risk. I’ve the least risk and the lowest interest rate.

It just isn’t mix low risk and high risk and we get low risk. It’s have a pile of high risk and allocate the risks to make low and high risk portions or the pile.

This is all just fine and is how securitisation works. It’s done with student loans, credit card receivables, it’s how the proposed eurozone eurobonds will work. It’s just fine unless….unless….you’ve made a mistake like, well, actually, all US house prices can go down at the same time.

“Goldman Sachs sold mortgaged-backed assets to big investors who didn’t know the riskiness of those assets. They also weren’t told it knew other Sachs customers were heavily betting those risky assets would fail.”

That one isn’t actually true. Abacus (because Abacus is what you’re talking about) was not a CDO. It was a CDO squared. It was made up of CDS on CDOs. It was an entirely synthetic transaction: a derivative if you like. As such, it isn’t possible for the buyers not to know that someone else was betting against it. Simply impossible: for a CDO squared can only exist if someone is betting against it.

As to why GS settled, that’s easy. The settlement includes immunity from prosecution from in all other mortgage CDO related cases. That’s what the SEC is offering and that’s why settlements are being made.

“not govt backed banks”

There were no Govt backed banks. Fannie and Freddie are not banks nor do they issue mortgages. They guarantee mortgages that have been issued according to certain criteria, then bundle them and sell them. Create CDOs in short.

As to too big to fail etc, yes, but we’re all complaining about the same damn things.

26. Luis Enrique

Tim

“You fail to note the ultimate cause. There was a housing bubble which then burst. $7 trillion of wealth that the US thought they had they found out they did not have. This will cause a recession ….”

if you combine two things, 1. a housing bubble and 2. a financial system that has managed to get itself into such a state that a bursting bubble will destroy it, how can you say which one is the “ultimate cause”

we didn’t just get a recession because house prices fell, we got a depression because the financial system nearly annihilated itself and is still teetering on the brink 4 years later, and the “ultimate cause” of that lies within the structure of financial sector, imho.

see Why does the economy fall to pieces after a financial crises

and on the continuing shit storm in the financial sector banks scramble to plug capital deficits from today’s FT

Rubbish. If there is one area of consensus about the whole crisis it is that banks being too big to fail was at the heart of the problem.

Really? What’s being done about that then?

Steve – I didn’t actually. I’ve linked to a report showing most mortgage lending was NOT backed by Freddie Mac and Fannie Mae. That blows out of the water the theory that this happened because of govt intervention. Nice try tho!

However, they don’t deserve 100% of the blame for passing off risky mortgages as AAA products, for in many instances they were lied to by mortgage companies and ordinary people.

Rubbish – they knew exactly what mortgages they were selling, and to who. They have risk management ppl for that.

Tyler – as usual your gibberish is hard to fathom so I’ll leave you to it.

Tim Worstall: Why there was a housing bubble is another matter. And no, it wasn’t banks which caused the bubble: they got caught up in it, pandered to it and ultimately suffered from it but they didn’t cause it.

Oh yeah – they just got “caught up in it” – nothing to do with their lending or bundling of assets as CDOs.

“Oh yeah – they just got “caught up in it” – nothing to do with their lending or bundling of assets as CDOs.”

Go back to the Ritholtz post that you link to. Note that the US bubble started in the late 90s. Private sector securitisations bubbled from 2003 onwards.

You’re the guy pointing to this evidence so you had better understand it. The bubble started, the bubble was well underway, before the private CDO market expanded.

Unless you want to start talking funny about time machines you can’t blame the priovate sector CDOs for the housing bubble itself. Make it worse, sure, make the crash worse, right with you. But they were not the cause.

@21 Luis: “Perhaps there’s some slight of hand – they were net long on some assets, but net short on others (where they were screwing their clients).”

That’s was the likely situation. As I recall, the GS narrative was that they were simply responding to buyer demand for property secured derivatives which GS duly supplied to market-informed clients who could be reasonably presumed to know what they were doing. GS then shorted those same derivatives without telling the clients – which they were under no obligation to do.

30. Chaise Guevara

It’s not a case of finding one cause: some people borrowed beyond their means (and some lied to do so), while the banks were happy to let them do so, and engaged in dodgy practice around sub-par lending.

I agree that banks are far more guilty than consumers. They were in a position of far more authority; less financially literate consumers may have assumed that a bank would not approve them for a loan with a high default risk; and many of those subpar loans will have been taken out by pretty desperate people, which is mitigating circumstances. But it would do some good for baby boomers to consider the part their generation played in creating this mess, considering that the government is now trying to divert as much of the pain as possible onto their children.

“if you combine two things, 1. a housing bubble and 2. a financial system that has managed to get itself into such a state that a bursting bubble will destroy it, how can you say which one is the “ultimate cause””

This is Dean Baker’s point which is why I pointed to him.

Whatever the state of the financial markets a housing crash of that size would have led to a recession. That the financial markets also fell over is another problem. It would be better if we didn’t have two problems to deal with, butwe do unfortunately.

32. Luis Enrique

Tim,

sure, if the financial sector hadn’t tied itself in knots, chances are would have had a recession anyways, but I thought we were talking about the situation we find ourselves in now – full blown rolling global financial crises and depression – it’s daft to say the “ultimate cause” of that was the housing bubble. More sense to say dysfunctional housing ultimate cause, housing bubble proximate.

on that note, if you look at link to economist article Bob provides, US house prices might have started moving upwards in 90s, but it all went crazy post 2003 so I’m not sure it makes sense to say post-2003 financial shenanigans merely made something that was already happen a bit worse – a lot worse, more like.

@25: “Unless you want to start talking funny about time machines you can’t blame the priovate sector CDOs for the housing bubble itself. Make it worse, sure, make the crash worse, right with you. But they were not the cause.”

That’s higly arguable. Consider the hypothesis that some investment bank – which can be named – realised that a lot of easy, high loan-to-value mortgages had been sold on promotional terms to households which were highly likely to come to grief making repayments on various contingencies – such as rising interest rates, employment difficulties or when the terms of the promotions expired. CDOs were a marketing device for selling on bundles of sub-prime mortgages. Warren Buffett went public in 2003 on his concerns about the lack of transparency with some derivatives:

“The rapidly growing trade in derivatives poses a ‘mega-catastrophic risk’ for the economy and most shares are still ‘too expensive’, legendary investor Warren Buffett has warned.”
http://news.bbc.co.uk/1/hi/business/2817995.stm

For a detailed account of the inception of CDOs, try Gillian Tett: Fool’s Gold (Little Brown 2009)

@Sunny Hundal

“Rubbish – they knew exactly what mortgages they were selling, and to who. They have risk management ppl for that.”

I’m afraid this is just factually inaccurate.

The Fort Lauderdale Mortgage Company offers a mortgage to Mr Charlie Brown. Together they exaggerate/lie about Mr Brown’s income. Mr Brown gets his mortgage and the mortgage adviser gets his $1000 bonus for selling a mortgage. Hence it is in their interest to lie.

That mortgage is then sold to Citibank.

Citibank looks at the mortgages they are buying in Florida. Mr Brown, the official mortgage records show, has worked for the same firm for ten years and gets paid $80,000. Thus a mortgage of $200,000 looks an AAA risk.

How are Citibank expected to know that Mr Brown has actually been in five different jobs over the last ten years and only gets paid $40,000.

Possibly naive of them to trust the Fort Lauderdale Mortgage Company but also reasonable of them to not know that fraud on a vast scale is being conducted.

I see our free market flat earthers are spinning like tops today. Their entire model, Zero regulation, huge salaries and bonuses, and risk takers must be treated like gods because if they fail, they go bust ………..has been shown to be a crock of shit.

Yesterday our pip squeak chancellor announced that the state(you know that thing the flat earthers tell us can’t do anything) will become the bank of last resort for business loans because their beloved free market model won’t lend. You can’t make this stuff up. It is priceless.

36. Luis Enrique

I meant of course “More sense to say dysfunctional finance ultimate cause, housing bubble proximate cause.”

37. Luis Enrique

more sloppy phrasing – @14 I should have written . “You could take 100 loans of the same quality – all sub-prime – and split exposure to defaults in that pool into 10 tranches”

The housing market would be very strange if the availability and terms of mortgages had no influence on the prevailing balance between the demand for houses for owner-occupation or to let and the supply of houses coming on to the market.

Most of the houses sold and bought in a year are second-hand houses, not new houses. I suggest the analysis in The Economist linked @19 above is worth reading. It shows that many countries were afflicted by house-price bubbles, including America, so it seems unlikely that all or most have bubbles caused by the same problems that Britain is supposed to have from planning restrictions on land for new housing development.

I recommend this from the Royal Town Planning Institute on: Planning Myth – planning forces up house prices
http://www.rtpi.org.uk/item/4798

The RTPI is saying, with links to supporting analysis from other sources, that constraints on the availability of land for housing development were not the main factor pushing up prices in the house-price bubble in Britain – the big house construction companies had several years of supply in hand.

@Sunny Hundal

I dont think you actually understand what the FM’s do.

“I’ve linked to a report showing most mortgage lending was NOT backed by Freddie Mac and Fannie Mae.”

Mortgage lending was never provided by the FM’s. They were wholesale producers of securitised debt. Meaning they packaged mortgage debt and sold it to anyone who would buy. (it was bought worldwide) Of course they did not back ALL mortgages, but when you hold 5tn worth of mortgages you are a massive market force.

I strongly suspect with an article like this you have never actually studied either the subject and/or economics. Strongly suggest you do, might enlighten your thinking.

@ sunny

Like I said, if you actually had any clue aboiut finance you would find my explanation pretty simple. Asit is, because you have no real clue what you are talking about you have to resort once again to ignoring criticism, brushing it off or abuse.

Let’s take another couple of gems from your article shall we?

“Banks borrowed even more money using them as collateral”

Nope. CDO tranches can’t easily be uised. The only exception to that general rule was TARP and that happened AFTER the crash, so not a cause of the bubble forming.

“That in one day they had to borrow 1.2 trillion to survive”

1.2 trillion of short term loans, probably as short as a day long, because money markets had stopped working because of credit/trust issues. Had money markets been working normally 1.2 trillion is not really that extraordinary for overnight funding, but would be provided from private sources, not the Fed’s deposit window.

“All that did not come from people borrowing too much from banks, but banks borrowing too much from each other”

And there we have, in one sentence, a guide to Sunny’s knowledge of finacial markets. Tell me Sunny, where did all those trillions of debt come from? Banks don’t really lend to each other except in short term money markets. Last time I checked it wasn’t banks buying housing either…that’s a liability for them, not an asset.

I’m not saying banks made no mistakes – most did – but most banks also actually believed in what they were doing and were holding large amounts of these mortgage assets.

The real cause of this crisis though were low interest rates, easy availability of credit, regulation promoting borrowing and an asset class mania. The result, people borrowed way too much, both public and private debt. As soon as repayments became a problem, the asset bubble was burst as foreclosures flooded the market, drving a stalling housing market into a dive.

That’s the real problem with borrowing. There really is only so much you can borrow before the interest payments wipe you out, even ignoring capital payments. With individuals it happens quickly, governments slowly, but it still happens.

@40

If yo uwon’t take Sunny’s word for it, how about (Nobel Economics Prize-winning) economist Paul Krugman?

http://krugman.blogs.nytimes.com/2011/07/14/fannie-freddie-phooey/

@ planeshift

I’m all for homeownership for many reasons including ones you gibe.

BUT

If you agree with that, and the idea of mortgage/debt financing you also have to agree to the risks. The underlying asset is only worth what people will pay for it…and people (and their governments) are greedy and they lie. If I was being nice youy could call it “overly optimistic”. Why wait to get your house/car/tv/holiday when you can get a mortgage/loan/credit card?

44. Frances_coppola

Sunny,

It would help if you appreciated the fundamental differences between the way the US housing market works and the way the UK one does. We are used to a simple model, where people get a mortgage from a lender and that lender keeps the loan on their books. In the run up to the financial crisis two banks – Northern Rock and HBOS – were securitizing their loans and selling them on into the wholesale market with the help of investment banks. But even that is very different from the US market, where the majority of mortgage loans are sold on and the originators keep servicing rights for which they are paid fees. The problem is that when the loans were sold on, important information essential to assess the risk of the loans was not always passed on as well, so securitizers did not properly understand the risk profile of the loan pools they are taking on and therefore mispriced the resulting instruments.

Also, US borrowers are not used to floating rate loans (or fixed plus reset), unlike UK borrowers: the standard in the US is a 30-year fixed rate mortgage. The GSEs act on behalf of the federal government to buy up loans from the smaller originators, at least partly to reduce the chances of those originators going bust if they had to finance 30-year fixed-rate loans themselves in a rising interest rate environment. A considerable part of the sub-prime problem was that people were sold variable rate mortgages – with a low fixed start rate – that they did not understand. When the teaser rates ended many of those people suddenly found themselves paying interest rates that they had not planned for and could not afford. Some of the mortgage lending in the US was unquestionably fraudulent, as the long-running Countrywide saga shows, and some of it, while possibly not actually fraudulent, would in the UK be classed as mis-selling. But a large part of the problem was people not understanding the nature of what they were taking on.

In the UK we understand variable rate mortgages much better, so by and large people don’t get themselves into that sort of mess. But we don’t understand securitization at all, because our market doesn’t work like that. And because we don’t understand it we have a tendency to blame the US securitization process itself – and the primary actors in that – for the financial crisis, and ignore the role played by fraudulent and excessively risky mortgage lending to naive borrowers. The truth, as Luis Enrique points out, is much more complex than that.

I take it that all the tory trolls who now blame the American housing market for our problems have now changed their position of it’s all Gordon Brown’s fault.

I always wondered when Brown had time to fly over to the US and work for all the major banks dishing out mortgages to poor people. I guess if managed to fit it in while simultaneously flying to Iceland to screw up their banking system, and then nipping off to Ireland to mess up their banks as well.

Tory trolls spinning like tops, hilarious!

46. Luis Enrique
47. Luis Enrique

Tyler

You might be correct that CDOs were not used as collateral … but the (generous) way of interpreting Sunny’s claim that “banks borrowed too much” is that they were over leveraged, hence vulnerable. That isn’t about “borrowing too much” in absolute terms, it’s about the ratio of debt liabilities to equity. I think Sunny has a point there – and banks did that to maximize returns on equity, nobody forced them to do it.

(Although this interpretation leaves me at a loss to explain why Sunny has previously been rather disparaging about regulators asking for higher capital buffers, seeing as that’s the cure for the “borrowing too much” thing)

Sally,

I’ll argue with you, if the others won’t!

Bailing out banks is not free market. Anyone supporting this is not free market.

Central banks keeping interest rates below their natural (market) rate is not free market. All their inflationary activities are not free market. Facilitating credit bubbles which inevitably go bust likewise.

We’re dealing with the consequences of a long period of monetary inflation, caused by big government, central banks and their crony capitalist chums.

The free market solution is to stop propping up the cocaine credit binge and take the cold turkey pain. But no politician dares allow this, so instead we’ve got Osborne dusting off his ‘New Deal Solutions’ manual, which will only drag out the misery.

@41: “The real cause of this crisis though were low interest rates, easy availability of credit, regulation promoting borrowing and an asset class mania. The result, people borrowed way too much, both public and private debt. As soon as repayments became a problem, the asset bubble was burst as foreclosures flooded the market, drving a stalling housing market into a dive.”

I’ll sign up to that – although we need to probe as to why interest rates were “too low” when the BoE was focused on maintaining an inflation target. IMO part or most of the explanation is because in February 2003 GB switched the inflation target from 2½ pc on the RPI – which included an element for housing costs – to 2 pc on the CPI, which didn’t.

The graph here shows how far the two price indices diverged. The policy implication is that interest rates to curb inflation on the RPI index would have been higher.
http://www.economicshelp.org/blog/1338/inflation/difference-between-rpi-rpix-and-cpi/

Several years back when posting in ConHome, I criticised John Redwood for claiming that the recession following the business cycle peak in 2008Q1 was caused because interest rates were too high. What nonsense, I posted. We had the credit boom leading up to the busted banks because interest rates were too low. ConHome deleted the post. So much for an open debate on policy issues.

The unresolved controversial issue is whether house prices should be included in the inflation target set for the BoE. Charles Goodhart has argued that house prices should be included in the target.

48 But you have just confirmed my belief that there is no such thing as a free market. I ridicule the free market trolls on here because I believe there is no such thing as a free market. Osborne, with his tax payers state bank of last resort scheme just re-enforces my view.

First of all you have to have a currency, and then some one has to set interest rates. Either a central bank does that or you let banks set their own rates. Either way you have just taken a giant axe to your so called free market.

Next …..you need some basic property laws. Someone has the write these laws , and some one has to be employed to officiate and implement them. By now your so called free market is on life support if even alive.

There is no such thing.

51. gastro george

Isn’t it simple maths that if a country (like the US or UK) has a massive external trade deficit, then that has to be funded either by a government deficit or a private deficit. As the former is “not allowed”, then the latter was inevitable in order to keep the economy running, but was always going to end in tears eventually.

@ 50

“But you have just confirmed my belief that there is no such thing as a free market … Osborne, with his tax payers state bank of last resort scheme just re-enforces my view.”

Certainly the status quo is not a free market, but it is a market. What economics shows is that the market works better, the freer it is allowed to function. Throughout history, governments have interferred and messed things up, creating monopolies for favoured friends, blocking imports and exports etc.

“First of all you have to have a currency, and then some one has to set interest rates.”

Stop right there. Money came into being naturally, evolving from whatever served best as a medium of exchange. Gold and silver are clearly far more suited to this purpose than fresh fish or whatever else. Interest rates represent the cost of borrowing. They do not need any Wizard of Oz figure setting them, they should act to co-ordinate supply of credit with demand for credit.

“Either a central bank does that or you let banks set their own rates. Either way you have just taken a giant axe to your so called free market.”

Central banks are at the heart of the problem. A quick glance through history reveals them to be essentially crooked enterprises. The B of E wouldn’t have lasted long if the government hadn’t stepped in to allow them to continue when they couldn’t pay their debts. In the US there is far more hostility to central banks, because the history is much fresher and because people like Jefferson and Andrew Jackson fought against an American central bank,and in current days, libertarian hero Ron Paul likewise calls to “end the Fed”. So, if you’re saying central banks are contrary to free markets, I most certainly agree. Indeed, they feature at point five of the Communist Manifesto’s plan of action.

“Next …..you need some basic property laws. Someone has the write these laws , and some one has to be employed to officiate and implement them. By now your so called free market is on life support if even alive.”

Well, the free market is based on voluntary actions. It is definitely the case that we, humanity, benefit greatly by working together, the division of labour, rather than each living an isolated autarkic existence, and if we are to live peacefully, we need to defend ourselves against the aggression of those who would rather live on plunder at our expense, be they petty criminals or the predatory state itself. Property rights do not prevent the free market, respect for property rights is a necessary precurser to the free market.

“There is no such thing.”

To reiterate; there is a market, hampered though it is, and we all benefit in the long run if those things which hamper it are removed. In past times, it was monopolies granted to the king’s favourites, and it ain’t changed that much since!

53. Luis Enrique

actually, I understated things @47 – its not that higher capital buffers ‘cures’ over leverage (‘borrowing too much’), it’s that lower leverage means higher capital buffers, they are two ways of saying the same thing.

[Sally even Milton Friedman accepted that central banks play a lender of last resort role - evidently it's possible to be an extreme "free marketeer" knowing this]

54. little keithy

The report Sunny linked to “Examining the Big Lie” (http://tinyurl.com/7tbxkmn) pretty much refutes the argument that it was Community Reinvestment Act and FMs that were responsible for the housing bubble in the US. Rather an explosion in risky private sector lending and securitisation. See also Bloomberg’s Awful Comment http://tinyurl.com/5ul7qhl

Examining the Big Lie also echoes the Economist article cited above in showing the global nature of the housing boom, which would suggest that the UK and US (and Spain and Ireland and so on) had particular conditions that shaped the crisis in their own countries but that something more fundamental was afoot. Add the booms in financial industries, stock markets, cheap money etc and maybe a look at some underlying causes in the world economy is in order.

Finally, if we are to take seriously the argument that “it was the poor that did it” is there much of a future for a system based on the reproduction of capital that is brought to its knees by people who have very little of it? That can’t actually deliver a house to significant part of the population without sending the system into a crisis?

“Workers of the world unite you only have your mortgages to lose”.

Note that the US bubble started in the late 90s. Private sector securitisations bubbled from 2003 onwards.

That there was more than one bubble doesn’t mean the CDO bubble didn’t exist.

Shinsei67: Together they exaggerate/lie about Mr Brown’s income.

Sorry but this is also rubbish. Companies have been prosecuted for lying about the extent of payments people have to make – not the other way around. Its not so simply to exaggerate about your income and wealth to mortgage companies.

In your example, Fort Lauderdale company clearly did lie – there are several documented examples. But further up the chain, those risky mortgages were tied up with safer securities and sold on. They were all to blame. No point blaming Charlie Brown.

Frances you say: The problem is that when the loans were sold on, important information essential to assess the risk of the loans was not always passed on as well

But that is exactly my central point. Everyone bundling and selling on those assets were unwilling to or were unable to judge the risk (which was a key mistake) and the regulators had no clue what was going on (another big mistake).

“Isn’t it simple maths that if a country (like the US or UK) has a massive external trade deficit, then that has to be funded either by a government deficit or a private deficit.”

No. Because there’s this thing called the capital account. So, English peeps buy more, by £1 billion, than English peeps export. There’s a trade deficit, sure.

Other peeps build 100 Hyde Park (or whatever it is) and charge foreigners £1 billion to buy flats there.

Poof, balance of payments balances, we’ve balanced a deficit on hte current account with a surplus on the capital account.

No, a trade deficit does not mean, necessarily, debt.

57. Frances_coppola

Sunny,

Your point about the misunderstanding of risk and therefore the mispricing of the instruments is absolutely right. And the fragmentation of regulation, which led to systemic risk appearing at the boundaries between different parts of the system where there was no effective regulation. The regulatory “black hole” between mortgage origination and securitization still has not been addressed by Congress. I was simply drawing people’s attention to the very different nature of the US mortgage market and the tendency people have to blame what they don’t understand. In the US they are busy blaming adjustable-rate mortgages for the crisis. Here we blame securitization. Neither view is correct.

I have been shouting for some time now that excessive risk in mortgage lending and lax underwriting standards made quite a contribution to the financial crisis on both sides of the Atlantic, but because of the “urban myth” that it was all the fault of evil investment bankers gambling with our money people don’t – or won’t – see the whole picture and therefore risk making the same mistakes again. As we are already seeing with the resurgence of 95% mortgages and Osborne’s idiotic idea to prop up the construction industry by guaranteeing sub-prime mortgages to first-time buyers.

58. Frances_coppola

45 Sally

The problem is that although the worldwide financial crisis was underpinned by excessively risky and fraudulent lending in the US housing market, the UK had a credit bubble and financial crisis of its own making. Three UK banks and a building society went bust because like the Americans they were making huge amounts of excessively risky loans to people who couldn’t afford them in the expectation that house prices would continue to rise. And a fourth UK bank, RBS, made massive losses on sub-prime lending in the US. There is no doubt that the Brown government did believe that the boom caused by (what we now know to be) excessive credit would last, and even after the crisis started Brown was still insisting that the problems were temporary and normal service would be resumed shortly. So I’m afraid my view is that although the worldwide crisis was not Brown’s fault, the UK one was.

59. gastro george

@55

Well I’m trying to find the correct figures for 2010 at the ONS and it looks to me (I could be wrong) that the current account was 98 billion down and the capital account less than 4 billion up. So not much balance there. No in any recent year before that. But correct me if I’m wrong.

60. Luis enrique

Sunny,

Um, it’s not rubbish. You might say the lender (mortgage originator) is more to blame than the borrower, but falsified income data happened. Check out, for example,

http://www.housingwire.com/2011/07/20/fed-fines-wells-fargo-85-million-for-questionable-mortgages

And academic treatment, a paper called Liars Loans
http://www.aeaweb.org/aea/conference/program/retrieve.php?pdfid=34

61. Frances_coppola

58 gastro george

Tim has correctly pointed out that a trade deficit does not necessarily mean there has to be either government or private deficit – it depends what the capital inflows are. But the UK’s trade deficit over the last few years has without question been funded by fiscal and private deficits.

62. Amateur Economist

@14 etc

Luis Enrique – your comments on this blog consistently bring sense and understanding to the issues of the day. If only others could see that there’s very rarely a simple or single explanation for complex problem scenarios…

This blog would be a shadow of itself without your insights.

63. Luis enrique

. . . the fact that mortgage originators had every incentive to falsify loan application data, and did so, is one of the arguments against securitisation plus CDOs and CDSs The person who originated the loans dont end up holding the baby, and the people who did end up holding it didnt care if loan quality was iffy because they thought they were protected by the risk tranching (CDO) and insurance (CDS).

Of course everybody may have learnt their lesson for this generation … Give it another few decades and another generation wil forget history, think they know better and do it all again.

64. Luis enrique

@61

Bloody hell mum, go easy!

(I mean …thanks!)

Frances: “But the UK’s trade deficit over the last few years has without question been funded by fiscal and private deficits”

Exactly – quote:

“For those readers who have ever done economics, you’ll remember things like Y = C + I + G + (X-M). Or perhaps you won’t, because nothing so puts off the ordinary reader as a bit of algebra. So I’ll spare you the algebraic definitions and derivations of the savings balances. You’ll simply have to take it on faith that, at any moment in time, the sum of the private and public sector surpluses (the difference between income and spending) must equal the external current account, or what is commonly know as the extenal balance. Economists and national accountants write this in shorthand: (S-I) + (T-G) = (X-M).”
http://blogs.euobserver.com/irvin/2010/08/03/the-basics-of-budget-balance/

But see also Martin Wolf in last Friday’s FT on: “Why cutting fiscal deficits is an assault on private profits”

Btw a correction: in @49: “IMO part or most of the explanation is because in February 2003 GB switched the inflation target from 2½ pc on the RPI – which included an element for housing costs – to 2 pc on the CPI, which didn’t.”

February 2003 should have been February 2004.

66. Frances_coppola

63 BobB

Thanks, that’s a useful link. I’ve been arguing some time that attempting to cut a fiscal deficit when the private sector is net saving and there is a substantial trade deficit is nigh on impossible and if it somehow manages to succeed will drive the economy into recession. Relieved to know that the likes of Irvin are saying the same. If only the leaders of the Western world were listening – because that is what they are ALL trying to do. Madness.

Frances

This from Martin Wolf without algebra is perhaps more illuminating on the relevant policy options for more readers than Prof Irvin:

Why cutting fiscal deficits is an assault on profits
http://www.ft.com/cms/s/0/448bb4e0-15f2-11e1-a691-00144feabdc0.html#axzz1f2m41CUg

“So I’m afraid my view is that although the worldwide crisis was not Brown’s fault, the UK one was.”

IMO Brown was to blame in switching the inflation target to the CPI in February 2004 – although that was supported at the time by Mervyn King – and in not keeping a more watchful eye on what was happening with the regulation of bank lending and the house-price bubble – see the link @49 to the analysis in The Economist.

The Financial Services Authority – via the Turner Review of 2009 – has already admitted to failings in its job of regulating the banks. 130pc loan-to-value mortgages should have set alarm bells ringing but then too many were lulled by those soothing fantasy visions of self-regulating free market capitalism. I’m blaming Brown for going along with that fantasy but that is not what most of his critics are saying.

In the FT, Bob Diamond, head of Barclays Bank, was recently reported as saying in a BBC Today interview on 4 November that the Banks must accept responsibility for what went wrong. In the interview – which I listened to – he repeatedly said that banks must work towards a situation where banks could be allowed to fail without taxpayer support and without causing systemic instability if they did fail. We are nowhere near that situation yet.

@ Sally

Your ignorance is breathtaking.

1) Free markets can happily co-exist with central banks, currencies etc

2) No one said Brown was responsible for the US sub prime crisis. No one. However he is responsible for the UK sub prime crisis (Northern Rock, HBOS and RBS). And for presiding over an economy ill-equipped to deal with a financial crash.

3) Not a single person on here commenting has stuck up for banks being too big too fail, or large bonuses being essential for capitalism to thrive or for zero regulation. So why your stupid strawman arguments about flat earthers ?

You do realise it is people like you that ruin the sensible arguments of Occupy LSX or UKUncut by your ignorant trolling ?

Luis, from the article you linked to, it says:

It is the largest fine yet issued by a federal agency when protecting consumers. It is also the first enforcement action taken against a lender for allegedly steering borrowers into higher-cost, riskier subprime loans.

In other words the bank tried to persuade people to take out riskier loans (knowing they were risky) and pushed them to falsify information so they could take out those loans.

How does this absolve the banks exactly? I’ve linked to this in my article… see the Pro-publica link. Say hello to your mum from me too :)

70. Luis enrique

Sunny,

It doesnt absolve them in the slightest. @55 you were telling Shinsel67 his story about falsified income data @34 was rubbish, I was merely pointing out what he describes the Fort Lauderdale mortgage company as doing, was in fact common.

t falsified income data @34 was rubbish

Ahh. I meant the implication that people were deliberately exaggerating their income (as he implied) because they wanted bigger, riskier loans, rather than companies themselves helping push dodgy products, was rubbish. In the case you cite, its still the bank to blame than people. They took on those risks deliberately and sold them on.

72. Luis enrique

If you meant to say it’s rubbish to think this exonerates the banks that then securitised the fraudulent mortgages others originated, I tend to agree, but @ 55 you seem to be saying borrowers exaggerating their income didn’t happen. Apols if that’s not what you meant.

Fact based on your opinion…..

Interest rates were kept artificially low for a long time.

Perhaps we require a banker purge……..

@68: “No one. However he is responsible for the UK sub prime crisis (Northern Rock, HBOS and RBS).”

I’m unclear as to how the prime minister is politically responsible for the catastrophic way some private sector banks elected to manage their banking business to the point of collapse.

Was GB also reponsible for the ill-fated acquisition of the Dutch bank ABN AMRO by RBS in 2007? In testimony to the US Congress on 28 October 2008, Alan Greenspan was saying: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.”

Does all that mean heads of government, in supposedly “free-market capitalist” economies, are accountable for failing management in private shareholder-owned capitalist enterprises? If so, free-market capitalism takes on an entirely bizarre meaning.

Btw in the news, I see the reports of the present government’s housing strategy document include this: “Since 2007, the biggest constraint on homes being built has been mortgage availability.”

If so, that is an issue we might reasonably expect a prime minister – or a minister responsible for housing – to address.

75. Frances_coppola

@68 and @74

I agree with Bob on this one. It’s unfair to blame a prime minister for the stupid business decisions of banks. In the end Northern Rock, HBOS and RBS all failed because they were badly managed, not because of anything the government did.

When I said that Gordon Brown was responsible for the UK financial crisis I meant that it was on his watch – including his time as Chancellor – that the credit and house price bubbles developed that caused the UK financial crisis and ensuing recession.

It’s disappointing that pretty much four years after the credit crisis we still get such vast misunderstandings of what caused the biggest event of most of our lifetimes.

I don’t wish to add to poor Sunny’s woes but as a professional working in securitisation let’s just say he needs to do some work on it.

“Wot caused the crunch” is a question asked by many ideologues and none get to the correct answer (because, presumably it doesn’t fit their pre-decided answers. Imagine if Sunny DIDN’T blame the bankers!)

The answer to the USD 1 trillion (or whatever) question is … liquidity. Government and financiers mistook excess liquidity for a low risk environment, which allowed silly structured products to thrive, everyone’s risky bets to pay off, capital growth in strange places, weak European countries to borrow excessively etc.

Everyone – and that means central bankers, financiers, governments – knew there was excessive liquidity by late 2004 at the latest; they knew it was distorting the market and causing poor decisions. They just decided to do nothing about it.

Sunny, I wrote this in 2003 – it’s more than faintly prophetic – and may help you understand securitisation a bit.

http://www.ak13.com/article.php?id=3

Here’s something much more recent about liquidity

http://www.cashandburn.com/2011/04/sailing-on-pool-of-liquidity.html

The U.S. government filed a lawsuit against Deutsche Bank this past May for $1 billion. The bank is being sued for “repeatedly lying” to the Federal Housing Administration about mortgages issued by a company called Mortgage IT Inc, which it purchased in 2007. The bank assurred regulators that the loans met federal standards, but taxpayers ended up paying out hundreds of millions in insurance claims when the majority of the company’s borrowers defaulted.

http://www.reuters.com/article/2011/05/03/us-deutschebank-mortgage-lawsuit-idUSTRE7423LY20110503

A notary public who signed tens of thousands of false documents in a massive foreclosure scam before blowing the whistle on the scandal has been found dead in her Las Vegas home.

http://usnews.msnbc.msn.com/_news/2011/11/29/9099162-foreclosure-fraud-whistleblower-found-dead

Goldman Sachs Group Inc., the most profitable securities firm in Wall Street history, made an estimated $3.7 billion in 2007 by placing “heavy bets” against mortgage-linked securities, including some it created, a U.S. senator said today.

Yes they bet against their own customers

http://www.bloomberg.com/news/2010-04-26/goldman-made-3-7-billion-by-betting-against-own-deals-senator-levin-says.html

@ Guy

“Yes they bet against their own customers”

But Goldmans will also have many customers who are short mortgages.

So they would have been betting with those customers.

Pretty much any investment Goldman makes is going to be for one of its customers and against another one.

They also have analysts who will put out sell notes on technology companies and then have traders who take buy orders in tech companies from customers.

If your problem is with investment banks taking positions on their own book (prop desks) you’ll be glad to hear these have now been made illegal.

81. Shinsei67
HI i think you misunderstand, that F is for is fraud.
From another article Senator Levin
“They bundled toxic mortgages into complex financial instruments, got the credit rating agencies to label them as AAA securities, and sold them to investors, magnifying and spreading risk throughout the financial system, and all too often betting against the instruments they sold and profiting at the expense of their clients.”

Here’s more from Zerohedge
The SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.

article cont

“The product was new and complex but the deception and conflicts are old and simple,” said Robert Khuzami, Director of the Division of Enforcement.
“Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party.”

Kenneth Lench, Chief of the SEC’s Structured and New Products Unit, added, “The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the U.S. housing market as it was beginning to show signs of distress.”

http://www.zerohedge.com/article/breaking-sec-charges-goldman-sachs-fraud-subprime-mortgages

F – is for fraud

F
Fox News blames Democratic Congressman of Massachusetts Barney Frank for the mortgage meltdown that led to the recession – are they right? The Young Turks host Cenk Uygur sets the record straight.

http://www.youtube.com/user/TheYoungTurks#p/u/1/ty1CW2zr1uc

This is as bad as just blaming the borrowers.

The banks and the borrowers (plus the government that let it all happen) are as bad as each other,

People borrowed moneythey could not afford – a significant number lied to obtain credit.

The banks carried out limited checks and lent cash.

The government let it all happen, lack of regulation and a booming economy on the back of it.

Gordon Brown should have regulated the market, if the government were not aware of what was going on then thats even more damming as to their abilities. Regulation was needed and was not put in place.


Reactions: Twitter, blogs
  1. Liberal Conspiracy

    Was the Crash caused by people borrowing too much? No http://t.co/fG4VK8G2

  2. Wildey

    Was the Crash caused by people borrowing too much? No http://t.co/fG4VK8G2

  3. Wildey

    Was the Crash caused by people borrowing too much? No by @sunnyhundal …@libcon http://t.co/1i8YrAM8 #bankster #libcon

  4. Molly

    Was the Crash caused by people borrowing too much? No http://t.co/fG4VK8G2

  5. Rob Waller

    @libcon Genuinely the most ridiculous post on the 'Crash' I have read… http://t.co/lw5YakaE @sunny_hundal

  6. sunny hundal

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  7. Lee Hyde

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  8. Jack Ashton

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  9. Scott

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  10. Jon Archer

    Brilliant stuff! RT @libcon: Was the Crash caused by people borrowing too much? No http://t.co/Lgu2ARXV #fb

  11. Eddie Robson

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  12. Lorenzo Amisano

    Was the Crash caused by people borrowing too much? No | Liberal Conspiracy http://t.co/zQCYdh2h via @libcon

  13. Jill Hayward

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  14. Nikeel Kazmi

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  15. John Warrender

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  16. Scott McLean

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  17. Chris Gravell

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  18. Rod Adams

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  19. Alex Braithwaite

    Was the Crash caused by people borrowing too much? No http://t.co/fG4VK8G2

  20. Don Van Natta Jr.

    RT @sunny_hundal: There's a simple lie about the '08 crash: 'It was caused by people borrowing too much.' http://t.co/ubGdZIEr

  21. Joseph Burnett

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  22. Mikey

    Beware of the lie that "we" borrowed too much… http://t.co/TGytVxZd

  23. Glen Owen

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  24. David Atkinson

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  25. Colin Hughes

    RT “@sunny_hundal: There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. http://t.co/l4JsAuWx” @ichiboz

  26. Mike Ranscombe

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie http://t.co/ib1nzuq8

  27. Boneshaquitalafonda

    RT “@sunny_hundal: There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. http://t.co/l4JsAuWx” @ichiboz

  28. sunny hundal

    @dlknowles whatever, bankers screwed us http://t.co/ib1nzuq8

  29. Feral_britain

    Was the Crash caused by people borrowing too much? No by @sunnyhundal …@libcon http://t.co/1i8YrAM8 #bankster #libcon

  30. DPWF

    Was the Crash caused by people borrowing too much? No | Liberal Conspiracy http://t.co/GZZVbNtu via @libcon

  31. Jose Aguiar

    Was the Crash caused by people borrowing too much? No | Liberal Conspiracy http://t.co/nygr8JL7 via @libcon

  32. Nicholas Ripley

    Reasonable basic analysis RT @libcon: Was the Crash caused by people borrowing too much? No http://t.co/YTqUBakn

  33. Christian Wilcox

    Some important facts on the banking crisis: http://t.co/lkTAygpJ. In case The Torys try to get their Banker donors off. #Croydon #Labour

  34. Simon Filiatrault

    There's a simple lie about the '08 crash: 'it was caused by people borrowing too much'. Why this is a lie? http://t.co/qv5p84L9

  35. Alan Moore

    Was the Crash caused by people borrowing too much? No. Lib Consp http://t.co/nUSc5kSJ via @addthis Nice piece Sunny Hundal #torylies #occupy

  36. Jamie

    Interesting argument: Was the Crash caused by people borrowing too much? No http://t.co/y00UR9R3

  37. Chris Butler

    Was the Crash caused by people borrowing too much? No | Liberal Conspiracy http://t.co/PKoK4gye via @libcon

  38. Tim Holmes

    Ordinary people caused the crash? Don't fall for this lie: http://t.co/QwdpXBaM via @libcon

  39. Why I am Striking on November 30th | John Ruddy's Politics Blog

    [...] sector workers to pay an extra 3% of their wages in order to reduce the deficit caused by the banks? No, of course not. Is it right that people should be expected to work longer, pay in more and [...]

  40. sunny hundal

    @Yogi_Chan …and who bundled assets badly and misled clients? Not poor people! http://t.co/ib1nzuq8 – you're making excuses for bankers

  41. sunny hundal

    @johnhigginson 'Was the Crash caused by people borrowing too much? No' http://t.co/ib1nzuq8





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