Friday, September 19, 2008

Okra season and the financial crisis

In May when I was thinking about digging up the rose bushes in the side garden and planting okra seeds in their place, a gentleman named Ian Macwhirter wrote the following in the British newspaper The New Statesman:

This is the worst financial crisis in 60 years, and it has shaken the banking system to its foundations. Even the Chancellor, Alistair Darling, has compared the crisis to the Great Depression and he is not given to overstatement. Banks are in the business of lending money they don't have - it is called "fractional reserve banking". But every so often the banks succumb to irrational exuberance, lend too much and find their reserves have been eaten up too fast, forcing them out of business. This is what happened to Northern Rock, and is now happening to all the big banks. That is why they had to be rescued to the tune of £50bn last month by the Bank of England - ie, us. They will be back for more.

This in answer to the question "How bad is it?" in a story headlined Everything you want to know about the bank crisis published on May 1st of this year. The next question MacWhirter set out to answer:

Do the banks know what they are doing? Well, they know now. During the house-price bubble, the banks were lending recklessly to people with no prospects. In the US it was called "sub-prime" lending, and amounted to organised fraud. Loans were knowingly given to "Ninjas" - people with "no income, no job or assets" - who could never hope to repay them. Britain too had sub-prime lending. At the peak of the boom UK banks offered "suicide loans" of up to 120 per cent of the value of the house with only self-certification of income. The mortgage holders were in negative equity as soon as they got the keys. These people are in real trouble as mortgage rates rise and house prices fall. Northern Rock lent out roughly 200,000 of these in the two years before it went bust and had to be nationalised. This makes the government the biggest holder of sub-prime mortgages in Britain.

The next question?

How could the banks be so stupid?
Partly this was down to the delusion that house prices could only ever go up. But the other reason was a practice called "securitisation". The banks packaged the dodgy loans into interest-bearing bonds and sold these to financial institutions across the world. This took the loans off the banks' balance sheets and allowed them to lend even more money they didn't have. The banks thought, wrongly, that they no longer bore the risk of default on these mortgages because they had been sold on to other people. This was a big mistake. The debts came winging back. Now the entire financial system is in cardiac arrest because banks no longer trust each other.

But you may ask and so does Macwhirter:

Didn't the regulators see this coming?
Regulators such as the Financial Services Authority and the Bank of England were asleep at the wheel. The Treasury, Bank and FSA are run by relatively low-paid civil servants who are in awe of financiers and their lifestyles. They believed that the banks were run by masters of the universe who knew what they were doing, with their mathematical formulas and leveraged deals. In fact they were run by bonus-greedy wide boys, who gave no thought to the future and had no concept of social responsibility. The City bonus culture encourages short-termism and risk-taking. It was in these people's interest to pretend the credit boom could go on for ever, and that securitisation had taken the risk out of lending money. They thought they wouldn't be around to clear up the mess. In fact, even when the roof did fall in, those such as Adam Applegarth of Northern Rock still got their pay-offs and bonuses - in his case a "golden goodbye" of £750.000. Shareholders seem unwilling to curb the greed of the new generation of CEOs who run City firms. The regulators don't even try.

Back in May when I was just thinking about planting some four year old okra seeds in the side garden a British journalist was writing about a banking crisis in England. It is September now and my 10 okra plants are still producing more than enough okra for my husband and I to eat. But their growing season is nearing its end; the old leaves are turning yellow and rusty brown and the new leaves are small and thin.

It's September and the U.S. is in the midst of the worst financial crisis since the Wall Street crash of 1929 which set off The Great Depression of the thirties. I have included excerpts from Macwhirter's story about the British banking crisis in May because I think it's instructive about our own. The entire story can be found here. In fact, his story gives us distance--real and emotional--which makes it easier to grasp what is going on here. He is also a bit more frank than I've found most American commentators to be. And less confused.