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We lose in Greed Game

Robert Peston | 12:05 UK time, Friday, 28 March 2008

I’ve spent much of the past few months investigating the causes and likely consequences of the credit crunch for a BBC2 documentary, Super Rich: the Greed Game, which will be broadcast at 9pm on Tuesday.

And as scheduling chance would have it, a radio documentary I’ve made on British attitudes to business, Britain’s Business Problem, will be transmitted on Radio 4 this Saturday at 8pm, in the Archive Hour slot.

As it turns out, the programmes are complementary.

At the heart of the television film – for which we interviewed some of the most influential players in global finance, including George Soros, Stephen Schwarzman, Michael Hintze, Jim Chanos, Sir Ronald Cohen, Mervyn Davies, John Moulton, Terry Smith and Paul Myners – is an examination of how remuneration practices at private equity, hedge funds and banking encouraged excessive risk-taking.

The first important point to grasp is that bankers, the private-equity partners, the hedge-fund managers were all using other people’s money for their deals.

Investment bankers invested the capital of the banks for which they worked. Hedge-fund and private-equity executives invested their backers’ funds.

And they topped this up – they “leveraged” their deals – by borrowing enormous sums.

In some cases, they put modest amounts of their own wealth at risk. But their personal exposure to these deals was usually paltry.

The structure of their remuneration represented – in many cases – a rigged bet for them: heads they won, tails everyone else lost.

As for those winnings, when the going was good rewards were on a scale that were beyond most people’s wildest imagining: millions of pounds, tens of millions, hundreds of millions.

Of course, not all private-equity or hedge-fund players earned quite such fabulous rewards. And their activities can help the process of allocating capital in an efficient way - which ought to stimulate economic growth and should be of benefit to all of us.

But they created a system of remuneration whose consequences do not appear to have been benign.

Here are the rules of what one hedge fund manager called the “greed game.”

The partners of the private equity and hedge funds would receive 20% of the gains made on investing their backers’ funds (and 2% of the value of the funds as an annual management charge).

And if there were no gains, only losses, the backers – which could be other financial institutions such as US pension funds or wealthy individuals – would feel all the pain: there would be no sharing of the losses with the partners of the private-equity firms or hedge funds.

That is what’s known as an asymmetric reward system. And it’s very nice work if you can get it.

Thus if a private-equity firm or hedge fund generated a capital gain of £1bn – and in the boom conditions of the past few years, that wasn’t unusual – the partners in the relevant fund would trouser 20%, or £200m.

But if there was a loss of £1bn, well only the backers would lose.

Why did the backers of these funds agree to be so generous? Because the better private-equity firms or hedge funds had provided them with good returns, even after paying the managers so much, for many years.

Also in the early years of this century, with interest rates very low and asset prices surging, most investors were carried away on a dangerous wave of euphoria that the good times could never end.

One consequence of this mouth-wateringly attractive remuneration system was a massive exodus of the brightest and the best from the investment banks and commercial banks into private equity and hedge funds.

That in turn prompted the banks to put in place analogous remuneration schemes in their own firms, to persuade their putative stars not to quit.

So the annual bonus for clever bankers became – in effect – 20% of the notional profit on the deals they carried out with their banks’ money. And it became commonplace for bankers to pocket millions and tens of millions of dollars every year.

Again it was a one-way bet for the bankers. If the deal went right, they received the enormous bonuses. If the deal went wrong and the banks made losses, what was the worst that could happen? The bankers wouldn’t receive a bonus for that year and might lose their jobs. But how much of a worry was that to those who had already earned many millions, more than enough than they could ever spend?

The remuneration system therefore encouraged those in charge of trillions of dollars of other people’s money to take much greater risks with that money than they would have done if their own money had been seriously at risk.

And, as we now know, the risks they took were – in many cases – crazy, and on a scale that has wreaked havoc on the global financial system, pushed the US economy into what many economists are already describing as a recession and is precipitating a serious slowdown in the UK.

If, for example, individual investment bankers’ own money had been invested alongside their banks’ and their clients, would they have been quite so enthusiastic to convert subprime loans into investments for sale to financial institutions around the world – and wouldn’t they have looked a little more closely at whether the borrowers of these subprime loans really could repay?

But with none of their own money on the line and the potential to generate colossal bonuses from selling these investments, many were seemingly seduced by their own propaganda: they apparently believed that structured finance was revolutionary financial technology for transforming poor quality loans into high quality investments.

There was an epidemic of Nelsonian Eye Syndrome on Wall Street and London. And bankers, private-equity partners and hedge-fund partners acknowledge – or at least some do – that the cause was good, old-fashioned greed induced by a turbocharged remuneration system that promised riches in return for minimal personal risk.

Reform of this dangerous remuneration system probably ought to be a matter of some urgency for shareholders in banks, the backers of hedge funds and private-equity firms, financial regulators and politicians – though right now their priority seems to be weathering the current financial crisis rather than pre-empting the next one.

As for the reputation of the City, Wall Street and the global banks that underpin our economy, that’s taken a serious knock.

Which brings me back to my Radio 4 documentary on why the British appear to be no more in love with business than they were 30 years ago, even though we’d all be a lot poorer if there hadn’t been a serious improvement in the productivity and competence of our wealth creators over the past 30 years.

My primary thesis is that the widespread unease of many Britons with the profit motive and their wariness of the private sector – especially of our biggest companies – is not conspicuously founded on reason. But my case hasn’t really been helped by the irresponsible way many bankers and financiers played the Greed Game over the past few years.

Comments   Post your comment

  • 1.
  • At 01:54 PM on 28 Mar 2008,
  • James Whitaker wrote:

I believe the banks have all traded these CDOs knowing that they were hot potatoes. They were making loads of money in the short term and it was worth their while to risk passing them on. Afterall, it was not their money to risk. All the top people responsible for this fiasco are now retiring with their bonuses of the last few years.
The damage has been done and we the public are picking up the tab by means of lower house prices, higher inflation, weaker currency and probably lower wages, although the job market down turn has yet to happen.
The fairest way to get out of this mess is to force the banks to auction off their dodgey loan assets in order to raise cash themselves. It might mean that some banks will not survive as the true value of these CDOs becomes apparent. The shareholders will loose some money. The depositors, ie savers should be reimbursed by a fund donated by all the all banks, private equity firms and traders through a windfall tax on passed bonuses and profits. The banks and equity firms caused this problem they and their shareholders and overpaid employees should pay to put it right.

  • 2.
  • At 02:06 PM on 28 Mar 2008,
  • Simon R wrote:

I believe that the reason people are not happy with big business in Britain is that a lot of the economic gains are just an illusion. Growth over the last ten years has been 120% government spending, debt and financial services. That is true wealth creation such as manufacturing and farming has actually been in recession since the Millennium.

The current credit crisis is now showing the true position. A few have prospered greatly but many have suffered. The profits of the banks can now be seen as a conjuring trick
we are now about to pay for. Debt levels and government spending are unsupportable.

We are now reliant on producers to export us out of the mess were in. The big problem is that a lot of the "earned" wealth of the last few years was simple asset stripping of the very producers we now need. The "New Economy" was a cancer sucking life from the "Old Economy" We have killed the golden goose and feasted lavishly. The big problem is we have sold all the golden eggs for years to come as the last drops of goose gravy dribbles down our economic lips.

  • 3.
  • At 02:20 PM on 28 Mar 2008,
  • Toby wrote:

The greed didn't just extend to the banks, but also to the regulators, and even the MP's via company boardrooms.

It's not like new wealth was being created, just money generated out of mortgages, with some thrown in from pension funds.

The net effect was a vast transfer of wealth from the public to the financial people.

This is a complete indictment of capitalism, but I don't expect that anything will be done to remedy the situation.

  • 4.
  • At 02:30 PM on 28 Mar 2008,
  • Deepak Chawla wrote:

In my view the banks should be made to take the losses and not pass them to us(customers) for there negligence.

This will stop this happening again.

If that needs legislation so be it.

  • 5.
  • At 02:39 PM on 28 Mar 2008,
  • Richard wrote:

Paying bankers in stock goes at least a little way towards sharing the pain when it goes wrong - look at the Bear Stearns staff who have lost millions and millions. If anything I'd imagine there will be a push towards all-cash bonuses to avoid that risk in future.

  • 6.
  • At 02:56 PM on 28 Mar 2008,
  • phil wrote:

Excellent points Robert.

Did anybody make them 2 years ago?

Its not rocket science - where were the media, the regulators et al?

  • 7.
  • At 03:15 PM on 28 Mar 2008,
  • Mad Max wrote:

It also marks the upper limit of an economic model that was allowed to operate without political intervention. The theory dictated that a freely operating market would always correct itself and that political intervention only hampered the market.

Well it did go wrong and the politicians had no choice but to intervene. The markets are still correcting themselves and hopefully this will be a slow drawn out process that allows a soft landing.

  • 8.
  • At 03:37 PM on 28 Mar 2008,
  • Ben Holland wrote:

The latest incarnation of the self-styled 'Masters of the Universe' would be very welcome to the bonfire of their vanities if it wasn't us feeling the heat from it all too.

  • 9.
  • At 03:40 PM on 28 Mar 2008,
  • shawshank wrote:

The problem with any such analysis is linked to your statement "we’d all be a lot poorer if there hadn’t been a serious improvement in the productivity and competence of our wealth creators".

Who are the wealth creators exactly?
The main problem is identifying the wealth creators and encouraging them. But its extremely difficult to quantify how much wealth a given individual creates, and because of this difficulty we see shortages in key sectors. Let me give you one example: at least 25% of UK secondary schools do not have a specialist science teacher in each of the three core sciences (source: BBC News website). What effect will that have on the UK productivity? A disasterous one for sure. But can you quantify it? How much wealth does one insipirational science teacher create? You simply cannot quantify it in any reasonable way, and that is why with our limited outlook we don't have enough incentives in place. Instead qualified graduates go off to work in sectors like finance. Who creates more wealth, a successful pension fund manager or a successful teacher? I really can't say for sure, but I bet you that the salary differences don't reflect the real contributions to productivity.

On the other side of the coin there are problems with ideas such as "competition". I agree that humans are lazy, and so we need competition as a motivator. But too much competition leads to poor division of labour. This is espeically true when the competitors are playing a zero-sum game: someone who works hard and is ambitious will still end up being a loser. So smart kids working at Bear-Stearns have lost out, and we too have lost out by not applying their talents somewhere more productive.

There are just so many ways in which the current system is flawed as a management tool for society. Although people might not be able to rationalise their suspicions of big business, I think that fundamentally their suspicions are sound.

  • 10.
  • At 03:47 PM on 28 Mar 2008,
  • anon wrote:

“The first important point to grasp is that bankers… were all using other people’s money for their deals” – Well yes, in the same way that someone who works on an assembly line in a factory does not personally pay with anything other than human capital for the production of the goods their company manufactures.

“The structure of their remuneration represented a rigged bet: heads they won, tails everyone else lost” – Actually it is more, heads EVERYONE wins, tails EVERYONE loses (including the employee who not only loses his job and possibly his business, but also suffers serious reputational damage. And to suggest that remuneration is somehow ‘rigged’ is pure fallacy. Don’t think that the people who invested in hedge funds and private equity are naïve. They are sophisticated investors, and I’m afraid that if you want to make huge profits, you have to take large risks and be prepared to take huge losses – private equity and hedge fund investors know this and they buy into investments knowing what a fund manager’s strategy is. Besides, there are many funds out there that offer low risk for low returns if the investor so wishes. If you were to insist on fund manager’s investing in their own products, what that actually means is that fund managers would be encouraged to follow investment strategies that suit their needs, not those of their clients.

“In some cases, they put modest amounts of their own wealth at risk” – tell that to the employees at Bear Stearns or LTCM who not only lost their livelihoods but their savings as well. Why should banking employees put all their eggs in one basket anyway? Robert Peston, of all people should know that diversifying your risk is one of the fundamental tenets of Finance.

As for suggesting that every banking employee makes 7 figure salaries or more, it is simply not true. For every one big earner, there are twenty or more people making mid-five digit salaries, which is by no means poorly paid, but certainly doesn’t mean that you can dine out at Michelin starred restaurants every day. In fact, perhaps we should complain more about how much BBC economists are paid? After all, it is actually the public who are paying for them, irrespective of their performance.

  • 11.
  • At 03:47 PM on 28 Mar 2008,
  • Bedd Gelert wrote:

Mr Peston, Surely one only has to look at the bunch of unsavoury characters that appear on the 'Apprentice', none of whom you would want to share a train journey with, tell you all you need to know about why the British detest these charlatans ?

I find great reassurance in the fact that there is more respect for academics and doctors even, dare I say it, for the lawyers and journalists of this world than for a rude, bullying egomaniac like Alan Sugar.

Sir John Harvey-Jones had more business acumen in his little finger than Mr Sugar possesses, and with wit , charm and civility thrown in.

  • 12.
  • At 04:09 PM on 28 Mar 2008,
  • B M wrote:

Before another penny of taxpayers' money is handed over to bail out these creeps they should be made to hand back their bonuses and the keys to the Aston. They should be grateful they're left with a job afterwards, let alone their ill-gotten gains.

  • 13.
  • At 04:09 PM on 28 Mar 2008,
  • paul_m wrote:

I look forward to the TV programme. For too long the public have been unaware of the extent of the financial industry's reckless behaviour and self-serving methods or remuneration. It is a blot on civil society and a national scandal.

Martin Wolf of the FT has written an excellent article on this theme two week ago entitled "Are Hedge Funds a Scam?"

In a system designed to protect the perpetrators, the worst that can happen to a banker is to lose their job. For an engineer or doctor, calamities on this scale would lead to them being sued for professional negligence and barred from practising their career.

I sincerely hope that the entire
credit crunch episode leads to society scrutinising the way this venal industry rewards itself and legislating to ensure responsible practices prevail. It becomes mandatory for bankers to risk their private wealth when dealing with other peoples money.

Proper punishment must also be meted out against those who have already "trousered" their bonuses after unethical behaviour. Fines at a minimum but preferably custodial sentences.

  • 14.
  • At 04:21 PM on 28 Mar 2008,
  • Bryan wrote:

Lets face it everyone in the know was in on this scam, and for the past year or so have been getting their 'retirement' packages safely out of reach in preparation for the reckoning. There will probably be some FBI investigations in the US. The ratings agencies should be the first port of call, after all they provided the false IDs (AAA) for the giant CDO ponzi scheme.

For the UK the full impact has yet to manifest. Falling asset values coupled with rising inflation (in reality already close to 10%) should grip the ecomony by early summer.

  • 15.
  • At 04:51 PM on 28 Mar 2008,
  • martin wrote:

Does anyone remember the Dot Com bubble ? I do it cost me a fortune . But its old news and so will this credit crunch in a few years .

People got greedy and it paid off for a few .I say good luck to them ,if someone offered me a million quid bonus I would take it like everyone else .

We are, where we are, so its time to knuckle down and get on with it. Complaining about greed is a pointless exercise and I expect something similar will happen again in the not so distance future

  • 16.
  • At 05:00 PM on 28 Mar 2008,
  • warwick wrote:

If these people must insist on huge bonuses for when they get it right, then how about we balance it with prison sentences for when they get it wrong?

  • 17.
  • At 05:01 PM on 28 Mar 2008,
  • frank.F wrote:

I see that 'our' greed has brought about this catastrophe in the markets. As a pensioner in a part of the country where none of this vast wealth has penetrated, yet which will bear the brunt of its consequences,I completely repudiate this. This is a result of the complete subordination of the state to finance capital, especially by 'new Labour'. Capitalism as a system has proved to have long outlived its progressive mission and it is time that its power to lead the world to ruin was taken from it.

  • 18.
  • At 05:17 PM on 28 Mar 2008,
  • Terry wrote:

At the end of the day, it goes without saying that whenever there's a bubble there's two things going on: a fast buck and a scam. Getting the financial system right is going to be a hard slog if the introduction of corporate governance systems is anything to go by. The first incorporated company (a bit like the kind we have today) was founded around 1650. Cadbury produced his report on corporate governance in 1992 which all listed companies have to follow (under "comply or explain"). So by my reckoning, a general sorting out will take around another 350 years.

  • 19.
  • At 05:17 PM on 28 Mar 2008,
  • Dave Ken wrote:

Mad Max, I'm sorry but that's rubbish -if this was a truly free market world then the banks wouldn't have loaned money that couldn't be re-paid in the first palce.
Economic models break down when they meet the hazy edge of human psychology,there's been many a person -more intellignet than me, that has tried -and fialed to bridge this gap between rationale, greed and fear. the world econemies run on specualtion and rumour, and a lot of people get rich or wrecked from the like -take HBOS for example.
A person is inteligent, people are irrantional, People are unpredictable -that's what makes it interesting

  • 20.
  • At 05:20 PM on 28 Mar 2008,
  • Chris_K wrote:

Whilst the wizz-kid financial people are to blame for a lot of the problems in the UK economy due to their repackaging of turd as sweet smelling rose petals, there must also be some blame put on Joe Average.
How can people have increased their consumption of FMCGs over the last ten years whilst they haven't been able to afford it? By banking on their property increasing in value forever.
The 'I WANT, I GET' culture is coming home to bite us all on the backside now.
Unfortunately even people that have been sensible are getting bitten.

  • 21.
  • At 05:22 PM on 28 Mar 2008,
  • adam wrote:

i can't help thinking that the same greed/optimism that led to the sub-prime debacle is still with us. Take a look at the equity markets. How can current valuations still be justified ?

  • 22.
  • At 05:23 PM on 28 Mar 2008,
  • Stephen Holding wrote:

I've done some figures, and they don't look too good!
We are told that current UK banking problems are down to lack of liquidity which is due to the inter-bank lending credit crunch, caused by the US sub-prime problem. It is now known that this problem was not caused by the borrowers, (scapegoats), being sub-prime, but by compliance at all levels of the banking system effectively generating sub-prime assets, causing huge amounts of money to be 'secured' against assets whose 'value' had been totally artificially generated by over supply of cheap money. (Ring any bells?). Thus, we are told, this problem is not of the UK's making, we are just suffering from it.

However, I am very concerned about the latest developments in the rules for emergency funding. A few days ago, the B o E asked the retail banks to apply for shares in £ 5 billion of emergency liquidity, whilst, of course, insisting there was no real problem. The total requests of the banks added up to 22.5 billion! A surprisingly large amount for institutions who still insist that there is no true liquidity problem. They are now trying to run a witch hunt for apparent scare-mongering short-selling traders. There is much made of it in the news, however, talk of the £22.5 billion cash request is conspicuous by its absence, yet this is just short of the £25 B originally pumped into the NR when it fell over for the same reason. In the recent meeting at the B o E, it was then decided to allow our retail banks to get much more emergency liquidity for longer; as much as they feel necessary, in fact. (A major excuse, err, reason for this, is to protect them against scare-traders)[Strangely convenient timing, that 'scare-trading'] Coupled with this, they are now to be allowed to offer mortgages as 'security'. (Ring any more bells?)

The average price of a house is ~230k. There are ~ 20M addresses. 230k x 20M = £4.6 trillion.
Average UK wage ~ £20k. Say household income ~£33k. At 3.5 x salary( the maximum multiplier used before lunacy managed the lenders, and brought UK property to its current 'value'), this makes the real value- that which is supportable by earnings- about £120k tops. This is a total of ~ £2.3 Tr

If a) the world system deciding that it's tired of lending good money to cowboys causes b) further real liquidity issues, which cause c) a substantial down turn in the housing market, which precipitates d) the selling of buy-to-let properties (whose value has been totally engineered by artificially low interest rates covered by inflation denial), and thus e)Merv doesn't get away with his potentially khamikhaze tight rope act, then a property crash, exacerbated and prolonged by major negative equity, (all of which has happened before), will ensue. The difference is that where, previously, reckless borrowers were left to pick up the pieces( not reckless banks), this time it is one huge step bigger. It pervades the UK banking system, to the tune of a staggering sum: it would leave us with a financial black hole of some £2.3trillion.

This is 4.5x the US sub prime situation of $1 trillion, £500 billion. Now tell me there's no liquidity problem! That could take the B o E out! Even the usual end of the line fall guy, the GB taxpayer couldn't foot that bill! Also, no one else is going to be stupid enough to lend money to a nation that exports its industry to China, and then gets into trouble because the half wits who are trying to bring about a social regression into the Rackman days, over bake the cake, and generate a melt down.

Where would the B o E find the money?
Could they perhaps trade on the global credibility of the City, use housing stock as security, and borrow it?


Steve Holding
Northorpe Grange
Gainsborough rd
Nr Northorpe
DN21 4AR
01427 628640

  • 23.
  • At 05:30 PM on 28 Mar 2008,
  • Neil wrote:

CDO structures are actually very smart things. They do work and they earn lots of money. AAA ratings can be justified normally - they get this rating because it would require say 30% or more of the portfolio to default before their payments are affected. The only problem with securitising sub-prime mortgages is that they are highly correlated and therefore if a few people are suffering it is likely that all the others will be suffering too. This is the reason why they shouldn't have been given a AAA rating.

Securitisation is used in many other circumstances, for example CLOs where the loans are spread between different companies in different industries and countries, i.e. low correlation. The same financial magic is used to create huge arbitrage profit as was used in sub-prime CDOs and there is no problem with them. It seems like people just don't really understand this.

I think those that assume bankers knew that this meltdown was going to happen are being a little skeptical. Being within a bank at the moment I can tell you this is not true, everyone thought this market was going to continue to boom.

Robert, you say, "My primary thesis is that the widespread unease of many Britons with the profit motive and their wariness of the private sector – especially of our biggest companies – is not conspicuously founded on reason. But my case hasn’t really been helped by the irresponsible way many bankers and financiers played the Greed Game over the past few years."
We ignorant plebs out in the sticks have realised for years that the City is populated by spivs and self-serving, greedy b*****ds. Our "unease" has always been well founded. We did not need you to enlighten us; but we are pleased that you seem now to be cottoning on to the unpalatable truth.

  • 25.
  • At 05:42 PM on 28 Mar 2008,
  • TRUST_NO_1 wrote:

Let's have a government inquiry (paid for by the PAYE taxpayer)
That's what usually happens after the event,followed by..
"...we will put measures in place to make sure this doesn't happen again....blah blah blah "
As if they didn't know this has been going on for ages.

  • 26.
  • At 05:48 PM on 28 Mar 2008,
  • Peter wrote:

Good article about greed.Can't help but think,however, that the public are both the fools and the victims.Fools because we are all now paying the price of the profligacy of the greed merchants........... and victims (or at least the backers of the private equity/banking houses are and their shareholders)for not obeying the first rule of investment..caveat emptor.

What will these greed merchants dream up next time?

Will the FSA fail to detect a problem?

Is the Pope a Catholic?

  • 27.
  • At 05:58 PM on 28 Mar 2008,
  • ChrisK wrote:

Whilst the wizz-kid financial people are to blame for a lot of the problems in the UK economy due to their repackaging of turd as sweet smelling rose petals, there must also be some blame put on Joe Average.
How can people have increased their consumption of FMCGs over the last ten years whilst they haven't been able to afford it? By banking on their property increasing in value forever.
The 'I WANT, I GET' culture is coming home to bite us all on the backside now.
Unfortunately even people that have been sensible are getting bitten.

  • 28.
  • At 06:02 PM on 28 Mar 2008,
  • bok choy wrote:

when will we see these bankers pay for their crimes ?

never I suspect , in the meantime these toxic loans/debt will ruin everyone else

its not joe public who has got richer over the years on this so called boom - only the wealthy getting wealthier - huh! nu labour strikes again !

  • 29.
  • At 06:10 PM on 28 Mar 2008,
  • stanilic wrote:

It is all about other peoples' money, isn't it?

As someone who has spent their entire working life in the real economy I have always been surprised at the periodic failure of The City to understand that added value or the return on the investment is what the economy has to be about.

I know when things are going wrong when besuited young men try to tell me there is a new paradigm and the only way is up. This has happened four times in my working life and I only believed them once.

However the occasional delusion in the financial sector is offset to a degree by the relatively modern British obsession that the state is the best provider of public services. This is another economic illusion that refuses to understand the concept of added value.

I suppose as a country we now have a culture in which investment is deemed as spending other peoples' money without regard to any return.

We have a serious problem: no wonder things are getting very tough for a lot of folk.

  • 30.
  • At 06:22 PM on 28 Mar 2008,
  • Chris wrote:

I'm surprised the BBC puts up with this sensationalist, one-eyed and misleading reporting. (Or the awful journalese and slang in which it is couched). Quite why Mr. Peston insists on lumping the whole of the City into the same stinking melting pot I do not know. Envy? Probably worse than greed.

I can only speak up for the private equity community, in which the managers maligned above are almost wholly aligned to their investors. They have nothing in common with the purveyors of US sub-prime mortgages. (The root cause of this temporary crisis).

Contrary to what is implied above, most private equity investors insist on c.10% contributions from those that manage them. That is a meaningful commitment. They also have to achieve an annual return of at least 8% (typically over ten years) for the profit share to have any value at all. Maybe that does not sound high, but average stock market returns over the last ten years have been round about zero. Not a penny of that profit share is seen until investors have all their money back, and that typically takes four or five years.

It is also ridiculous to suggest that private equity managers have routinely "trousered" £200m from the funds they manage. There are a few who have, certainly, but most private equity funds are far to small to generate anywhere near that.

If a private equity manager fails to hit this hurdle (and many do), not only do they get no profit share, but they are in severe danger of being unable to raise another fund and going out of business. That hardly encourages the sort of reckless investing of which the entire City is, apparently, guilty.

Those who have money in UK pension funds (most of us) have good reason to be grateful to the private equity industry for their contribution to their pension fund returns. (Which have outperformed over many years, not just the last few). They do not deserve to be bad-mouthed with other asset classes. I cannot pretend all is well in the square mile, but like it or not, it is one of the UK's greatest successes. It will emerge relatively unscathed from this crisis and in a much better position to compete against the US and other foreign banks that were the worst culprits in all this.

That should be roundly applauded and not done down at every opportunity by a journalist who supposedly represents another of the UK's most respected institutions. (For now).

  • 31.
  • At 06:23 PM on 28 Mar 2008,
  • Tim C wrote:

Chase mortgage memo pushes 'Cheats & Tricks' The bank says it never backed the strategies, which detail how to get an iffy loan approved

A newly surfaced memo from banking giant JPMorgan Chase provides a rare glimpse into the mentality that fueled the mortgage crisis.

The memo's title says it all: "Zippy Cheats & Tricks."

Oregon Live

  • 32.
  • At 06:23 PM on 28 Mar 2008,
  • alex wrote:

if only clever bankers did something useful with their lives - they are a sad waste of other's money

good to see so mnay going down now

  • 33.
  • At 07:55 PM on 28 Mar 2008,
  • Ted wrote:

With The LIBOR decoupling from the "official" interest rates doesn't that just mean the global market is, in effect, so large that it is beyond the ability of central banks, even acting in concert, to control effectively....after all they are trying to use money as a pole to lever a rock out of the ground that the "Off Balance sheet" ruses mean could be far,far larger than it looks above the surface.

At the same time when things are done basically to "restore confidence" BUT everyone knows that is why they are being done--- then isn't the effect actually to create an equal and opposite reaction to the one intended.

  • 34.
  • At 08:05 PM on 28 Mar 2008,
  • Ron Rankin wrote:

The top hedge fund guy in New York "earned" in 'incentive bonuses' in 9 months last year $2.7 Billion - that's 27,000 million dollars. Cross reference Time magazine.

He was the only one at the time that bet the bubble would burst. No s... Sherlock. Maybe he had heard of the South Sea Bubble while others were deaf and blind!!

  • 35.
  • At 10:25 PM on 28 Mar 2008,
  • Peter wrote:

Nobody forced clients and customers to agree to a '2 and 20' fee structure. Why did clients agree to it? Was the 'greed' of potentially good returns from hedge funds and private equity funds too much to resist?

This isn't a non-financially educated 'Joe Public' who got suckered in to funds with asymmetrical fee structures, its supposedly 'professional' pension funds, consultants and professional investors. Should we not be faulting them as well?

In essence, if I tried to sell you something at an extortionate price and someone who is meant to know exactly what it is goes and buys it - are the repurcusions of that my fault or theirs?

  • 36.
  • At 10:36 PM on 28 Mar 2008,
  • Mark my words wrote:

Overstating the present state of the economy is nothing new and has been done for years. What is shambolic is that greed led US lenders to lend money from the hardest up who would never be able to repay it. Then the City makes even greater profits by selling it on as attractive bonds.

In the USA there was no "Robin Hood" to see that the poor are not being missold massively-unaffordable loans.
(eg need for independent advice as here)
To enable the City to remain global there is no single, audited and imposed method to measure the value of assets. So , shareholders should be able to sue responsible partners as "experts". That would even out the boom and bust.

  • 37.
  • At 11:16 PM on 28 Mar 2008,
  • Harry S wrote:

The only thing that protected us from following the exact same route as the USA was the need for lenders to advise the hardest up to seek independent financial advice (and not, frankly to con them with unaffordable mortgages). To take us one stage further than this, investors should be able to sue "expert" partners and managers in companies for any loss sustained which could have been avoided by analysing what they are buying. Equally they should be able to sue for a relevant charity anyone who knows the asset exploits children or third world countries.

  • 38.
  • At 11:48 PM on 28 Mar 2008,
  • Peter Thompson wrote:

It's very difficult to be sure where this will lead next, we can only hope that it will end up with a more responsible and realistic financial sector, whether through regulation or self-policing. Somehow I doubt it though and scarily feel Mervyn King is right to summise that one day we will be here again. Is this the reality of capitalism or is it possible to find someone to take the reins and look after society as a whole rather than pander to the supposed financial alchemists and sharp of suit.

  • 39.
  • At 12:20 AM on 29 Mar 2008,
  • Tony wrote:

Excellent summary Robert ……worth pointing out though that the money these bar stewards pocketed when times were good came from the unsophisticated investment pockets of joe public.

The hedge funds manipulate stocks at the expense of the small investor and our pension funds. The banks make obscene profits which in turn trigger obscene bonuses when they should be giving a better deal to savers and small businesses. Ordinary shareholders get a raw deal whenever private equity firms get involved with a company.

While the availability of capital and the profit motive is vital, unbridled greed is not yet we pay undue deference to the city. No problem if you’re a Hedge fund manager or a Philip Green raking it in, we’ll give you non dom status and you can tell the Sunday supplements how you ‘made it’.

10 years ago Barclays gave 100 managers bonuses of £1m, and a boss received £21m in 2007 for doing his job! Maybe customers and shareholders should go elsewhere, but to where?

I sense a business opportunity, to increase market share, for the financial institution prepared to limit bonuses and tie the personal financial scrotum of the managers to the funds in their care!

Shame ‘anon’ didn’t seem to get the point but then methinks he is a banker!

  • 40.
  • At 12:32 AM on 29 Mar 2008,
  • Robin Wilson wrote:

You say "the widespread unease of many Britons with the profit motive ... is not conspicuously founded on reason", and yet your article states excellent reasons for our uneasiness. What is unreasonable in being wary of a system with such blatant assymetry between their gains and our losses?

  • 41.
  • At 01:09 AM on 29 Mar 2008,
  • Rick wrote:

This article has some interesting points but they should in general be rebuffed. The schadenfreude and scapegoating probably needs to run its course but before any actual action is taken there needs to be a proper assessment of the contribution made to the global economy by financial engineering.

Firstly and most obviously there is the employment and taxation of the thousands of people in the industry and the highly profitable banks and related institutions themselves. Yes some individuals and institutions can structure their tax affairs so that they avoid liability but the tax take is significant despite this. There is also the food chain benefit to everyone supplying these people with goods and services wherever they choose to spend their money, irrespective of their tax status.

Secondly there have been huge benefits to the global economy from the ability to match the risk appetite of widely differing investors across the globe (from the pension funds and annuity providers to outright speculators) with carefully tailored packages which redistribute risk from individual consumers and complex infrastructure financings into carefully assessed structures. This process has benefitted every mortgage borrower, credit card user, and consumer, and has enabled the financing of hospitals, bridges, tunnels and operating businesses which impact everyone.

The process is not foolproof but a lot of people in the banks and private equity houses have spent a lot of time trying to do this right, and a lot of people (regulators, auditors, rating agencies and investors) have examined these restructured risks from many angles to ensure to the best of their ability that the repackaged risks have the intended characteristics.

The current systemic seizure has two key sources.

Firstly, the US subprime market was allowed to get into serious mis-selling territory by under-regulation, and the risk assessment process downstream from the ultimate borrowers simply GOT IT WRONG for reasons being discussed here and elsewhere but including outright lies and fraud by individual mortgage borrowers.

Second, investors had become complacent about the levels of risk they were actually entering into, and began to rely almost entirely on credit ratings, at least at the less risky end of the spectrum. A credit rating is simply an opinion. The rating agencies develop their assessment methodologies very carefully and look in detail at every deal, but in the end the rating is just their opinion - it does not tell you anything about what is going to happen to the investment, just what some bunch of people think is the likelihood of getting your money back - and they can be wrong about individual deals and about whole sectors if they missed an important point.

What has been very poorly reported in the media about the losses made by the banks is that these losses are mostly notional losses caused by the falling value of all asset backed securities, not just CDOs. Very few of these have stopped making their interest and principal payments and the vast majority of them will eventually pay back in full.

There are genuinely loss-making securities out there but they are still fortunately rare and largely confined to US sub-prime mortgages - and even there these losses have largely yet to be crystallised by the process of foreclosure on properties at a net loss.

The current drop in the value of all of these types of repackaged securities is principally driven by the increased interest rates banks and investors require in the market for lending or investing. This in turn is driven by fear of losses in lending to each other, and the whole process is massively reinforced by forced sellers of assets, principally hedge funds facing demands from their creditors due to reduced collateral value and many SIVs who have, bizarrely, clauses in their legal constitutional documents that demand that they wind themselves up and dump all their assets in a short time period if values fall. That was clearly a stupid idea as it guarantees a loss for investors when the underlying assets are still performing well. The point here is that a lot of these losses will magically reverse if things stabilise - but that will be too late for anyone that sells into the distorted market we are in today, with massive over-supply caused by forced sellers and massive under-demand because these sellers were historically some of the largest buyers of these same assets.

The saga continues, and the knock on effect of the increased costs of renting money on the real world have yet to be really felt - but they will be painful and the chill is setting in.

The private equity investors and investment bankers have been providing intelligent and original solutions to financial problems and have often become very rich by chipping small chunks off very large lumps of money as they have sailed past, but this has only worked because millions if not billions of other people have benefitted in much smaller ways because capital has been finding its way to where it is needed in the most efficient way possible.

Public buildings and infrastructure projects have been financed cheaply, anyone who wanted a mortgage in the UK or the US has been able to get one. Everyone could have a credit card if they wanted one, or a car loan.

Perhaps people should live within their means, save rather than borrow, and PAY THEIR DEBTS - then there would be no crisis, but they generally find it easier to blame someone else, especially the relatively anonymous and generally wealthy financiers.

Please do not join in the witch hunt but take a more balanced view on the whole capitalist system where there is a necessary imbalance between the successful and the unsuccessful. By all means consider ways of reducing this divide but do not condemn the successful for playing by the rules and winning. The compensation structure in the City and on Wall Street works, but society needs to limit the gap between rich and poor and manage the redistribution of wealth without destroying the benefits which result from dangling the carrot of high potential earnings in front of talented individuals.

Generally this system works very well but like all living systems it has a tendency to over-react on both the positive side and the negative side and right now we are in a correction to over-availability of credit. This has already swung too far towards lack of availability of credit, but there still may be further to go before the pendulum swings back, and all the benefits we have seen from the availability of liquidity are going to be harder to obtain for a while.

This will hurt all of us, but we all share some of the blame and need to grow up a little, tighten our belts, and learn from the experience, not just kill the golden goose.


  • 42.
  • At 02:28 AM on 29 Mar 2008,
  • Pete wrote:

CDO structures are actually very smart things. They do work and they earn lots of money. AAA ratings can be justified normally - they get this rating because it would require say 30% or more of the portfolio to default before their payments are affected. The only problem with securitising sub-prime mortgages is that they are highly correlated and therefore if a few people are suffering it is likely that all the others will be suffering too. This is the reason why they shouldn't have been given a AAA rating.

Securitisation is used in many other circumstances, for example CLOs where the loans are spread between different companies in different industries and countries, i.e. low correlation. The same financial magic is used to create huge arbitrage profit as was used in sub-prime CDOs and there is no problem with them. It seems like people just don't really understand this.

I think those that assume bankers knew that this meltdown was going to happen are being a little skeptical. Being within a bank at the moment I can tell you this is not true, everyone thought this market was going to continue to boom.

Alex Post #15, I guess you are a low income earner, shame. I am happy to be "less intelligent" and earn more money than you. My small bonus will at least help pay off the mortgage on my million pound house.

Most people are workers, not owners.

Why on earth would the profit-motive be popular?

Robert, you make the mistake of assuming that there is no alternative to capitalism so workers should just be greatful for being powerless in the workplace.

But there is an alternative to tyrany in the economy - it is democracy in the economy.

  • 44.
  • At 08:19 AM on 29 Mar 2008,
  • Joe Par wrote:

How come so few publications are reporting on the attached letter that was written by Eliot Spitzer just weeks before he was arrested on prostituion related charges? Spitzer wanted to straighten up the banking system, the banks didn't want any part of that!

By Eliot Spitzer
Thursday, February 14, 2008; Page A25

Several years ago, state attorneys general and others involved in consumer protection began to notice a marked increase in a range of predatory lending practices by mortgage lenders. Some were misrepresenting the terms of loans, making loans without regard to consumers' ability to repay, making loans with deceptive "teaser" rates that later ballooned astronomically, packing loans with undisclosed charges and fees, or even paying illegal kickbacks. These and other practices, we noticed, were having a devastating effect on home buyers. In addition, the widespread nature of these practices, if left unchecked, threatened our financial markets.

Even though predatory lending was becoming a national problem, the Bush administration looked the other way and did nothing to protect American homeowners. In fact, the government chose instead to align itself with the banks that were victimizing consumers.

Predatory lending was widely understood to present a looming national crisis. This threat was so clear that as New York attorney general, I joined with colleagues in the other 49 states in attempting to fill the void left by the federal government. Individually, and together, state attorneys general of both parties brought litigation or entered into settlements with many subprime lenders that were engaged in predatory lending practices. Several state legislatures, including New York's, enacted laws aimed at curbing such practices.

What did the Bush administration do in response? Did it reverse course and decide to take action to halt this burgeoning scourge? As Americans are now painfully aware, with hundreds of thousands of homeowners facing foreclosure and our markets reeling, the answer is a resounding no.

Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye.

Let me explain: The administration accomplished this feat through an obscure federal agency called the Office of the Comptroller of the Currency (OCC). The OCC has been in existence since the Civil War. Its mission is to ensure the fiscal soundness of national banks. For 140 years, the OCC examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers.

In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government's actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.

But the unanimous opposition of the 50 states did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation.

Throughout our battles with the OCC and the banks, the mantra of the banks and their defenders was that efforts to curb predatory lending would deny access to credit to the very consumers the states were trying to protect. But the curbs we sought on predatory and unfair lending would have in no way jeopardized access to the legitimate credit market for appropriately priced loans. Instead, they would have stopped the scourge of predatory lending practices that have resulted in countless thousands of consumers losing their homes and put our economy in a precarious position.

When history tells the story of the subprime lending crisis and recounts its devastating effects on the lives of so many innocent homeowners, the Bush administration will not be judged favorably. The tale is still unfolding, but when the dust settles, it will be judged as a willing accomplice to the lenders who went to any lengths in their quest for profits. So willing, in fact, that it used the power of the federal government in an unprecedented assault on state legislatures, as well as on state attorneys general and anyone else on the side of consumers.

The writer is governor of New York. Eliot Spitzer.

This letter was written on February 14, 2008. Interesting that this legitimate attack on the bankers and administration was justifiable. More interesting, JFK and Lincoln were dealt bankers blows, while Spitzer was spared his life, snubbed none the less by the banks!

  • 45.
  • At 11:26 AM on 29 Mar 2008,
  • Parry HM wrote:

Step back from the heat of the moment. Greed is a fundamental driver of capitalism. As is beating the next guy and having a bigger car.

The remuneration systems at the origin of the credit crunch can be considered "sick" or as simply a feature of one extreme point of the cycle. If we are free to get 100% mortgages and switch our credit card debt around frenetically,then this is just another part of the same model.

Don't label the bankers as villains if you enjoy extreme leverage on your house financing or the spending power of credit card debt.
It's part of the same freedom and abuse of that freedom.

I was an Englishman living in Paris in 1987. I remember the process of saving at the BNP for a mortgage - the rules, the timescales, the lack of choice. But as it was the same for all, no one was miserable. Now 300,000 French live in London free to make money more easily.

So is it all "sick"? Do we want all this freedom to get rich quick? Is it a way to happiness? Not sure - but I do know it's not worth poking private equity/
hedge fund managers and bankers with sticks as if we were nothing to do with it.

  • 46.
  • At 02:56 PM on 29 Mar 2008,
  • Steve wrote:

What if you have had the misfortune of living in a part of the world (the south East of England for instance) for the last few years where these rich city traders are so prevalent? House prices are set by estate agents etc at a level just barely afordable by the average person within their immediate environment or catchment area, unfortunately the definition of "affordable" for richly remunerated financial whizz-kids is about 250,000 pounds and upwards, whilst for the rest of society the definition of "affordable" is a lot, lot less! It's all very well that such financiers write and tell us to "live within our means", what are you meant to do if you are say a couple of school teachers trying to bring up a child in an area where such conspicious financial earnings has pushed up the price of property to over 400,000 pounds for a tiny flat? The rise of a financial bonus driven culture for ever increasing swathes of the population has had a more direct effect upon life in the south East of England than just the current credit-crunch related concerns! There are many facets to the financial concerns facing this country at present, and whilst it is fare and correct to both blame the financiers for recklessness and the public for over-spending, I can imagine for a young couple living in this country today high spending is almost unavoidable! By the way, I am not an example of either a financier or the teacher example quoted, but I did live in London for a few years and I've seen what high purchasing power in a restricted sector of society can do to the overall cost of living-the average person on the average wage in this country is very, very financially squeezed at the moment and it will get a lot worse!

  • 47.
  • At 07:47 PM on 29 Mar 2008,
  • Jeremy wrote:

Robert - your mis-representation of the facts of the credit crunch is the sort of nonsense that feeds people's ignorance of how business operates and why we need entrepreneurs. As another comment on your blog already states, the investors in mortgage backed bonds and hedge funds are not naive victims but highly sophistioated investors who see the benefit of agreeing the types of deals such as the standard 20%/2% to which you refer. Perhaps, therefore, it isn't quite as unreasonable as you assume. Low quality assets can and have been turned into high quality investments - not by alchemy or sleight of hand but by carving up the loans into different strata of risk (and return) from AAA to BB ratings, based on rigorous statistical methodologies. The fact that not all of this worked perfectly does not alter the truth that the financial innovations of the last 20 years have served to direct capital ever more effectively to where it is needed, thereby promoting significant economic growth. It is inexcusable that you fail to mention this significant point. Even now, the vast majority of asset backed bonds will pay in full and most of the write downs are due to over-reaction, fear and panic. To damn the whole notion of securitisation for its recent failings is akin to damning the entire car manufacturing industry following the failure of British Leyland. You should understand the importance of failure in a successful economy. As for heads they win, tails the investor loses, show me a pension fund, managed ISA or equity fund where the managers don't get rewarded for success unless they agree to repay the investors if there are losses. Welcome to fund management!

  • 48.
  • At 08:57 PM on 29 Mar 2008,
  • Rude Boy wrote:

#2 Simon R

You have provided a neat summary of the conjuring trick.
Your suggestion that we will have to rely on producers to export ourselves out of the mess we are in ignores one factor though; who are these exporters?
As part of the conjuring trick universities and other state subsidised bodies have been busy slapping themselves on the back and destroying industry.
Wage levels at these bodies have raced way ahead of what can be earned in the "Old Economy". The result is that we have a generation that thinks hard work consists of filling in grant application forms.
Hardly the skills required for an exports led recovery.

If proof were needed of this madness that has engulfed the nation look no further than up on Teesside.
PD Ports have just been given the go ahead to build a £50M Import Terminal. Note "Import" not Import/Export. Just plain Import.

Invisibles will save us I hear. Invisibles like banking services?
Er... We need saving due to the failure of the very "Industry" that is to be our savoir? Stroll on.

  • 49.
  • At 09:56 PM on 29 Mar 2008,
  • harry e wrote:

The thing is Robert, it's not just CDO's, private equity or even hedge funds.

The City is essentially founded on the mis-selling of risk because of the asymmetric risk-reward you mention..."heads I win, tails you lose".

It doesn't matter whether it is endowments, pensions, bonds, split capital investment trusts. The list goes on and on and on.

Even the LSE is at it by inviting miners from exotic parts to enter the Footsie, so all those people who thought they had safe trackers,,,

I don't really have an anser for it apart from, only invest in truly what you can understand. So, if that is any form of an amalgam (with a nice name 'low cost endowment', 'high yield bond') avoid it like the plague.

  • 50.
  • At 10:07 PM on 29 Mar 2008,
  • tonyw wrote:

The bankers, hedge fund managers & private equity have created zero wealth. All they have done is taken our money and gambled with it for their own reward. The interest and charges that are charged by banks is taken from people and businesses.

It is this sheer greed that stops people loving business because all businesses get tarred with the same brush.

When individuals and people deposit money with banks they want it to be secure and not for the bank to gamble to the extent their money is at risk. The senior guys in these institutions should be held responsible and lose everything not walk away with a big payoff.

The traders' bonuses should be put in a pot that is not able to be touched for fuive years. In the event of losses they should be deducted from the pot.

  • 51.
  • At 11:13 PM on 29 Mar 2008,
  • R McAuley wrote:

This is indeed exactly what happened - but what must follow as a consequence of this wholesale destruction of our currency and economy is ruthless asset stripping of those involved in this monstrous fraud.

  • 52.
  • At 12:10 AM on 30 Mar 2008,
  • Dmitri wrote:

No matter how 'sofisticated' the debt-channeling financial tools were called, this was a trivial pyramid con which has finally collapsed. Those who were in the first few waves got what they wanted, and the remaning majority get the pain. Well, I expect that many rogue bankers in the US will go to jail and pay for what thay have done while chaps from the City will probably get state honours for timely donations. For many years now, in various dealings with financial sector people in this country I consider them as crooks by default, even though I know that this is probably unfair. Whatever the odds, I have found that my attitude has been productive.

  • 53.
  • At 02:43 AM on 30 Mar 2008,
  • John Evans wrote:

After reading most of the posts here, it is still clear it is the blind leading the blind. The most blinkered is Mr Peston, who clearly has not a clue of what is actually going on in financial markets, and only reports upon things what he reads on columns on other websites. Not an original thought in his mind.

The blind horde is the rest of you who call bankers 'scum' and silly things like that. Take the chap who said it isn't the fault of the borrowers who defaulted, its the fault of the bank who leant. Yes, big bad banks are all to blame for leading you mindless sheep to dispair. Wake up, take responsibility for yourself and stop whinging about something you know nothing about.

Dear Robert,

sorry to be off topic, but can you explain the lack of reporting of Sterling against the Euro.

Try visiting the BBC's business page:

Search for the words "Sterling" and "Euro", you won't find them.

You would never have guessed that Sterling fell to a record low against the Euro from any wing of the BBC.

In a 52 week timescale it's fallen from €1.49.69 to €1.26.08.

Maybe it's me, but I would have thought it was worth mentioning, doesn't it come under your own heading of:

"my regular take on the business stories and issues that matter."

  • 55.
  • At 11:44 AM on 30 Mar 2008,
  • Chris wrote:

Mr. Holding (no. 22), your numbers certainly don't look good. In fact they are shocking.

Firstly, we live in the 21st century now and interest rates are not going to return to the (artificially) high levels of the early nineties. A mortgage multiple of 4-5x earnings at 6%-ish is eminently affordable.

Secondly, your average homeowner is on above average earnings so an average household income to support an average mortgage will be higher than your £33k.

Thirdly, UK house prices are supported by accumulated wealth as well as income. The net worth of the UK population is c£7 trillion, of which property is just over half (£3.7 trillion). Mortgage debt is c£1.2 trillion, relatively modest compared to the assets on which it is secured. For every poor soul who has obtained a 100% mortgage at the top of the market, there are hundreds of property owners with no mortgage or mortgages at less than 50% of their homes' values.

Anyway, the point is that if there is a gap between the Steve Holding imputed worth of UK residential property and its real worth it is nowhere near £2.3 trillion. That is ridiculous. And, furthermore, the only potential black hole is the possible gap between housing assets and the lending secured on them, not the difference in imputed and real asset values. This gap can be no more than the total mortgage market of £1.2 trillion and is likely to be no more than a mere fraction of that sum. (Even in the dark days of the early nineties annual repossessions ran at much less than 1% and most of the mortgaged value was recovered - the lending banks actually did rather well).

So, let me see, if there is significant correction in the housing market (and God knows we are all doing our best to talk ourselves into one), I think the net effect of all the above probably leaves a potential black hole of no more than £10-20 billion, compared to your £2.3 trillion. (Equivalent to 1-2% of total mortgage lending, or several hundreds of thousands, perhaps a million, repossessed homes, depending on your view of average values and recovery rates).

Painful, but we could all cope.

  • 56.
  • At 12:18 PM on 30 Mar 2008,
  • John wrote:

An analysis that ignores 1) co-investment in PE funds by the partners(usually 1-5% of the fund- a meaningful amount to lose) and 2) The Hurdle - ie the rate of return required to be earned by the investors before the 20% "carried interest" is earned (usually around 8%). Contrary to Robert's example, if a fund makes £1bn and then loses £1bn, there is NO 20% carry in a PE fund. Hedge funds are different to PE Funds but there's no enough space to explain why - maybe Robert could do that next time.

  • 57.
  • At 12:46 PM on 30 Mar 2008,
  • Milton Keynes wrote:

I doubt if you will approve this post but at least you might read it and think a bit.
Somebody needs to start talking about the booming food and commodities markets. We are sold the lie of food shortages, when the real cause is speculation by the very same people who brought about the so called credit crunch.

If there is a credit crunch, why is M4 still growing at 12% a year.
The crunch is just that banks don't want to lend to consumers because they know we are a risky bet, that houses are overpriced and they will make losses on many of these loans.
This new money is still being created, but it's going into commodity speculation. The BoE/Fed/ECB are facilitating this with liquidity injections.
Interest rates need to be raised sharply to kill off this speculation on essentials which will put inflation through the roof and harm everybody.
Everybody except the same super-wealthy idiots who created the credit crunch.

We are like lambs to the slaughter.

  • 58.
  • At 12:48 PM on 30 Mar 2008,
  • John from Hendon wrote:

"The profit motive" eh? Why do you, Mr Peston, think the British are uneasy about it? I would suggest that greed and inequality are better understood by most people.

"Excessive Profits" worry (should worry) most people. Every business needs to make some profit to finance its capital and investment in the future. This 'Profit Motive' is not a worry when explained properly.

Journalists primary role is only partly to explain but also to entertain. Write boring badly written copy containing the truth and you might as well have not written it at all.

Please explain to your audience why a business needs capital to provide the secure jobs that most of us crave for. "Excessive profits" is the concern not the "profit motive". Footballers and Bankers make excessive personal profits at the expense of the majority of us and we all know this. At least Footballers entertain - bankers just change us excessively for their services and because of their protective regulation can get away with it!

Financial Services is not an industry it only makes money from foreigners the rest of us simply pay excessively for their 'skilled (!!!)' services.

Regulation prevents competition that might have kept down prices. Increasing regulation will only further entrench the banking cartels domination of the market. That is the biggest risk of this slump - some well meaning administration will increase regulation and by so doing further protect the bankers from the cold winds of the reality that the rest of us live with on a daily basis.

So, Mr Peston, please avoid frightening us any more!

  • 59.
  • At 04:40 PM on 30 Mar 2008,
  • David Gray wrote:

Dear Robert,

Please could you tell us what effect the central banks lending so much money to financial institutions will/may be? Aside from moral hazard, can we be sure that the central banks will recoup all of this money? Is it wise of them to lend money to people who have clearly been foolish with it for so long?

Yours David Gray

  • 60.
  • At 05:20 PM on 30 Mar 2008,
  • john morton wrote:

Tulip mania all over again!dont forget LTC in the 90,s these institutions really have not got a clue!I think a better investigation would be into the utility bosses remuneration packages,all for nil risk!Dont get me on about the FSA and there £1m deals again without risk,I am a one man IFA and live in constant fear of these regulators not that I have ever been dishonest but they can fine me or shut me down at a moments notice,were they fined following the Northern Rock debacle!no! did any heads roll I dont think so.John

  • 61.
  • At 06:56 PM on 30 Mar 2008,
  • Valentina wrote:

Just a historical comment, to put things into perspective.
In chapter 12 of his 1936 masterpiece, "the General Theory", Keynes explicitly warns that "worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally".
This is exactly what you described with your article: fund managers preferring to risk all, and all-together, because cases of systemic failure are not as penalized as cases of individual failure.

  • 62.
  • At 07:35 PM on 30 Mar 2008,
  • Fraser from Telford Park wrote:

Shouldn't our government be held vicariously liable for permitting such contracts (including an asymmetric reward system) to exist in the first place? Is this not an unfair term which would render any such contract void in any case?

What exactly were the FSA doing? Sleeping as per usual, simply waiting for the next disaster to strike so that they could "huff and puff" a lot of hot air, YET again?

Watchdogs and Regulators in Britain are a TOTAL joke and a SAD ones at that!

So Tony Blair's legacy truly lives on then!
  • 63.
  • At 08:33 PM on 30 Mar 2008,
  • andy williams wrote:

There seem to be a few commentators on here that are obviously in the financial trade in one area or another.

What surprises me is they seem to think nothing serious is going to happen in the UK.

This just goes to show how bad they actually are at their jobs, and why we are on the edge of a precipice.

It's all to do with America. If America goes down, we're going with it no matter how 'sound' we are.

It's a little thing called globalisation.

  • 64.
  • At 09:48 PM on 30 Mar 2008,
  • Steve C wrote:

Unfortunately, this is just another example of how our society and social psyche has changed; and not for the better. We have forgotten certain standards and morals. We have forgotten how to respect and treat each other. We are only thinking "I'm alright Jack and to hell with everybody else".
Many people are only thinking about themselves and of materialism. This does not bring out the best in us. We get to a point where it controls us and we lose our normal senses. We have forgotten how to be human. Or have we? Is this our natural progression? I sincerely hope not.

  • 65.
  • At 07:34 AM on 31 Mar 2008,
  • Geoff Brown wrote:

Robert your article "we all loose in the greed game" made excellent reading and highlights the reasons why the financial markets are now in such a mess.

The examples you quote about the enormous and unsustainable risks that were being taken, by basically corrupt people and without any risk to themselves simply in order to make vast sums of money for themselves, goes to the nub of what is wrong with the financial system.

My only criticism is, why wasn't this article written say 2 years ago when it became evident to everyone working outside the city, that the practices being adopted by these greedy and corrupt people were morally and ethically unacceptable to the vast majority of hard working people.

On the matter of why the British are no more in love with business than they were 30 years ago the reason is quite simple, it comes down to effort and reward. Starting up a small business often requires people to put up some if not all of the capital required and then many years of hard work before any proper rewards are forthcoming. Choosing to work in industry is just as hard and precarious and less rewarding than being a city trader, finacial consultant or corporate lawyer. Jobs in the media can also be financially lucrative. Against that background why should anyone decide to go into business.

However having spent my entire career in industry I can say that running a business might not be as finacially rewarding but it can often be more fulfilling and enriching in many other ways. Maybe this crisis will force many of the city folk to come and work in the real world.

  • 66.
  • At 10:46 AM on 31 Mar 2008,
  • lossaversion wrote:

We are seeing the usual fallout where society takes the hit and the finance industry takes the profit - as a Private Eye cartoon recently put - privatise the profits and nationalise the risks.

Our "system" is showing that the markets are only viable in the econonics vacuum of a textbook as the world is populated by Homo Spaiens and not Homo EConomicus.

We need a paradigm shift that involves bravery and courage by those who need to ensure the excesses of the markets can be kept in check and minimise the fallouts in the future. The world is in the midst of one of the biggest systemmic failures that has exposed the limitations of regulators, free markets and corporate governance.

The gatekeepers of te financial markets that ae supposed to impose market discipline have failed us through the pursuit of their self-interest becuase instead of contributing to economic effciency the opposite has occured as a result of financial engineering built on excessive and lax lending

The Ponzi sceme we have become addicted to has now fallen in on itself leaving all those that had been suffering from ostrichitis looking exposed, lost as to what to do, and blaming everyone but themselves while the rest of us suffer the consequences.

The Central Banks (which are taking different aproaches to address a global problem) that are weaned on the limiting economics paradigm are using this aproach to intensify the moral hazard while the other policymakers shy away from taking long needed hard decisions and let a major instituion fail.

Our financial system has once again let us down and perhaps this is the time to not only change our approach to it but also alter how it functions so that self-interest is
managed to minimise the situations like we ae experiencing in the future

Our regulators FSA in particular have show that light ytouch is really no touch and that the media calls for more regulation is misguided. Action is needed not more policy ie monitor and enforce what we have in place already rather than introduce new policies which can only make existing polices more complex.

If we need a new policy the only one I would demand is that we effectively monitor and enforce what we have alreadt and that the regulators have the resources and courage to do this, otherwise and sadly as FSA has found for the second time ( the first being Split Capital Trusts) it shows itself to be no more than a figurehead.

I would suggest that our current situation is the result of a set of interedependent failures ie not just regulators and people who were unable to pay their mortgages but the entire system.

Otherwise we will continue to lose out in the game of greed.

  • 67.
  • At 12:56 PM on 31 Mar 2008,
  • observer wrote:

I think this is all down to the principal agent problem and information asymmetry. Two problems that will never be solved, agents will always know more than principals.

Financial crises are as old as money itself - suggest reading Kindleberger's 'Mania's Panics and Crashes'. Isaac Newton got wiped out on the South Sea Bubble. We're all fallible...let's not deceive ourselves and finger point.

  • 68.
  • At 01:12 PM on 31 Mar 2008,
  • Dave wrote:

Errm, all investment schemes work like this, don't they? The managers take a management charge and transaction costs, whether the market is going up or down and indifferent to the returns experienced by the clients.

At least with bonus schemes there is some reason for managers to try to increase the returns.

So it's the details that are wrong, not the principle.

  • 69.
  • At 02:29 PM on 31 Mar 2008,
  • David wrote:

Fascinating how many comments are based on prejudice and hate and strong desire to feel clever.

I freely confess to having questions not answers on exactly what is going on at present - and I am a political lobbyist turned MBA turned management consultant turned private equity investor.

Assets gains and losses are pretty much zero sum - some one sold and someone bought. Some banks and funds may be deep underwater, but others should be very happy. Perhaps they are keeping quiet or don't make the connection?

But what real loss of value has taken place as a direct consequence; a glut of forfeited but unsold housing in the US - therefore not be economically used - is the only intrinsic loss I can think of.

But loss of confidence and counter-party risk concerns can have a depressing effect on real economic activity.

What friction then caused the problems with the credit markets. I have heard several plausible explanations. Which ones stand up? Perceived counter-party risks because of lack of transparency? Capital hoarding because of pressure on capital ratios when faced with unanticipated balance sheet obligations? Or what?

And what are the consequences of the resulting shocks? How do we best get out of them with least damage. It seems often that it is the extreme reactions to problems that causes the damage rather than original shock.

And as some people above have said, if you have doubts about the benefits of entrepreneurial free-market economies, take a look at the alternatives. Capital may not be pretty but it works. There are no real-world alternatives that I would wish on anybody. And that applies to ordinary folk especially.

  • 70.
  • At 04:44 PM on 31 Mar 2008,
  • Hayden Clark wrote:

Ha? Hedge fund managers? What about every other lying, cheating financial investment organisation that takes money from the public? If you look at pensions, unit trusts, endowments, unit-linked saving plans, stock ISAs, they are all arranged so that in the event of a profit being made, you see some of it, but if there are losses, you still have to pay the management fee. Whatever the nice salesman says, it's a kind of bet, and the company is the bookmaker, not a co-investor.

Every exec who makes investment decisions should have a proportion of their salary at risk of fund loss.

robert - there should be no going back to state funded institutions --- civil servent will make it white elephent.

  • 72.
  • At 08:23 PM on 31 Mar 2008,
  • Mad Max wrote:

Caught the radio show but felt it was rather vague, operating at too higher a level.

The devil is in the detail and for that we must look at studies. For example the Annual Survey of Small Businesses: UK 2004/05:

One must draw ones own conclusions but for me its an inability to scale a business that leads to the prevailing attitude.

  • 73.
  • At 07:36 AM on 01 Apr 2008,
  • Mart wrote:

I'm afraid people only wise up to this sort of thing after the event. Then we will get the reaction. For sure much of the public has been complicit in the greed, only rather foolishly. I have been studying cycles for some time and when this ends there will be massive social unrest throughout the West, probably involving various revolutions (Some peaceful, some violent), probably around 2015.
As a race we are so far behind where we should be now. I feel coming up will be the last chance to put in a fair and responsible system, and by that I mean to the planet as well as people. I very much doubt it will happen.

  • 74.
  • At 10:09 AM on 01 Apr 2008,
  • Richard wrote:

Chris@54: How remarkably optimistic you are!

"Firstly, we live in the 21st century now and interest rates are not going to return to the (artificially) high levels of the early nineties."

Iceland has recently raised interest rates to 15%. Or perhaps Iceland is not a first world country with sophisticated financial institutions?

"Mortgage debt is c£1.2 trillion, relatively modest compared to the assets on which it is secured. For every poor soul who has obtained a 100% mortgage at the top of the market, there are hundreds of property owners with no mortgage or mortgages at less than 50% of their homes' values... if there is significant correction in the housing market [...], I think the net effect of all the above probably leaves a potential black hole of no more than £10-20 billion, compared to your £2.3 trillion."

If we charitably assume a flat distribution of mortgage debt - that equal numbers of homeowners still owe 5%, 10% ... 100% on their homes - then the amount of money actually owed on >80% mortgages is actually 44% of the total debt, so nearly half of the total mortgage debt is at risk of negative equity, a rather larger amount than your estimated £10-20 billion, and a better reflection of the apparent panic in the markets.

  • 75.
  • At 01:29 PM on 01 Apr 2008,
  • Tom wrote:

This documentary may look like eye-opening stuff but it isn't.The workings of the capitalist system has been known for decades.Maybe the so-called anti-City brigade of fashion socialists (ask them to give up their materialisim ...) should ask their pension fund managers where much of those funds get invested (yes,in private equity and hedge funds.All Mr Peston is doing is bleating from the sidelines because he is incapable of succeeding at the game himself or too scared to try.The notion that government should regulate remuneration is Orwellian,unworkable,unnecessary and ridiculous.

  • 76.
  • At 05:54 PM on 01 Apr 2008,
  • Swerve wrote:

I cannot understand why fund managers lend their shares to companies that have a strategy in shorting? whilst the company can make millions , when they hand back the shares they usually , i.e. in the case of Northern rock and Bear Stearns , are worth much less than when they were borrowed.

  • 77.
  • At 08:11 PM on 01 Apr 2008,
  • Chris wrote:

Richard @73, I prefer to think of myself as balanced rather than optimistic, but am happy to debate the point.

Iceland has its own self inflicted wounds, but the post-war trend in interest rates the developed world (notably the US and Germany/Eurozone)has been inexorably down. Rates may have generally bottomed (good!), but the next move in the UK will certainly be down if the housing market moves into negative territory (which it probably will do). We are certainly worlds away from the ill-fated ERM which did so much damage in the last century. I could be wrong, but I don't think that would be taking a balanced view of the evidence.

Re. your analysis of outstanding debt; I don't entirely follow/agree with it. This is mainly because the market has moved so much in the last few years that 100% mortgages done a few years ago are already well covered by equity and 100% mortgages are a much smaller part of the market than many would have you believe. I therefore very much doubt that anything like 44% of total mortgage debt is at 80% or above of today's valuations.

But that is not the real point. Even if you are right - and it would be good if financial journalists went beyond pontificating into some proper analysis - that would suggest c.£500bn of "risky" debt. But how much of that debt would not be recovered in the event of a severe housing downturn? The evidence of the last one suggests very little of it, because people will not surrender the keys of the homes they have worked so hard for the moment their equity goes notionally negative. For as long as they can afford the mortgage and live in the hope and expectation that their homes will once again be worth more than their mortgages they will hold on.

My £10-20bn was just a guess at what might not eventually be recovered in a downside scenario, and I am sticking to it for now. You may not agree, but I am sure you do agree that it will be a lot less than £2.3 trillion.

  • 78.
  • At 10:44 PM on 01 Apr 2008,
  • John Law wrote:

The programme might better be termed the Bonfire of the Inanities.

Where was the heaping of scorn on those highly leveraged speculators otherwise known as first time property buyers buying with a 10 per cent deposit (a level of leverage unheard of in private equity and uncommon in most hedge funds)?

Where was the explanation of the fundamental differences in fee charging between private equity and hedge funds?

Where was the explanation that pretty well on financial service products are charged on a one way bet basis and private equity is in fact exceptional in having to achieve hurdle rates and only getting the incentive payment after 7 years?

Yes there is an important story - economies are cyclical, bankers need regulation - but this is a story of a premeditated laxity in US regulation and regulatory incompetence in the UK, driven by a failed regulatory structure. The target should be policy makers whose "prudence" who have permitted the debt fuelled boom - but fundamentally this is about a consumer boom - and where does responsibility for that lie - with the consumer.

  • 79.
  • At 10:48 PM on 01 Apr 2008,
  • P wrote:

First Congrats on the program on BBC2 about the Super Rich and Greed.

Could have focussed on these points:-
1)The biggest missing discussion is 'The 500 trillion derivatives' that are leveraged?

2)And also who is responsible; becuase everybody is just holding up their hands and saying they did not create the game but are just playing it lest they should be left out.

3)What are the governments and regulatory bodies going to do about it?
4)Could have highlighted more how everyone of us is going to pay for it

  • 80.
  • At 11:18 PM on 01 Apr 2008,
  • clem alford wrote:

Really good programme showing the crisis of capitalism, as Marx predicted. The cycles of crisis are coming round quicker and will eventually have to be resolved usually with the classic capitalist solution of war. As one Nazi once said 'give the people bread and circuses'
No society will be safe with such a gulf of wealth division. If the rich think they are secure then they had better think again as the history of revolutions has shown!
What I can't stand about the new rich is how crass and uncultured they are. Blair and Brown have a lot to answer for!

  • 81.
  • At 10:11 AM on 02 Apr 2008,
  • Richard wrote:

Chris@77 - I'm not sure that I'd agree that post-war interest rates have been moving inexorably down. Looking at the historical data on the BoE (back to 1975) and US Fed (back to 1950) websites would seem to confirm this: the UK rate jumps wildly around ~12% until 1993, when it settles at a low rate and the US discount window rate rises inexorably to a peak in the early Eighties, since when it has substantially declined.

I would agree that the total amount of risky debt does not represent the total capital which may be lost, but I think that it does represent the amount that banks are worried about finding on their books. Plus, of course, with the current reserve ratios of banks a £10bn loss in capital would result in a reduction of possibly more than £100bn in lending ability. As I see it, it's not the end of the world, just another bubble in a system which is fundamentally prone to bubbles.

  • 82.
  • At 11:07 AM on 02 Apr 2008,
  • Martin wrote:

I enjoyed the program, just wondering if it will be aired again, as i did miss chunks of it. And also not living in the UK any more i am unable to use the Iplayer... I would be willing to pay the Fees.

  • 83.
  • At 11:32 AM on 02 Apr 2008,
  • Raviraj wrote:

Hi Rob

The film was very informative. The program tries to give an insight into the ugly side of the lucrative world of finance. The interview of some of the known personalities made startling revelations into the present crisis. The way fundamentals of finance were molded to suit the greed of the rich and the smart is amazing. The film presents a case for normal people how vulnerable they are when they invest into something they think will make them a millionaire or super-rich. Thanks for the show.


  • 84.
  • At 02:13 PM on 02 Apr 2008,
  • Jim Martin wrote:

Now we know how it happened, what can we do to stop them doing it again in the future?

  • 85.
  • At 01:59 AM on 04 Apr 2008,
  • Sean wrote:

Hi Mr. Peston,

I just finished watching your "Greed Game" feature on BBC's iPlayer. I wanted to congratulate you on an extremely helpful insight into the credit crisis and the profiteers that emerged from it, exposed in the green-tinted like of liquid cash.

I didn't know if it was best to leave a comment here or contact you directly, but as a soon-to-be graduate spending a lot of time writing and yet highly interested in the finance markets (in actually doing something in an environment of speculation) I related to your slant on the issue. I know the "Greed Game" hour of insight was a broad approach, but it really helped to fit the pieces together.

I'd really appreciate any direction anybody in your department could point me towards, in terms of entering the market. Surely the way forward is to get Britain manufacturing again. Create capital through capital goods and jobs for the non-super rich and they'll be depositing in banks again, who can then buy these assets being created. It has to move away from a picture where Britain's manufacturing companies employ a total 60% of their in-house workforce in sales and customer service.

That's just my initial theory. But any response from yourself or anyone your department would be appreciated, with regards to how and where I can work to develop these ideas and get a better appreciation for the finer detail.


  • 86.
  • At 10:40 AM on 11 Apr 2008,
  • Sam wrote:

Hi Rob,

Your documentary on the super rich greed was brilliant. I only managed to watch part of it. Do you have a way I can access the video as i would like also to share it with my MBA colleagues as part of learning.

Many thanks

  • 87.
  • At 12:33 PM on 14 Apr 2008,
  • martin fox wrote:

dear Mr. Peston, I would like to concentrate how authorities might be able to curb this type of business where we see that losses on sub-primes will be deducted from profits before taxation. May be by making this impossible we might find a step towards a solution.
Furthermore banks should be obliged to administer a tight and strict ratio between income and cost of rent when individuals apply for mortgage loans.
I will very much appreciate sharing your reflection on this.

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