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Liars’ loans

Robert Peston | 08:00 UK time, Monday, 20 August 2007

The underlying cause of the current global financial crisis is a system in which there’s little personal responsibility for lending decisions.

Here’s how it all works (or, as we now see, how it doesn’t work).

In the US, some half a million mortgage brokers have been incentivised to “sell” mortgages to potential homebuyers.

They don’t work for the providers of the loans. They are paid commissions for the volume of mortgages they arrange. So, of course, they try to arrange as many mortgages as they can, not minding the consequences.

If the customer wants to borrow more than he or she can really afford, then that’s no problem, thanks to a wonderful innovation called “stated income, stated assets” loans.

These allow US homebuyers to give a personal undertaking that their income is a certain level, even if they don’t provide any proof.

Such loans have been taken out by hundreds of thousands of US citizens who are pay-as-you-earn tax-payers and could therefore have easily provided proof of earnings, had they wanted to do so.

Surprise, surprise: studies have shown “discrepancies” between what such borrowers say they earn and what they actually earn, in 95 per cent of these loans.

These mortgages are now colloquially known as “liars’ loans”.

But liars’ loans are just the extreme manifestation of a US system for generating home loans which is predicated on turning a blind eye to economic reality.

When a borrower has difficulty making repayments on a loan, a mortgage broker would typically encourage them to pay off that loan by taking out a new one for an even greater amount! These are the infamous “rolling loans” which “gather no losses”.

When a loan is rolled over, no one need know that defaults loom – at least not for a while.

Wall Street’s sausage machine

What happens to all these hundreds of billions of dollars in home loans?

Well the paperwork and administration is usually done by specialist home loans companies, such as New Century Financial (which went into bankruptcy protection in the spring).

Then the debt itself goes into a giant mincing and mixing machine on Wall Street operated by the biggest US investment banks, led by Goldman Sachs, Morgan Stanley, Merrill Lynch and the like.

They take all this debt and they process it into asset-backed securities, or bonds.

Note that Goldman, Morgan et al have NO CONNECTION with the borrowers and NO IDEA whether an individual borrower is a good risk or a bad risk.

But they have historic data on default rates.

And this data allows them – or so they claim – to assess whether a bond is a good risk or a poor risk, and therefore to price it for consumption by international investors.

What’s more, verification of the riskiness of a bond is provided, for a fee, by the specialist credit-rating agencies, led by Moody’s and Standard & Poor’s (let’s for now ignore the obvious conflict-of-interest that as the market for these bonds expands, the rating agencies make bigger profits).

There’s a conspicuous problem here. An important part of the US home loans market, the sub-prime mortgages provided to those with poor credit histories, is a young market which has grown like topsy.

Or to put it another way, data gathered from past performance of loans in a small market may not be much of a guide to the future performance of a trillion dollar plus market.

But that hasn’t stopped the big investment banks citing this questionable data to convert sub-prime loans into bonds that they claim are risk-free and which have a so-called triple-A credit rating.

Here’s how they do the clever engineering.

For argument's sake, let’s say that they estimate that as many as one in two home loans will default and that on average there will be a 40 per cent loss on those defaulting loans. That, in turn, gives a maximum risk of 20 per cent losses on a portfolio of these loans.

Bad news? Not for creative investment bankers. Out of this portfolio of low-quality loans, they can create supposedly high quality bonds by putting in place covenants which stipulate that the first 20 per cent of losses would be attributed to one bunch of really poisonous bonds, usually called toxic waste, leaving the rest of the bonds almost as safe as US Treasury bonds (in theory).

Before we move on, it’s probably worth recapping the phoney assumptions made by the investment banks as they create these bonds:

1) That historic data on default rates is useful even though the market has exploded in size

2) That data of any sort is useful even though the system for originating the loans, with mortgage brokers paid by the volume of loans they make, actually encourages fraud.

So far, so disturbing. But it gets worse.

Because the demand for toxic waste isn’t as huge as all that (some purchasers of this poison have suffered horrendous losses), investment banks have looked for ways to slice and dice the toxic waste, to create something almost edible.

They’ve mixed it up with other securities in collateralised debt obligations, which are bonds created out of other bonds – or sometimes they are bonds created out of bonds, that are in turn created out of other bonds (collateralised debt obligations squared, as if you wanted to know).

Even these bonds made of bonds rely to a worrying extent on all that dodgy historic data to determine their risk of default – the credit risk – or the risk that they’ll be vulnerable to interest-rate changes.

But notice too that once the original sub-prime loan is in a collateralised debt obligation, that loan could be one of perhaps a million different loans all mashed together to form this new bond.

What that means is that the eventual purchaser of the collateralised debt obligation has no more idea what’s in that bond than a sap eating a Turkey Twizzler knows what he or she is eating. Little wonder that when there’s a global scare about what may actually be in these bonds, no one wants to touch them.

That said, the investment banker will argue, on the basis of portfolio theory, if you put one load of toxic waste with another seemingly independent load of toxic waste, then the risk of holding them will fall. But for that to be true, each bunch of toxic waste would have to be uncorrelated to the other bunch – and that ain’t necessarily so.

Here’s the bottom line: for the past few years, Wall Street has operated a giant machine for turning mind-boggling amounts of US home loans – which are hugely vulnerable to losses from fraud and the inescapable cycles in interest rates and housing prices – into supposedly risk-free investments for risk-averse investors in Asia, the Middle East and (as it turns out) for Europe’s big banks.

Now if I worked for Goldman Sachs, Morgan Stanley, Merrill Lynch or the other big US investment banks, I might be considering my career options at the moment. It is inconceivable that they will escape unscathed from this debacle. Whatever the financial cost to these banks, which will not be trivial, there will also be significant damage to their reputations.

Europe’s shame

But Europe’s banks are hardly blameless either. If the underlying cause of the global financial crisis is fraud and greed in the US home loans system – from mortgage broker to investment bank – the trigger of the crisis was chronic folly by big international lending banks, notably some in Europe.

I am talking about banks’ use of “conduits” and “structured investment vehicles” (SIVs).

These are special off-balance sheet companies set up by banks for borrowing cheap short-term funds from the money markets in the form of securities known as asset-backed commercial paper.

Now, as their name implies, the commercial paper is secured against asset-backed securities, such as mortgage-backed securities and collateralised debt obligations. According to Citigroup, European conduits held more than $500bn of assets to back commercial paper at the end of March.

But there’s an intrinsic weakness to this funding: commercial paper of short duration has been sold by banks to finance their purchases of long-dated bonds whose assets include those dodgy sub-prime loans to US homeowners.

It’s a classic liquidity mismatch, except when there’s a reliable, active market for such bonds. To reiterate, European banks have been borrowing money that has to be repaid or rolled-over every 90 days to fund their ownership – direct or indirect – of 30-year US home loans.

They did this because they received more from the holdings of asset-backed bonds and collateralised debt obligations than they paid out in interest on the commercial paper. In theory, they made an attractive return.

Here’s the Catch 22: such funding schemes only work while the market has confidence in the value of the collateral backing the commercial paper.

When investors start to have qualms about asset-backed bonds and collateralised debt obligations, banks are squeezed in a vice: short-term funding disappears and there is a collapse in the value of the assets they hold.

So what happened over the past fortnight was a highly predictable – except by the big banks – double whammy.

Lenders to banks refused to repurchase commercial paper when it matured. And the banks that issued that paper faced a funding crisis, because they were unable to sell the collateral or raise new money against it.

Everyone had suddenly woken up to the idea that this allegedly safe collateral of mortgage-backed securities and collateralised debt obligations was the equivalent of a palace built on paper foundations.

That inability of major banks to raise short term finance is why the European Central Bank – and the US Federal Reserve and other central banks – recently pumped tens of billions of pounds of additional liquidity into the banking market at interest rates well below the new market rates (that had risen sharply).

This was subsidised lending by the ECB and the Fed. They have been bailing out silly behaviour by banks that should have known better. State-insured banks had no business engaging in such short-sighted financial engineering, which is a million miles from their core banking operations on behalf of Europe’s consumers and companies.

There is – contra the Economist – a serious moral hazard problem here. The Bank of England, by contrast, would only lend emergency funds to banks at a punitive interest rate, which seems a more prudent way to be the lender of last resort.

What horrors await

On Friday, in an attempt to shore up the US housing market, and by extension the value of all those crappy mortgage-backed bonds, the Fed signalled that interest rates would come down for all of us sooner rather than later.

But that’s to treat the symptoms rather than the disease itself. To avoid a repeat of this kind of crisis, there needs to be a return to lenders taking some responsibility for the loans they make.

Most bankers now think it’s quaint and absurd that once-upon-a time a bank manager actually managed a loan book and even talked to the individuals to whom he or she lent.

Our brave new world – in which a Parisian or Frankfurt bank doesn’t even know whether it’s exposed to the US housing market through its Turkey Twizzler collateralised debt obligations – is neither healthy or sustainable.

Comments   Post your comment

  • 1.
  • At 09:02 AM on 20 Aug 2007,
  • Ian Kemmish wrote:

There are already bank managers who take personal responsibility for their loans. Just last year there were a couple in the Old Bailey who'd arranged millions of pounds worth of fraudulent loans, either for themselves or their mates.

Natural selection suggests that the current system has historically lost less money in these ways than the old system did. I'd venture to suggest that returning to a system where bank managers personally approved loans in the modern world, where HR departments themselves operate by checking boxes and following instructions ("Computer says no") rather than by having more senior managers form relationships with more junior managers, then the number of rogue managers would end up being far higher than before. And the losses in higher in proportion.

  • 2.
  • At 09:05 AM on 20 Aug 2007,
  • Juan C wrote:

Thanks for this article, which i found quite enlightening. In the US side of things there is also the problem that this "liar loans" or as we call them in the UK "self certified" were an ideal money laundering scheme for drug or other ilicit money. So not only were they lending to people with "dodgy" credit histories but also to altogheter "dodgy people". Apart from CDO's and all that stuff, the lax lending practices are rife in the UK as well. I have myself been offered "self cert" loans by brokers who operated on a commision basis. Some of these loans where the old "interest only" mortgages (MADNESS!) because the brokers where more interested in selling payment protection than to see if the person could actually repay the capital... My guess is that a few lids will be lifted in the UK as a result of this and we won't like the smell.

  • 3.
  • At 09:14 AM on 20 Aug 2007,
  • Lizzy wrote:

Lie to Buy is huge in the UK too. Bring on the House Price Crash and let's see an end to state, bank and media sponsored house price inflation.

  • 4.
  • At 09:30 AM on 20 Aug 2007,
  • Lloyd Richards wrote:

Thanks for the incisive explanation of the current sub-prime situation. What I would like to understand as a UK bank shareholder is the extent to which the big UK Banks are exposed?

  • 5.
  • At 09:45 AM on 20 Aug 2007,
  • Ian wrote:

A very concise and frightening summarisation of the current crisis.

The abilities of the so called "masters of the universe" has again been shown up as negligible.

I don't know who to feel sorry for in all this apart form the honest saver and borrower. The bankers have yet again shown a knowledge of Economics that would shame a first year under graduate student let alone a bunch of multi millionaire so called experts.

However they seem to find a new sucker every day whether it is gullible European and Asian banks or the Fed and the ECB.

As Barnum said "there's one born every minute". Why should we bail them out? Let the Masters of the Universe hang. After all they have spent long enough living in dreamland built on a house of cards.

Anyone know where I can buy a cheap Porsche or Ferrari? I think a repossed hedge fund super yacht may be beyond me though.

I can pay cash. Obviously subject to a proper credit check to make sure it isn't actually still owned by the loan company.

  • 6.
  • At 09:47 AM on 20 Aug 2007,
  • Bill Shewan wrote:

An extremely disturbing article by Robert Peston. I find it rather interesting that nobody from any of the US Investment Banks named in his piece has rushed into print to deny their involvement in such shoddy and untrustworthy practices.

  • 7.
  • At 10:02 AM on 20 Aug 2007,
  • Graham Coveyduck wrote:

Thank God that the Bank of England decided last week not to bail out those institutions in the UK stupid enough to bet our shirts on yet another piece of financial wizardry most found difficult to understand, including it would appear, the Great and the Good of the banking world.

Warren Buffett once said that he would not invest in a business he did not understand and avoided the .com boom where we were then asked to believe that very large debts, few assets, and no profits were the 'new' way of making money.

Less than 5% of the daily foreign currency trading is to finance trade, the other 95% is pure gambling.
No doubt over the past few years many in the City have received very large bonuses for helping to engineer the latest debacle which puts at risk the pensions of many.

When will we learn................

  • 8.
  • At 10:09 AM on 20 Aug 2007,
  • Ian wrote:

Bill, I imagine they are all desperately trying to sort out their finances and sell off stuff they can before all the other soon to be ex-bankers force the price of luxury cars, penthouse apartments and holiday homes through the floor.

  • 9.
  • At 10:09 AM on 20 Aug 2007,
  • Tom Taylor-Duxbury wrote:

So right. We too have a self certified market scandal, only being masked by a supply /demand imbalance. It will come undone!! As you intimate banks need to get back to basics.
What on earth are the FED & the ECB doing throwing (my) money at these guys who made the mess. No risk - no reward. They took the money from a risk they didn't have. The bankers consrued products to pass their risk on. Other greedy bankers bought into what they thought was a risk free deal. The banks have to take the hit, not the tax payer.
Is this the other side of the concept that house buying carries no risks. What about the tax payers in rented houses, are they maing unwilling subsidies now?

Threadneedle street - stay well out of it please

  • 10.
  • At 10:11 AM on 20 Aug 2007,
  • mr wrote:

With recent rises in US property values surely there are actually a number of banks standing to make considerable gains. If somebody defaults on their mortgage payments can the bank not simply repossess the property

  • 11.
  • At 10:12 AM on 20 Aug 2007,
  • Gillies McKenna wrote:

It is absolute rubbish to blame the current world financial crisis on the sellers of sub-prime mortgages, or the poor fools who took them out. The villains are the people who bundled these high risk debt instruments together and then, in cahoots with the debt rating agencies, passed these bundled debts off as low risk debt. This is exactly the same problem that we had with Enron. It was in Enron's case the Accounting firms who failed in their duty. In the current crisis it is the bond raters. All pyramid schemes eventually collapse, and Gresham's Law always applies. Bad money drives out good.

  • 12.
  • At 10:18 AM on 20 Aug 2007,
  • matthew wrote:

sigh, rather typical leftism here. The fact is that these quaint ideas of people knowing who they are lending too, and inviting you in for a chat are just that - quaint.

Selling off debt obligations to third parties makes a great deal of sense and we should be applauding the ingenuity of the fact that banks can do this; rather this than the 70s style of queueing for a loan.

The present system has cut costs and increased flexibility. While there are clearly problems with some aspects of it, the snide comments about Turkey Twizzlers and 'moral hazards', and a clear desire to punish those beastly bankers, forget the economy, just let everything crash, that will get those nasty rich people.

And I'm sure a BBC journalist you won't have to worry about the effects of a recession, your final-salary public sector pension will be covered by the poor old licence payers, so bombs away on the bankers, let's PUNISH them, and ignore the effects that 10% losses from the FTSE have on real people.

  • 13.
  • At 10:19 AM on 20 Aug 2007,
  • Glenn Smith wrote:

...the real issue Robert is not the irresponsibility of those who made commission out of mortgages for those who lied about their income to buy a home; no, the real issue is a culture of everyone wanting and being pushed into owning their own home and making money out of it (on an individual and corporate level)...if this wasn't so, many people (who could not afford to buy without fibbing) would be content with renting decent social housing, and old style building societies with a sense of moral duty would have dealt with the "toxic waste" of "liar loan" people, therefore leaving the market more stable. The fault lies squarely with those in finance and in government who have failed to reflect the diverse needs of their population, and have implanted the idea of investment into housing on a scale never been seen before, while at the same time making rented social housing a sign of failure and desperate need. Now, when things are going wrong the same people who bang on about "risk" and their skills at investing are, like those who simply cannot afford to have a home of their own - whether rented or not - out in the cold.

  • 14.
  • At 10:24 AM on 20 Aug 2007,
  • Leandra wrote:

Excellent article. And doesn't this just prove that "free markets" don't work either, because they forget the"greed is good" mentality of those operating them? And what about all the poor working saps who invested their pension money, absent a sensible state pension, in the UK and in Europe, in these "bonds" (once upon a time, a man's word was his bond? remember that?!)and bad luck if these pension schemes happened to crystallize on a down day in the market due to irresponsible nonsense in the USA?!! If David Cameron had any sense, he wouldn't worry about tax cuts - he would go for a rock solid, valuable, state pension in the UK - now that all this jiggery pokery is revealed as pure smoke and mirrors, voters would flock to him!

  • 15.
  • At 10:26 AM on 20 Aug 2007,
  • ThatNonsenseTalker wrote:

Excellent article.
This is history repeating itself, just in another guise. I understand that the S&L collapses in USA in 1990/91 were to a large extent because people were able to lend up to $99k to the dodgy S&L offering the highest rate, without risk, because it was federally insured. ie, the people getting the benefit are different from the people carrying the risk.

Also at that time, a friend of my father was a senior bank manager at an Oz bank. He said they were encouraged to lend as much as possible, find new customers etc, and their bonuses were based on sales. That bank failed in one of the biggest financial collapses in Oz history.

  • 16.
  • At 10:26 AM on 20 Aug 2007,
  • Frank Bridge wrote:

I am an ordinary punter with no or little knowledge of the money markets who has already been stung by the Equitable Life farce and the endowment mortgage swindle and is trying desparately not to "borrow" my way out of monthly shortfalls due to 1% or less pay rises over the last 5 years.

I find it unbelievable that there has not been one financial person prior to this revelation shouting at the top of their voice at the regulatory authorities that these practises have been going on. Even I know that the money markets are based on confidence and this article blows wide open any such notion showing yet again that it is run by fraudsters who are solely out for selfish gain and contolled by a bunch of well paid incompetents.

Who, yet again is going to pay for the mess. Yes - the ordinary punter. The million pound bonuses have been banked and that's enough to live on until their next opportunity.

  • 17.
  • At 10:29 AM on 20 Aug 2007,
  • Richard Leighton wrote:

Many thanks to Robert Preston for such an interesting article. It explains a great deal. The problem revolves around a mix of greed and stupidity which is inherent in the Capitalist ethos. There is no way anyone can make a "big killing" without risk. The Banks and others in the Money Market rely on individuals greed and stupidity to boost their profits. As Robert Preston says it works solely on trust and so long as trust exists it seems to work. When some idiot wakes up to the fact they are a mug and panics it all falls down. This fiasco must generate serious reviews of the way the system operates to allow the Markets to drive the economy but with safer and more robust rules to safeguard the honest ordinary investor whose life savings, pension or livelihood depends on the health of the Bourses where ever they might operate. For too long we have allowed an unregulated feeding frenzy to go on where some fortunate few generate vast bonuses and salaries but to the detriment of the economy and individuals as a whole. This circled needs to be squared and Mastered.

  • 18.
  • At 10:30 AM on 20 Aug 2007,
  • HarshV wrote:

Good article. It would be nice if you put some numbers up too like how much those mortgage based assets are worth or how much value they have lost. How do the balance sheets of some of these banks look? What proportion of the debt market is full of these toxic bonds?

  • 19.
  • At 10:30 AM on 20 Aug 2007,
  • Anonymous wrote:

"At 09:47 AM on 20 Aug 2007, Bill Shewan wrote:
An extremely disturbing article by Robert Peston. I find it rather interesting that nobody from any of the US Investment Banks named in his piece has rushed into print to deny their involvement in such shoddy and untrustworthy practices."

Bless your heart! Bill Shewan - "shoddy and untrustworthy practices" are how the system works now! This IS the system!! this is the miraculous much-vaunted free market 'financial services' which is at the heart of the British 'economic miracle'. Financial services (services??!) now comprise, I believe, 43 per cent of the 'turnover' of the UK economy. Yikes! Wake up and smell the coffee!

  • 20.
  • At 10:33 AM on 20 Aug 2007,
  • Roger Bull wrote:

Why are we all so surprised? I turn down tens of thousands of pounds worth of offers of loans each year but how many do not? Just look at the average UK personal debt book. Just how did we think the bankers were earning such vast sums and buying up multi million properties’ - expensive cars and huge yachts? On the back of suckers who pay the fees and invest through our pensions that will now be trashed once again ~ it is not over yet by a long way.

  • 21.
  • At 10:37 AM on 20 Aug 2007,
  • Mandy Hosking wrote:

A very interesting article. - There has been a similar problem in South Africa with large amount of short and long term loans being given out with very high default rates. The solution - The gov. has introduced a new law -If you loan out money, you have to work on the basis of percentages of wages per type of loan - eg 30% of net earnings for house car etc.

The person requesting the loan has to declare other loans or leans to the bank.

The bank cannot go above the percentages given, and if the user defaults - then they are considered guilty of fraud if they have not declared their details correctly. If they have - then the bank takes the blame.

Looking at the Jhb stock exchange over the last few weeks, it looks like this has allowed SA to limit its losses in this credit squeeze.

Brilliant analysis, well worth the license fee. The UK housing market has also seen an explosion of "self certified mortgages" which, according to broker friends, are only used by people lying about their income. The difference is that here in the UK house price inflation has saved lenders from any losses. If house price inflation turns to house price deflation, a financial disaster of similar proportions will be upon us.

  • 23.
  • At 10:39 AM on 20 Aug 2007,
  • Pete Twickers wrote:

A great piece .Now I understand it a bit more.

Surely this has to spill over into the real world of the economy and politics.

Why are the European and US Govt's (via their central banks) actually bailing out this crazy system of encouraging reckless borrowing that has allowed a number of companies and their members who received huge salaries and bonus's which in London has been partly responsible for distorting the very market,property,that has made them rich from another part of the world.

It appears that the ECB and FED are using their citizens money to bail them out. This is a potential political timebomb, if only people understood what was happening.
Like an addict if these people do not learn from their actions you will keep doing it.This is exactly what appears to be happening.
These super rich companies are being bailed out for their mistakes by the average citizen.This situation where the Central Banks are only thinking short term and not 2/3 years hence as I thought was part of their role is very dangerous for the future unless regulations change and are enforced.

I would not expect to be bailed out by the central bank if I found I could not repay my mortgage. So why are they doing it for companies that have been reckless?

Well done BOE for sticking to its defined role.

  • 24.
  • At 10:40 AM on 20 Aug 2007,
  • PeterG wrote:

Well blow me down! The market says: "We've lent some money to people who can't pay us back, but we don't know how much and we don't know who's owed what - we'd better panic!" Am I alone in believing that's utterly pathetic in the wired age?

Time for some meaningful regulation methinks! And before everyone starts bleating about the costs using the Sarbanes Oxley regs as an example, that is a convenient myth aired by people with ulterior motives.

Putting some effective controls in place would not be difficult if the collective will was there.

  • 25.
  • At 10:47 AM on 20 Aug 2007,
  • Leandra wrote:

"10. At 10:11 AM on 20 Aug 2007, mr wrote:
With recent rises in US property values surely there are actually a number of banks standing to make considerable gains. If somebody defaults on their mortgage payments can the bank not simply repossess the property."

How quaint! Bless your heart, mr. Of course houses are being repossessedin the US - in SPADES!!! - just look at California, the heartland of land speculation for at least a hundred years, for one. And what are the banks going to do with the houses they repo? Live in them? Hell, no. Sell them? At what price? A fire sale in a devaluing market, to cut their losses and hope to break even? again, look at California - We have every reason to fear the grotesque spectacle in the US and in the UK and Europe, of empty bank-owned housing the length and breadth of the land, and nobody able to afford to buy them - except the next round of speculators who will buy (cash in king) at fire-sale prices.

What I'm wondering about is whether there are actually hundreds of thousands of American home owners evicted from their houses because they cannot keep up their mortgage payments right now.

  • 27.
  • At 10:53 AM on 20 Aug 2007,
  • Vernon Wright wrote:

I'm surprised, although perhaps ought not to be, that no-one has mentioned a large contributory cause : variable interest rates.

It is absurd that, for the last four decades or so, people have been entering in to mortgage contracts of which the most fundamental term -- the interest rate -- is unknown.

Whilst it is true that many a mortgagor has over stated his income and assets, the problem lies chiefly in his having assessed his own ability to maintain the payments on the basis of interest rates at the time of the mortgage's creation ; on the other hand, 'the average man' cannot be expected to have the financial foresight to give himself the margin to cope with rising rates ; where rates are fixed to-day, they are so only for the first couple of years of a term of perhaps thirty.

It is, then, above all the greed of bankers and their not being prepared to take the decision, with attendant risk, that all other businessmen must take -- fixing the price of their products -- that has precipitated this situation.

  • 28.
  • At 10:58 AM on 20 Aug 2007,
  • Kathy wrote:

Thanks for an excellent article. Its a pyramid scheme built by rogue traders. I have always been intrigued at how research analysts and Investment Bankers, who are mostly not qualified accountants ( I am a qualified accountant) are able to design products, predict future prices etc without accounting knowledge and experience. People should read research on the accuracy of forecasts of investment bankers and the like ( in any reputable finance journals esp US ones) and see how wrong they are. Alot of studies have been done on this. I am all for financial innovation but please, only by properly educated, tested , responsible people, certainly not by high flying rogue traders with big egos who cannot be controlled.

  • 29.
  • At 11:09 AM on 20 Aug 2007,
  • Andrew P wrote:

A really informative piece. One thing I haven't yet got a feel for is what the cost (if any) to the taxpayer of central bank intervention is. Are we actually bailing out the fat cats ? Is there, in addition to the "moral" cost the author refers to, a real financial cost to the taxpayer as well ? Can anyone enlighten me ?

  • 30.
  • At 11:11 AM on 20 Aug 2007,
  • Chris Bowie wrote:

Nice article Robert, but it paraphraesd too much from Caroline Baum's "Wall Street Mill Churns Out Bad Wurst" column on Bloomberg dated August 13th. She used the sausage machine analogy a week ago, but also took it further.

Robert - Great analysis - agreed - Greed is sheer region for any financial debacle rather than blaming war, oil or higher interest rate!

  • 32.
  • At 11:19 AM on 20 Aug 2007,
  • Iliana Deevska wrote:

Somebody should also take a look at the balance sheets of mortgage lenders in Eastern Europe. To get a mortgare, no official income documentation is necessary, since hardly anybody has declared real income. This might not concern the same amounts, but European Banks will soon start getting the shock waves from their backyard too.

  • 33.
  • At 11:20 AM on 20 Aug 2007,
  • Graham Coveyduck wrote:

Mandy from South Africa points out that her government has introduced a form of credit control.
We used to have those, where the government controlled the deposit level and term of any credit agreement, it was called Hire Purchase in those days.
If you wanted to buy a house, you had to be a saver with the Building Society for at least 3 years before they would contemplate a maximum mortgage of 75% of valuation and a maximum of 3 times your annual verifiable earnings. Your Building Society was ‘local’ and lent to your neighbours so that they could buy their homes, and the local manager knew his area and his customers.
No credit cards and overdrafts for university students, and little or no store credit so if you wanted to buy the latest Big Boys Toy, you saved up your pounds and pennies.
Now you can get 115% mortgages on a property with no equity, have as many credit cards as you want, and hope to God that your pension fund has not gone bust before you retire and end up with nothing. That is assuming of course that you can get a job which actually has a pension scheme.
Somehow, progress might not be all it is cracked up to be!!

  • 34.
  • At 11:28 AM on 20 Aug 2007,
  • Mark Bell wrote:

Good to read that it has nothing to do with Joe Stiff being priced out of the housing market or the all consuming greed of yet another Yuppie generation.

I can rest easy now I know that it's just a liquidity mis-match caused by a poorly enginered financial instrument.

  • 35.
  • At 11:30 AM on 20 Aug 2007,
  • Tony, London wrote:

excellent summary with excellent choice of words

  • 36.
  • At 11:45 AM on 20 Aug 2007,
  • mr wrote:

With recent rises in US property values surely there are actually a number of banks standing to make considerable gains. If somebody defaults on their mortgage payments can the bank not simply repossess the property

  • 37.
  • At 11:45 AM on 20 Aug 2007,
  • Swerve wrote:

Many, many thanks for a fine series of articles and an engaging forum.

I used to work for a bank that decamped to these shores from the Far East soon after its take over of one of our venerable institutions (which itself was nearly brought down by scandal across the Atlantic).

I came across products such as CDOs and RMBSs, and the people who devised/marketed them. There is a lot of that toxic waste in the UK financial system. It doesn't bear thinking about.

Last summer was somewhat "entertaining" with a newly recruited 20-something "rocket scientist" harassing us for suitable contracts to be bundled up with the dodgy mortgages. Thank goodness, he was transferred to NY HQ as, it appears, London/International HQ was too small a pond for his talents.

Why do I suspect that the ne'er do wells responsible will be retiring to somewhere warm and sunny, free to enjoy their gains? To make it worse, these people and their firms aren't keen on even a minimal welfate state, but are more than happy to take corporate welfare.

I am all for a well-balanced, mixed economy, but financial speculation, Kathy's pyramid scheme, detached from reality has to be firmly controlled.

To be frank, this may just be what the UK economy needs so that it can come back to reality. It's a pity that innocent people will pay the price and in all sorts of ways.

  • 38.
  • At 11:46 AM on 20 Aug 2007,
  • TheTruth wrote:

Sorry to burst anyones belief bubble,
but these instruments were not set up to succeed, nor will they be corrected with laws.

The whole FIAT currency ponzi fraud
is in place to strip all of us (regardless the nation) of our wealth. And what you saw with the injection of Multi Billions was the dilution of more of your wealth.

Google* Weimar hyperinflation.

We're in it now. The next depression is set to arrive. Wake up.

  • 39.
  • At 11:50 AM on 20 Aug 2007,
  • Pete wrote:

It's not at all clear to me that the actions of the Fed or ECB have been inappropriate. They are doing what all central banks are supposed to do - ensure that inter-bank lending rates don't stray too far from their own predetermined official rates.

Brilliant article, Robert, really informative.

  • 41.
  • At 12:15 PM on 20 Aug 2007,
  • Peter wrote:

I just want to say thanks for the article. It's by far the best explanation of what's going on that I've seen.

  • 42.
  • At 12:16 PM on 20 Aug 2007,
  • Richard wrote:

Thanks for explaining how this works.

Any thoughts on how much money the so caller Masters of the Universe raked in for what looks to be no more than a sophisticated con trick?

Or more interesting how much of the City bonuses depended on it ?

  • 43.
  • At 12:21 PM on 20 Aug 2007,
  • Brian MacMillan wrote:

Interesting article, a further possible complication is if "Boomergeddon" comes early.

The US baby boom generation is getting close to retirement. Recent market volatility may encourage them to remove more of their retirement funds from the stock market and other investments thet consider higher risk.

This could further destabilize stock markets in the short term.

  • 44.
  • At 12:29 PM on 20 Aug 2007,
  • Stephen Evans wrote:

It's not rocket science, banks led to those less satisfactory credit histories and in some cases less than honest about their income. Interest rate goes up, people can't afford to pay......

Thank you Robert for the very lucid summary.

I think your final point about the Bank of England is spot on - yes the Fed should have offered liquidity but at penal rates (effectively it should have followed the market rates higher rather than trying to buck the market - which even Margaret Thatcher realised can not be done for long or with any credibility).

Cutting rates now would only add another tot of cash to the drunken debt binger's cocktail - and reinforce the Greenspan Put that effectively says no risk is too high for the return if you have the Fed propping you and the punchbowl up.

Borrow beyond your means of repaying and the central banks will bail you out - every time - until the next time when the crisis is even deeper because the risks taken were even higher and the contagion becomes uncontrollable.

Central banks need hard hearts and steady nerves (and should have raised rates sooner and faster when the asset bubble first appeared).

Yes the hangover will be painful (that's always true in real life) but that is necessary reminder that the rewards of risk must come at a price.

A healthy economy is like nature - red in tooth and claw - muzzle the teeth and cut the claws and you end up with a circus.

We should not subsidise speculators. Volatility and pain are actually healthy - surprises are good - because they keep everyone on their toes, looking over their shoulders and peering round corners - not lolling by the pool raking in cash without a care in the world, oblivious to storm clouds and reality.

Show me a multi trillion dollar market and I'll show you a multi trillion dollar fraud.

the real fraud underlying all of this is the idea that the central banks have any money with which to provide liquidity.

They create money out of thin air and then charge interest upon it. The Federal reserve have allowed the banks to borrow their way out of a hole. Again with fiat money (the interest of which has not been created). The banks have delayed and guaranteed the inevitable crash. With nobody lending anymore, where is the interest on the new liquidity going to come from?

  • 47.
  • At 12:33 PM on 20 Aug 2007,
  • Stuart Moore wrote:

I'll be honest, I still don't understand 90% of what you said and I'm not dumb but a long shot.
And theres the rub. I have this philosphy with money which is "if I don't have the money in my back pocket then I can't afford it !" and apart from my repayment mortgage I have never been in debt to anyone.
If I want something then I save for it and when I have enough money then I can have it. It's a simple plan but it works.
If the banking industry worked to such a plan everyone would understand and trust because everything would be transparent and simple.
Modern day banking is nothing more than smoke and mirrors.
The biggest crooks wear suits and work in the city.
And why are the national banks bailing out these idiots, let them suffer just like I would if I bought someone elses deferred toxic debt. It reminds me of when Lloyds went tits up, the powers that be soon stepped in to save their friends ,but when that xmas club savings scheme went pear shaped did anyone step in to help the ordinary man of course not ?.

  • 48.
  • At 12:35 PM on 20 Aug 2007,
  • Mark wrote:

Re post 39: Yes the central banks are supposed to try to keep the overnight interest rate at the target but the information I have seen reported suggests that the Fed rate was down at 1% at one point!!! This IS giving taxpayers money away. I believe they also accpeted unusual (i.e.dodgy) forms of security for these loans which also risks taxpayers money.

  • 49.
  • At 12:37 PM on 20 Aug 2007,
  • Chrissie wrote:

Excellent article.

I have always vigourously opposed the introduction of targets and bonuses for staff based on their sale of bank products. Not that the bosses cared, as their bonus also depended on those sales, and so on up the food chain.

Now there are signs of such corporate greed coming home to roost. I do hope they take note.

  • 50.
  • At 12:37 PM on 20 Aug 2007,
  • Chrissie wrote:

Excellent article.

I have always vigourously opposed the introduction of targets and bonuses for staff based on their sale of bank products, and got out of branch banking as soon as they were forced upon me. Not that the bosses cared, as their bonus also depended on those sales, and so on up the food chain.

Now there are signs of such corporate greed coming home to roost. I do hope they take note.

  • 51.
  • At 12:43 PM on 20 Aug 2007,
  • Sanjeev Talwar wrote:

let me tell the story about India. private bankers are treating their customer like anything. they just want to sell, sell and sell and if that does not happened then sell, after that sell. Public Sectors are not working at all. employees of these banks are just concern about the salary they are taking home.
Government policies are still not appropriate whether in India or in western world.

  • 52.
  • At 12:56 PM on 20 Aug 2007,
  • Andrew H wrote:

"The past performance of a financial product does not give an indication of future performance"

Oh, the irony! The banker forgot to read his own small-print.

Now to resist taking that Porsche of his hands when I should continue saving for the home repossession auctions...

  • 53.
  • At 01:03 PM on 20 Aug 2007,
  • Chris wrote:

Thank you for pointing out the mechanics of how the subprime crisis has translated into the financial meltdown of recent weeks. Another sorry story of how vasts amounts of money have compromised the integrity of institutions supposed to protect investors interests. Was this foreseeable? Yes. Was anything done? No. Now wait for a Sarbanes Oxley type rebound. Who will survive to peddle the financial instruments that bring about the next cyclical downturn. The major investment banks mentioned above. It is unfortunate that during periods of hubris regulating institutions do not appear to regulate the conflicts of interest that are the root cause of these problems in the first place.

  • 54.
  • At 01:08 PM on 20 Aug 2007,
  • Heather wrote:

Like yourself, I've long felt that the high levels of personal debt and default in the UK are linked to the policy of paying financial services employees with low base salaries and high commission potential. A 20 year old staffer earning a base salary of £11k is not going to make it unnecessarily difficult for a family to get a mortgage of six times their income or a massive and unpayable loan, not when a cut of the cash is the bank staffer's for the taking.

Problems don't begin in the boardroom, they begin at the front line, so this is where we need to start dealing with the problem, and on both sides of the service counter.

  • 55.
  • At 01:08 PM on 20 Aug 2007,
  • Chris wrote:

The article is a little tendentious, but interesting nonetheless.

However, the article fails to emphasise the benefits to everybody that this 'repackaging' of mortgage debt created - the main one being much cheaper mortgages for everyone, which saved the average mortgage payer hundreds (if not thousands) of pounds.

  • 56.
  • At 01:19 PM on 20 Aug 2007,
  • jasper wrote:

Damn good article mate.

More like this please.

  • 57.
  • At 01:20 PM on 20 Aug 2007,
  • Sam G wrote:

Very informative article.

After Enron collapsed I remember reading that the losses were spread so far across the market in bundled derivatives that were repackaged in seemingly endless variety that the loss had no obvious impact and no one was sure where the financial buck stopped.

While the banks' problems with short term debt show up pretty quickly how long is it going to take for the repackaged bad debts (the twizzlers) to untwizzle enough for the impact on the economy to become fully apparent?

  • 58.
  • At 01:28 PM on 20 Aug 2007,
  • Chris Roper wrote:

An excellent article - very concise summary of the current situation.
I can't help but get the impression that a severe crisis in the banking industry is not long in coming.
The United States has spread this problem around the world ensuring that this becomes a global issue.

It's all driven by the greed of the large institutions, and it will be the pensioners and private savers and investors that will undoubtedly suffer in the end... as usual.

  • 59.
  • At 01:29 PM on 20 Aug 2007,
  • Bija wrote:

Well done on writing about this in such a clear way - not easy in such a jargon-full market. I love the turkey twizzler analogy. That sums it up for me!

  • 60.
  • At 01:34 PM on 20 Aug 2007,
  • Another Charley wrote:

Hello Robert,
If I had made such accusations against Morgan Stanley and Goldman Sachs I would be quaking in my sandals, not just for me but the public BBC too! I will try hard to be more circumspect.
What bothers me is why you, the BBC, didn’t tell everyone about this a few years ago. “Liars Loans” have been available for years, which is why they are going bad now. Half a million mortgage brokers couldn’t find sufficient unemployed pyromaniacs happy to sign bits of paper in exchange for a free lunch so they had to make up a few names.
The following is extracted from a newspaper, I think it is probably the most amazing piece of reporting I have ever seen:
“The Bank of England deliberately stoked the consumer boom that has led to record house prices and personal debt in order to avert a recession, the former Bank Governor Eddie George admitted yesterday.
Lord George said he and his colleagues on the Monetary Policy Committee "did not have much of a choice" as they battled to prevent the UK being dragged into a worldwide economic slump by slashing interest rates. And he said his legacy to the current MPC was to "sort out" the problems he had caused.
Lord George, who headed the Bank for a decade from 1993, revealed to MPs on the Treasury Select Committee that he knew the approach was not sustainable. "In the environment of global economic weakness at the beginning of this decade... external demand was declining and related to that, business investment was declining," he said. "We only had two alternative ways of sustaining demand and keeping the economy moving forward - one was public spending and the other was consumption.
"We knew that we were having to stimulate consumer spending. We knew we had pushed it up to levels which couldn't possibly be sustained into the medium and long term. But for the time being, if we had not done that, the UK economy would have gone into recession just as the United States did."
He said he was "very conscious" that stimulating consumer demand could give rise to problems in the future. "My legacy to the MPC, if you like, has been 'sort that out'," he said. Under Lord George's governorship, rates were slashed from 6 per cent in 2001 to 3.5 per cent in 2003, pushing house price inflation above 25 per cent and high street spending growth to its highest since the late-Eighties boom.”
So, we are now in the “sort that out phase” and the recession has been successfully delayed and Gordon is Prime Minister. If Lord George can admit what happened surely Gordon Brown knew, as well as the European Parliament and European Bank. The same trick was, I fancy, being used by Sir Greenspan in the USA. All this talk of working for “low inflation” is nonsense when they know that governments are printing money like mad.
What we haven’t see yet is how many of the trillion dollars of American debt in Chinese hands is tied up in these bad debts. Only a little bit has been disclosed by western banks and Mr Bernake will have to revise his 100 billion dollar estimate.
I think that the scenario unfolding could now be rather grim. I think that we could see a rapid fall in the US dollar when interests rates are lowered which could lead to a continued race to the bottom for all international currencies. The day may come when EU citizens will not be able to take money out of Europe.
So, thank you for your article, it would have been a lot more helpful a few years ago.
By good fortune I was sufficiently untrusting of the “unreal” world of bankers and their politician lackies to purchase some of the gold that Gordon Brown sold at a rock bottom price but I admit to being a fool by having my pension with Equitable life.
I guess that you, like Gordon and Tony, have no fear of your inflation guaranteed pensions; most people looking at their next pension statement will be in for a real shock. The missing buck stops somewhere! The days of politicians looking after the horses and soldiers have long since passed.
Good luck with any forthcoming litigation.
Another Charley

  • 61.
  • At 01:35 PM on 20 Aug 2007,
  • Chris Roper wrote:

An excellent article - very concise summary of the current situation.
I can't help but get the impression that a severe crisis in the banking industry is not long in coming.
The United States has spread this problem around the world ensuring that this becomes a global issue.

It's all driven by the greed of the large institutions, and it will be the pensioners and private savers and investors that will undoubtedly suffer in the end... as usual.

  • 62.
  • At 01:40 PM on 20 Aug 2007,
  • John E wrote:

Good article - above all, the overall degree of risk/exposure still remains unknown, so the problem remains unsolved. Perhaps it would be a good idea to start putting the UK's house in order, by having a thorough investigation into all self-certified mortgages - I'm sure a few well-publicised fraud prosecutions would concentrate minds wonderfully - or would there be too big a risk of collapsing the entire edifice?

Yes thanks for taking the trouble to explain this. I see it's much more complex than people in the US defaulting on mortgages; there's a chain involved.

  • 64.
  • At 01:50 PM on 20 Aug 2007,

This may be time to think about the very old and deeply desired dream of owning one's own stand alone home. It is a nice idea which is not good for our society any longer. To heat and cool an individual home is extreemly expensive in comparison to units which have central systems. They also take up hugh amounts of space which kills farming and general green space. The owners of these homes also become slaves to morgages and the family spends a high amount of it's income maintaining the structure and all the contents. They would be better served economically with a more centralized and cheaper structure. Let's think about this!

  • 65.
  • At 01:57 PM on 20 Aug 2007,
  • kevin wrote:

ha ha I hope we all live in tents,some of these guys need to make 200 million in a career,bonds made out of bonds secretly and sold by some of most "respected"holding corps.
when will the human factor be inefectual in financial legislation.
suckers I hope half of the multmillionares end up having to dig ditches and live in tents

You've missed a key event that lead directly to this mortgage mess. In 1999 the US passed legislation that repealed the Glass Steagal Act. The Glass Steagal Act was passed in the 1930's during the Great Depression to separate the securities industry from the banking industry because of the mess they made then.

Once this firewall was removed in 1999, it was just moments before mortgages were turned into securitized bundles and started generating huge fees for the securities industry... at the same time causing a huge demand for more and more mortgages to sell (and collect even more fees...) so loan origination requirements were tossed out by the bankers because someone in Japan would hold the mortgage and because of bundling would not have much exposure if a single loan defaulted so who cares?

8 years later, suddenly we all care.

  • 67.
  • At 02:05 PM on 20 Aug 2007,
  • babyblueblanketboy wrote:

Chrissie - you've hit the nail on the head. The problem of irresponsible loans and mortgages is a question of incentives and accountability.

In sub-prime, those selling the mortgages are on commission and therefore care primarily about volumes of mortgages sold. More mortages sold = more commission. For these sellers, the subsequent performance of the mortgages has no impact to their pay packets. So why should the salesman care if the loan he sold defaults? Furthermore, salespeople generally move jobs frequently, which means that often they aren't in the same job when the chickens come home to roost.

It is exactly the same for the sellers of leveraged loans for LBOs. Origination teams in investment banks (the guys who structure the debt in a proposed LBO) are paid based on their net fee income, which is usually a % of the size of the debt in the deal. This means, in very simplistic terms, that the more LBOs the team transacts, AND the bigger the debt in a given deal, the bigger the end of year bonus.

If a LBO goes wrong, it typically takes two to three years to default, if not longer. By this time, the person who originated the deal at the bank may not be there anymore. Furthermore, the business subject to the LBO will now be managed by a different area of the bank, a step removed from the originator. Plus, the way the bank makes the original decision to lend is through a series of committees which effectively spreads the responsibility even thinner.

So who at the investment bank gets fired when a LBO goes wrong? Answer... nobody.

That's why bankers say, as I read in the Economist, that "It's better to have lent and lost, than never to have lent at all"

  • 68.
  • At 02:06 PM on 20 Aug 2007,
  • Bob wrote:

"The article is a little tendentious, but interesting nonetheless...However, the article fails to emphasise the benefits to everybody that this 'repackaging' of mortgage debt created - the main one being much cheaper mortgages for everyone, which saved the average mortgage payer hundreds (if not thousands) of pounds."

You're kidding aren't you? Those cheap mortgages just meant house prices rose (as, apparently, the only important metric is whether you can afford the initial monthly payments)... So in the end almost everyone lost out.

  • 69.
  • At 02:11 PM on 20 Aug 2007,
  • babyblueblanketboy wrote:

Chrissie - you've hit the nail on the head. The problem of irresponsible loans and mortgages is a question of incentives and accountability.

In sub-prime, those selling the mortgages are on commission and therefore care primarily about volumes of mortgages sold. More mortages sold = more commission. For these sellers, the subsequent performance of the mortgages has no impact to their pay packets. So why should the salesman care if the loan he sold defaults? Furthermore, salespeople generally move jobs frequently, which means that often they aren't in the same job when the chickens come home to roost.

It is exactly the same for the sellers of leveraged loans for LBOs. Origination teams in investment banks (the guys who structure the debt in a proposed LBO) are paid based on their net fee income, which is usually a % of the size of the debt in the deal. This means, in very simplistic terms, that the more LBOs the team transacts, AND the bigger the debt in a given deal, the bigger the end of year bonus.

If a LBO goes wrong, it typically takes two to three years to default, if not longer. By this time, the person who originated the deal at the bank may not be there anymore. Furthermore, the business subject to the LBO will now be managed by a different area of the bank, a step removed from the originator. Plus, the way the bank makes the original decision to lend is through a series of committees which effectively spreads the responsibility even thinner.

So who at the investment bank gets fired when a LBO goes wrong? Answer... nobody.

That's why bankers say, as I read in the Economist, that "It's better to have lent and lost, than never to have lent at all"

  • 70.
  • At 02:17 PM on 20 Aug 2007,
  • Dave Henderson wrote:

This crunch has been a long time coming, and I'm only surprised it hasn't happened before now.
I recommend anyone interested in this read "Liar's Poker" by Michael Lewis, in which he describes how Salomon Brothers (and others) invented a new bond in the early 80s. The very root of the problem we are now seeing. The Mom and Pop Savings and Loans were persuaded to sell on their loans via Salomons and the whole giddy merry-go-round has continued to this day.
Lewis wasn't hopeful that the long-term outcome would be good. I imagine he's saying 'I told you so' about now.

  • 71.
  • At 02:20 PM on 20 Aug 2007,
  • Professional Cynic wrote:

Quote 53. At 01:08 PM on 20 Aug 2007, Heather wrote:

"Problems don't begin in the boardroom, they begin at the front line, so this is where we need to start dealing with the problem, and on both sides of the service counter."

Actually that is EXACTLY where the problem starts, when Directors who may have little or no recent front-line experience (if any!)dictate that Payment by Results will be the order of the day.

Make it illegal to set such targets and the problem will be solved overnight.

  • 72.
  • At 02:26 PM on 20 Aug 2007,
  • P Lee wrote:

Both my husband and I used to work in lending (not mortgages).

We feel the rule should be that if you lend money you should go out and deal with the loans when they go bad.

I used to go out and collect money & repossess cars from people in default.

If the current lot of bankers were made to do this this whole disaster would not have happened.

  • 73.
  • At 02:38 PM on 20 Aug 2007,
  • Lee Kelly wrote:

There is a very simple and instructive explanation of the problem, which seems to have been overlooked by many commentators so far.

It begins with the simple question: why are people taking out risky and expensive mortgages?

The cost of any commodity or service, whether chocolate, housing, or entertainment, will increase when supply decreases relative to demand.

And the "cost" can be reflected in many ways, one being the price tag, another being risk.

There is a shortage of housing, and so supply has been decreasing relative to demand, forcing the cost of purchasing a home to go up.

In other words, there are more people bidding for fewer homes, and so to have any hope of outbidding a competitor, ever more risky mortgages are demanded.

That is fuelling a demand for risky and expensive mortgages, and it hurts the pockets of the poorest among us the most.

But why is there are housing shortage? It seems to me that "greedy" businessmen are never quick to turn down a profit-making opportunity. So why are they not rushing to satisfy this huge demand?

I would conjecture that government meddling in the market, from price controls, land controls, safety legislation, court battles and every kind of red tape under the sun are responsible.

The current crisis in the mortgage industry is just a symptom of a problem politicians have been sowing for decades. By reducing the inentive to invest in building new homes.

There is a shortage, not a scarcity. The materials, builders and land are there, it has just been made prohibitively expensive to use it by legislation.

I fully expect it will not be long until the very same politicians begin proposing legislation to "solve" the current problem, and blame the unregulated market for the disaster.

Prepare to say goodbye to yet more of our liberty, no doubt for "our own good."

I agree with all you say. But surely such failures of the marketplace are the responsibility of governments too?
In France to buy a house requires a minimum 20% deposit, and repayments cannot be more that 30% of your proven income. Such a control makes sub-prime loans illegal, and the banks cannot end up owning more than 80% debt on the asset.
I can understand why the US Govt dare not control its pack-of-cards economy, currently $1.3 TRILLION in debt to China - it would probably all come tumbling down!
But why doesn't Britain do this?

  • 75.
  • At 02:50 PM on 20 Aug 2007,
  • Shayne wrote:

As usual, Preston (a "journalist") offers up a superficial analysis of an economic phenomena evidently with the intent of illustrating that the entire thing is the designed result of some evil conspiracy. It wasn't. Also, Preston's superficial analysis would lead one to believe that the evil old bankers and mortgage facilitators are the only "greedy" participants. They aren't. And finally, Preston's article leads the reader to believe that only negative outcomes resulted (except for the evil old "rich folks") and that the economic sky is falling. There were and are enormous positive outcomes and the economic sky isn't falling.

Preston's description could have been a fairly good description of the mechanics underlying the current situation had he left out the metaphors, adjectives and other journalistic fluff AND explained that a liquidity crisis is not the economic disaster the other superficial journalists tout it to be. Thank your lucky stars Preston isn't a government, economist, central banker or other policy maker. I just wish he (and others like him) were actually journalists.

  • 76.
  • At 02:53 PM on 20 Aug 2007,
  • Shayne wrote:

My apologies - Peston, not Preston.

  • 77.
  • At 02:53 PM on 20 Aug 2007,
  • Steveh wrote:

It might have been better to point out that if the assets backing asset-backed loans are wont to evaporate, they are not really to be considered assets at all. This is evidenced by the fact that these loans are sold at penal rates of interest greater than those charged to most private borrowers for unsecured debt.

We shouldn't assume that these NINJA and LIAR loans are purely a US phenomenon. There are mortgage companies, sometimes the same companies, operating in this way in the UK. The are also presumably selling on their dodgy loan books to the same banks.

The employees of Goldman Sachs et al need have no fear. The history of Enron, Worldcom etc. shows that apart from a handful of Bernie Ebbers caught with their hands actually in the till, everyone else simply carries on unscathed and with bonuses intact. Arthur Anderson rebrands itelf as Accenture and carries on in business.

  • 78.
  • At 02:53 PM on 20 Aug 2007,
  • Richard Mac Cracken wrote:

An excellent article: 'If Bagehot were alive today, he would be rolling over in his grave'!

  • 79.
  • At 03:04 PM on 20 Aug 2007,
  • P.Dough wrote:

"To avoid a repeat of this kind of crisis, there needs to be a return to lenders taking some responsibility for the loans they make." Robert, I couldn't agree more, though I can't see them cleaning up their acts voluntarily. The question is with what carrot and with what stick? Not so long ago central banks and regulators' revision of banks and institutions in their market jurisdictions was part and parcel of operator life. The trend for revision boards to be influenced away from imposing inspections and sanctions in their jurisdictions has to be reversed first and foremost. Only then will a chance for the much needed cultural change and return to standards of which you speak within banking and finance arise.

  • 80.
  • At 03:11 PM on 20 Aug 2007,
  • Peter wrote:

Thanks for a great article Robert.
I have been watching your gloominess grow over the past few weeks but think that you missed that the worst is yet to come. Why limit your concerns to US residential sub-prime lending? It came to my attention recently the perpetrators of Commercial Backed Mortgage Securities (CMBS) don't really have a clue about the quality of the underlying assets but investors have been rushing to buy the stuff on the basis if a AAA rating, and what about the UK's 'Self Certified' mortgages?

  • 81.
  • At 03:15 PM on 20 Aug 2007,
  • Robin Fernandez-Medina wrote:

Thank you for your enlightening article. I work for a finance company, and can add, that the banks themselves have lend quotas, and that many times their employees are forced to overlook some risk factors in hopes they meet these targets. We do exhaustive checks on potential loan recipients, and even so, there are a lot of grey areas. To find them at such high levels is unnerving. Thanks for the elucidation on the potential scale of this whole fiasco.

Hello Robert,

There are a number of words that describe our present financial situation, including: greed, wishful thinking, greed, stupidity, greed. As you can see, I feel it mainly is driven by greed and lack of moral values. Unfortunately, our centeral bankers in the U.S. and Europe are controlling the economy with interest rates, but I've always felt it would be better to control the economy with loan to value ratios. If someone doesn't have any equity in an investment, they will always be willing to take risks based on greed. We are in fact pushing the day of reckoning into the future. These problems will not go away using some magical interest rates. We know that we must pay, sooner or later, for the bad decisions that we make in the present. I'm hoping that the children will understand that it's not good to be greedy, and that we all need to focus on our moral values.

  • 83.
  • At 04:02 PM on 20 Aug 2007,
  • jac wrote:


What surprises me is that any one is surprised!

  • 84.
  • At 04:04 PM on 20 Aug 2007,
  • Martin Usher wrote:

Great piece, the best explanation of the scam so far.

One thing that needs emphasizing, though. Every time this paper changes hands, from the mortgage broker on up, the pot is being skimmed. No intrinsic value is being created but real value is being extracted. This is inflationary, which is why I don't look at my house as having made money but rather the value of money itself having shrunk.

The UK market seems to have much higher inflation than the US one and equally creative mortgages (I know at least one recent purchaser who's on one of those "teaser rate", possibly even negative amortization, ARMs). Whether the market there explodes depends on how much new money -- real money, that is -- that's being pumped into it from outside.

  • 85.
  • At 04:37 PM on 20 Aug 2007,
  • Michael Wild wrote:

J K Rowling said it best: "'Ginny!' said Mr Weasley, flabbergasted.
'Haven't I taught you anything? What have I always told you? Never trust anything that can think for itself if you can't see where it keeps its brain'". (Harry Potter and the Chamber of Secrets)

  • 86.
  • At 04:57 PM on 20 Aug 2007,
  • Gordon Gekko wrote:

"Greed, for lack of a better word, is good. Greed is right; greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit."

  • 87.
  • At 05:04 PM on 20 Aug 2007,
  • phil wrote:

can anyone explain how long this US mortgage madness will go on or take to unravel fully. The banks who hold this debt have no direct knowledge of the liar loan holders, so how can it be resolved until the end of each individual mortgage.
How can any of these bundled loans be risk assesed ,as they are so far removed from the original mortgages Is a property market crash around the corner ? not just for US , but us as well.

  • 88.
  • At 05:28 PM on 20 Aug 2007,
  • Richard wrote:

I thought you shouldn't borrow short to pay long?

  • 89.
  • At 05:39 PM on 20 Aug 2007,
  • Helen in Seattle wrote:

Thank you the detailed analysis. We only get bits of the story. I'll look up the Caroline Baum article in Bloomberg.

  • 90.
  • At 05:44 PM on 20 Aug 2007,
  • Robert Lindh wrote:

Why should anyone be amazed at this situation? The laws governing banking in the US are manufactured to order by the Congress who sell them to the lobbyists. It's called Boutique Capitalism.

When the scheme fails, (which it is designed to do) the Fed simply bails out their capitalist pig friends on Wall Street by inflating the currency, thus providing the masses the opportunity to pay the cost through higher prices of goods. Not even Lenin could have imagined the extent to which these pigs would graze upon the commons.

  • 91.
  • At 05:48 PM on 20 Aug 2007,
  • george wrote:

There is growing belief that the big players have cheated investors while stuffing their own pockets with big pay packages

  • 92.
  • At 05:56 PM on 20 Aug 2007,
  • Matt W wrote:

Here's my tuppence:

We've got ourselves into a precarious situation. Our growth has been fuelled by a credit boom - allowed because the laws instituted to stop credit booming instituted because of the Great Depression were dismantled - that has permitted stocks and assets to appreciate beyond a sustainable price (fuelled by credit).

But here's the worrying part as far as I understand it. 6% of money in the economy has been accounted for by people removing equity out of their homes and spending it.

House prices just need to freeze for a period and, well, 0 growth just means thousands of job losses. Recession means hundreds of thousands. 6% (or even a close figure...) = you work it out.

Even worse - given the contractual nature of much employment job losses can be executed almost overnight. The downturn, when it comes, will not have the gradual shrinkage of even the late 80s recession.

Knock on effect? Obvious. Govt, even in this boom, has overborrowed to a shocking extent, therefore re-flation will be extremely difficult even just to slow things down.

Many of the large investors are quietly withdrawing from the market and leaving those who hesitate to make the losses.

Pension funds have commitments and will dump seemingly stable property assets to meet them. Hence...

It's not helped by the fact that the focus seems to be the American sub-prime market. Bad debt is endemic in this country. Self-certification has allowed too many irresponsible people to own property way beyond their means.

If you want to make money or even be safe. Sell-up and wait.

  • 93.
  • At 05:57 PM on 20 Aug 2007,
  • Traveler wrote:

One of the interesting things about this scandel is the simlarity to the energy comodities trading that occured in the US a few years ago. As a result of that, a major player in the trading, ENRON was singled out and the executive sent to jail. I am wondering if there are any bank executives that will be going to jail for this? I doubt it.

I may be wrong, but I have the perspective that the banks and banking executives appear to be too tightly associated with the leaders of the governments for the governments to be willing to prosecute. From my perspective, this is the reason that the FED and ECB chose to bail out the banks instead of letting them fall like they did ENRON.

I am not saying that what happened to ENRON all all the people that had invested in the company should have been delt with differently. What I am suggesting is that there is more to this story than what has been printed so far.

  • 94.
  • At 06:38 PM on 20 Aug 2007,
  • Naresh Sharma wrote:

Very good article.

Having previously worked as a secured loans underwriter, I have first hand experience of how the systems works.
We would get loan application packs from the high street branches from "reputable" lender. Having put the application through the lending process, when an application failed on affordability, we would advise the branch who in turn would then contact the lending manager as they were not happy with the decision. Now, as the branch based sellers were commision based the loan failing would hit them in the pocket. Two or three minutes of buttering up the manager, he would "amend" the income/expenditure details and low and behold, it's now affordable. When I questioned him on how it is now affordable, the answer came "it's secured, nothing can go wrong and we are not going to lose"
I often wondered why they bothered to have lending criteria............I left after about 3 months.
As and when the UK sub prime goes bad (which I think will be pretty soon judging by the volume of sub prime lenders)The whole industry is going to hauled over the coals by a MP's select commitee as possibly every MP has this "market" in their neck of the woods.
Now, where do I get tickets for this???

  • 95.
  • At 06:59 PM on 20 Aug 2007,
  • Anthony wrote:

I worked for a number of years as an abstractor of land title for a law firm here in the States. We specialized largely in foreclosures of sub-prime paper.

Mr. Peston called into question the "stated assets, stated income" mortgages made by mortgage brokers. I would also have to point to the problem of grossly inflated house appraisals, which were used to make some of these loans. Often we would see loans for at least two times the amount of what the house was realistically worth-- even in good market times. Sadly, appraisers are supposed to be professionals with professional standards.

Another often encountered problem with these sub-prime loans was that the title to land had so many clouds(problems with the way the rights in property had been conveyed in the past) and defects (prior liens and mortgages which had never been properly cleared.) In certain instances, we advised the client that his mortgage/note couldn't be collected because of all these prior problems and that he had a claim on his title insurance. And sadly, some of these mortgages were backed with very sketchy, if not nonexistant, title insurance.

  • 96.
  • At 07:16 PM on 20 Aug 2007,
  • John Albert wrote:

Good stuff. But all this was true and apparent 1 year ago and no one in the media had the courage to blow the whistle. Greed and excessive salaries in Banking, Hedge Fund cons etc are a scandal. The Governments are compliant with all this stuff as they are in the continuing acceptance of dodgy money into the markets from criminal sources and the drug world. The problem is mainly one of lost integrity and abandoning the moral high ground. Large salaries were only paid to people in the past after years of dedicated service , now any little fart who has 'attitude' is good for a million a year. It is a hopeless scenario and we are all guilty for not bringing the system to account.

  • 97.
  • At 08:11 PM on 20 Aug 2007,
  • Edward Desuque wrote:

Not all the wood in the fire-place has yet set ablaze. When US consumer confidence drops off, demand will fall, as will tax-revenues, widening the never mentioned ´defecit´, which will force the government to borrow even more, ´crowding-out´ everyone else from the market, and causing interest rates sooner or later to rise! And what will happen when the Chinese panic and sell US bonds? BOOM!

  • 98.
  • At 09:10 PM on 20 Aug 2007,
  • H. Chr. Hyltoft wrote:

Sir !

Thanks for the concise and professional presentation of the sub-prime issue >
highly appreciated > this article should
be mandatory reading for any of the heads of the Fed , ECB > Bank of UK ++ >
Thanks >

Question Sir !
How to get a copy of the article

  • 99.
  • At 09:14 PM on 20 Aug 2007,
  • CJ wrote:

An decent summation with one flaw, it seems to imply (and this may by my own misinterpretation) that we have seen the worst of the problem. Unfortunately this issue could have disturbing macroeconomic effects: The secondary MBS market has provided liquidity to a wide range of borrowers in the US, many of whom should never have received loans. With the introduction of more harsh lending guidelines and the originators inability to as effectively offset risk, the borrower is thereby faced with a tougher time getting a mortgage and when successful they are faced with a higher rate putting strains on personal finances. The culmination: falling house prices in the US and falling consumer confidence both of which have underpinned the strength of the US economy over the last few years.

  • 100.
  • At 09:23 PM on 20 Aug 2007,
  • Phil wrote:

Thanks for this article - and thank you too to posters here for continuing the agony of insight.

If elements of the UK or the US or the global economy become unsustainable or noted for foundations of sand and fraud where can a relevant buttress of regulation be created to understand the dangers and stop operators early in their tracks? Would any government be willing to create such?

  • 101.
  • At 09:35 PM on 20 Aug 2007,
  • jon frederics wrote:

Super article and frightening in the expose of the gullibility of the Banks concerned. But it doesn't explain the involvement of the hedge funds, which also must be trading these high risk bonds. Banks have deep assets and friendly central bankers - what cover and friends do secretive heavily leveraged Hedge Funds have?

  • 102.
  • At 09:39 PM on 20 Aug 2007,
  • Boris wrote:

Sorry -but this is simply wrong. I am about to damn the entire financial industry - from the lenders to the journalists.

I ought to preface my comments by quite categorically stating that I am a true capitalist, and in no way have any problem with the aquisition of wealth, however

In a word they are simply stupid.

They NEVER learn from their mistakes. They - mostly - are employed for their aggressiveness and ablilty to close.

The stock market is nothing more than a more fanciful form of gambling - run by the uneducted for the hopeful

I can think of no other industry in which fewer academic qualifications are needed for positions of such responsibility.

I can think of no other industry in which the REPEATED failure to learn from mistakes is rewarded with unerring regularity with the ability to make them again

I know of no other industry in which failure to adapt to REAL WORLD situations is again rewarded with unerring regularity with the guarantee to make them again

As someone who sneers at the financial industry from the sidelines - whether it was the "Dot Com Revolution" (where valuations of three-men companies was so obviously out of proportion to ANY sense of reality and yet fed-on with alacrity by traders) or the calamitous and precarious state of the lending institutions, it REALLY doesn't take either a genius or a statistican to see that they were all built 95% on hope - and hope alone

Prior to each financial crisis - and I am really not a student of finance - my real world antennae told me that the markets were on an unfounded frenzy of self-hyped excitement

I make a guarantee here that the very same mistakes will be made again, by the very same institutions, and yet again there will be an outpouring of analysis and counter-blame by the very same financial media and watchdogs. And this will happen within 10 years.

This is - of course - an astonishingly unscientific analysis on my part, however time has proven that my almost TOTAL lack of insight into this sector is only MARGINALLY less credible than the stream of 'analysts' we see on our screens who patently have even less core insght into what they are doing than I do - they are just on the other side of the fence.

I would be less incensed if it wasn't the average person on the street (of which I am not one) who ultimately shows faith and then loses-out.

It really is quite criminal how this sector manages to pull the wool over the faces of so many - largely because everyone involved WANTS to believe that things are fine and dandy

Can you imagine if doctors operated on patients because they HOPED that things would work out?

Please - any industry in which a successful company's annual results are met by a fall in their share price due to some spurious detail which doesn't affect the bottom line - really needs its wings clipped.

Get real people!!

  • 103.
  • At 10:26 PM on 20 Aug 2007,
  • Niels wrote:

Keep writing Robert. Yours is a voice of clarity and reason in what has become a financial world of increasingly obfuscated practices. We've always known that city kids have mentalities closer to barrow boys than choirboys, but your frank descriptions of what has been going on in the US mortgage market (and elsewhere) surely point to new lows of avarice and amorality. It's not nice to read, but it's better to have it out in the open. So blog on mate, and keep telling us what you know.

  • 104.
  • At 10:44 PM on 20 Aug 2007,
  • Mike Dixon wrote:

Fear follows greed as prodictably as night follows day. So what is the fear based on? Firstly must be uncertainty. That is clearly the immediate situation with the house mortage market and the banks exposure to it directly and indirectly is far from clear. What is most concerning is the knock-on to the wider commercial and manufacturing sectors. Many multi-billion buyout and mergers have taken place loading some very doubtful companies with debt with is unlikely ever to be repaid. Finally there is the question of national balance of payment deficits and rising national and state levels of indebtedness. The United States, of course, stands out on both counts but they are not alone. What happens if China and other holders of vast quanities of U.S.Bonds decides the either want a much higher rate of interest or indeed calls a halt to their acceptance. The United States did this to Germany in the 1930s, one of the main reason that the German Mark collaped. The boot might just be on the other foot this time round. It just might happen and this is enough to bring a feeling of panic.

  • 105.
  • At 12:42 AM on 21 Aug 2007,
  • Paul wrote:

Once again, hysterical socialists are eager to blame the industry for the failings of the individual. Those who lose their homes or miss payments or see their payments increase have no one to blame but themselves. Truth in lending laws require every loan agreement to clearly state the terms of the loan. If some choose not to read such details or elect to lie and overstate their income is it the government's responsibility to bail them out? If you don't understand the deal, don't take it! If you don't earn enough to support your lifestyle, spend less! These individuals are only too eager to scam the banks and misrepresent their assets but when the bill comes due, why, boo hoo, its not their fault. Its the evil money lender who seduced them into over extending themselves. Kind of like blaming McDonalds for making people fat.

  • 106.
  • At 12:52 AM on 21 Aug 2007,
  • Eric, Hedman wrote:

The world is not coming to an end. We go from boom to bust and back to boom. In 1902 it was the ridiculous stock boom based on power companies. In 2000 it was the internet stock bubble. In between there have been all sorts of financial booms and busts and in the long haul we keep on average getting richer. You just have to have a strong stomach for the cycles that are inevitable based on human greed. I know that the sky is not currently falling where I live in the USA. I've seen it before and I'll see it again. It takes these busts to figure out which market segment is the unsustainable one. People will remember this sub-prime market collapse until they find the next segment to over inflate. It is simple human nature.

Your Article should be placed, as essential reading to all would be students hoping to join the world of investment banking. It’s too late for our current commercial banks, as reputations have forever been tarnished. As they say in any business you are only as good as your last job. What can take years to build can be destroyed in an instant. Case in point here. I have never trusted even my own bank that as it happens offered these investments as secure safe as houses. But the individual banker was a bit to eager to have my deposited money transferred into these products. Only my gut instinct saved me from this horror. I still have my deposits. My next visit to my bank should make contact with this person somewhat strained to say the least. Unfortunately these banks are a necessary evil and will likely survive this. However I feel a change in the air and will no doubt hurt a lot.

James Kiernan

  • 108.
  • At 01:59 AM on 21 Aug 2007,
  • rod francis wrote:

Very interesting. Thank you for putting this information in clear black and white for the uneducated.

  • 109.
  • At 02:11 AM on 21 Aug 2007,
  • rob wrote:


There are about 44 million mortgages in the U.S., and less than 14 percent of them are sub-prime. And only about 13 percent of those are late on payments, with the majority of late payers working through their problems with the banks.


Only about 0.6 percent of U.S. mortgages are currently in foreclosure. That’s up from roughly 0.5 percent last year.

The recent increase in sub-prime foreclosures amounts to 0.01 percent of net U.S. household wealth.

The BBC has a vested interest in keeping you afraid, whether it concern terrorism or financial collapse.

Relax people.

  • 110.
  • At 06:39 AM on 21 Aug 2007,
  • Glen wrote:

Hi Robert

Great article and nicely written so that a lay person like me can make sense of such a complicated issue. Keep it up!

  • 111.
  • At 08:22 AM on 21 Aug 2007,
  • patrick wrote:

Paul (post 105)

Your post should be the last word on the subject. I couldnt put it better myself. There is a lack of acceptance of personal responsibilty in society as a whole....everything is someone elses fault, but as you point isnt.

James kiernan (post 107) banks are neccessary...not evil. As paul said if you dont understand/cant afford something dont bother take it. Banks are knocked far too much by people who simply ignore senisble financial practice (dont spend what you havent got).

can we please stop knocking the banks?

  • 112.
  • At 10:11 AM on 21 Aug 2007,
  • Peter Moran wrote:

I believe it was J K Galbraith who said that the first signs of economic madness are actually rather pleasant.

The UK economy has grown on the back of huge increases in house prices and the loans used to buy or improve them. Yet to a large extent costs of housing are excluded from the inflation statistics and hence any system feedback that would correct overlending is missing.

Could it be that if housing were not the engine of economic growth our record on manufacturing would be exposed and our true economic position obvious for all to see. No government could survive this and hence the needs to keep private sector loans funding the economy whatever the long term cost. The US is just learning this - us next? although we do have a genuine housing shortage we are not actually building the type of housing that would fill the gap.

  • 113.
  • At 10:46 AM on 21 Aug 2007,
  • Stephen O'Mara wrote:

Fantastic description of the creation of equity tranches or toxic waste. The problem is that the organisations responsible will not bear the cost. There has to be a way of forcing the investment banks, rating organisations to pay the cost of deceiving investors into purchasing this debt. For every piece of toxic debt marked a or aa or aaa, the investors need to punish the advisors. Governments need to withdraw there license to trade and force them out of business.

The mortgage brokers have their commisions, the partners and staff of Goldman Sachs have their commisions. The people most affected are the people who will lose their jobs as a result of the loss in confidence and demand. I am sure no investment bankers child will go hungry! Governments need to re-regulate, because these greedy individuals running the financial markets cannot be trusted to be ethical. For too long investment bankers are making money from tricky deals where there is nothing novel or real increase in productivity. For too long the Fed reserve has bailed them out. Real interest rates need to increase as a result of lack of supply of money. The Fed is simply putting the crash in financial markets off to another day, but it will happen. It will be bigger.

  • 114.
  • At 11:04 AM on 21 Aug 2007,
  • Marc wrote:

Hi Robert,

let me congratulate you for writing such a lucid article so as to make things sufficiently clear for the layman

  • 115.
  • At 11:15 AM on 21 Aug 2007,
  • R Taylor wrote:

While it is true, as Rob writes, that the media "has a vested interest in keeping you afraid", he fails address the fact that the Fed, the ECB and others are desparately attempting to keep the cogs on the banking machine moving. This is not a figment of the media imagination.

Credit has been lax across market sectors and the true exposure to the liabilities is unknown. Many of us, including many in the new 'emerging' economies throughout the world, have benefited from this easy money. It has generated consumption and employment which snowballed from the multiplier effect - classic Keynesian economics. There have also been downsides resulting from very uneven economic development, exploitation and increased global pollution leaving many poor and vulnerable people having to cope with the reality of the 'toxic waste' fallout.

Despite Rob saying "relax people", it seems likely that the squeeze on credit will continue and may well lead to a recession. If it happens, it will not be the end of the world. On the contrary, it may make people think more about the type of world they want to live in and how future development should be structured.

  • 116.
  • At 12:02 PM on 21 Aug 2007,
  • Dondon wrote:

let me get this straight. On one hand we have a load of people who borrowed money they could not afford to repay. And on the other we have people who invest in bonds they did not understand.

And the fault lies with .... the banks who sit between these two sets of people and find ways to channel money from one to the other?

What a load of rubbish. Don't borrow money you can't afford to repay. Don't invest in things you don't understand. Banks are there to match up borrowers with lenders, not to act as nanny to both of them.

  • 117.
  • At 12:41 PM on 21 Aug 2007,
  • Down in the woods he wrote:

This article only shows how lax the BBC has been in reporting the bad loans that have been made during the last few years.
Perhaps saying this is a little unfair as even Mr Bernanke said only recently:
"we believe the effect of the troubles in the sub-prime sector on the broader housing market will be limited, and we do not expect significant spill-overs from the sub-prime market to the rest of the economy or to the financial system".
And German state banks and US mortgage companies have assured us that all is well before acknowledging huge loses.
If you have any doubts of how bad things really are here is yesterdays news:
“A flight to safety on Wall Street caused yields on 3-month US treasury notes to plummet at the steepest pace since modern records began, eclipsing moves at the height of the 1987 stock market crash.”
(Even the BBC world service heard about that and reported it a few minutes ago. Well done!)
Now here is todays news from the USA: “LOS ANGELES (AP) -- Foreclosure filings rose 9 percent from June to July and surged 93 percent over the same period last year, with Nevada, Georgia and Michigan accounting for the highest foreclosure rates nationwide, a research firm said Tuesday.
This rticle is more history than news!
if you had been well informed a year ago and sold all your shares and bought a bit of gold it wouldn’t be looking too bad.

If billions of government money hadn’t been used to try to prop up the worlds stock markets the last few weeks things would be looking even better for us bears.

The Chinese seem to have become smart capitalists recently and the worlds free economies are now trying a little socialistic market intervention.

  • 118.
  • At 04:30 PM on 21 Aug 2007,
  • vms wrote:

In my view, the ratings agancies should be blamed.Clearly, they misled investors by giving AAA ratings to some sub standard products. Now when things go bad, its the investors who are paying the price , while these agencies are sitting pretty with the commisions they have earned over the years. Investigation is needed to unearth any potential scams.

  • 119.
  • At 04:44 PM on 21 Aug 2007,
  • John wrote:

Great article. But what worries me is all the unsecured credit card debt that is also dished out to borrowers. I know of borrowers with dozens of cards and have maximum borrowings on each - yet they only pay the mimimum amount each month as required. How foolish it is that banks issue cards to these people when they can easily check how many cards a person already has. And there is no house to sell and cash in when the judgement day for this unsecured borrowing arrives.

  • 120.
  • At 04:58 PM on 21 Aug 2007,
  • mike the economist wrote:

"Leandra wrote:
nobody able to afford to buy them - except the next round of speculators who will buy (cash is king) at fire-sale prices."

Wouldnt it be nice for the goverment to actually purchase these homes at fire sale prices to eventually sell on... and use the profit for social good??
personally i would love to see the morons who borrowed big get stinged!
mwah ha ha!

  • 121.
  • At 05:12 PM on 21 Aug 2007,
  • mc wrote:

Many seem to believe that the rich, the investment bankers, hedge fund managers, analysts etc will not suffer if asset prices crash. I can reassure you all that this will not be the case. A few may be able to get out but as soon as the majority head for the exits it will be too late. The riches held in assets will be wiped out leaving behind the debt that will stand as a testament to their folly. Then these nouveau poor will shuffle shoulder to shoulder in the bread queues along with the rest of the unemployed.

This is what happened the last time debt triggered a meltdown in 1929. The long night is about to begin again.

  • 122.
  • At 06:00 PM on 21 Aug 2007,
  • DaveT wrote:

I find it disturbing that this subprime meltdown is happening again. We had a similar situation with the S&L (Savings and Loan) bust in the late 1980's in the US. Many similarities: zero-down, aggressive ARMs, negative amortization, piggy-back loans, conflicts of interest with property appraisors...etc.
So it appears to me that the regulators cleaned up these kind of practices with the S&L/Banking institutions themselves but over the course of the BushSr, Clinton, BushJr adminstrations they didn't think the same bad practices would be a problem when loans were securitized and sold as a CDO or MBS on the secondary market. How should this be a surprise to any informed and competent participant (industry or government) that the same type practices would again cause the same type results. In the case of the S&L bust, Congress had to create the RTC (Resolution Trust Corp) to be a clearing house for all the foreclosed property so the market could clear and not implode prices with disorderly firesales. With global investors a many levels removed from the actual collateral that they soon will own, the next step is to figure out a new clearing house structure to address this festering problem.

  • 123.
  • At 06:16 PM on 21 Aug 2007,
  • Karl Eysenbach wrote:

One drop of sewage in a vat of wine makes for one vat of sewage.

  • 124.
  • At 08:10 PM on 21 Aug 2007,
  • Steve wrote:

Wonderful article.

I am amazed that such financial
engineering was possible at such a
large scale. Leave alone the saps
who got loans they didnt understand -- how could bankers who presumably understand such things get into a spot?

I guess the old adage of "Let the buyer beware" was forgotten. Since lending money fundamentally depends on trust that it will be repaid -- when you lose trust why would you lend ?

As a follow-up article can you explore the consequences of this? that is, will anybody buy turkey-twizzlers anymore?

  • 125.
  • At 08:28 PM on 21 Aug 2007,
  • Tony Pettman wrote:

Thank you for the article.
Even clearly written, it deals with very complicated matters and so is hard to take in. This is the reason why repackaged loans were taken up by banks far away.
Only now, as the stock markets react, do the Governments react.
The response by US and EC and even Australian and Japanese banks has been truly huge. We have seen nothing like it before.
Why am I not worried? Because it seems far away.
Actually, 1929 was a long time ago, but there are parallels.
The point I am making is no one knows where we will be in 2 weeks time. Truly, nobody knows.
The only thing I am sure of is how worried those people who are running the above national banks now are. Now, that's got me worried!

  • 126.
  • At 09:25 PM on 21 Aug 2007,
  • Scott Robinson wrote:

why all this blame game against bankers, rating agencies, mortgage brokers etc.. when so much of this labelling and fear is based on ignorance and naivity!

Markets behave the way they are due to, as Keynes described it "animal spirits". Yes, there have been problems in the US sub-prime sector, but it has created contagion across to other areas of the financial markets because of human fear.

I work in structured products as a lawyer acting for all the big banks and these products are performing how they should - The people taking the most risk are losing and those with the least are not. And it is only those products that reference US subprime that are performing poorly. Others referencing high grade credits or reference other asset classes continue to perform. Furthermore, the fact is that the "AAA" rating of various tranches of these products hasnt been affected - its the ones with the lowest ratings that are.

These products are legal, valid and binding and not against public policy - the foundations of any contract under English law. The problem is that these products are working the way they should in a downturn and people as a result are nervous about investing in them. Suddently returns that were well above par are not so attractive with the risk involved. With adequate disclosure, this is a risk that investors take when investing. "Toxic waste" cannot be such if investors do not read between the fine lines. Sophisticated investors know the risks they are taking - humans are smart creatures and financial engineering and ingenuity is a product of that.

  • 127.
  • At 09:01 AM on 22 Aug 2007,
  • Brian wrote:

When I see top-flight bankers I see sheep, sheep and more sheep following the path that leads to easy profit and more often over a cliff. Dodgy loans to dodgy foreign leaders in the 1970s and early 1980s. Pile-it-high investment in frothy property in the 1980s and early 1990s. Now subprime loans. The first question, for those keen to make a quick buck, is which clever little ruse will be the next one followed by the ovine bankers. The second and more important question is why are the shepherds so prone to this 10-year cycle of narcolepsy?

  • 128.
  • At 09:35 AM on 22 Aug 2007,
  • Ed Addis wrote:

Not so that the people taking the most risk are losing. I'm a private net investor in the UK, with pension and ISA funds, and like anyone else in this position I lose when the markets fall. Any kind of behaviour as described in this article, which leads to an unstable market, harms me and people like me. It's to be hoped that those responsible will pay the price through loss of bonuses or even jobs, but I doubt it - the financial establishment will close ranks to protect its own.

  • 129.
  • At 10:01 AM on 22 Aug 2007,
  • John Greenhalgh wrote:

Mr Peston, I found you article very interesting along with the various comments posted by readers. In respect of sub-prime in the U.K., I value property in the North West and believe the following:

There are two potential domestic sub-prime markets in the U.K., the first being owner occupation, and the second domestic investor.

On balance I suspect that it will be the investor market, that is most at risk of contraction and default on mortgages. The volume of apartments/flats that have been, and are being constructed is significantly in excess of the number of tenants waiting to fill them.

The over-supply has led to a stagnation/fall in rental values, and an increase in repossessions.

The situation is such that some institutional valuers have been instructed that when valuing apartments/flats, it must be a forced sale or repossession value only.

We value domestic property for part exchange [main stream house builders] and believe that the value of flats/apartments in the Manchester area has actually fallen in the last twelve months.

In respect of commercial and domestic property, the yields have fallen dramatically in recent years due to exceptional demand to invest in property, correspondingly years purchase multipliers have increased along with capital values.

However it is believed that if the Government introduces the new empty rate relief scheme [which if it comes in] will significantly reduce the current empty rate relief available for commercial [as opposed to domestic] property, values will be affected and yields and Y.P. multipliers will drift back towards historic levels.

As a consequence of the above and the current loss of confidence on mortgages secured against property in the U.S. it is possible, that we could see a decline in values in the U.K..

One market force that may hold up domestic values is the volume of people coming into the country. There have been cases where Local Authorities have placed refugees and/or other immigrants in new apartment buildings. Needless to say some investors and more particularly owner occupiers [of which there are few] have not been too happy with this.

The recent Housing Act may also have some effect as it gives Local Authorities the opportunity to take over empty dwellings and make a management order.

In essence the investor of the empty house or flat would have to pay an occupied council tax charge, or risk the property being taken over by the Authority.

As regards traditional houses, in the North West tenant demand tends to be good, but less so for flats. On balance whilst there are clearly problems with the debt spread from U.S. mortgages, providing institutions do not reduce their loan to income ratios [which I understand can be as high as 6, where traditionally they would have been 3], the owner occupied market should not suffer significant loss of value.

Although as my son pointed out to me, it would be better for him if there were a wholesale collapse in prices, because then he could afford a house. I conceded the point given that water, food, clothing and shelter are essentials, if shelter [homes] become more affordable, it will be a great benefit to the young.

To conclude, whilst we do have an owner occupied sub-prime mortgage market, it seems to me little different than that of the last housing boom 1987 - 1990.

  • 130.
  • At 12:23 PM on 22 Aug 2007,
  • Chris G wrote:

Thanks for a great article

Where do we go from here? Who can be trusted? Are we sitting on a time bomb? How many dodgy mortgages exist in the UK?

Where is it safe to save?

Is it not about time for our government to take action against irresponsible lenders who seem to plough on regardless?

Now I am worried

  • 131.
  • At 01:03 PM on 22 Aug 2007,
  • Deepak Chawla wrote:

I'm a "to be" first time buyer and have waited for years for the housing market to fall. Now when the market is slipping and taking its natural course. there are talks of reduction of interest rate in US and not to raise them in UK even though its needed to calm the economy.

In simple terms, all the economic plans are made to suck the last drop of blood of the common man and give it to the rich.

Either you are in Zimbabwe or England. The only difference is PR.

  • 132.
  • At 01:37 PM on 22 Aug 2007,
  • andrew wrote:

I am a solicitor and a trader.

It is a criminal offence to overstate your income on a mortgage application and would usually lead to prison. Similarly if banks, financial firms and lawyers fail to notify the national criminal intelligence service of any suspicions of fraud, including suspected overstating of income on a mortgage applictation, then that too is a criminal offence carrying a prison sentence.

So where are the police investigations and prosecutions?

  • 133.
  • At 02:27 PM on 22 Aug 2007,
  • matt wrote:

Why do you say "There is - Contra the economist- a serious moral hazard problem here"?

My understanding of the Economist's position is that they don't believe central banks should bail out financial institutions - they are all too aware of the moral hazard problem. Rather they welcome the squeeze as a way to make banks face up to risk properly.

Why then do you say "Contra"?

  • 134.
  • At 04:59 PM on 22 Aug 2007,
  • Daniel Law wrote:

The article was great, but I as a banker who has set up two banks and also worked for two of the named first tier brokerage houses [correct name, I just want to point out that most employees in the New Issue Departments have no idea what they are trading nor what they are doing. If they can make a "buck" then it is a buck, as it all goes to their year end bonus.

There is no thinking of what can happen two months down the line or are we at risk. Basle II demanded from the banks that the shore up their capital base, however as all in the banking industry know profits are "moved" offshore to companies in the BVI's and other places, thus hiding profit from the share holders and the tax authorities.

If there are loses due to "trading" these profits are returned via an off balance sheet booking and the loss is then only $500 million.

That others are hit like small customers, small councils and the average person on the street, does not reflect in the thinking of these people. BONUS is the word of the day and nothing else.

Maybe one day the banking world will go back to the point where one made a nice profit but did not go over bodies...

Good work Robert, not only for the concise professional writing but also for the exposition of facts. Off sheet markets lure too many unsuspecting investors, rely too easily on untested packaging, are watched only by deferent regulators and will never be reliable. Without your journalism, credulity cannot be measured.

  • 136.
  • At 09:58 AM on 23 Aug 2007,
  • Graham wrote:

Surely its the fact that accountability and responsibility are divorced from one another in all this that lies at the root of the problem. If the securitisation of loans were not permitted then the risk would lie with the lending banks shareholders. Now any form of morgage requires large long term lending met by short term deposits. we all want 25 year loans but instant access on our savings. This don't mix easily does it? Therefore the bank has to secure long term funding to meet the long term requirements of its customers. This should come from the retail banks lending to the mortgage banks (some of course are both). What those with cash deposits need to remember is that only something like the first £35,000 has any legal protection, a fugure set in 2000 and now withering from inflation. We haven't had a run on a mainstream bank in living memory (i'm thinking BCCI wasn't a mainstream bank) but there is always the possibility, and thus people with significant cash deposits should make use of accounts in separate names and with a variety of institutions of distinctly separate ownership (barclays /woolwich, Lloyd /C&G, Halifax/ Birminham midshires are not separate!!)to protect themselves. I've started to do this myself - while the risk of a banking collapse is very very very small, the risk of keeping all one's eggs in one basket is just too high for me to contemplate. Chasing the highest return from just a single institution isn't for me now. I recall everyone running around when relatively few people lost relatively small amounts of money when Farepack collapsed, saying how terrable it was. Notwistanding the pain and grief suffered there, which i admit was very real for those involved, the consequences of a bank going bust would be astronomic by comparison. And before anyone says it couldn't happen, just reflect that the Government will not guarantee that it couldn't happen, and limits your legal protection.

  • 137.
  • At 11:46 AM on 23 Aug 2007,
  • Galloping inflation wrote:

Moral Hazard can be forgotten as something rather old fashioned. “Liars Loans” and “moral” do not really sit well together.

Bottom line is that BANKS CAN NOT FAIL. A few funds, mortgage companies yes, but banks NEVER.
Bankers want bonuses; they make their profits in far away places leaving loses for councils, pension funds etc. Why should Barclays be scavenging around for a few bob? I thought they had billions of pounds ready for a take over.

Now governments are bailing out banks to save the day, they use Joe Blogs’ money to buy worthless mortgages from the same Joe Blogs who cant afford to finance them.
What will this rapid printing of even more dollars and euros and yen do? It’s really not hard to work out, even though for some reason the USA no longer publishes their M3.
“Why the USA no longer publishes M3 figures?” – now that would make for an interesting and news worthy subject for your next article !

Note: It is unlikely that governments or banks or their spokes peoplewill ever tell you that things are going badly.

  • 138.
  • At 12:23 PM on 23 Aug 2007,
  • Symo wrote:

As a financial idiot who knows nothing of the market place can I ask this. If these companies were small engineering firms not in the City of London with a turnover of "only" £50million, and they spent money they did not have; would Mr Darling, the BoE and the ECB be rushing to loan them out of trouble?
Of course not. Whilst the market is not like betting on a horse in that in general you are buying into something what JP Morgan et all have been doing is buying into risk. As such the risk has not paid off and the treasury should gain a back bone and not loan the money. What the FED have done is taught everyone of these investment banks that they will never lose out on risk, and as such the situation can only repeat itself.

  • 139.
  • At 02:18 PM on 23 Aug 2007,
  • Lee CLayton wrote:

I found the articlue very usefull, but I would like to say that not all Borkers are rouges or lead by commissions!!!!!!

  • 140.
  • At 04:43 PM on 23 Aug 2007,
  • Chris wrote:

My question is .. Who is being sent to jail? ..

  • 141.
  • At 04:57 PM on 23 Aug 2007,
  • dfcoates wrote:

So, commissioned paid mortgage brokers were complicit in exaggerated income claims so lying house buyers could borrow more than they could afford or pay back - I bet some landlords are worried if their tenants cannot pay the rent to pay the mortgages! A pyramid scam is illegal even if the salesman is a pin striped city type on a massive bonus for selling a worthless structured investment vehicle. But a real estate broker in Baltimore is making a $1m a month selling repossessed houses in outcry auctions to cash rich investor landlords to rent to people who just lost their houses because they lied about their income! Swings and roundabouts eh?

  • 142.
  • At 10:44 AM on 24 Aug 2007,
  • Jacques Cartier wrote:

People haven’t yet grasped the scale of the problem, which might be smaller than we thought. Let’s use some rough estimates to get a handle on the matter. If we assume there are 250 million people in American, and that one in 5 has a sizable mortgage, and that 1 in five of those is "sub prime", and that 1 in 3 of those will suffer total default, then we have around 3 million mortgages. Anyone was has noticed the relative decline of the US economy in global terms would soon realise that such a figure could not effect the whole world’s economy in the long term. We are not talking World War II figures, when entire economies were obliterated.

Sure, it has a bad effect in the short or medium term, and it is right to take note of it to avoid such poor investments in future. But the world keeps turning and it "ain’t no big deal" as they say in America. The message to take away is that a fool and his money are easily parted, as ever.

  • 143.
  • At 01:12 PM on 24 Aug 2007,
  • newspaceman wrote:

In the late eighties, I worked for the Halifax Building Society, progressing through the ranks of cashier etc - to mortgage admin - to mortgage application admin - to mortgage sales/customer services.

At this time, the Halifax was beginning to change from a laid back savers place into an aggressive, americanised, maximum profit making company.

It used to be the case that potential borrowers would have to save for 2 years, in order to obtain a 95% loan. 100%'s were almost non existent.

This changed almost overnight - as did our sources of mortgage business - business development became essential, and it was no longer carried out on the golf course on a friday afternoon - in the manner of a gentleman - rather it was a "what can we do to get your mortage business" - with regard to estate agents, brokers, solictors, accountants etc. Any source was welcome.

Now, obviously, not all the introduced business was top quality. It was more or less known that lending criteria could, in some instances, be reduced, or sub standard proofs of income etc accepted. However, a lender had to sometimes accept sub standard business - in order to obtain the quality.

Soon though, we were offering self certification. 80% LTV - no questions asked. We moved into commercial lending, 100% plus loans were commonplace. (as long as we got the endownment, b&c insurance, and MPP - plus often a referral to a local solictor - who in return would provide us with business.)

Then, almost overnight, it changed. Self cert - no chance. Dodgy refs - no chance. 100%'s - no chance. Back to 2.5 plus 1 income multiple. So no one could borrow money anymore - certainly not enough to pay the sky high house prices. So the market crashed.

Are we not just back to the same stage ?


  • 144.
  • At 01:45 PM on 24 Aug 2007,
  • Timmy Mac wrote:

This reminds me of the spiral of losses that purchasers of reinsurance ended up buying into during the 80s and into the early 90s that wreaked so much havoc for Lloyds and companies.

The, the ease of laying off risk into a soft reinsurance market put the onus onto writing a quantity rather than a quality of business, with little control over the content of portfolios.

A funny thing, but the Reinsurance world often tells itself it has much to learn from the Banking world and much to do to catch up with it!

  • 145.
  • At 02:44 PM on 24 Aug 2007,
  • enviromentalist wrote:

How this logic works?
Year end bonus is directly proportional to stock market rise
This means stock market fall will lead to fall in bonus payments.
less bonus means people will buy less number of cars.
less number of cars means less pollution.
less pollution is good for the environment.
So well done everybody.

  • 146.
  • At 06:54 PM on 24 Aug 2007,
  • Mike Dixon wrote:

The Spanish have been lucky in that there are no brokers in the mortgage business. All mortages are granted by Savings Banks which are Nutual Societies (as were the old style Brithish Building Societies) or by the commercial banks. There are a lot of 100% mortages out there, some with cars etc thrown in and some homeowners will be in trouble if interest rate rise significantly but the overall damage will be limited.

Another issue that has been rumbling on for years in both the U.K. and the U.S.A. has bee credit card debts. This is very difficult to do in Spain because the minimum monthly payment is 100%. The whole debt will be charged to your current account on the last day of the month and if that put you into an overdraft situation will be, well basically, your problem. Concentrates the mind somewhat.

  • 147.
  • At 08:44 PM on 24 Aug 2007,
  • Charles wrote:

Fantastic! Robert Preston has explained this situation so that all we laymen can understand it. It sounds like a James Bond movie, with all the necessary evil characters and plot twists. It's funny that Warren Buffet says he wouldn't invest in this stuff because he doesn't understand it. But Robert Preston has described it so clearly and accurately that all the previously ignorant people reading his article now do. Yeah, sure.

  • 148.
  • At 09:12 PM on 25 Aug 2007,
  • andrew wrote:

I feel many are missing the point here. In the uk the providers and the appliers for liar loans are engaged in criminal activity defrauding £10s-100s thousands on each transaction. The government has known this for years. No action was taken to curtail or stop it. Millions of brits and our biggest financial companies have committed serious criminal offences, while our government has been complicit by it's silence and reaped the benefit of re-election on the back of resulting rises in house prices.

It is madness to have allowed our major industry, one of the top providers of financial services to the world, the centre around which the majority of our economy is built, to have taken an active and criminal part in frauds totalling £100s billions.

We are not an engine of the world economy like the USA. Our financial industry's strength has been it's percieved integrity, honesty and incorruptability. Now that's about to go international capital will move elsewhere. The ECB's injections of liquidity and portrayal of it's banks as the victims of poor banking practice in the US was the first of Europe's plays to replace the City of London.

  • 149.
  • At 11:28 PM on 25 Aug 2007,
  • GFoster wrote:

Comment no. 142.

Unfotunately you are wrong and this is very serious. Sub-prime US loans were only the start, as is evident from the credit crunch that is now occurring. I do not believe it is contained and the head of the largest mortgage retailer in the US (CFC which is on the verge of bankruptcy)this week said this is likely to lead to a US recession.

I am also surprised the BBC hasn't picked up on the Fed's decision to let BAC and C (two of the US's largest banks) ignore standard bank reserving practices which increase the risks to the whole of the global banking system.

The UK may seem far away from the US at the moment, however the interconnected banking systems ensure that this problem is likely to migrate over here shortly.

As comment 143 suggests, we probably are going to face similar problems here in the very near future. I think we are just slightly behind the US. Let's just hope that the common assumption that "house prices always go up" holds true!

  • 150.
  • At 10:20 AM on 26 Aug 2007,
  • DaveH wrote:

Except environamnetalist, you are wrong on two grounds:

a) The words you should be using are "fewer" cars or "lower" bonuses!

b) Secondly, it is perfectly possible by shorting the market to make large profits and so, maintain a decent bonus.

The most interesting recent developments have been the near- collapse of several hedge funds and two German Landbanks, while the FT this Saturday reckoned that the ratching up of subprime loans would hit the central London property market (one of the two engines of so-called house prices rises). This crisis has plenty of life left in it yet.

  • 151.
  • At 03:35 PM on 26 Aug 2007,
  • ian h wrote:

I was encouraged to lie about overheads when applying for a mortgage last year.

House prices have been rising due to this attitude , yet I could not through principle lie about my overheads and didn't buy.

I now feel I've been cheated when reading about the housing market not falling as it certainly would have without these loans and 6x salary multiples.

We need as a society to become financially literate and stop these dodgy actions as people will get very hurt from them.

  • 152.
  • At 05:14 PM on 26 Aug 2007,
  • Anonymous wrote:

Comment no. 149.

> the interconnected banking systems
> ensure that this problem is likely
> to migrate over here shortly.

Then it is surely a very good thing that this has already happened and is now out in the open.

> we probably are going to face
> similar problems here in the
> very near future.

What problems? House prices in the states are down 1%, so no big deal there.

> I think we are just slightly behind
> the US. Let's just hope that the
> common assumption that "house
> prices always go up" holds true!

On the contrary. Those sitting on cash piles want to see house prices halved so that they can fill their boots. And even more, they are hoping for a steep decline in dollar value so they can fill their boots in America and (especially) Canada too.

And don't forget my kids ... they need starter homes at 3 times earnings.

One thing is for sure -- it's an ill wind that blows no man good. Is this really such an ill wind? Where is the uplift? At the end of the day, people have always lent money to wastrels and then lost it. If you want to keep your money, don't lend it to wastrels ... it's so easy.

  • 153.
  • At 10:17 AM on 27 Aug 2007,
  • mc wrote:

A lot of the money made in the city is through gambling. We hear much about 'sophisticated investing strategies', 'derivatives trading', 'short selling hedge funds', 'highly leveraged vehicles' and the like but these are smokescreens for what is, at base level, gambling.

I have been a gambler for many years, including trading futures and options on the markets, and one thing I have learnt is that eventually you lose. There are gambling strategies on even such basic games as roulette that can seem to be winning ones - they yield a steady trickle of profits over time but eventually you are wiped out by the improbable but inevitable run against you.

When the inevitable financial collapse happens new laws and restrictions will be brought in to prevent it happening again. Until the next generation, in its wisdom, sees fit to repeat the mistakes which are ultimately driven by that basic human emotion, greed.

The awful thing this time is that it is peoples homes that have been the subject of so much leverage and speculation. The economic consequences of what is coming could be devastating and the lessons hard.

  • 154.
  • At 10:40 AM on 27 Aug 2007,
  • Chris wrote:

Re Robert Peston's article " Liars' Loans". A first rate description of the current problems. Looking at readers' comments on your blog, noone appears to have questioned how safe is it to keep money on deposit with those UK banks whose main business is mortgage lending and who also have exposure to US sub prime debt. Some of these banks/building societies are offering above market interest rates, which could indicate that they are having difficulty in raising sufficient funds from the money markets. Should savers be worried about the risk of lending to these institutions or can we all relax because the Bank of England will bail them out if they have liquidity problems.

  • 155.
  • At 03:17 PM on 28 Aug 2007,
  • Teresa wrote:

"The UK housing market has also seen an explosion of "self certified mortgages" which, according to broker friends, are only used by people lying about their income."

If my experience is at all typical, your broker friends may be very wrong. Five years ago, when I last needed a mortgage (following a divorce), I was self employed. My bank (one of the UK's big four) refused to consider me for a 75% mortgage, despite the fact I had been a customer with it for over 10 years and had an exemplary credit record. Ironically, for years, the same bank had been exhorting me to take out unsecured loans. The reason the bank refused to consider me for a mortgage was that I could not provide audited accounts, though there was a simple reason for that. My self-employed earnings were below the level at which the IR required me to have my accounts audited, so I did the accounts myself and saved the accountancy fees.

I found my only option was to apply for a "self certified" mortgage, which I did. I have never missed a repayment and the mortgage will be repaid early. Needless to say, the bank that refused me the mortgage also lost the rest of my business.

  • 156.
  • At 04:25 PM on 28 Aug 2007,
  • Justin Pentecost wrote:

Thankyou for a very interesting and concise article.

Several people have said "Why did you not print this sooner", "Why didn't anyone predict this".

The answer of course is that everybody KNEW this was going to happen (Just do some searches on the net for "Market Crash"), and you will see people have been predicting this for ten years or so. Of course anyone who actually SAID it was subjected to gales of laughter.

The other point is that "self certified" mortages may well become a licence to print money, A friend explained it to me like this ... (And this terrified me and I don't have a motgage!) ..

The Buisness buys the loan at 10-20% of it's balance Ie:- House repossesed and sold .. £100,000 outstanding purchased for £20,000.

Then they investigate the selfcertification .. they ask the borrower to provide proof of thier earnign when they took out the loan, loan is proved fraudulent. Borrower now has no house and a £100,000 loan to pay back, no chance of bankrupcy (because he obtained the money fraudulently).

The buisness will make £5000-6000 from such a borrower FOR THE REST OF THIER LIFE.

According to my friend financial groups have been raising money for these ventures in the event of a market crash for several years. With the proviso that the law is on their side and that if the police stopped or refused to prosecute people fro fraud in these circumstances then the government would have to compensate the bond holder.

Of course Britain is an Island and they are not making any more land so it's impossible for house prices to go down here and as I am repeatedly told house prices are related to demand and no other factor (such as the availiablity of credit) we are all safe in our 110% mortgaged £250,000 one bedroomed starter flats in Peckham for the near future ..

  • 157.
  • At 11:42 AM on 29 Aug 2007,
  • Jacques Cartier wrote:

> Of course Britain is an Island and they are not making any
> more land so it's impossible for house prices to go down
> here and as I am repeatedly told house prices are related
> to demand and no other factor (such as the availability of
> credit) we are all safe in our 110% mortgaged £250,000 one
> bedroomed starter flats in Peckham for the near future.

Yes, but demand wanes when prices are high and wages are poor, for who could demand a house that they cannot ever afford to buy? And when demand wanes, prices go lower. So no, your Peckham flat may be a bad buy after all.

And, if anyone doubts this, consider the German property market, which was once on the up and up like here, but has been in a state for some years. A simple case of waning demand when prices are high and wages are poor.


  • 158.
  • At 12:50 PM on 29 Aug 2007,
  • Andrew Phillips wrote:

An excellent insight into the murky world of finance and refinance ad infinitum. The suggestion from contributors that the banks and the hedge funds will take a hit is laughable though.
The simple fact is we have been there before, the banks made big losses a few years ago from their equal economic incompetence in overseas lending and aquisitions. Guess what within a few months they were squeezing their ordinary customers till the pips squeaked and all sorts of quangos were brought in to ensure the banks followed an industry "code of conduct" remember them ?
Sadly it is the average joe who has to use our high street banks who will bale the banks out with eye wateringly higher banking costs and more almost fraudulent charges.
Watch while their chief executives get bigger pay rises or fat pay off's, enjoy the spectacle of no one but no one taking the rap (financial or otherwise), bask in the glory that it is you the ordinary customer that will pick up the total tab.
Perhaps we get the banks we deserve, perhaps we should do somethng about it.

  • 159.
  • At 01:14 PM on 29 Aug 2007,
  • Paul wrote:

Reading through a lot of this its surprising how much blame is attributed t banks/lenders etc rather than the individuals who take out these loans. If people themselves don't take responsibility for their own financial decisions then why should anyone else. I have a mortgage, I am not a mathematcial wizard, but I was easily able to figure at the time of borrowing that a) interest only makes no sense b) interest rates can rise and this will cost me more. There isn't much more to it that that, so anyone who doesnt even grasp those basics is probably in for a rough ride - but they should be few and far between. As for banks selling other institutional investors agency rated paper of varying grades, thats just the marketplace, and appetite for risk belongs with the purchasing institution. From where I sit, the biggest reputational losers here are the general public for demonstrating that they need more government to run their lives, and the ratings agencies who - for some time now - have demonstrated a troubling lack of autonomy. I think if anything related to 'more government' makes sense coming out of this, it's that goverment can play a role in funding and enabling an independent credit ratings agency, as well as mandating financial education as part of school and college curriculums

  • 160.
  • At 01:06 AM on 01 Sep 2007,
  • Sam wrote:


Breathtaking. We all knew this was coming, and probably will get worse! But by how much?

The resposibility has been put in the corner of the Banks and Financial Instituations; Well yes on one hand - they definately should have had tighter controls and stuck to them.

But what about the Home Buyers; The Buyers who took loans over their means are equally, if not more in some cases, to blame.

And the Fraud; Again two sides - Firstly Banks and Financial Institutions should, again, stuck to their controls and checked thoroughly everyone - rejecting all suspect applications. And as for the people who were known risks, should they have applied in the first place, let alone had applications accepted.

One big mess. And the Banks, Financial Institutions should act now to sort it.

(Revised - better phrasing and pronouns)

Following the news stories of this credit crunch and the alternative news sources (that have stated for years that something was going to make the system burst but not knowing exactly what was going to do it except in a few prescient cases), I am struck by the fact that the ones who will be hurt the most will be the little people, the hard working millions of drones who faithfully raise their families the best way they know how and pay their taxes on time. The rich will have the resources to weather the coming storm and ensure their children's future (yes, nepotism is alive and well in the Western world). For instance, many rich have many of their assets named in a business, perhaps even their house(s). If the business is able to stay afloat, they are able to tap credit and to cut costs (layoffs) to keep the business going, keeping the assets. But not so the working majority. They may "own" a house, car, furniture, etc... - all of which are collateral for debt. In fact, many people here in the States who live in condominiums (farcical sardine cans pushed onto the poor as a "home") are now not worth living in compared to renting when rising taxes and rising "association fees" stole what little advantage they had compared to just a couple of years ago. I know, I am one of them. And costs are rising, which means taxes and "fees" will be rising too. But not the "wealth" that was to promise nirvana; it is evaporating under my very feet as the "unit" loses its value under a sinking RE market.

And to those gold and silver bugs out there (of whom, I am also one), thinking that the rich are going to be outsmarted. Hah! We will wake up one day and find that the rich have passed laws to punitively tax hard commodity sales by any American citizen, and to avoid doing so would risk being caught when going to the blackmarket. Our heirs will forever be the feudal tenants of the rich who will place their children in places of power to control us and tell us when and where to live and what we will do for a living (if you can call working 2 or 3 low-paying, intensely cut-throat jobs and being totally exhausted all the time, living!). Pandering to the rich will become all the rage, and those who can please their masters will be given a few extra mealy scraps for dinner so they can go on pleasing them and thereby enshrining their power over the masses in a perversely textbook case of "competitive advantage". Through relentless Rationalizations and M&A, the rich will accrue so much advantage over the rest of us, that there will be no room for dissension. When we go back to the table and pleadingly ask, "Sir, please, may I have more porridge?", we will be met by the most derisive and utter rejection. Yes, it will be a New World Order. That, in the Old World Order, was otherwise known as SLAVERY.

  • 162.
  • At 03:22 AM on 02 Sep 2007,
  • Mark wrote:

Should I take out my violin and play a sad song or just get out my crying handkerchief and shed crocodile tears for the multimillionaire bankers who were too busy at "business lunches" to do their due dilligence and investigate where they were putting their clients' money? The great thing about dealing with suckers is that they come back every single time no matter how many times they get burned. I always look to foreign investors in the US but European investors in particular as contr-indicators. Whatever they are buying, I am selling.

Bad loans on a massive scale and housing boom bust cycles in the US are hardly anything new. Experts in housing have been warning of a coming bubble in the market for at least two years. How many hundreds of billions were loaned to third world countries by US banks at the urging of the US government which eventually had to be written off as bad debt? Argentina alone was in hock for $125 billion and the US bailed out among others Russia, Mexico, and southeast asia. The S&L crisis is not so long ago that some of us don't remember. And what about all those "structured notes" and other "derivatives" which were highly leveraged instruments based on the assumption that interest rates would always go down? Those guys sure looked like geniuses but when the went back up they looked like dummies sending entire banks like Banker's Trust in NYC into bankrupcy. The financial boy genius Robert Citron who managed the Orange County California County pension fund lost $1 billion and then sued Merrill Lynch saying he was a babe in the woods who had been duped. It just keeps happening over and over again. At least these sub prime mortgages are backed by tangeable assets, genuine US homes which while they may not be worth as much as the buyers paid for them now or as much as the mortgages themselves, will eventually gain in value even if it takes 5 or 10 years to come back. There are always more and more people who want to live in the US. Welcome to a lesson in Americanomics. Another is inevitable, the massive inflation (devaluation) of the currency. It happens every time the US government goes deeply into debt, it just turns on the printing presses and prints more money paying back expensive loans with cheaper money. It's still the safest investment in the world, you will always get something back, the government is not going to fall...we think, unless there is another 9-11 like attack. So the good news is that when inflation comes, those houses will be worth a lot more money and the lenders will get paid back...with much cheaper dollars. As everyone knows, the thing to buy during inflation is gold and real assets. Any Rembrandts or Picassos for sale...that aren't fake?

  • 163.
  • At 10:42 PM on 02 Sep 2007,
  • Dennis Stuart wrote:

bla blah blah Its just criminals in the finacial sector trying to make money out of thin air again like pyramid selling when the music stops its the customer who cant find a seat and has to pay the bill

  • 164.
  • At 12:53 PM on 04 Sep 2007,
  • Lossaversion wrote:

What we have seen in the past few weeks is an outright systems and governance failure stemming from the usual sources of greed and fear - essentialy behavioural issues that expose the limitations of free markets and capitalism.

Recent market turmoil is not just about sub prime but also relates to

1) Investment banks being unable to shift high risk securities

2) CDOs etc that have been structured on theoretical principales in finance theory and priced acording to models that assume that outcomes are normally distributed and of couyrse that there is always a market price.

3) Yen cary trade

The drying up of liquidity highlights the facts that we do not live in the rational normal distributed world of finance theory populated by Homo Economicus and that we are prone to have an overconfident/loss averse approach to these issues no matter how many PHDs and "experts" we throw at them.

This also raises major issues for the Central Banks with the Fed repeating previous errors by cutting rates and increasing the moral hazard associated with this type of lender of last resort activity i.e the Fed is supplying something market playrs want at a lower price - does the US have a negative sloping money supply curve? I think not I though these high powered Economics types would be providing money at higher not lower rates!!

BoE has done what is it can only do ie lend at higher rates

BUT we are in a situation not seen in history when markets (equity and non-equity) are more integrated han ever, the number of players larger and the level of leverage greater altough the seperation of brains from capital is now a common feature of the financial markets

There is probably worse to come but we can only see this sooner if CenBanks reduce the moral hazard they are currently imposing - similarly there is a real need to examine and assess how we got into the current situation where there have been significant goverance and systems failures. Plus ca change, meme la chose

  • 165.
  • At 01:26 PM on 04 Sep 2007,
  • Weng Ang wrote:

Replying to comments 136 & 154:

there is a compensation scheme to reimburse people who have money in a bank that fails. The Financial Services Compensation Scheme (FSCS)

FSCS can pay compensation for financial loss of up to £31,700 for deposit claims (made up of 100% of the first £2,000 and 90% of the next £33,000)

Banks rarely fail. The last deposit-taking bank to collapse was BCCI - it failed in 1991. (Barings failed in 1995 but I don't think it took deposits ie savings from the public)

  • 166.
  • At 07:05 PM on 04 Sep 2007,
  • John, Devon wrote:

Woody Guthrie said it all years ago:

"Some will rob you with a 6-gun, and some with a fountain pen"

What action will the central lending bodies (USFR & ECB) take, if the banks, where we are customers, decide that we should pay for their greed? It's difficult enough to live till we're dead with a government that's bleeding us dry.

  • 168.
  • At 09:43 AM on 05 Sep 2007,
  • karthik wrote:

good article. smart people wins allways. hedge funds run by best fund manager not going to be affected. government doing the best they can both us uk other countries.home buyer done the decision at best time at best price enjoy. the me too kind of hedge funds home buyer pay a heavy price some government also if they make any unwanted decisions. it happened in every boom dot com old commodities boom. please dont blame any one. intellegent people enter first and exit first. it is every one have to know their risk tolerence.look for next boom may be it is already of luck.

  • 169.
  • At 03:10 PM on 08 Sep 2007,
  • Paul, Leeds wrote:

What about the problem in the U.K. Even after the FSA regulations changed in Dec 2004, within the sub prime mortgage market people are still self certing more than there income. I have seen that in the firm I used to work for and been sold mortgages with SPML and I Group with teenagers promoting debt consolidation and incentivised with the number of sales they get according to morgage value. Then CeMap sales people sign them up. The majority of the mortgage applications I saw included income that raised suspicions to say the least e.g. 3k income from siblings for rent etc. A lot of these customers were starting with SPML that went 4 times peoples income in the first year then remortgaging after a year with I group as they could go 5 times there income and incorporate more debt.

  • 170.
  • At 11:30 AM on 14 Nov 2007,
  • Chris wrote:

The laws need to be changed with regards to who creates our money. If you believe money still comes from the mint go back to lala land. In a financial world where all money is created as debt(money=debt) we need to take control back from the land grabbing bankers and their puppets the politicians.

"Let me issue and control a nation's money and I care not who writes the laws."
Mayer Amschel Rothschild, 1790

Robert, an exceedlingly clear article, stating it exactly as it is. I have spent twenty years inside the cutting edge of the banking sector, and fundamentally what we've seen here is a slight of hand. Clever financial engineers have created instruments which appear to be haute cuisine, when inside they are laced with rat poison. The traders love them because they generate big bonuses - selling mutton disguised as lamb at a heavy mark-up. Their bosses in turn have turned a blind eye because they have delivered promotion and profit. The shareholders and the bosses at the top are happy because the bank has a higher credit rating, which ironically means it can lend more to the less credit worthy, boosting the institutional share price and the individual net worths which are linked to it. The situation we're now in is one where internally these instruments have been diluted by bad debt to such an extent that what you've actually got is a junk bond mildly contaminated by good debt, rather than a AAA+ rated bond diluted with minimal bad debt. Yet because of their false ratings, these bonds have continued to attract premium, treble-A prices, creating a credit avalanche like we've never seen before. Everyone inside the industry knew what was happening back in the 90's, it really should come as no shock to them, their bosses or the regulatory authorities.

  • 172.
  • At 11:41 PM on 26 Jan 2008,
  • Ganter wrote:

Regarding environmentalist at 145:

There will not be fewer cars on the road if bonuses are cut. There will be proportionately more old cars with poor emission performance. Hence MORE pollution ...

  • 173.
  • At 03:12 PM on 27 Jan 2008,
  • Tim C wrote:

I'm surprised that in these illustrious blogs I have not seen any calls for government taxation like a new kind of Betting Tax on trading of financial products.

Suitably detailed reporting of the nature of the traded product and the parties to the taxable trade, for example, might shed light on what is going on and the potential risks for all concerned (or as they say in Oz "Who's up who").

With powerful computer systems in use in most financial organizations I would guess such reporting could be made in real time, with settlement a little (daily?) later. A modern day twist would be to openly publish on the internet all such taxed transactions. Being able to see what positions, for example, hedge fund managers are taking could be most illuminating.

Such taxation would, of course, be a political matter and I guess we shouldn't hold our collective breaths in expectation of any early government legislation despite the obvious advantages another fiscal tool would provide to help manage what has become so important a business activity and wealth creator (for some) than trading in real goods and services.

President Sarkozy recognizes that there are new industries such as mobile phones and internet access providers that have matured and are now good and reasonable targets for taxation in France.

Is he wrong to move some of the tax burden to such growth sectors?

If not, then some suitable new indirect taxation of financial services may also be on the EU's agenda before long.

  • 174.
  • At 12:49 AM on 05 Feb 2008,
  • Soma Priddle wrote:

I agree with comment 171; this is an excellent article which neatly summarizes the situation. I am emailing it to several of my friends who have asked me how there can be such a crash when the loans are underwritten by real estate.

I would like to point out that these products sold because even professional money managers who are supposed to make sound analytical decisions got lost in the 'simulation' phase and made the intellectual error of believing that artificial symbols represented reality; easier when 'everyone else is doing it' (lemming fallacy).

I am a professional pilot. We train very thoroughly in complex simulators; however, the novice pilot is often interrupted by the instructor at key moments: "hey, look out the window". The mental habit of inputting complex data, forming mental representations of reality, and then abruptly discarding those representations when confronted with new facts is a key part of our training. (Motivation to live helps.)

In a previous life I took some degrees in Economics; ergo my following the profession with interest. I long to grab anyone who listens to the 'spiel' of the investment bankers and their minions and point out "hey, look out the window".

Alas, it is too late for so many innocent decent people, as ever, taken down with the scoundrels.

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