Most people are confused about how the banking crisis started and why we are where we are today. Once you understand the actors involved and the motivations of those actors, it is actually very easy to understand exactly what happened to get us where we are today.
Some people reading this might call me a cynic but they should understand I was an investment advisor and am very highly qualified financially, a field which I worked in for many years. In addition, I have personally managed millions of pounds in investment portfolios. So, here’s a story you’re never going to see on the mainstream media.
First of all, a strong signal was sent to the banks that they could not fail. This happened after the long-term capital management got into trouble in the late 1990s. Large financial institutions looked on the bailout of LTCM and figured that they would get tax payer help if ever they got into trouble.
Considering that their bets were protected on the downside, they began to make hugely risky bets using credit default swaps and by providing loans and selling them in what is known as collateralised debt obligations. Once the huge pyramid scheme blew up, the banks refused to allow the market for their debts to operate. Let me explain how it works.
Let’s say I am a bank which was written 100 mortgages. These mortgages were all sub-prime. Today, 30% of those mortgages are at least one payment late. The price of the property on which the mortgages have been secured have fallen 33%. This means, but the £150,000 loan which was advanced is now secured on a property worth $100,000. In addition, there is a strong chance that the owner of this property will default on the mortgage.
As the banker, I go to the open market and try to sell this debt. The amount that I want to receive for this debt is $100,000. This means I have lost one third of my money as a bank. However, investors who are looking at the debt are telling the banks that they this debt is not worth $100,000. The investors make a few calculations. They figure that the house will need to be repaired, the property prices might fall another 30% and that they will also need to have a return on their investment in order to protect against the risk.
The investors will only offer £50,000 for this debt. The banks want $100,000 and investors are only prepared to offer $50,000. This is the reason the credit markets are frozen. The banks are refusing to accept what the investors are willing to pay! It’s that simple! It’s like if you want to sell your computer for $1m, but no one wants to buy it. You could say that the market for your computer is frozen and apply to the government for help!
The investors know they will lose money if they pay as much as the banks want and so they decide not to pay what the banks want. The banks are in a pretty comfortable position because the government has already said they will use taxpayer funds to make up the difference between what the market says the debts are worth and what the banks say they are worth.
If the banks weren’t protected by the government which is backed up by the taxpayer, the banks would have no choice but to take the losses onto their balance sheets and many would go out of business.
The entire reason the banks are doing this is because they were explicitly told that this would never happen to them. It is the government guarantees to the banks that they would make up the shortfall in the value of these assets which is causing the problems. If the government’s would get out of the way and allow the banks who have made silly bets to go broke, this problem would be over within two weeks… and many of the banks would find a way to hobble along and recover. Right now, they have no incentive to even try.
