Excellent point!

We hear a lot about needing to \”protect safer retail banking from risky investment banking\”. In my opinion this is the wrong way round. The global investment banking system was nearly brought down by excessive risk-taking and fraud in retail lending on both sides of the Atlantic.

14 thoughts on “Excellent point!”

  1. I much prefer John Kay’s point which is that we do not want to avoid failure, since that is a defining characteristic of healthy markets, but we want mechanisms to stop failures becoming systemic. Retail or IB. it doen’t matter which. The problem is contagion and lack of system resilience, not failure per se.

  2. Just what I’ve been saying for years. Northern Rock went bust from simple vanilla mortgage lending; HBOS mostly from lending to businesses. Both simple retail banking of the sort that we are told to encourage more of.

    And surely joining two different businesses together (retail & investment) reduces the risk of complete failure. That’s basic portfolio theory.

    In the last crash, those banks that survived did so because the investment arms were able to prop up the retail arms. In other crises it could be the other way round. But having the two together does increase the chance of the whole thing surviving.

  3. A bit of a grey area surely?

    The dodgy loans were aggregated together and sold as assets. Those assets were overvalued by the investment arms. Add in gearing and we have the bones of the problem.

  4. @tdk,

    You fail your own argument when you start your phrase with “dodgy loans”. These were not created by the investment side.

  5. In a comment there “So no one thought that national [US] house prices could be so correlated”. What brought about the correlation? Greenspan? Fannie/Freddie? Federal Law?

  6. @monoi

    The obvious response to your asinine point is that the investment side knew they were dodgy when they bought them.

    But let me rephrase .

    All loan businesses expect a degree of default. Some loans are inherently more risky than others and normally the rates or fees reflect that. All loan businesses reinsure against default to spread the risk. In particular, it is standard practice to sell bad debts at a fraction of their value to debt collection agencies. None of this is exceptional.

    A buyer of a bad debt will know that they may eventually collect none, some or all of a bad debt. The price they are prepared to pay reflects that risk. They expect to turn a profit.

    Who is at fault if they pay too much and fail to collect enough to cover their costs? There must be an element of caveat emptor.

  7. “The obvious response to your asinine point is that the investment side knew they were dodgy when they bought them.”

    Eh? Why would they do that?

    “Who is at fault if they pay too much and fail to collect enough to cover their costs? There must be an element of caveat emptor.”

    If I buy a AAA-rated bond, it’s my fault that it turns out to have been junk? Interesting theory. Is it my fault for being “too greedy” and expecting to make just a few points of interest?

  8. I suppose it would be in bad taste to suggest that many of the dud retail mortgaes which led to the collapse were made on the basis that they were offers that couldn’t be refused.

  9. Johnathan Pearce

    One of the main culprits – apart from central banks’ mad cheap money policy, of course – are Basel capital rules that encouraged banks to remove credit risk off their balance sheets, facilitated by an opaque credit derivative market. Add in the conflicts of interest of the rating agencies, the daft mark-to-market accounting rules, the short-termism of listed banks and misalignment of the interests of bankers, clients and owners, and you have a recipe for disaster.

  10. @Kay Tie

    Why would they do that?

    1. Do acknowledge that in any lending business there will be an element of risk: some loans will not be repaid?
    2. Do you acknowledge that these loans which I have labelled “dodgy” are bought and sold, and that the buyers expect to be able to collect more on them than they pay?

    If I buy a AAA-rated bond, it’s my fault that it turns out to have been junk?

    A triple-A rating is advice not a guarantee.

  11. “2. Do you acknowledge that these loans which I have labelled “dodgy” are bought and sold, and that the buyers expect to be able to collect more on them than they pay?”

    I don’t accept that anyone knowingly buys dodgy loans without a commensurate “dodgy” price. The loans that were bought were not bought at discount to par, and were rated “not dodgy”. It’s inconceivable that (barring some kind of fraud) anyone would buy a dodgy loan for a non-dodgy price.

    “A triple-A rating is advice not a guarantee.”

    And you think this facile statement of the obvious somehow bolsters your claim that people knowingly bought dodgy loans because of greed?

  12. @TDK,

    The fact of the matter is that as is being proven now, a lot of those loans were dodgy to start with for varying reasons but, IMHO, mostly to do with political interference, via fannie and freddie for example but not only.

    One has to see now the “foreclosure gate” story and how the whole system was corrupted.

    However, I do agree with you with the caveat emptor principple, from the borrower who took on unsustainable debt (nobody ever actually forced anybody to borrow) to the bank which lent it, to the investment banks who sold the risks, to the retail banks (them again) who thought they were easy investments.

    The main culprit though is the political class who created the conditions for this to happen.

    Personally, I am one of the mugs who used the low interest rate environment to reduce my mortgage. Now I pay taxes to bail out the idiots.

  13. @monoi

    I agree with all that. The political classes distorted the market. They take the lion’s share of the blame, but the banks were foolish too.

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