Why did banks lend so much money to people who could not pay it back? To many, the answer is simply greed: individuals could get bigger bonuses and banks could make bigger profits if they did more business. But I would argue that it has even more to do with our consumer culture.

How about the least interesting but true answer: it was a mistake?

8 comments on “Charlie….

  1. “How about the least interesting but true answer: it was a mistake?”

    For an illuminating comparison, see this Wikipedia entry to remind ourselves about an earlier financial debacle in America – the Savings and Loan Association financial crisis of the 1980s and 1990s:

    “The US Savings and Loan crisis of the 1980s and 1990s was the failure of several savings and loan associations in the United States. More than 1,000 savings and loan institutions (S&Ls) failed in ‘the largest and costliest venture in public misfeasance, malfeasance and larceny of all time.’ The ultimate cost of the crisis is estimated to have totaled around USD$160.1 billion, about $124.6 billion of which was directly paid for by the U.S. government, which contributed to the large budget deficits of the early 1990s.”

    On the face of it, looking at the recent supendous losses made from subprime loans by the biggest banks in America, there seems to have been a truly remarkable regulatory incapacity in America to learn from past mistakes. In recent commentary on why London is currently challenging the premier status of New York as a global financial centre, it is suggested among other factors that London benefits from a lighter regulatory regime compared with New York. If so, heaven knows what consequences might befall the world if a lighter regulatory regime were adopted in America:

  2. The question being asked is what motivated the lending. It turned out to be a mistake but I don’t think that was anyone’s motive.

  3. Incentives matter. When you pay people bonuses to buy and sell stuff, but don’t look too closely at what they’re doing, and people find out they aren’t under scrutiny, they do what humans have done for generations: take the piss.

    And lo it came to pass that pensions were mis-sold, people were slammed on to new gas suppliers, mortgages were falsely self-certified, repayment insurance policies were mis-sold, NINJA mortgages were issued, dogshit CDOs were sold, etc.

  4. Kay Tie about sums it up. It’s almost entirely a matter of incentives.

    The American S &L debacle is an almost perfect case in point. S & Ls had historically been limited in their lending activity to some consumer finance but chiefly mortgage lending on residential property. Though regulated similarly to commercial banks, they were at a business disadvantage: they were limited in their volume to their loanable deposit funds (while “fractional reserve” membership in the Fed system allowed commercial banks to loan beyond such limit). To compensate for this disadvantage, they were permitted to offer depositors a slightly (1/4 or 1/2%–I forget) higher rate of interest.

    It should also be pointed out that an S & L depositor was in the position of a dollar-denominated shareholder, to the extent of his deposit, in the S & L: NOT a creditor of the institution (though the great majority of such depositors were completely ignorant of the distinction). The insurance fund covering depositors was distinct and separate from that of federally-chartered banks.

    I don’t know where and when the “trouble” started (but if I had to guess, it’d be California).
    It probably involved a relaxation or change in law. In any case, certain kinds of projects became eligible for S & L loans: larger projects like tract developments for developers, condominiums, even shopping malls, etc. (where the previous typical loan had been a single-family residence). Naturally, the gross loan volume potential increased dramatically, deals were bigger and jucier (rather than the pesky, detail-ridden, paper-volume-heavy individual loans) and the demand for “performance” (volume) began both to focus on the differential performances of the loan officers and on their pay. It hardly needs pointing out that the simplest expedient to larger volume for one so oriented is a relaxing of loan standards nor that there arise opportunities for “under-the-table” cash or other considerations from marginal entrepreneurs.
    Trouble was certain, given the landscape. I am still of the opinion that the law should have been enforced and the general taxpayer spared. To make all those depositors good (to $100,000 per, on a poorly-enforced “one account per person” basis) was outright theft on a scale not seen in the U.S. since FDRs 1933 seizure of individual’s gold. Up to then, the Rs could accuse the Ds. Now, they’re both perfectly obvious brazen thieves only content to steal slowly through inflation but also in huge amounts whenever “circumstances demand.”

  5. In recent months there has been a protracted debate in the FT – access mostly subscriber restricted now – in which there is an emerging consensus that incentive systems in the pay of bankers is largely to blame for these periodic crises in banking. Try:

    Basically, the argument made is that bankers tend to be hugely well-rewarded by bonuses for taking successful investment risks but suffer little downside penalty when the results of past decisions turn sour. At worst, they lose their jobs but they don’t have negative pay and they retain previous bonuses. In short, reward systems are asymmetric.

  6. Btw which misguided idiot said “keynesianism” was dead and buried? Evidently, obituaries were entirely premature.

    “Bush is expected to promote and call for swift passage of the $150 billion economic stimulus package brokered between House leaders and Treasury Secretary Henry Paulson.”

    “Jan. 26 (Bloomberg) — Treasury notes gained a sixth straight week, and 10-year yields touched the lowest since 2003, as the Federal Reserve [Bank] cut interest rates in an emergency move to head off a recession. Volatility in Treasuries reached the highest in a decade as policy makers slashed the benchmark rate by 0.75 percentage point.”

    The really fascinating novel direction in Japan and Taiwan is proposals by politicians to use sovereign wealth funds, formed out of accumulated national foreign exchange reserves, to prop up share prices in their respective national stockmarkets.

    Surprise, surprise, some leading LDP politicians of the governing party in Japan are reportedly very enthusiastic about the idea. Of course, the fascinating question is which (or, perhaps, whose) particular shares should be selected for purchase by the stockmarket intervention funds?

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