Greedy Bankers Are Bailed Out Yet Again

by Bruce Jackson on 19 January 2009  |  22 comments
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All the pieces are now in place. Economic stability will come. It will still take time, but it is coming. But watch out for Global Financial Crisis II.

Four months into the global financial crisis proper, and we're still no closer to solving `the problem'.

Summarising how we got here, in a rather long nutshell.

 Greedy banks lent too much money to greedy consumers, often in the form of massive mortgages to people who couldn't afford them over the long-term.

 Some greedy and some naïve consumers bid higher and higher prices for property. The greedy banks happily lent more and more money to greedy and naïve consumers.

 Greedy banks and greedy bankers repackaged pools of mortgages into exotic, opaque and ridiculously-named `structured products' which were then sold onto other greedy banks and generally greedy yet stupid financial institutions. Greedy bankers were paid massive bonuses, the bankers.

 Not surprisingly, in hindsight, greedy consumers struggled to maintain their mortgage repayments as interest rates rose. As house prices fell, the `structured products' slowly and surely turned toxic. This is turn forced the greedy bankers to write off billions of pounds, dollars and euros, amongst other currencies, in losses.

 House prices continued to fall. Greedy consumers felt desperately indebted as many struggled to meet their monthly mortgage repayments. Greedy banks felt desperately indebted as they stopped lending in the face of massive mortgage and `structured product' losses.

 As desperate banks stopped lending, the economy started contracting. Unemployment started rising. More desperately indebted home owners missed their mortgage repayments. House prices kept falling.

 Desperate banks, despite raising billions in new money, couldn't afford to lend, even to credit-worthy consumers and businesses because the value of their existing assets - mortgage and `structured products' -- was still falling.

 The downward spiral continues, down, down, down.

`The Problem' Hasn't Been Solved, Yet

Policymakers around the globe have attempted to tackle `the problem' -- the problem being falling asset values. Interest rates of not much above 0% haven't solved `the problem', yet. Injecting billions into the banks hasn't solved `the problem', yet. Massive government spending programmes haven't solved `the problem', yet.

The latest attempt to solve `the problem', according to FT.com, involves the government insuring banks "against potential losses on risky loans in return for firm commitments to increase lending to credit-starved consumers and businesses."

Just like a normal insurance arrangement, the government is expected to charge a fee to the banks for insuring their loans. As to how this insurance premium will be calculated is anyone's guess.

Pouring Petrol Onto The Fire

Will this solve `the problem'? Remember, `the problem' is falling asset values. I don't know. It's a creditable attempt, although one that is easy to pick holes in, the biggest hole being that lending more money in an already overly indebted economy is akin to throwing petrol on a fast burning fire.

Many respected economists, including Chairman of the US Federal Reserve Ben Bernanke, have said the key to stabilising the economy is to restore the flow of credit from banks to credit-worthy consumers and businesses.

This is exactly what the latest bank bail-out is attempting to achieve. For banks, their asset values will stop falling because government insurance caps their losses. It won't mean all asset values stop falling. For example, I still believe house prices will keep falling, because they are still unaffordable based on historical multiple of incomes.

Global Financial Crisis II

Of course, you can think of all sorts of undesirable outcomes from this whole sorry debacle we conveniently call the global financial crisis. For example, `bailed out' banks are forced to lend money. Greedy consumers obtain a £400,000 mortgage from majority government owned Royal Bank of Scotland (LSE: RBS), paying interest of just 3.5%. Today those repayments, based on their current salary, are affordable. Tomorrow, when interest rates rise again, as they surely will, those mortgage repayments become unaffordable. Cue Global Financial Crisis II.

Back to `the problem' - today's problem that is, of falling asset prices. It won't be solved by the latest banking bail-out. But it will likely help. What with record low interest rates, massive government spending programmes, and now banks having their losses capped and at the same time committing to lend to the credit-worthy, all the pieces for firstly stabilising the economy and then growing it again are in place.

Now we just need patience and time.

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